Usefulness of the article: this article provides a macroeconomic analysis of the Argentine economy. It assesses the current government’s economic performance and discusses the main challenges facing the new government that will be elected at the end of October 2019.
Summary :
- While access to international capital markets in 2015-2016 offered a new wave of optimism in Argentina, the upward trend in economic activity subsequently reversed, with the economic performance of recent years ultimately proving to be less than favorable.
- Macroeconomic indicators remain worrying: GDP growth has been uneven and external debt has risen sharply.
- The country is still reeling from the aftermath of the 2018 currency crisis and increased uncertainty following the results of last summer’s primary elections: the peso continues to depreciate and economic indicators continue to deteriorate.
- Finally, controlling inflation and restoring public finances remain major challenges for the next government.
On the eve of the upcoming presidential elections, the first round of which will take place on October 27, the Argentine economy is still causing a great deal of concern. Since the currency crisis in early 2018, the economy has been unable to return to growth, entering its fourth consecutive quarter of recession (as of the first quarter of 2019).
1. A mixed picture
The economic record of Macri’s presidency is rather mixed. The election of the « pro-market » candidate was a breath of fresh air for the Argentine economy, which had been stalled for years by endless negotiations with « vulture funds. »This situation effectively prevented the country from accessing international markets, blocking the inflow of foreign currency (mainly the US dollar) and limiting both imports and exports. However, the economy’s adaptation to this new openness did not have the expected effects on the economy.
The new access to international markets, allowing free access to foreign currency, led to a sharp deterioration in Argentina’s foreign trade. The current account deficit represented 5.4% of GDP in 2018.The trade surplus recorded by the Argentine economy since 2000 was « artificial »: currency purchase quotas inevitably led to a limitation of imports. The opening up of the economy therefore allowed for the liberalization of international trade, causing an acceleration in imports and thus a negative contribution of foreign trade to growth.
Another negative factor was the financing of the economy through debt. Argentina’s external debt represented only 25% of GDP in 2015, the year Macri was elected, but reached 61% of GDP in 2018. There are three main reasons for this sharp increase: (i) the settlement of the dispute with vulture funds, (ii) the financing of the public deficit (-5.4% of GDP on average over the period 2015-2018) and finally (iii) the currency crisis of 2018.
The 2018 crisis is one of the main factors hindering the country’s economic growth. Structural issues such as the lack of independence of the central bank (BCRA) are among the causes of this crisis. In early 2018, as Argentina faced rampant inflation (25.5% on average in the first quarter), the central bank decided to slightly lower key interest rates (a decision justified by real interest rates that were still positive). The markets did not understand this decision and reacted with both panic and speculation, causing a sharp depreciation of the peso (see BSI article on the subject).
The Macri government had two reactions to the emergency situation: (i) a very sharp increase in key interest rates (from 26.8% to 38.3% in one month) and (ii) a request for a $57 billion loan from the International Monetary Fund (IMF). These two decisions certainly helped to put out the fire (notably by halting the sharp depreciation of the peso), but ultimately proved very damaging to the economy. Argentina’s key interest rate is currently 68%, making the cost of credit extremely high and thus penalizing any form of investment in the real economy. As for the IMF loan, it was obtained in exchange for structural reforms such as reducing the public deficit, which inevitably requires a cut in public spending. This reduction has a threefold negative effect that directly impacts household purchasing power: it leads to (i) a decline in public consumption, (ii) an increase in unemployment, and (iii) a reduction in subsidies to the private sector. The latter two factors have inevitably caused a decline in private consumption.
Finally, GDP, the benchmark indicator, has been highly erratic over the term of office. GDP growth in 2015 (2.7%) was followed by a recession in 2016 (-2.1%), then another phase of growth in 2017 (2.9%) before the country sank into a deeper crisis in 2018 (-2.5%). IMF projections estimate that the recession will continue at least until 2020 (-3.1% in 2019 and -1.3% in 2020).
2. Economic conditions deteriorating as elections approach
In the first quarter of 2019, growth declined slightly (-0.1% year-on-year compared to the previous quarter[1]). The sharp contraction in private consumption (-5.4% year-on-year) and investment (-3.2% year-on-year quarter-on-quarter) were offset by growth in public consumption (7.4% year-on-year quarter-on-quarter) and a sharp decline in imports (-8.8% year-on-year quarter-on-quarter).
Economic indicators for recent months are hardly more optimistic, particularly since the results of last August’s primary elections. The elections held last summer were Simultaneous and Mandatory Open Primaries (PASO in Spanish)[2]. The outcome of this vote, considered a precursor to the national elections, was unexpected: the Frente de Todos party (whose vice president is former President Cristina Fernandez de Kirchner) came out on top with 47.6% of the vote (compared to 32.1% for the current government, which is running under the name Juntos por el Cambio)..
In an already fragile macroeconomic and financial context, these results have « added fuel to the fire. » From a purely financial point of view, the markets panicked at the risk of seeing « Kirchnerism » return to power, which for the financial markets is synonymous with the risk of default, less fiscal discipline, and complex negotiations with the IMF and other creditors. This wave of panic is illustrated by the evolution of 5-year sovereign credit default swaps (CDS), whose price has skyrocketed since that date. The peso, meanwhile, has continued to plummet, losing nearly 52% of its value since August1, 2019. Economic indicators are only just beginning to reflect this trend: the seasonally adjusted manufacturing production index for August fell by 2.8% year-on-year.
3. Key challenges for the next president
Argentina remains the only country in Latin America that has not managed to curb its inflationary demons. While all countries in the region have had controlled inflation for several years, most of them in line with the targets set by their central banks, Argentina’s inflation rate stood at 54.5% in August 2019. To combat this inflationary spiral, the central bank raised key interest rates to stratospheric levels: 68%.
To better understand the issue of inflation in Argentina, some statistical insight is needed. For many years (until the election of Mauricio Macri), the IMF had repeatedly asked the Argentine government to implement reliable and consistent statistical methods for measuring inflation. While the inflation figures put forward by previous governments were around 10% for many years, there was a second set of inflation statistics, which showed a figure closer to 40% (this set of statistics was used and compiled by the opposition in Congress). The surge in inflation coinciding with Mr. Macri’s arrival in power corresponds to the revision of the statistical series by the national statistics department (INDEC) starting in 2016.
Historically, Argentina’s hyperinflation can be explained in large part by the lack of independence of the central bank, which has been financing public deficits for many years through money creation. This phenomenon was obviously accentuated following the debt default in the early 2000s, which was followed by the inability to obtain financing on the financial markets. The current government has merely shifted the problem, no longer financing the deficit through simple money creation, but through the issuance of foreign currency (dollar) debt, causing a double acceleration of inflation due to the maintenance of the public deficit and the phenomenon of imported inflation caused by the almost constant depreciation of the peso.
Normalization of Argentina’s economic and financial situation will inevitably require a reduction in public spending and a stricter definition of the role of the central bank, leading to greater independence for the institution.
Conclusion
The Macri government has kept its promise to change course from the previous government. Negotiations with vulture funds, the end of exchange controls, and statistical transparency have been major differentiating factors. Nevertheless, this has not been enough to bring about a real recovery in the country’s economic activity, as evidenced by the ups and downs of GDP. In addition to the 2018 currency crisis, the scale of which completely overwhelmed the government, inflationary issues remain a major challenge for the Argentine economy. This historic inflationary spiral, which can be explained by ever-increasing public spending and its financing through money creation (by the Central Bank), will be a key concern for the next president.
Sources:
https://www.lanacion.com.ar/politica/mapa-resultados-elecciones-paso-2019-nid2274716#/presidente
https://www.argentina.gob.ar/justiciacerca/VotoenlasPASO
https://www.indec.gob.ar/uploads/informesdeprensa/ipi_manufacturero_10_19E7BDE8298E.pdf
https://oec.world/en/profile/country/arg/
https://www.indec.gob.ar/uploads/informesdeprensa/ipc_09_19181A16C44F.pdf
https://www.indec.gob.ar/uploads/informesdeprensa/bal_06_198DB4469606.pdf
[1]Annualized quarterly growth rate.
[2]Each political party may have several candidates. However, all political parties are required to hold open primaries (in which all citizens, including non-members, can vote) on the same day, which is set in advance by the electoral calendar.
[3]As of October 14, certain rating.
