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Emerging Markets

Law of the pampas

Largely spared the brunt of the global crisis, Argentina’s economy continues to defy expectations. After all, the nation has had it worse – and not so long ago

Ask an Argentine economist these days where the South American economy is heading, and most will tell you it will probably blunder through.

“I see no explosion on the horizon but a muddling through economically,” says Mario Brodersohn. This is a country where inflation is five times the international average, unemployment is in double digits, investment levels are among the lowest in the region, the national account statistics are regarded as a joke – if not a fraud – and capital flight has been hovering around $20 billion a year for the past two years.

The government admits to a shortfall of close to $1 billion in its debt obligations for 2009, the primary fiscal surplus has collapsed to 1% of GDP from 3% in 2008, and the country currently lacks access to international capital markets.

Yet the capital is trickling back in, the currency is stable and sovereign bonds have staged a rally.

The feel-good factors

Why are markets regaining confidence? The main reason is that Argentina has had it worse – and not so long ago. The collapse of the convertibility regime, the banking freeze and the enormous debt default that followed Argentina’s 2001 crisis did not take place during a worldwide slump – one that today provides a range of scapegoats and some sense of shared misfortune. Moreover, there are signs the government may move – however tentatively – towards normalizing relations with international creditors.

As a result, more and more investors are downplaying Argentine sovereign risk and assessing the country on mainly macroeconomic data.

There are concrete grounds for optimism, too. Argentina’s foreign exchange reserves, at around $46 billion, are plentiful, with an estimated $20–28 billion in disposable reserves. And the central bank, under its president Martin Redrado, has kept the exchange rate both steady and competitive.

Despite the adverse local conditions that have marked the last 18 months – the worst drought in a century, volatile prices, and, above all, a continuing brawl between the government and the agricultural sector – Argentina’s year-on-year trade surplus has jumped by around a third.

To cap it all, local economists say, the banking system is in good shape, with significant amounts of liquidity in both pesos and dollars.

Not so fast

Yet while largely spared the full brunt of the global recession, Argentina has not escaped unscathed. By the end of last year, output had begun to shrink, after more than five years of roughly 8% GDP growth.

The consensus view among economists is that the economy will contract by between 1% and 2.5% this year – with all that implies for tax collection. Next year “doesn’t look much better”, says former economy minister Roberto Lavagna.

Argentina’s borrowing requirements rose to $10.73 billion this year from $5.9 billion in 2008 as the global financial crisis choked demand for commodity exports, according to a report by Credit Suisse. The nation’s borrowing needs will reach $8.24 billion in 2010.

The outlook for Argentina’s fiscal accounts is opaque, at best. The official figures, as economist Miguel Kiguel points out, are hard to believe, while the government’s likely approach to public spending cuts remains a mystery.

To reduce its financing needs, the government has moved to swap some of its debt as part of a plan to replace inflation-linked notes, while extending maturities and reducing its financing needs to lower the chances of a second default. But more urgently, Argentina needs to reach an agreement with the holders of debt not tendered in a 2005 restructuring and resolve doubts about inflation reporting.

The new economy minister, Amado Boudou, seems to have come closer to making progress than any of his predecessors – after suggesting the country was prepared to start talks with the IMF, which would pave the way for renewed international capital market access.

The difficulty lies largely in the politics – particularly in the role of former president Nestor Kirchner and his wife Cristina Fernandez, the incumbent president. Kirchner – who is widely viewed as the power behind the throne – has made no secret of his disdain for the IMF, though he knows he must come to terms with the Fund if there is to be any rapprochement with markets (and this would also include paying the roughly $8 billion owed to the Paris Club).

Yet the prospect for normalizing relations with global markets seems a long way off. Kirchner’s attitude towards the bond holdouts has proved even more inflexible: three successive economy ministers have been censured for attempts to create the space for negotiations on the issue.

Next step

Restoring credibility to the national statistics-gathering organization Indec must be a first step towards normalizing economic affairs. A 2007 scandal, reportedly understated, still looms large. Yet if inflation has been underestimated, the government may have ended up pocketing billions on payments to those holding bonds indexed to inflation.

While inflation is declining in many Latin American countries as the global economic crisis continues to take its toll, prices in Argentina are on the rise. Moreover, expectations for high inflation are ingrained in the economy. Indec reported that Argentine inflation was a higher-than-expected 0.8% in August, raising expectations the government may bring price data closer to private estimates.

Such hopes were raised in July when Boudou launched a programme to examine Indec’s workings – a move widely interpreted as a commitment to bring the statistics agency’s numbers more in line with private-sector estimates. But recent inflation reports have failed to calm fears among the private sector, whose estimates of actual inflation are two or three times higher.

The problem is that by publicly acknowledging past inflation reporting errors, the courts could be avalanched by legal challenges. About a third of Argentina’s debt load is made up of so-called CER paper that pays according to consumer price rises.

Until meaningful progress is made, official statistics will at best continue to be viewed with scepticism. Yet with Argentina in another presidential election cycle – one which Kirchner wants to win – few expect such conundrums to be resolved any time soon.

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