Increasing uncertainty at Argentina

Argentina`s economic performance will be negatively affected by slowing growth of Brazil, its main export market, and the fact that agricultural commodity prices are no longer rising.

Madrid - 24-jan-2012

2010 and 2011 at Argentina have been characterized by high GDP growth [more than 8%] resulting from expansionary macroeconomic policies, government intervention and the high prices of agricultural exports [soya beans]. The expansive economic policy [e.g. a child support system for poor families and cheap mortgages for first-time buyers] has stimulated domestic demand, albeit artificially. At the same time, strong demand for commodities from the booming markets of China and neighbouring Brazil has boosted Argentine exports.

However, growth is expected to slow down in 2012, with export growth decreasing and more restrictive fiscal and monetary policies now urgently required. In addition, government intervention is impeding GDP growth.

Unreliable official inflation figures

Since the second half of 2009, the recovery has triggered a rise in inflation: officially estimated to be 9.9% for 2011 but in reality probably exceeding 25%. Official inflation figures have become questionable.

General confidence in banks is low as, despite adequate provisioning and capitalisation, savers still clearly remember the peso-crisis of 2001. There is a growing divergence between public and private banks, with state banks generally in a poorer state because of increasing exposure to public sector debt.

The Argentine governments interventionist and pro-cyclical policy has led to increased state control and the current inflationary climate. This economic strategy is also too ad hoc, with the government resorting to price controls, export bans and trade protectionism. Monetary policy is highly politicised and, with generous public spending and subsidies to consumers, has contributed to a budget deficit of 1.4% of GDP this year.

Because of adverse international investors´ sentiment and still unresolved issues with bondholders who boycotted 2005s debt restructuring, the government cannot borrow freely on the international markets. To bolster public finances, in 2008 government and Congress approved the nationalisation of a private pension fund worth US$ 30 billion. A part of its foreign reserves has been transferred to the Treasury, averting liquidity problems in the public sector and possible sovereign default. At the same time, the government has ordered the central bank to transfer parts of foreign reserves to a fund to service the public debt.

So far, structural reforms have remained minimal [banks, pension funds, energy sector, provincial/local governments]. Price controls cover 70% of items in the consumer basket, and foreign investors had already turned their back on Argentina before the credit crisis because they were not allowed to raise prices to consumers.

At the end of 2001, Argentina defaulted on US$ 94.3 billion of public sector debt - mostly sovereign bonds and, in June 2005, an involuntary debt restructuring with the bondholders was completed. US$102.6 billion of old debt [including interest due] was turned into US$ 35.2 billion of new debt after 76% of the creditors accepted the deal. In June 2010, Argentina managed to restructure another swap of US$ 12.2 billion in bonds omitted from the 2005 exchange, bringing the total amount of debt restructured to 92.6%.

By prepaying the entire US$ 9.8 billion of IMF debt by the end of 2005, Argentina ended its obligation to that organisation. But there is as yet no solution for Paris Club arrears of US$ 8.8 billion, and this is blocking Argentinas access to international financial markets. Without that access, Argentina faces ongoing problems in covering its external financing requirement.

As a result, the Argentine government has shown increased willingness to settle those outstanding issues as a way of regaining access to capital markets and thus avoid a new sovereign default. In November 2010, President Fernández de Kirchner announced that the Paris Club had agreed on talks to settle the outstanding debt without the IMFs supervision [a precondition demanded by Argentina], but a solution is still uncertain.

Deteriorating current account and increased capital flight

Although exports have grown in 2010/11, as a result of the economic upswing imports have grown faster, causing a lower trade balance surplus and a marked deterioration in 2011s current account. Moreover, ahead of the general and presidential elections, capital fled the country because of concerns about inflation, a weakening peso and uncertainty about economic policies. According to the central bank, between January and September 2011 capital outflows doubled year-on-year: to US$ 18 billion. In Q3 of 2011 alone, capital outflows totalled US$ 8.4 billion. This eroded the level of international reserves considerably: from more than 12 months of import cover in 2010 to less than 8 months by the end of 2011.

This weakened liquidity position has driven the government to take the measures to stem capital outflows, such as the introduction of various trade, capital and tighter foreign exchange controls [e.g. ordering companies to repatriate export revenues and return foreign investments]. Foreign companies have been encouraged to increase their investments in Argentina and to produce more goods locally. These measures have improved the external accounts, albeit artificially: by government manipulation of the market. Argentina continues to be a highly dollarized economy.

Outlook: Strongly increased arbitrary risk

The official economic figures point to a moderation of GDP growth in 2012 - to 3.5% - and continued high inflation. Argentinas economic performance will be negatively affected by slowing growth of Brazil [its main export market] and the fact that agricultural commodity prices are no longer rising. The economic policy is too expansive in view of the real inflation figures of more than 25% and the risen budget deficit [1.4% of GDP in 2011]. The unreliability of official data and excessive fiscal/monetary stimulus give an artificially positive view of Argentinas real economic performance.

The end result of massive state intervention in the economy [trade, capital, foreign exchange restrictions and manipulation of economic figures] is the build up of tensions in the markets that cannot continue indefinitely. The peso is now strongly overvalued - with real inflation by far exceeding the slow depreciation - and this needs to be corrected. But the authorities are refusing to adjust the peso by a stronger depreciation of the official exchange rate. Instead, import restrictions and exchange controls have been applied, leading to more payments delays for foreign importers and a sharp increase in the financial risk of trading with Argentina.

Argentinas liquidity position is not yet in danger. However, it has deteriorated significantly this year as real inflation exceeds peso depreciation [leading to a loss of competitiveness] and a further decrease in international reserves is expected in 2012. External accounts continue to weaken and relations with the international financial markets will remain shaky as long the arrears of US$ 8.8bn, owed to the Paris club to complete the foreign debt restructuring, remain outstanding. A resolution of this issue is necessary before Argentina can again tap into global financial markets.                   

To regain investors´ confidence and to stem capital flight, the government should also decrease public spending [i.e. reduce subsidies, which amount to more than 4% of GDP] and lift foreign exchange restrictions. However, more arbitrary actions by the government cannot be ruled out as economic tensions mount and key figures deteriorate; but those actions would only further aggravate the existing economic imbalances. Therefore it is vital to be very cautious when dealing with this market and to continue closely monitoring developments.

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