MIÉRCOLES 19/12/2018
Dólar Banco Nación

How to read Argentina: Challenge and Opportunity

Argentina has embarked on an economic reorganization process this year. In this article, several local economists and analysts take stock of the situation to date and summarize what it will take to attract foreign investors.

por  Flavio Cannilla

Managing editor at magazine group Apertura at El Cronista Comercial
(Translation Adriana Caminiti)


Brexit; the US elections; terrorist attacks in Europe... The global economy is undergoing a period of change and uncertainty. Concurrently, Argentina has undergone an internal reorganization process intended to attract a large share of foreign direct investment (FDI), which has eluded the country for years. According to latest data available from ECLAC (Economic Commission for Latin America and the Caribbean), the local economy (the third largest in Latin America) barely received USD 11.65 billion of the USD 179.1 billion flowing into the region in 2015. A 4% increase is expected this year, driven by announcements made in the services, agriculture, and auto-making industries, among others. Six months after Mauricio Macri took office, the major Argentine economists acknowledge that several of the steps required for the local economy to compete in the "beauty contest" have been taken.  They are not sufficient to warrant success, however. The burden of what has not been done is still significant. According to a survey by Boston Consulting Group (BCG), inflation, the exchange rate and fiscal costs; on the one hand, and the regulatory framework and labor costs; on the other, appear as the No. 1 concerns among investors and large hedge funds.

To grow and not to bounce

The Argentine annual inflation rate was above 30% by late 2015, with a cumulative 520% price increase in the period 2007-2015. "This is eleven times the average for the region," notes Diego Giacomini, Chief Economist at consulting firm Economía & Regiones. In turn, the primary fiscal deficit amounted to 5.4% of GDP, while liabilities totaled ARS 291.16 billion, some ARS 123.25 billion more than the previous year. The average exchange rate was 15 pesos to the dollar, but it was not standardized. The GDP per capita was 20% lower than by the late '90s, whereas it had increased by 74% throughout the region, with Chile being atop the ranking with 170%. The bargaining chip used by both Presidents Néstor and Cristina Kirchner was the deleveraging achieved under their relevant administrations. By late 2015, Argentina was the fourth Latin American economy with the lowest debt ratio. But, as the saying goes, there is no such thing as a free lunch: the growing fiscal deficit was funded through currency issue, impacting on the cost of living.

Today, nine months later, the country is going through the first stage of the process (estimated by economists to take a minimum of three years) to bring its economy back to normal. The current picture shows a domestic market that withstood a 30% currency devaluation, standardized the FX market, and, following the agreement reached with holdouts, regained access to international financial markets. The downside: Recession, which will translate into a 1.5% drop in GDP for 2016 as estimated by ECLAC and the IMF. The upside: 3% GDP growth in 2017. The unknown: how sustainable this rebound may be. Marina Dal Poggetto, Partner at Estudio Bein & Asociados summarizes it as follows: "This is the first time that the recession is not driven by capital flight, but by attempts to change the circumstances." In turn, Eduardo Levy Yeyati, former Chief Economist at the Argentine Central Bank, researcher for institutions such as the Inter-American Development Bank and the Brookings Institution, and cofounder of the consulting firm Elypsis, underscores the mindset that this change requires on the domestic front. As he concisely puts it, "Argentina needs to learn to grow, not to rebound.” The general outlook is positive, agrees economist and former president of Argentina´s Central Bank, Javier González Fraga: “There is a clear determination to fight and reduce inflation and to constitute policies that foster macroeconomic conditions that attract foreign and domestic investment."

The top five of the Argentine economy

1. Inflation, a very local ailment

Following its initial actions to respond to short-term expectations -relaxing FX controls, removing trade barriers and reaching an agreement with holdouts creditors- the efforts undertaken by the economic team to achieve its mid-term goal of lowering the inflation rate are shaping up well. Following the enforcement of a contractionary monetary policy leveraged by interest rates in the realm of 30%, the monthly inflation rate showed a downward trend in July, in the range of 2% as estimated by the Argentina National Institute of Statistics and Censuses (Indec). The cumulative rate is estimated to reach around 40% by this year´s end, however, well above the 21% target set by Government. This overshooting is driven by the combined effect of the return to a single FX market and the rise in utility rates. Lorenzo Sigaut Gravina, Chief Economist at Ecolatina consulting firm, considers that the impact was hard to avoid in the face of the legacy mismanagement that the Macri administration had to fix. He goes on to admit that "the overreaction could have been avoided through better communication, which would in turn have called for a prices and income accord." For his part, Giacomini recalls that 12 to 18 months normally elapse before the impact of the monetary policy is actually felt on prices. Rodolfo Santángelo, director of consultancy MacroView, projects: “In order to reach a level of more or less 17% of an anual inflation next year, we will have to make a big effort in terms of the  macro economy. Specifically in terms of fiscal policy. All in all, I expect the Argentine economy to see a recovery in the first half of 2017.”   

Irrespective of predictions, the question remains how sustainable this downward trend in the inflation rate will be. Miguel Ángel Broda, partner and Executive Director at Estudio Económico-Financiero M. A. M. Broda Asoc, believes that a comprehensive economic stabilization program is a prerrequisite to achie-ving this goal. "The monetary policy will not suffice. Even if the rate may be brought down to 2% per annum, a further decrease may not be achieved by leveraging the interest rate alone," he adds.

2. The US Dollar,  an Argentine passion

All players in the game of supply and demand in Argentina have historically danced to the tune of the US dollar. In the light of the recurrent inflationary crises and subsequent rebound periods, the greenback proved the best anchor to remain liquid while protecting from depreciation of the Argentine currency. The most recent example of the above are the restrictions imposed by Cristina Kirchner's administration on the FX market (the "cepo cambiario"), intended to have the currency market under control through a fixed exchange rate and avoid a run on the US dollar. This resulted in the manifold exchange rates mentioned above, which swayed in the winds of supply and demand on the secondary market.

This strategy changed with the new administration. Under the supervision of an independent Central Bank, the US dollar is allowed to fluctuate between a band of rates in a single FX market. As this issue was going to press, the greenback was in the range of 14.50 to 16 pesos to the dollar. Miguel Kiguel, director of EconViews consultancy firm and former president of local Banco Hipotecario, says: “Fort he time being, the flotation has been working. The Central Bank has only sporadically intervened, but always without influencing the general tendency of the FX rate.” Dante Sica, former Minister for Production for the Province of Buenos Aires and founder of consulting firm ABECEB, acknowledges that thanks to this, the Government can project a 2017 without FX volatility. "We envision a liquid market, with improved export and financial supply," he says.

In the face of the current scenario, where Argentina is rated as an expensive country when compared to its neighbors and even to other markets such as the USA or the UK, Ramiro Castiñeira, Chief Economist at Econométrica, is of the opinion that: "The standardization of the FX market was successful, but an equilibrium exchange rate is yet to be achieved. This has not been possible because of the sustained net demand from the private sector." The expert believes that Argentina's return to the international credit market allows to mitigate the impact. The inflation rate is not responding as expected. This affects the intended impact of the political measures adopted by the Government and caps future economic growth, which Félix Piacentini, Director of NOAnomics, a Salta-based consulting firm, estimates at 3%.

3. The deficit dilemma

The taxation burden on production activities is one of the major drags on the Argentine economy. "The tax pressure is brutal. It should go down to at least half the current rates," says economist José Luis Espert, Director of Espert & Asociados. We should at this point recall that the Argentine economy increased its tax burden by 18% of GDP over the past 12 years, currently ranking as the highest in the region, and 11% above the average for the countries participating in the Pacific Alliance. Ferreres goes on to add: "Eight years ago, the aggregate expenditure (including the National, Provincial and Municipal governments) was 30% of GDP. This percentage climbed to 53% during Cristina Kirchner's administration."

In turn, Government's ability to act in the fiscal front is curtailed by a historical inconsistency: "We want a Welfare State, in the Swedish fashion, but with the lowest possible tax burden," says Dal Poggetto. The experience of the past few months further exemplifies this statement. Until last April, the Government had implemented a contractionary fiscal policy that included announcements to reduce distortionary taxes such as tax withholdings on foreign trade (agriculture, mining) and the relief of Income Tax or Turnover Tax for taxpayers, among others. This strategy was abandoned following the social impact and the fall in consumption and production generated by the rise in gas and electricity bills of up to 500% and 1000%, respectively.

In recent weeks, President Macri anticipated his Government will analyze a comprehensive tax reform during 1Q 2017. Sica, from ABECEB, believes that: "The Government has taken a tactical detour to ensure governance. This is the reason underlying the decision to stay the reforms." Levy Yeyati, from Elipsys, adds: "They must be patient. Any abrupt turn may jeopardize the whole process. In line with the above, Mr. Ferreres recommends the path of staggered reductions, and further expands on this idea by noting that: "A reform of this sort requires cutting down expenditure. This calls for a stepwise approach however, so as to reconcile short-term objectives with long-term results." Espert, on the other hand, is more critical of the situation: "In my opinion, the Government has showed clear signs of its disregard for the fiscal deficit." He bases this conclusion on the Administration's projections for the end of this year. Santángelo, of MacroViews, adds:

"The fiscal cost will unfortunately stay with us for a long time. The amnesty might and should become a tool to make sustained progress to reduce it, however."

On the upside, the Argentine economy may boast a low level of liabilities to international creditors. Despite projections that forecast a primary deficit in a frightening range of 4.8 to 5% by year end, the financial deficit would apparently be around1.5%, Dal Poggetto recalls. As Piacentini, from NOAnomics warns, the question remains whether the country has additional borrowing capacity. "Today, we are paying high rates compared to the international standard. In sum, being overoptimistic may cause the Government to go only halfway in its tax reform efforts." It is worth recalling that, in aggregate terms, public and private sector borrowings totaled USD 29,235 billion during 1H 2016, according to data supplied by the consulting firm Research for Traders. Most of the USD 16.5 billion borrowed by the State was raised in international markets and allocated to paying the holdouts. This figure will be supplemented with another USD 10 billion expected by year-end. Despite being at its lowest since the 90s, the corporate debt ratio is  growing, "Additionally, companies are hedging against the exchange risk," says Sigaut Gravina.

4. Regulatory Framework: A Better Outlook

On the .upside, analysts underscore the signals given out by the Macri administration regarding the rules of the game, as well as legal and regulatory certainty, and especially note the appointment of new justices to the Argentine Supreme Court, the reorganization of the National Institute of Statistics and Censuses or the National Commission for the Defense of Competition, among other measures. Additionally, they emphasize the professional skills of the experts selected to lead regulatory agencies. All of the above are major steps forward for a country like Argentina. "We have recovered our status as a democratic Republic. Institutions are working again. This is the clearest signal of Government's respect for rules", says Nicolás Dujovne, director of Nicolás Dujovne y Asociados. Nevertheless, Santángelo stresses: “For the regulatory framework to work the economic growth is of the essence”.

Experts also underscore the shift in the realm of international partners, signalled by the approach to the Pacific Alliance and the Organization for Economic Cooperation and Development (OECD), and the decision to drift apart from old partners such as Russia or Venezuela. Analyst  Sergio Berensztein, Director of Berensztein®, argues that: "Argentina has entered a transformation process intended to generate a completely different investment climate from the one prevailing over the past few years. A material change started on 10 December, and conditions are also different. A reform agenda has been developed at a microeconomic level in order to capitalize on the things that Government has done right."

Nevertheless the analyst also acknowledges the mistakes made, for example, in relation to utility rates. "The Government  allowed a strictly political decision, which falls under the jurisdiction of the Executive, to reach the courts. This could have been avoided had consensus been reached with political forces."

As Rosendo Fraga, director of think tank Nueva Mayoría puts it: “It is as always a question of time: the Government might establish rules but it will be the upholding in time of this rules that will generate the so much needed confidence”. Eduardo Fidanza, director and partner at Poliarquía Consultores, coincides: “If the Government manages to establishes itself and pursue its plans, the rules will adjust gradually”. Daniel Marx, former Finance Secretary at the Trade Department and founder of Quantum Finanzas, a financial services firm, emphasizes: "However fast we would want things to get resolved, they actually take time. It is part of playing the democracy game." From his office at Fundación de Investigaciones Económicas Latinoamericanas (FIEL), Chief Economist Daniel Artana, agrees: "My perception is that both the institutions and the pertinent agencies have taken the path of showing their respect for the Law.” Kiguel, of EconViews, adds: “Today, the independence of the Judicary is respected and that is a first in modern time Argentina".

5. Labor Costs: A historic challenge

The Global Competitiveness Index developed by the World Economic Forum ranks the Argentine economy amongst those with the highest labor costs, considering it is a market of more than 15 million workers. It should be noted here that the average monthly cost per wage earner is estimated at around USD 1,600, compared to USD 600 in Brazil, for example. This will become one of the thorniest issues facing the Government in the medium term. As Artana puts it, too stringent legislation for a XXI century reality, and too high a tax burden, are the two main reasons underlying the problem. Added to this is a union model with a mid '70s mindset.

The Government will need to gather up all of its innovation and negotiation skills to get rid of this burden. These initial actions are reflected in the inclusion of productivity as a variable in some sector-specific contracts (e.g. Oil and Gas). A first step in this direction has been taken in the field of Workers' Compensation Insurance, the objective being to put an end to labor lawsuits, which have become ann industry on its own and encumber this market's dynamics. "We must understand that today, with the economics of technological change, we may no longer abide by the rigid norms of the '50s. We need to adapt to the new scenario. This has nothing to do with the so-called junk contracts of the '90s, however. Following the changes to labor regulations undertaken when unemployment was at its peak, Spain is among the countries with the highest job growth rate in Europe. Ideally, this should be done before the crisis actually strikes," he concludes. In turn, Berensztein adds: "Actions should also target informality, which is the source of huge inequalities, in addition to discouraging investments."

One of the factors playing against the coalition led by Mauricio Macri is the lack of union support. Fidanza recalls: “Sindicalism has always been a difficult topic for a non peronist administration.” Sica recommends a line of action: "With a union model still anchored in the '70s and production costs tied to wage levels, we need to understand that successful investments are not those which prioritize low wages, but creativity, talent and productivity. It is along these lines that the Government  should work," concludes Sica, while Ferreres recommends waiting until 2018, a post-election year, to implement the bulk of reforms. In turn, Berensztein favors the idea of focusing on win-win benefits: "It is not a time bomb. There are countries with significant competitive levels, strong unions and high wages. Argentina needs to move in that direction. Labor legislation may be improved, but we need to believe both things are possible and may coexist, even through profit sharing schemes". 

A new  determination

The question remains whether the Government will have the resiliency and flexibility required to revert some historical trends, such as a labor market trapped in an old-dated model, and the role of the State as the primary employer, coupled with macroeconomic reforms. The Macri administration appears to be resolved to seize the opportunity, but the next challenge is already in sight as González Fraga points at  the midterm elections of 2017. “The voting results will have to show that we Argentines don´t want to go back to a populist policy that promises well being for the short term only." Rosendo Fraga summarizes: “The most important asset of the Admnistration is that it was able to prove that even as a minority party it can to get new legislation through Congress. But it´s mayor room for improvement lies in understanding the differences between the public and private administration procedures and requisites.” One thing is clear, though: the battle will call for a strong and clear leadership.

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