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Argentina - Macroeconomic issues

Page history last edited by Brian D Butler 11 years, 7 months ago





Macroeconomic issues

The devaluation and the debt moratorium (2001-2002) helped turn the corner on the country's worst economic and political crisis of modern times.
Since 2003, spurred by rising exports and business profits, the country has grown at an average annual rate of almost 9 percent, although no one would say Argentina has completely recovered.  Argentina still needs to improve economic management through tighter fiscal and monetary policies, allow the currency to fluctuate more freely and improve its business climate.

2009 - potential crisis:

Problems:  Argentina currency needs to depreciate, but has been supported so as to not devalue (why not?).
Other issues:  commodities fell, and Argentina heavily reliant on revenue from exports (taxing exports)

Argentina’s economy, meanwhile, may shrink 0.9 percent this year after expanding 6.5 percent in 2008, according to the median estimate of eight economists surveyed by Bloomberg. The economy expanded more than 8 percent every year from 2003 to 2007.


“The peso has nowhere to go but down,” said Win Thin, a senior foreign-exchange strategist at Brown Brothers Harriman & Co. in New York. He predicts it will end the year as weak as 4 per dollar. “The central bank is trying to control the pace of weakness, but the pressures are unavoidable.”


source:  http://www.bloomberg.com/apps/news?pid=20601086&sid=aUNLwlQpjmdA&refer=latin_america


2008 - Farmers protest


Ms Fernández's problems began in March 2008 when she decreed a sliding scale of tax rates on Argentina's farm exports. The tax on soyabeans rose to 40% from 27% under Mr Kirchner. It would reach a marginal rate of 95% if the price of a tonne of soyabeans were to rise from $571 (its level on June 18th) to $600. With inflation already eroding their profits, farmers' patience snapped. They staged protests across the country and halted grain sales.


Good things happening in Argentina

In General
Poverty and inequality is much lower there in most of Latin coutries. Illiteracy rates are among the lowest of all countries in Latin America. In Argentina people are extremely politicized, and for latin american standards, there is a great educational system
Economic growth
For the past five years, Argentina has been growing not quite like China, but close. Everything indicates it will do it again this year. There are some folks out there who think that the reason this is happening is because Argentina is following the same model as China. They may be right.  Whether this is a good thing is another matter.  see our discussion:  Changes are happening in China
Future legislation 
The administration is currently trying to engineer lower borrowing rates for long-term investment projects (especially if they are export-oriented.) This is not wrong, but it arrives late.  The trouble is that thisshould have been the engine of growth instead of domestic consumption in the very recent past if the goal was long-term growth




Areas of concern:

Argentina has never really implemented the necessary structural policy changes since their collapse in 2001 and 2002 (see discussion below).  
While the global economy was booming in the mid 2000's, that was ok.  Commodity prices were climbing, and exports were easy.
But, what will happen if the US goes into recession, what happens to Argentina as a result of climbing inflation, rising cost of food, a global recession, or a commodity bubble bust?   None of these things have happened (yet), and many of them might not....but the key question to ask is:  is Argentina ready to withstand changes in the global environment? 
Probably not.



1.  Inflation (under-reporting):
Argentina cut $16 billion off its inflation-linked debt by underreporting its consumer price index during the past two years, Clarin said.

The government reported retail prices rose 16.3 percent during the past two years, while provincial statistics agencies estimated that prices rose 50 percent, the Buenos Aires-based newspaper said.


So far what the government is doing is clearly not going to control inflation. It does not anchor inflation expectation neither with its monetary policy, nor with its exchange rate policy or its fiscal policy. On the contrary, it looks more likely to make it get worse—inflation seems to be accelerating.  Also, Argentina’s “un-edited” (i.e. true) 2007 annual inflation rate is in the 20-25% range (despite what official numbers suggest). 
reason to combat inflation:  high inflation creates a dis-incentive to plan long-term projects (which are essential for long term growth).   Low inflation stimulates longer term investments, and better real rates of return on those projects.  Current investment in Argentina is mostly short-term projects as a result.  
High inflation also produces less fair income distribution because high inflation hurts poor people disproportionately more than rich people.  (food prices and energy prices are more important if those purchases are vital to survival). 
2.  Unions are demanding wage increases
This is more proof that actual inflation is higher than official inflation.   Even the governments official unions are demanding wage increases starting at 30% and up.    In addition, unions are requesting to renegotiate wages every 6 months, another indication that they are seeing basic food and energy price inflation (above official statistics).   The unions are probably observing a reduction in the purchasing power of wages (past and future.) Since any wage negotiation in the context of an inflationary process should be both backward- and forward-looking, this means that: (i) not even “official” unions believe in the massaged official inflation rate—they understand that the true inflation rate experienced by workers have been higher that the government’s figure; (ii) they anticipate a high inflation rate for this year (probably not lower than last years’; my “gut feeling” guess in the 35-40% range); and (iii) there are reasonable chances to expect the inflation rate to accelerate, which generates the need to have a sort of “escape of clause” to re-negotiate every six months. You do not need to be an economist to realize that a higher frequency of contract renewal is based on an expected increase in the rate of change of prices. Unions sit at the negotiation table trying to recover the lost purchasing power due to past inflation (the backward-looking component) and taking into account their expected inflation (the forward-looking component.) And like I said, the faster they expect inflation to increase, the sooner they would like to renegotiate
3.  Price controls & subsidies
Fear that price controls will not work (long term) in controlling inflation, and that they will have the negative effect of limiting investment (and shortages of services such as electricity and food)  .  The government would do better to follow Brazil's lead and target inflation with monetary policy rather than by price controls.  Eventually, they should let all relative prices be really free to adjust to equilibrate demand and supply (i.e. eliminate all the price controls and any type of capital controls).  The problem is that these industries that receive subsidies become very resistant to eventually removing the subsidies.    The result:  implying wrong incentives for individual’s consumption and firm’s investment decisions—while spending tax-payers money worthlessly
see our discussion on:  energy industry in Argentina

I think it was Ronald Reagan who once said something along the lines that when business does well, the government taxes it, when it keeps doing well despite the higher taxes, the government regulates it, and when it finally starts to sputter, the government subsidizes it. Nowhere is this truism more, well ... true, than in Argentina in the roaring 2000s.

4.  Taxing exports
Argentina’s fiscal revenues are in a substantial part based on export taxes.   But, it the US, Europe (or even China) were to go into recession, we have to assume that Argentina’s exports will decrease, and the fiscal balance is likely to deteriorate.  Most of this revenues come from export taxes as well as consumption (e.g. VAT),
Every time international prices go up, the government raises export taxes or, if this is not enough to keep domestic prices from rising, it flatly bans exports. Since the policy of taxing and banning exports is not based on any particular rule, but plainly on governmental discretion, there is no guarantee that when international prices go down export restrictions will be (symmetrically) reduced or lifted. More likely, the government will do its best to avoid a reduction in fiscal revenues implying that producer revenues will fall. The result is one in which there is no upside for investing in agriculture or agribusiness and plenty of downside: a sure way to kill the proverbial hen that lays the golden eggs.
5.  Artificially undervalued currency
Foreign exchange rate not floating freely.  This is artificially making the current account surplus seem ok.   Also, an artificially weak currncy is causing additional inflation by making imports more expensive.    Also, since the the central bank is not "inflation targeting"...so the currency does not respond to "natural" inputs (?).  letting the currency float freely would let an independent central bank focus on its only goal: to preserve the value of the (domestic) currency.  The trouble is that to fight inflation, they would need to raise interest rates, which would cut growth.  Also, raising interest rates might attract foreign capital, appreciating the currency (in the short term), and reducing export competitiveness. 
Like China, Argentina has been able to manipulate (albeit only for the past five or six years) the real exchange rate through a combination of sterilized FX intervention, capital controls, and massive subsidization of wage goods including foodstuffs (via export taxes and  moral suassion), transportation (via budgetary transfers to private sector providers), and energy and other utilities (via the freezing of tariffs).
But, unlike China, however, Argentina has:

     * a low saving ratio (less than 25% of GDP).;

     * binding supply constraints (due to a lack of investment in key sectors such as energy);

     * a tight labor supply (as formal workers are nearly fully employed); and

     * an inflationary history that renders capital and price controls quite ineffective

6.  Foreign reserves
the accumulation of reserves is mainly borrowed (and thus more unstable since as easy as they entered the country, they can leave it; and capital controls never work.)
7.  Commodity prices might fall
8.  Budget surplus seems inflated
One example:  the fiscal surplus is partly based on computing the flows of the future retirees that decided to switch to the state-based pension fund as current income. And the amounts of these monthly flows were somewhat arbitrarily decided to make the flow fiscal surplus look stronger than it really was. More importantly, these are only considered as (current) assets without taking into account the future liabilities that they generate—which are not trivial and increasing over time.   The current financial program includes borrowing from these accumulated funds of future retirees to finance current expenditures!
9.  Government spending too high
It could be much better if the government would focus on reducing government expenditures (not just reduce the rate of growth to be lower than the growth rate of tax revenues—which are just casually high do the unusually high commodities’ prices)
The budget surplus is mainly due to capital flows (portfolio money), and less on a structural trade surplus which would be a result of more exports than imports (this is inspite of the currency being undervalued as mentioned above)
11.  Provinces - adding a drain on the national budget
provincial fiscal imbalances. Many provinces—some of a relevant size in terms of GDP—show deteriorating fiscal balances; some are already running a substantial deficit. Since ultimately the federal government is a “payer-of-last-resort”, it would be worth paying attention to this point.


12.  Lingering problems from crisis of 2001-2002:
  • Wall Street and other investors have not forgotten Argentina's default and devaluation of the peso at the end of 2001 and beginning of 2002. That means Argentina will have to pay higher interest rates in international markets for some time in the future. 
  • Argentina paid of IMF so as to not be forced to make structural changes (which the IMF claimed were necessary to avert future crisis).  Most importantly, the IMF was demanding that Argentina change the relationship between the national government and the provinces.   Currently, the national government is responsible for all (unpayable) debts of the provinces.  So, the powerful local governors can blank check spend money, and the national government is obligated to step in to save them.  Brazil changed this law (after the last crisis in Brazil in the 1990's), but Argentina chose to postpone this necessary legislation. 
  • Venezuela (and Hugo Chavez) stepped in to lend money to Argentina (instead of the IMF).  But, what happens if oil prices fall?  Who will step into Venezuelas shoes?  For this reason, Argentina needs to work to fix their damaged reputation with international creditors.  Argentina's ability to access financial markets was assisted by Venezuela. which stepped in as the underwriter for almost $4 billion in bonds. The move, Venezuelan President Hugo Chávez declared, was aimed at helping Argentina free itself from the IMF. In the process, Venezuela used its dollars -- available from oil exports -- to purchase Argentine bonds and then turned around, like an investment bank, and sold them in the domestic market -- often to Venezuelan banks. The banks, in turn, sell the bonds, Bonos del Sur, to individual or institutional investors.  Sellers can even make money on the difference between the official and parallel exchange rates in Venezuela when they sell the bonds abroad in dollars.  So while Venezuela acts as lender of last resort, it also recoups its original investment.
  • For Argentina, despite the new credit and the rescheduling or repayment of nearly $100 billion of debt, problems with creditors linger.
  • The country must reschedule or repay its $6.3 billion defaulted debt with the Paris Club, an informal group of official creditors in industrialized nations. Doing so would allow Argentina to access new international credit.
  • But rescheduling debt with the Paris Club normally forces a country to sign up for an economic program with the International Monetary Fund. Such a move would be politically difficult for the government since the January 2006 repayment of $9.8 billion in IMF loans was considered a major victory for Argentina.
  • 2008 will be fine, but raising the money in 2009 might be more difficult.
  • ''That will force the government to tap the international markets,'' Krause told the conference. ''How are they going to do that?'' The difficulty, he said, is that the government is still distanced from regular international financing channels and might need more funds than the amount Venezuela is underwriting.
  • The country also faces pressure from holdouts from the 2005 restructuring of the defaulted international bonds. Many creditors complained the Kirchner government handed them a take-it-or-leave-it deal and balked at negotiations.
  • Holders of around $28 billion in bonds -- some original bond holders and others who acquired the debt on the secondary market -- are demanding the government negotiate a restructuring with better terms. 

On the surface:  todays "Trade Balance" seems ok,

but exports are being encouraged actively by a government policy to keep the currency undervalued.

Trade Balance                                                                                                                                   imports / exports


Courtesy www.latin-focus.com




Since the Cristina presidency began, there have been no moves away from the weak peso policy. Currency reserves keep ballooning under the present policy of bank intervention, now standing at U$47.3Bn and up another U$15.2Bn since January 2007. There comes a moment when a country has enough “rainy day” reserves and Argentina has long-since passed that point. Maybe they are considering starting a sovereign wealth fund to buy up cheap real estate in the US? Or maybe they are keeping the Peso low to attract an influx of Brazilian tourists to keep growth going?


Eventually the country will have to face reality and allow its currency to appreciate to stop growing consumer imports from fuelling the inflationary fire.


The alternative is that eventually George Soros or one of his acolytes will do the currency revaluation for them, and if that happened we confidently submit that the transition would not be as smooth as it might have been. One way or another, the free market has this nasty habit of eventually dictating true values.




Courtesy www.yahoo.com




comparison with Brazil


1.  FX exchange rate Policy 

Both Argentina and Brazil have enjoyed good growth in the last 5 years. Both have exports as key policies to support the good times. But one major difference is the monetary policies the two countries have adopted. Brazil has not been afraid to let its currency float relatively freely, and as a result the Real has appreciated significantly against all world currencies in the last 5 years. Argentina has taken a different approach. Using aggressive Central Bank intervention policies, it has maintained its currency at an artificially low level. The mantra in Argentina all this time has been, “The low exchange rate is good for us. It helps exports.” Well tell that to Brazil; they continue selling goods to the world without too much hassle from a rising currency. The result is fig. 3 below, which shows the forex rates of the Real versus the Argentine Peso.


2.  Inflation targeting vs. Price controls

Both Arg.and Brazil have been able to achieve a current account surplus....but, Brazil obtained it at the same time that its central bank was able to dominate the domestic  inflation rate (and with no observable drawbacks in terms of growth; on the contrary, but based on higher productivity instead.

3.  Borrowed reserves

Argentina borrowed money from Venezuela's president Hugo Chavez in order to pay off the IMF.   Brazil earned money from exports and used that money to pay off the IMF.  As a result, the situation in Argentina is not as good because they still owe money to Chavez, and because they didnt attempt the necessary reforms that the IMF was demanding.  

History  of past economic crisis'


 2001-2002 Crisis


What caused it to happen?

In response to runaway inflation of 200% per month ( 5000%) per year, Argentina passed the  "convertability law"  (using a currency board) that pegged the peso to the dollar at one-one exchange rate, and gave anyone the right to change pesos for dollars at any time they wanted....until 2001 /2002.  
this peg was credited with solving inflation, and for a decade of economic growth of 7% / year.


1.  Budget deficits
Internally the Argentinian government was spending too much, and taking in too little taxes.  This was largely caused by reckless spending by the governors of provinces, who knew that they would be bailed out by the national government.  A blank check by remote governors, with federal guarantees was a bad idea, and led to massive budget deficits
2.  A fixed exchange rate -
pegged 1:1 with the dollar made exports too expensive, and led to massive current account deficits.   The trouble was that in the 1990's , the US dollar appreciated (alot) and that made the Argentine currency also much more valuable in international markets...making exports un competitive.   The twin deficits was deadly (budget and current account)...which made it much more expensive to borrow money...
The trade deficit made it impossible for Argentina to earn foreign currency which was necessary to pay the interest on its foreign debt...
3.  Massive amounts of foreign debt
was required to finance the twin deficit.  But, once it becamae apparent that the twin deficits might become unsustainable, then foreigners fled the country, taking their money with them.   Foreign debt eventually reached 50% of GDP by late 2001
4.  Herd-mentality of foreign investors:
international bond markets were not as efficient in predicting a crisis in Argentina as they were supposed to. And everyone waited until the last minute, and exited en masse.

Results:  devaluation & default

In early 2002, when it became clear that Argentina could no longer borrow enough money to pay off their interest payments, they were forced to default, and devalue the currency. 
the devalued currency had the effect of:


1.  increasing export competitiveness


But also, 


2.  widespread bankruptcies  (of businesses that borrowed in dollars)

3.  banking crisis (as loans couldnt be repaid)

4.  unemployment

5.  painful effect of devaluation when debt denominated in dollars



Could it have been avoided?


why didnt the argentinian economists allow the peso to depreciate in value slowly over time?

because the peg was credited with "solving" inflation, and for a decade of economic growth


note:  inflation before the peg was 200% per month, or 5000% per year




Great theory, unfortunate events

But, even with a fixed exchange rate, it would have worked...as long as Argentinian productivity had improved faster than wages, permitting Argentine prices to fall in relation to foreigners. 
In the beginning, it did work...as low inflation and privatizations led to more competitiveness...The way the system was designed...it probably would have worked.
Long before the govt ran out of dollars, the interest rates were supposed to get so high that people would be encouraged to keep their investments in Pesos, and foreigners would be attracted and send money in.   Also, high interest rates would slow the economy, and wages and prices would fall (deflation) until Argentina was competitve again....and exports would pick up.   (THIS SOUNDS A BIT LIKE THE THEORY BEHIND THE "GOLD STANDARD" OF FIXED CURRENCIES).
But,  problems happened: 
1.  The government was unwilling to raise interest rates high enough.   Yes, it might have attracted capital, but it would also kill economic growth
2.  Wages and prices didnt decrease...they increased....there was a problem with rigid labor laws, and strong unions that limited future productivity gains.
3.  The government raised interest rates, killing growth, but wages did not fall.
4.  low private saving rates (reducing domestic pool investment, and increasing dependence on foreign capital).....(sounds a bit like US today)
5.  inability to control spending at provincial level
6.  widespread tax evasion.
7.  revenue sharing rules in constitution which sends money from federal government to provinces  (so federal tax revenues leads to more provincial spending).


Global macro economic events that effected Argentina

1.  The USD appreciated, pulling the peso up with it.
                *  vs the Japanese Yen after 1995
                *  vs currencies of SE Asia after 1997 (crisis of 1997 and 1998)
                *  vs european currencies in 1999 and 2000
2.  Commodities prices were low 
                * terms of trade = negative
3.  Brazilian currency devalued in 1999
                * making Argentinian exports to Brazil non-competitive, and flooding the Argentinian market with Brazilian imports

 Troubles with IMF support

1.  The IMF poured billions of dollars into Argentina (in attempt to avert a disaster), only to see it default, and then blame the IMF
2.   IMF "conditionality" programs were not effective in getting Argentina to change the budget problems (relations between federal and provincial tax system)
3.  Money from IMF just allowed Argentina to postpone making necessary changes (like giving a credit card)
4.  IMF believed too long that the "currency board" system would work
5.  IMF was too easy and ready to bail out Argentina because they adhered to policies that the IMF believed were good (liberalism,etc).
1.  fixed exchange rate doesnt work
(note in 2008, Argentina is once again with a fixed exchange rate, but this time keeping it artificially low....did they not learn this rule?   It seems like they instead learned the lesson that the problem was an exchange rate that was "too high"  and so they have set out to keep it low.   lets see if this attempt is any more successful.)
2.  borrowing massive amount of a foreign currency is risky
Thankfully, they seem to have learned this.  (with exception to borrowing from Venezuela).








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