Clouds Gather again over Argentina

 

BUENOS AIRES (Economist) August 22, 2008  —  Ever since Argentina began its recovery in mid-2002 from a devastating financial collapse, it has seemed to defy economic gravity. After six years of rapid growth, Argentina’s economy is at a familiar turning-point, in which the president’s refusal to change course threatens to make it poorer. The country’s left-wing government, first led by Néstor Kirchner and then this year by his wife, Cristina Fernández de Kirchner, has violated many standard economic prescriptions: it has shunned the IMF and shafted private bondholders; kicked out foreign companies and set up new state-owned ones; imposed price controls; and even doctored the inflation figure. Yet over the past six years, Argentina’s economy has grown at an annual average rate of 8.3% — faster than any other big economy except China.

At last a turning point seems to have been reached. A slowdown, long predicted by the Kirchners’ opponents, is at hand. When compared with the same period last year, retail sales (measured by volume) are down 10% to 15%. On Calle Florida, Buenos Aires’s main shopping street, almost every block has at least one vacant shop front. Employment in the private sector is still growing, but at half last year’s rate, according to Nicolás Bridger of Prefinex, a consultancy. Meanwhile, inflation has taken off. Almost nobody believes the official index, which shows prices having increased by 9% over the 12 months to July. Credible unofficial estimates put the figure at 25%. By underestimating inflation, the official figures may also overstate economic growth.

Throw in the recent fall of up to a quarter in world prices for the country’s farm commodities, and the markets have suddenly become rattled. After years in which it bought dollars to stop the peso from appreciating, the Central Bank has been selling them to boost the currency. On August 11th Standard & Poor’s, a ratings agency, downgraded Argentina’s credit rating. The risk premium on Argentine public debt has soared to 670 basis points above the interest rate paid by American Treasury bonds. The equivalent figure for Brazilian debt is just 240 basis points.

Fears of another economic collapse of the kind that Argentina has made its specialty are, in fact, overblown. Most forecasters expect the economy to carry on growing, but at a more moderate rate of 4-5% in 2009. “Argentina’s hyper-growth period is over,” says Miguel Bein, an economic consultant. The country still enjoys budget and trade surpluses. But by common consent, maintaining these surpluses and engineering a soft landing requires policy changes. And therein lies the doubt.

Two things have underpinned the growth spurt. The first was the depth of the preceding collapse. In 2001-02 the economy shrank by 15%, unemployment climbed to 21% and poverty engulfed 56% of Argentines. The government defaulted on debts of $80 billion and devalued the peso, which sank to less than a third of its previous value. When growth resumed, idle plant and workers could easily be brought back into action. The second boost was the surge in world commodity prices, and thus in the value of Argentina’s exports and the taxes on them.

The government supercharged growth, stimulating demand with wage increases, price controls, an undervalued peso and public works. This formula worked for much longer than the critics expected. But it has generated big distortions. Inflation has cut into the real value of wages and profits, pushing up poverty again.

The government’s energy and farming policies have caused particular problems. It kept energy tariffs frozen at their 2002 level, deterring investment and prompting blackouts last year. Winter has been milder this year, and tariffs have recently risen. But uncertainty about energy supply is another discouragement to investors.

The Kirchners have relied on taxing farm exports to fund public spending. This originally had some justification, since farmers benefited hugely from the cheap peso. But Ms. Fernández pushed the policy too far, raising farm taxes in March. After months of protests by farmers, Congress voted down the tax increase. The conflict paralyzed parts of the economy, and undermined confidence.

The economy’s slowdown puts Ms. Fernández in an awkward financial position. Energy and transport subsidies now cost 3.5% of GDP, according to Ecolatina, a consultancy. And Ms. Fernández wants to spend money on renationalizing an airline and on building a high-speed train. To boost its primary budget surplus (excluding interest payments), the government now includes in its accounts revenue from the Central Bank and the pension system. It has also held back payments to provincial governments. But the president, who has become deeply unpopular, has lost the confidence of much of her Peronist party, making that harder.

At 55% of GDP, Argentina’s public debt is still large. But the cost of servicing it has been low, partly because of the tough restructuring Mr Kirchner imposed on bondholders. Even so, to service its debts, the government needs to find an extra $2.5 billion or so next year. It cannot tap the international capital markets, because it has still not settled with some bondholders nor its sovereign creditors in the Paris Club. Instead, it is relying on Hugo Chávez. This month Venezuela’s president bought another $1 billion in Argentine bonds taking his total purchases to $7 billion. The latest bonds pay interest of 15% — the same rate agreed by Domingo Cavallo, a former finance minister, in a notorious bond swap in 2001 on the eve of the collapse.

This time the government has plenty of policy tools with which to stabilize the economy. Start with energy, for which Argentines still pay a third less than their neighbors. Further hikes in energy tariffs would improve the public finances, and attract investment. Settling with the Paris Club and the bondholders would enable Argentina to secure financing from the markets on relatively favorable terms. Many economists reckon that these measures would be enough to keep the country growing at a still-healthy annual rate of 4% or so for several years.

“These problems should not be difficult to solve,” says Javier González Fraga, a former Central Bank governor. “But no one seems to want to do so yet.” By delaying the necessary adjustments, the government has already made them more painful. And the Kirchners, who govern as a couple, have made their defiance of the IMF, the Paris Club and the bondholders a point of pride. Unless they now swallow that pride, it will be followed by a fall.