RaboResearch - Economic Research

Argentinians vote: Macri, carry on!

Economic Comment

  • The ruling coalition Cambiemos has claimed victory in the mid-term elections on 22 October and thereby consolidated its presence in Congress
  • The victory endorses the reform path the government has embarked on to normalize the economy and create a business-friendly environment
  • We expect the reform pace to accelerate, fiscal consolidation being particularly important
  • The economic recovery is gaining traction, giving the government more room to implement austerity measures
  • A cheaper peso also bodes well for economic activity and stability, while high inflation remains challenging

Mid-term elections reinforce reform path

On 22 October, Argentina held legislative mid-term elections and the ruling coalition Cambiemos claimed the victory -an important vote of confidence regarding its reform path. The coalition received 42% of the national votes and claimed victory in 13 out of 24 provinces, including the five largest provinces that host two thirds of the total population. Most importantly, the Cambiemos senate candidate beat former president Kirchner in her own stronghold province of Buenos Aires by a significant margin. In the mid-terms one third of the senate seats and half of the lower house seats are up for renewal. While Cambiemos consolidated its position in congress significantly, they still lack majority in any of the two chambers of congress. Nonetheless, the victory reinforces the government’s mandate to continue on the current policy path to normalize the economy and create a business-friendly environment. It also boosts the coalition’s political clout for building alliances in congress. Hence, we now expect an acceleration of reforms such as austerity measures, capital and labour markets, governance, and tax and pension systems. Faster fiscal consolidation is particularly crucial, as it would reduce the country’s heavy reliance on external financing and thus its vulnerability to changing investor sentiment and international markets developments. So far, markets have been patient and Sunday’s victory is likely to further bolster their confidence. However, investor sentiment could turn sour if the government's post-elections actions disappoint. And that, in turn, could jeopardize Argentina’s efforts to reduce macroeconomic imbalances and further normalize the economy.

Meanwhile, economic recovery is gaining traction

Fortunately, improving economic activity gives the government more room for implementing austerity measures. The Argentinian economy is slowly getting out of the recession and the recovery seems to be broad based, although less sustainable growth sources remain important growth drivers for now. Real GDP growth in quarterly terms left the negative territory in 16Q3 and yearly GDP growth followed in 17Q1 (figure 1). In 17Q2, economic activity accelerated to 2.7% y-o-y, from 0.4% y-o-y a quarter earlier, and all growth components except for net external demand contributed to growth positively (figure 2). Investment growth turned positive in 17Q1 and accelerated to a whopping 7.7%  in 17Q2, setting a solid base for future output. In terms of sectors (figure 3), agriculture was the front runner, as the reduction in export taxes has led to a significant increase in planted area for wheat and corn, and grains output is expected to have picked up by 10%. Economic activity in construction and financial services has also picked up pace, though driven by sources that are not sustainable in the long term, namely the one-off capital flows unlocked by the amnesty law that ended in March 2017 and government infrastructure spending. Looking forward, the weakening of the ARS bodes well for export competitiveness and inflation falling below wage growth in 17Q2 bodes well for consumption growth. Weakness in the Brazilian economy, an important trading partner, is a negative though. All in all, we forecast the Argentinian economy to grow by around 3% in 2017, and thereby taking the lead amongst its peers (figure 4).

Figure 1: The economy is out of recession
Figure 1: The economy is out of recessionSource: INDEC, Rabobank
Figure 2: The recovery is broad based…
Figure 2: The recovery is broad based…Source: INDEC, Rabobank
Figure 3: …also across sectors
Figure 3: …also across sectorsSource: INDEC, Rabobank
Figure 4: Argentinian economy grows faster than its peers
Figure 4: Argentinian economy grows faster than its peersSource: EIU, Macrobond

A cheaper peso is good news

The Argentinian Peso (ARS) has come under downward pressure in recent months and that could actually be good for macro-economic stability. Between mid-June and end-July 2017 the ARS depreciated by 11%, one of the strongest value losses witnessed since the removal of the peg against the USD in December 2015. In the 1.5 years before the ARS value was supported by one-off USD inflows, as  Argentinian entities have issued new international debt of more than USD 50bn (roughly 10% of GDP) since regaining access to international capital markets and the amnesty law attracted USD inflows of USD 9.5bn. The depreciation is actually good news for macro-economic stability. Namely, before the recent depreciation, the strong ARS had bolstered domestic demand for imports (and not necessarily the most productive ones: passenger car imports grew most) and hurt export competitiveness.

Figure 5: The Peso has been depreciating in recent months
Figure 5: The Peso has been depreciating in recent monthsSource: CBA, Macrobond, Rabobank

As a result, the trade deficit became increasingly higher. As the one-off events that bolstered demand for the ARS are now behind us, we expect the currency to hover around 18 ARS:USD in the next 12 months. A weaker ARS will ease the pressures on the external balances, but not eliminate them. It will also boost export competitiveness, which bodes well for economic activity. The depreciation is bad news for holders of FX debt, such as the Argentinian sovereign, but not a macro- risk given the low FX debt levels in the private sector.

Inflation remains challenging

Firm action by the Argentinian Central Bank (BCA) has helped half inflation from its highs in 2017, a development that is good for the track record of the monetary authority. However, many challenges remain. Having introduced an inflation targeting mechanism in 2016, the BCA maintained policy interest rates high throughout 2016 and 17H1. Together with base effects, tight monetary policy reduced inflation from a high of 47% y-o-y in July 2016 to around 24% y-o-y in September 2017 (figure 6). Inflation expectations have fallen as well (figure 7).

Figure 6: Inflation falling rapidly…
Figure 6: Inflation falling rapidly…Source: BCA, Macrobond
Figure 7: …and expected to fall further
Figure 7: …and expected to fall furtherSource: BCA, Macrobond

However, challenges remains. First, inflationary pressures are likely to persist on the back of increases of administered prices and peso depreciation feeding through into prices. Wage stickiness due to powerful unions and a strong negotiation culture will also contribute to these pressures, especially since inflation expectations remain above the CBA’s official target. Second, slow fiscal consolidation and the partial monetary financing of the budget are counterproductive for containing inflation. An acceleration of austerity measures is thus also important for the success of monetary policy and thus crucial for normalizing the economy. On the positive side, by having acted firmly so far, the BCA is building a much needed track record and asserting its independence following years of erratic policy and heavy political influence during the Kirchner years. This is an important ingredient for monetary policy to function well and thus an important step towards anchoring inflation expectations and thereby reducing economic volatility to levels conducive to sustained economic growth.

Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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