Two years since taking office in Argentina, President Mauricio Macri’s administration is seeking to complete the economic shift it introduced, with further economic reforms planned following October’s key electoral test. The strategy, based on a new legal framework, is aimed at improving Argentina’s business environment and boosting economic growth.
Following a tough transition after taking over from the long-serving Justicialist Party, the government now intends to move beyond the economic issues of recent years – namely inflation and budget difficulties. According to the official vision, this will require a new focus on attracting long-term investment into Argentina’s real economy.
In this context, Cambiemos, the governing coalition, has been challenged at the halfway point of its term, with the economy still recovering from recession. It also remains under the watchful eyes of investors, who are waiting for stronger signals that the path taken in 2015 will be continued.
Macri has frequently mentioned the ‘heavy inheritance’ his administration has had to deal with, referring to the after-effects of high spending and galloping inflation. However, given that many observers now feel the government has had sufficient time to move past these problems, this year is widely being viewed as a crucial make-or-break period for the administration.
Macri has frequently mentioned his ‘heavy inheritance’, referring to the after-effects of high spending and galloping inflation
Tax and labour market reforms will be top of the agenda, with moves intended to send positive signals to investors, even if change does not take place overnight.
In the past few years, Argentina has experienced an ongoing transformation towards a pro-business, liberal economic model, away from the populist and protectionist policies of the previous administration.
The struggle between these contradictory paradigms has led to a significant ideological break among normal Argentines. For investors, however, the preference for Macri’s reforms is clear, particularly since last year’s key move to take the country out of the state of default declared in 2001.
This year, the October elections have given the government an opportunity to test its strength against what remains its toughest political opponent. Rising to the challenge, former president Cristina Fernández de Kirchner has returned to the formal political arena, running as a senatorial candidate for the Buenos Aires province.
Investors have been quick to interpret this as a threat to market stability, which serves to indicate the complexity of the task ahead for Macri.
That said, expectations have changed over time. Despite massive demonstrations of support following the end of her term, Kirchner’s political base has dwindled significantly.
“Kirchner is not likely to re-emerge as the leader of a hardline opposition to Macri’s reform agenda,” said Jeffrey Lamoureux, a risk analyst at BMI Research. What’s more, Kirchner’s return has served to divide opposition to the current administration, which might be an advantage when negotiating future deals.
Back on track
In the decade or so preceding Macri’s election, Argentina’s economy experienced significant expansion. Following the economic depression in 2001, the country enjoyed growth rates of around eight percent, amid the commodities supercycle that pushed the entire region up.
Kirchner’s followers described this as the ‘victorious decade’, emphasising in particular the benefits of what they saw as a process of inclusion and ‘unindebting’. However, by the end of the Kirchner administration’s term, financial issues had again multiplied, with increasing price distortion raising a red flag for the economy.
Now, Argentina’s economy is once again getting back on track, following a recession in 2016 in which per capita GDP fell back to around 2014 levels (see Fig 1). According to analysts, economic activity is set to grow by between 2.5 and 3.1 percent in 2017. “Recovery is launched and the pace will accelerate as the central bank eases monetary policy,” said Dante Sica, Director at Abeceb, a regional consultancy firm.
Sica added that a further push will come from Brazil, which is slowly emerging from a two-year economic decline. With the two countries’ economies so integrated, any issue on one side of the border is a concern for the other. This co-dependency has manifested itself negatively over the past few years, but, as Sica explained: “From now on, Brazil starts to affect Argentina positively, as exports have started to show.”
This may prove to be a vital factor for Argentina, as – in spite of other positive indicators – the country reached a record commercial deficit earlier this year.
The gap in the trade balance was narrower during the previous administration, which controlled Argentina’s deficit by restricting imports to protect local industry and the national reserve’s US dollar holdings. However, the approach also resulted in some negative outcomes, such as permits being granted at discretion, pressure on prices, and the growth of the black market.
Taken in combination, these factors were deemed sufficient for the World Trade Organisation to sanction the country.
Mariano Sardans, CEO of wealth management firm FDI, elaborated on the consequences: “Policies gave businessmen a comfort zone and allowed them to go hunting inside the zoo. They were organised in oligopolies, with prices under their control.” On the other side, business complained about increasing production costs.
Changing this complex business environment is taking time. Speaking in Congress, Marcos Peña, Chief of the Cabinet of Ministers, said Argentina is “one of the most closed countries in the world”.
This statement is supported by World Bank data, which in 2016 ranked Argentina as the world’s fourth most closed economy, behind Sudan, Pakistan and Brazil, in a measurement of external trade flows as a proportion of GDP. However, this at least represents an improvement against 2015, when the country was in the top three.
Making things even more complicated is that efforts towards openness have themselves been met with criticism, mostly by factions who view the move as contrary to development and growth. Such groups usually cite the examples of the US and Japan, both strong economies that also rank highly on the list of the most closed countries.
More to be done
Regardless of political differences, certain pending issues have taken the form of common denominators between successive Argentine governments. After a sharp fall from the 49.7 percent registered after the 2001 crisis, the poverty rate started to grow once more in 2011, reaching 29 percent during Kirchner’s final term. Last year, this climbed again to 32.9 percent, according to an indicator from the Catholic University of Argentina (see Fig 2).
The big economic issue behind this is inflation, which has hit the lowest income bracket the hardest. Despite monetary policy efforts to curb price hikes, the country still has the second-highest rate in the region, behind only Venezuela, at around 20 percent.
What’s more, not long ago, inflation rates reached 40 percent, with the government brushing the problem to one side and reducing transparency by taking control of the National Institute of Statistics (Indec) in 2007.
This move resulted in the creation of multiple alternative consumer price indexes, including one calculated by minority parties in Congress, which normally doubled Indec’s figures. This statistical confusion not only caused uncertainty, but also affected inflation-linked bonds, which damaged the country’s reputation in the markets. Thankfully, autonomous official statistics have been restored, but more work needs to be done.
Macri’s inheritance also included older problems, such as the default declared in 2001. In order to leave this behind, in 2016 Argentina paid as much as $9.3bn to its holdout creditors, and finally returned to international markets to relieve its budget deficit. In what Macri’s political opponents called “the swindle of the century”, this put an end to 15 years of market exclusion and resulted in the closure of a long-running trial in the US courts.
Macri’s strategy to cover the budget deficit has pushed Argentina’s debt up significantly
As an example of the turnaround these moves have sparked, in June 2017 the government received $9.75bn worth of orders for a $2.75bn 100-year bond issuance, even though its eight percent rate caused some controversy. What’s more, the issuance, said Lamoureux, is only one chapter of a process that drives towards “the good graces of market arbiters”.
For example, he said, Argentina has restored its relationship with the IMF, “which has previously censured the country due to data manipulation and sovereign credit rating upgrades”. He added: “In 2018, MSCI is likely to upgrade Argentina from ‘frontier market’ to ‘emerging market’ status, as concerns over policy direction are allayed. Over a multi-year timeframe, Argentina could join the OECD and the Paris Club, and could receive investment-grade ratings.”
Every action has a reaction, and the Argentine economy is no different. Macri’s strategy to cover the budget deficit has, following this rule, pushed the country’s debt up significantly. Official data shows that public debt rose by up to $288.44bn in 2016, a 13.6 percent year-on-year rise, climbing to 53 percent of GDP.
This has been billed as a success by the government, since the ratio of debt-to-GDP (see Fig 3) remains at a tolerable level (in Greece, for example, it is around 180 percent). However, some experts have started to issue early warnings about increasing liabilities.
Pedro Biscay, Director at the Central Bank of Argentina under the Kirchner administration – who was removed from his position this year – highlighted the risks of the official approach: “Although I agree with the idea of borrowing in international markets, the current capital flow is linked to financial speculation due to high rates in the country. These are now around 26.5 percent and at a level of 38 percent at the beginning, with no connection to the real economy – namely production and employment.
“Debt is being issued to finance capital flight in a context of financial deregulation under the current administration, where economic freedom is seen as a virtue without addressing any risks and, what’s worse, with a lack of legal regulation for the country to increase its external debt.”
Other specialists, however, agree with the official financing strategy. Juan Manuel Pazos, Head Strategist at investment bank Puente, thinks financial capital and capital for productive investment shouldn’t be mixed: “Argentina has urgent necessities, which only can be covered by external capital and, in this context, any attempt to moderate the flow is synonymous with rising financing costs for the public sector, which makes it more difficult to balance public accounts.”
Over the past few months, he added, financing costs have been falling in the country as long-term bond spreads have narrowed. In this sense, debt issuances can be related to investors’ “good expectations that the country has taken the right macroeconomic course, and will be normalised in the coming years as the changes that started in 2015 are irreversible”.
Despite efforts to improve the country’s image, capital flows to Argentina decreased in 2016. According to the UN Economic Commission for Latin America and the Caribbean, FDI in Argentina dropped by 64 percent year-on-year, a figure which puts the country far below the average for the Latin American region, where even Brazil grew in spite of a recession.
Juan Pablo Tripodi, Executive President of the Argentina Investment and Trade Promotion Agency, said that FDI represents between five and 10 percent of total investment, and explained its reduction mainly as a consequence of the fall in utilities reinvested following the removal of a ban on multinationals transferring earnings to their headquarters.
According to Tripodi, this trend is now being reversed, as FDI climbed by 30 percent year-on-year in the first quarter of 2017. “Even without restrictions, reinvestments of utilities from foreign companies were around 80 percent, which reflects investors’ positive expectations of the country,” he said.
Since Macri’s inauguration, the agency has registered announcements from 453 local and international firms for more than $69bn, to be disbursed in the next five years. The most attractive sectors so far have been oil and gas (with Vaca Muerta, one of the world’s largest shale formations, leading the way), mining and telecommunications.
Half of these are estimated to be under execution or completed. But this is not enough in terms of the country’s needs and the ‘dollar rain’ promised at the beginning of Macri’s term.
Although people are still waiting for better investment news, Sica believes that things will improve if the current stabilisation process is continued over time: “Institutional and macroeconomic risks will sharply fall, and that will boost investment projects, with companies focusing on the medium term instead of the short term as they have been until now, looking at inflation and the political fight.”
This has been a major issue for businesses in particular, with the government itself acknowledging that small margins are the reason why investment hasn’t been flowing in at the expected level.
But, although the Macri administration has already missed its goals for this year, Treasury Minister Nicolas Dujovne said the inflation rate would be halved by the end of the year against 2016, which he considered would be a strong achievement. A new legal framework would do the rest of the job in terms of attracting foreign capital.
“The most expected reforms are those related to capital markets, the tax system and the labour market,” said Sardans. “The latter being a priority in order not to lose competitiveness against Brazil, given the changes recently applied there.”
Official sources have stated that there won’t be any tax increase to alleviate public accounts, but rather the opposite. However, far-reaching changes seem a big challenge for a government that is currently dealing with a large deficit.
Macri’s labour market reforms, for example, seek to widen the base of contributors tackling informality in the work market, cut labour contributions to reduce costs (especially for small companies), and establish internships and training programmes.
But the process won’t be easy, as the largest and most powerful unions in the country have opposed the project with massive demonstrations. What’s more, beyond this context, increasing social conflict is a wider challenge ahead for Macri, who is also facing a rise in the unemployment rate, which stood at 9.2 percent in the first quarter of 2017, up from 7.6 percent at the end of 2016.
Argentina’s expected economic growth in 2017
Argentine unemployment in the first quarter of 2017
Amount paid to holdout creditors in 2016 to end Argentina’s long-running state of default
These roadblocks notwithstanding, the government’s fiscal reform bill will be introduced in Congress within the final months of this year, as Macri hurries to give positive signals to businesses. Today, corporations operating in Argentina tolerate the strongest fiscal pressure in the world; with a value of 137.4 percent over profits, Argentina was ranked 104th in the World Economic Forum list of 138 economies, from the lightest to the heaviest burdens.
Going some way to resolve this, one of the planned incentives is to allow businesses to implement inflation adjustments on balances for fiscal purposes. Also, VAT and income tax exemptions would be removed to increase equity within the system.
The move is expected to receive a warm welcome from the market, which has been anticipating policy continuity over the past few months. Alejo Czerwonko, Director of Emerging Markets Strategy at UBS, said reforms “could become the next positive catalyst for Argentine assets” in light of an improved outlook for the ruling party.
Looking forwards, opportunities for investors and a reduction in financing costs for the government seem likely. “We have been expressing a positive view on Argentine assets for some time, which has paid off well following the primary results, and we anticipate further upsides,” said Czerwonko.
Clearly, the country is experiencing a key moment in terms of enhancing its recovery and bringing growing optimism into reality. For Macri, however, the weight of inheritance still sits heavy; the economic situation is no simpler or easier than when he began his project, and that seems unlikely to change any time soon.