Risk drivers and outlook

Credendo upgraded its short-term political risk classification to category 4/7 in August 2016 thanks to the rising foreign-exchange reserves. However, less than two years after this upgrade, the outlook is negative. Although the rising foreign-exchange reserves are improving liquidity, the quickly rising short-term debt (which stands at an elevated level) is worrisome.

The medium- and long-term political risk classification was upgraded in October 2016 to category 5/7. The orthodox policies of Macri such as the dismantling of interventionist policies and targets to put the fiscal balance and inflation on a sustainable path in combination with the renewed borrowing option were the main reasons for the upgrade. However, again less than two years after this upgrade too, there is a negative outlook due to the swelling external debt, especially with regard to current-account receipts.

As for Argentina’s commercial risk, Credendo’s classification has remained in the highest category, C. This is explained by the high interest rates and inflation, the sharp depreciation of the peso and the relatively difficult business environment. There is a stable outlook for commercial risk as inflation is likely to come down only very slowly while, in the medium term, even if in the short term an appreciation of the currency is likely if confidence returns, the projected widening current-account deficits will put pressure on the exchange rate.

Facts & figures

Pros

  • Laudable macroeconomic reforms
  • Renewed access to international capital markets
  • Big potential in energy sector

Cons

  • Rising external debt
  • Stubbornly high inflation
  • Widening current account deficits
  • Elevated public deficit and public debt

Head of State

  • President Mauricio Macri

Next general elections

  • October 2019

Population

  • 43.8 m

GDP (in 2017)

  • USD 637.8 billion

Income per capita

  • USD 11,970

Income group

  • Upper middle income

Main export products (in % of current account receipts)

  • Manufactures (20.9), Soy (20.3), Cereals (10.0), Tourism (6.6), Gold (3.0)

Country risk assessment

  • The election of President Macri represented a distinctive shift away from the 12-year-old Kirchner brand of populism.
  • Since the arrival in office of President Macri, Argentina has undergone some important structural reforms but macroeconomic imbalances have increased (higher inflation, larger current-account deficits and rising external debt).
  • The current government is trying to put the fiscal balance on a sustainable path but the gradual pace is leaving the public deficit and debt elevated.
  • Rising foreign-exchange reserves are improving liquidity but the quickly rising short-term debt is worrisome.
  • After the recent confidence crisis, which led to the sharp depreciation of the peso, President Macri turned to the IMF and agreed on a USD 50 billion loan.

Important transition in politics

Modern-day Argentina began to take shape after 1983. The year before that saw the demise of the brutal military junta that had governed Argentina since 1976 after a failed attempt to conquer the Falkland Islands from the British. Since then, democratically elected governments have been governing the country. Despite the democratic consolidation that has taken place, Argentinian political institutions still lack maturity. Bribery, corruption and nepotism have been rife while democratic accountability has been regularly undermined. Indeed, politics has been more about securing benefits for particular constituencies than about building an effective state.

One example of this is the leftist administrations under Néstor Kirchner (2003-07) and his wife Cristina Fernández (2007-15). Their administration proved to be one of the most corrupt in modern Argentine history. During their reign, they carefully distributed subsidies to families to gain votes while buying the support of some political parties and marginalising others. Furthermore, executive efforts to undermine the independence of the judiciary and manipulation of the press were reported, while the government’s influence over Central Bank policies and official data released by Argentina’s national statistics agency expanded. The IMF shared the latter concern, as in 2013 Argentina became the first country ever to be censured by the organisation over statistical data deficiencies.

However, the events of 2015 marked an important transition as the presidential elections showed a distinctive shift away from the Kirchner brand of populism. During the presidential elections of November 2015, Mauricio Macri, former Mayor of Buenos Aires and leader of the centre-right alliance ‘Let’s Change’ (Cambiemos), defeated Kirchner’s candidate. Such change was somewhat unsurprising given the economic decline and political malaise between 2013 and 2015. Indeed, mismanagement of the economy and deteriorating terms of trade led to accelerating inflation and capital flight. Moreover, in the legislative elections of 2017, Macri’s coalition achieved a decisive victory against the Kirchnerist opposition. The elections were a huge blow for them as they lost some important strongholds and the party was left fractured. Hence, it seemed that the neo-populist experiment under the Kirchner era (2003-2015) had ended (at least temporarily).

Replacing Kirchneromics by more orthodox policies

Kirchneromics was implemented in a sequence of phases over 12 years. It began with a Keynesian-style diagnosis of unemployment (by raising public spending and introducing subsidies) complemented by rapid consumption growth, which was often funded by windfall gains in commodity exports. Over time, administered prices and export controls were put in place, which led to perverse results. Export taxes, for example, encouraged farmers to hoard grain. Furthermore, a dispute with bondholders meant that Argentina was locked out of international credit markets. Hence, the central bank printed money to finance the widening fiscal deficit, leading to accelerating inflation. Exchange controls were put in place, which artificially inflated the peso and led to a rapid depletion of foreign-exchange reserves and exchange scarcities. As a result, Macri inherited an economy that was on the brink of collapse.

Macri is trying to transform Argentina and bring it into a new era of market economics. Since taking office in December 2015, the government of President Macri has acted quickly to dismantle interventionist policies (by scrapping the bulk of import and capital controls) and restoring competitiveness (by freely floating the exchange rate). As a result, foreign-exchange reserves have quickly risen to a comfortable level of about 5.5 months of imports as of March 2018. These measures are also likely to boost competitiveness in the long term by underpinning confidence and to attract investment, with the country having suffered from years of underinvestment.

Macri has also begun a global campaign to repair Argentina’s reputation with foreign investors. The government defaulted on its debt after the 2001 economic crisis. The consequent dispute with holders of its defaulted debt shut off Argentina from international credit markets. Macri wasted little time in reaching an agreement with these bondholders. As a result, the renewed borrowing option accommodated much-needed public infrastructure investments and offered the government an alternative to monetary financing of fiscal deficits.

The government is also trying to put the fiscal balance on a sustainable path by using more orthodox policies. Macri has slashed blanket subsidies and put in place a tough structural reform package. However, Macri is following a gradual approach of fiscal consolidation. For example, he has boosted pensions and increased targeted cash transfers for the poor while only gradually withdrawing subsidies on transport and utilities. Hence, the fiscal deficit remains relatively prominent. In 2017, the deficit of the general government stood at -6.5% of GDP while its debt has been surging to around 53% of GDP, a relatively elevated level. Substantial cuts are necessary in the coming years to stem the debt build-up, while reforms could prove to be difficult as Macri’s party lacks a majority in Congress.

The reversal of serious imbalances and distortions inherited from the Kirchner administration had an adverse short-term impact on the economy. Indeed, in the last quarter of 2015, the economy started to contract, which led to negative GDP growth of -1.8% in 2016. However, these reforms could lay the foundations for robust future growth. Since 2017, Argentina has been experiencing solid economic recovery and, even in the face of planned fiscal consolidation and ongoing efforts at disinflation, growth is expected to pick up slowly in the coming years to around 3%. Nevertheless, the growth projections are likely too optimistic in the light of the tougher fiscal consolidation requested by the IMF (see below), though a new recession seems unlikely.

Bumpy road

Although the macroeconomic policies undertaken are encouraging and multiple distortions have been unwound, some macroeconomic imbalances persist and might even worsen in the coming years.

Firstly, the current-account deficit has been widening in recent years. In 2017, it widened to an elevated level of 4.8% of GDP (or 40% of current-account receipts), compared with 2.7% of GDP (or 20% of current-account receipts) in 2016. On the one hand, the rebound in oil prices (Argentina is an oil importer), the exit from recession and the strong peso led to strong import growth. On the other hand, exports only picked up mildly due to the slow economic recovery of important Brazilian trade partners. In 2018, the deficit is expected to deteriorate further to -5.1% of GDP due to the worst drought in 30 years (starting in November 2017 and lasting through to March, subsequently followed by flooding), thereby hurting soy exports (its main export product, accounting for about 20% of current-account receipts), and the rising oil price. Also, in the coming years, the current-account deficit is expected to widen to about -6% of GDP due to the economic slowdown in China, projected relative low prices of its main export products (mainly food including soy, accounting for about half of its export receipts) and import of investment goods. Furthermore, a downside risk is Brazil’s economic growth, which could underperform if investor sentiment weakens due to the general elections in October and their outcome, possibly reducing demand for Argentine exports.

Secondly, the country’s external debt is rapidly increasing. Debt stands at a relatively modest level compared to GDP (around 36% of GDP at the end of 2017) but, compared to current-account receipts, it stands at a relatively high level of around 300%.
Furthermore, external debt ratios are likely to rise in the near future due to the current-account and fiscal deficits and depreciation of the peso (as a large share of debt is FX-denominated). Hence, the moderate level of debt service is likely to rise as well, amid large MLT amortisations and interest payments. The latter could increase even further than expected today amid tighter and more volatile global financial conditions.

Thirdly, inflation remains persistently high. Argentina even has the highest level of inflation in Latin America, after Venezuela. The authorities have set ambitious targets to reduce inflation. Consequently, it dropped from an estimated 40% at the end of 2016 to about 25% at the end of 2017. However, in December 2017, the BCRA (Central Bank of Argentina) announced a relaxation of the inflation target for 2018 to 15%, up from the 10% target that was set at the beginning of 2016. Thereafter, the monetary policy rate was unexpectedly reduced by 150 basis points. These decisions have damaged the BCRA’s reputation and questioned its independence. As a result, inflation reduction might be more difficult in the future. For example, inflation is likely to be more than 20% in 2018, which is still a high level.

IMF trauma

The “gradualism” enacted by Macri required ample external financing. Ultra-low global interest rates made that easy: Argentina sold more than $100 bn worth of bonds in just two years. However, fortunes turned when rising global interest rates led to a run on the peso, which fell by about 25% against the USD between 1 May and 1 June, and reported capital outflows of as much as USD 10 bn in less than one month. The country was particularly hit among emerging markets due to worries over the elevated twin deficit and high inflation.

The BCRA reacted by raising its monetary policy rate in three stages from 27.25% to 40% and undertaking heavy foreign-exchange intervention, using about 10% of its foreign-exchange reserves. The drop in the peso also prompted the government to tighten its fiscal deficit target to 2.7% of GDP from 3.2%. Nevertheless, Argentina needed external help to halt the confidence crisis, and sought IMF support, a highly controversial move in the country.

Indeed, many blame the international organisation for having imposed austerity in return for loans before pulling the plug. The IMF programme started in 2000 as Argentina was in recession after a downturn in trading partner demand. The fund requested fiscal consolidation, but the fiscal deficit increased in 2001. Furthermore, the government imposed the “corralito” – barring savers from withdrawing their money to halt a bank run – which is the main reason the IMF halted its second tranche. At the end of 2001, Argentina defaulted on its sovereign debts – the largest sovereign default in history – and devaluated its currency. It led to a national trauma with sharp increases in poverty and unemployment and a deep economic recession in combination with high inflation. Five years later, then-president Néstor Kirchner turned the IMF into a scapegoat and ruined its reputations among Argentines.

Nowadays, despite the potential political damage the move could cost the President, Macri sees no other option than turning to the organisation.

A staff-level agreement with the IMF was announced for a stand-by arrangement worth USD 50 bn over three years, with much cheaper interest rates than the country can get on the financial markets. This staff-level agreement will be subject to approval by the IMF’s Executive Board, which is likely to follow soon . Other multilateral lenders may also add extra funds. Hence, the country will not have to turn to financial markets for almost two years, isolating it from further market turbulence when US interest rates continue to rise. The priority of the programme is to rebalance the fiscal position by accelerating the pace at which the public deficit is reduced and restoring the primary balance (which does not include interest payments) by 2020. Hence, the programme is likely to lead to a more rapid narrowing of the fiscal deficits, stemming the surge in external debt. The programme is also expected to restore investor confidence, stem the exchange-rate volatility  and in turn enable the monetary policy to be relaxed (though very gradually). Nevertheless, the peso is unlikely to return to its previous level as it was clearly overvalued (in 2017 it was around 15% stronger than its long-term average). However, the sharp depreciation will substantially boost inflation and it is likely to increase exports and narrow the current-account deficit. However, the programme could also pose problems. The tougher fiscal consolidation could lead to heavy protests, which in turn could derail fiscal consolidation. Macri is hoping that an IMF programme will improve the economy, preferably in time for the presidential elections in October 2019.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com