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A Storm Awaits Kirchner’s Successor

By: Iván Cachanosky - @ivancachanosky - May 12, 2015, 8:19 am
Hugely elevated inflation is one of the worst consequences of the administration of Argentinean President Cristina Kirchner.
Hugely elevated inflation is one of the worst consequences of the Kirchner administration. (El País)

EspañolAt the end of this year, a new president will take power in Argentina. The principal candidates are Daniel Scioli (FPV), Mauricio Macri (PRO), and Sergio Massa (FR). What picture will face the incoming government? What’s the legacy of 12 years of Kirchnerist rule? This article will lay out of the principle economic elements of the Kirchner inheritance.

In general terms, we can focus on an economy in recession; a growing fiscal deficit; massively elevated inflation; government controls shoring up a feeble exchange rate; and the ongoing affair with the holdouts. Regardless of who wins in December, they will have to confront these issues. Of course, there are many other things to consider — education, the energy crisis, poverty, public transport fares, and so on — but here we’ll confine ourselves to economics.

Economy in Recession

Last year closed with annual fall of 2.5 percent in levels of economic activity. Much of the same is yet to come, given that the first quarter of 2015 alone has seen a 2.3 percent fall in annual terms. Declining respect for state institutions and growing corruption have served to scare off much of the investment that could have encouraged progress in Argentina. The Freedom and Progress Foundation‘s latest Institutional Quality Index has Argentina falling 44 places in recent years, the worst decline registered by any nation, from 93rd position in 2007 to 137th in 2015.

This deterioration in institutions is one of the principal explanations as to why Argentina entered into recession, when every other country in the region (with the exception of Venezuela) continues to grow. Moreover, through their predilection for controlling the economy, successive Kirchnerist administrations have managed to damage various industries.

Among the sectors most at risk is the automotive industry, which shrank by 24.2 percent in 2014 in comparison to the previous year, and contracted by a further 16.2 percent in the first quarter of 2015. It’s also worth highlighting the continued suffering of the property sector, which began a sharp plunge two months after the installation of exchange controls in October 2011.

It’s no coincidence that Argentina’s Monthly Industrial Estimator (EMI) has registered 20 consecutive months of collapse, chiefly because of the crisis in the automotive sector. The government, of course, is trying to pin the blame on business leaders, instead of seeing it as a wake-up call.

Fiscal Deficit

The growing fiscal deficit is perhaps the most alarming problem. In 2014, the deficit almost reached 6 percent of GDP, and private estimates suggest that it could reach 6.5 percent this year. These figures stand despite the “fiscal makeup” which the government applies liberally, trying to claim inputs from the Central Bank (BCRA), Social Security Administration (Anses) and health insurance body PAMI as sources of income. This deficit is striking, even with the makeup applied.

Public spending has increased hugely in the last decade. When Néstor Kirchner assumed the presidency in 2003, government spending was around 30 percent of gross domestic product. Nowadays, the same is estimated to lie around 46 percent of GDP. The increase is accounted for principally by subsidies to companies, retirement payments, ever-rising public employment, and social spending.

The sources of this financing are increasingly exhausted. The tax burden is at its highest levels for some decades, as shown by an infographic created by the Freedom and Progress Foundation.

Meanwhile, monetary expansion is hardly the best option, given that annual inflation is around 34 percent, and printing still more money could send prices even higher, the reason why monetary debt (in LEBAC and NOBAC bonds) has increased so violently. Of course, those responsible for elevated prices, according to the government, are once more the “malevolent businessmen” who dedicate their every effort to increasing prices.

As if this weren’t enough, commodity price futures aren’t encouraging, increasingly losing the government’s competitive advantage. If, moreover, the United States begins to increase interest rates, Argentina’s tailwind will decrease still further, as commodity prices are increased in part by financial speculation.

The Clamp on Imports

Due to Argentina’s disastrous economic policy for attracting investment, currency reserves began to dry up in the second presidency of Cristina Kirchner. Today, they’ve picked up slightly, due more to a currency swap with China than a genuine increased supply of dollars. When reserves began to fall in 2011, the government installed a “clamp” on imports via tariffs. The strategy failed to produce results as reserves continued to evaporate, with the swap proving the only way to register an increase.

However, the worst aspect about installing the clamp is that, by limiting imports, we’re limiting exports: Argentina needs to import goods to be able to produce its products and then export them. The only thing that the clamp has achieved is to sabotage both imports and exports, without halting the flight of reserves.

With regard to exchange rates, the parallel dollar remains at a healthy rate due to the government’s policy of offering “dollar savings.” However, this is costing the government reserves. The numbers needed to anchor the parallel dollar for now are shored up by the currency trade with China. However, if a currency devaluation takes place in anticipation of a change of government, this situation, which depends upon the confidence enjoyed by the next president, will be difficult to maintain.

If the new government decides to clean up institutions (make National Statistics Institute INDEC more honest and transparent, reduce subsidies to agriculture, eliminate the imports clamp, and inspire confidence), it’s feasible that new dollars will be attracted for investment due to a global excess of liquidity. Depending on the quantity of dollars that enter, the parallel dollar could increase (if a few enter) or even decrease (if lots enter). The behavior of the blue dollar will depend upon how many dollars enter the country, which in turn will rest upon the confidence generated by the next president among his citizens and the world.

Holding Out for a Hero

With the rights upon future offers (RUFO) clause having come to an end, the dilemma with the holdout hedge funds ought to be resolved with a similar method used to pay Repsol-YPF: that is, with the greatest quantity possible in bonds. Leaving the issue of whether the holdouts acted ethically or otherwise to one side, what’s relevant is that for Argentina the cost of paying the debt is much less than remaining in default.

Kirchner can avoid using the word default, but she can’t avoid its consequences. This can clearly be observed with the latest bonds issued by Economy Minister Axel Kicillof, which obtained around US$3 billion. However, interest rates are at 9 percent, while neighboring countries pay far less: Paraguay pays for its commitments at 4.5 percent, and Chile at 3.0 percent.

Reaching a long-term payment plan with the holdouts will allow the world to trust again in Argentina, and in this way investment from various countries will return, avoiding dependence almost exclusively on China. It’s not that investment from China is bad per se, but everyone knows that spreading risk is always a wise move.

The short-term picture is not the most encouraging, but Argentina has the huge advantage of excess global liquidity at the moment. If the next government can generate confidence, part of this readily available money will flock to Argentina in the form of investment. However, this will require correcting the poor decisions taken in recent years. It could be that Argentina makes its peace with the market and receives overseas investment once more, thus generating national employment and reducing poverty.

Translated by Laurie Blair.

Iván Cachanosky Iván Cachanosky

Iván Cachanosky holds a bachelor's degree in business administration and a master's degree in applied economics. He's currently an instructor at CMT-Group. Follow him on Twitter at @ivancachanosky.