Country Report Argentina
The devaluation of the peso in January is likely to spur already high inflation in Argentina to over 30% and economic growth is expected to contract slightly in 2014. Meanwhile, improvements in monetary policy have been made and a new economic team has been installed.
Strengths (+) and weaknesses (-)
(+) Competitive agricultural sector
Argentina has a well-developed and dynamic agricultural sector. The sector benefits from the good quality of the Argentine soil, a favorable climate and good access to sea transport.
(-) Macroeconomic imbalances
Ultra-loose monetary and fiscal policies have resulted in high inflation and a deterioration of the current account balance. Argentina’s foreign currency reserves have fallen to USD 27bn, equivalent to 4 months of import cover.
(-) Unpredictable economic policy
In response to the growing macroeconomic imbalances, the government has implemented tight import and currency controls. It has also undertaken all sorts of other interventionist measures, such as the nationalisation of private pension funds.
(-) Lack of access to external financing
Argentina lacks good access to external financing. A renewed sovereign default may worsen the situation, for example by further restricting access to foreign trade credit.
1. Stabilisation after a large peso depreciation
On 23 January 2014, the Argentinean peso weakened by 12% against the USD, the highest one-day fall since the devaluation during the 2001/2002 crisis. Earlier in that week the central bank, Banco Central de la Républica Argentina (BCRA) had decided not to intervene in the foreign currency market. Its aim was to help protect the foreign currency (FX) reserves and to produce a peso adjustment that would allow for an improvement in the current account. The FX-reserves had already dropped from USD 43.3bn to USD 30.6bn in 2013 against the background of a weakening current account and continuing capital flight. The peso had already been allowed to gradually depreciate by 17% in 2013. After the fall in January, the BCRA had to intervene in the FX markets to stabilize the Peso/USD exchange rate at 8:1, which further eroded the stock of FX-reserves. The FX reserves have now stabilized and stood at around USD 27bn at end April, equivalent to only 4 months of import cover and are likely to remain stable in the near term. This is partly attributable to the good harvest of 2013/2014, with a record soybean harvest, which will bring in foreign currency from export earnings. Also, in an effort to further stem the deprecation of the peso, curb inflation and reduce dollar demand and capital flight, the BCRA increased policy interest rates from 15.1% at end-2013 to 19.6% at end-January and to 28.5% in February 2014. It also eased foreign exchange controls for savings in USD to anchor devaluation and inflation expectations. Furthermore, the government has renewed attempts to settle the USD 10bn debt it owes the Paris Club (an informal group of official creditors), with a view of obtaining dollars in the form of new bilateral credits. However, previous efforts to settle the debt have failed as the Argentine government did not accept the terms of repayment set by the Paris Club. As such, renewed negotiations are likely to be difficult. A positive development is the USD 5bn settlement of the Argentinean government with Spanish energy firm Repsol. Repsol sued the Argentinean government after it expropriated Repsol’s stake in Argentinean energy firm YPF. Overall, these measures are steps in the right direction, but do not resolve the strong macroeconomic imbalances of the economy in the long term. While the renewed negotiations with the Paris Club and settlement with Repsol sends positive signals to the international financial markets, to restore the faith of foreign investors more time and effort is needed as economic policy remains weak, especially since monetary financing continues and balance of payment risks remain high. As such, further episodes similar to that of last January are likely, in which the BCRA will allow the peso to devaluate steeply, before returning to aggressive intervention to calm the markets.
2. Economic growth contracts and inflation rises
Economic growth is likely to contract slightly by around 0-1% in 2014, down markedly from 4.9% growth in 2013. The contraction is largely attributable to Argentina’s unpredictable economic policies. Since these policies create high uncertainty, they adversely impact consumer, producer and investor confidence and gross fixed investments are expected to contract this year. An upside risk to our growth estimate is the new economic team which President Kirchner had installed in late 2013. It includes a new economy minister and a new BCRA president, who ended the loose monetary policy cycle by increasing policy interest rates after the peso devaluation in January. The devaluation, combined with heightened import barriers will make it difficult and costly for the local manufacturing sector to obtain the necessary intermediate goods to expand production. In addition, household consumption is expected to fall significantly since the devaluation has spurred expectations of rises in consumer prices, which will erode real wages because wage adjustments are likely to lag behind. Inflation has been at levels between 20-25% for several years in a row. In addition to the devaluation, the monetary authorities have again revised their money growth target upwards to accommodate the government’s high fiscal spending, and as such inflation is likely to exceed 30% in 2014. After having grossly underreported its inflation figures for years, Argentina was censured by the IMF in January 2013, which is the harshest reprimand the IMF can give. In response, Argentina introduced a new consumer price index in February 2014, which appears to show more plausible figures. Even so, it will be some time before trust in official statistics returns.
Argentina has experienced many political and macroeconomic crises. From the mid-1970s to the early 1980s, the military ruled, which ended when Argentina lost the Falklands war. In the 1980s, high inflation turned into hyperinflation. With a tight dollar peg introduced in 1991, the Menem government managed to bring inflation under control. However, in the late 1990s this peg left Argentina unable to deal with the combined impact of low commodity prices, an appreciating US dollar, substantial dollarization and pro-cyclical fiscal policies; the country was heading for a big economic, political and social crisis. In 2001/2002, Argentina had to abandon the peg and declared the, at that time, biggest sovereign default in history. Afterwards, the country managed to recover quickly and benefitted from the commodity boom. However, Argentina’s economic policies have become increasingly interventionist, ad hoc and unsustainable. Inflation has been high and severely underreported for many years, resulting in balance of payments pressures, which the government is trying to fight with tight import, currency and capital controls. Argentina’s institutions have remained weak and its politics are centered on persons, with party loyalties and, in particular, ideological leanings playing a much smaller role. The country has a very dynamic and advanced agricultural sector which accounts for 58% of total exports and 14% of fiscal revenue. Soybeans and soybean products are the most important agricultural export commodity and account for roughly one-third of Argentina’s exports. Manufacturing is another important pillar of the economy. The most important export market for Argentina’s products is Brazil. With a nominal GDP of USD 11,779 per capita, Argentina remains one of the richest countries of Latin America.