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Argentina: Waiting for Revenge

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No one knows how and when the Kirchners will strike, but retribution is inevitable. Investors are wary.

BY WALTER T. MOLANO

The brutal standoff with the agriculture sector ended badly for the Kirchners. The opposition snatched victory from the jaws of defeat, thanks to Vice President Julio Cobos, who broke the tie and voted against the measures. Although cabinet ministers and labor leaders were camped outside the congress, ready to celebrate, Vice President Cabos, with a quavering voice and shaking hand, cast the decisive vote at 2 am. There were joyous celebrations in the streets of Buenos Aires, but few people realized that Argentina was on the brink of institutional breakdown. President Kirchner, abetted by her husband, considered tendering her resignation, which would have plunged the country into chaos. The couple rescinded their decision at the final hour.

KIRCHNERS REVENGE

However, investors were wary of being overly optimistic. The Kirchners will not accept defeat calmly. Unfortunately, no one knows how and when they will strike, but retribution is inevitable. 

The Kirchners were noticeably silent after their defeat, retreating to their estate in the Province of Santa Cruz. Cristina’s reputation was sullied, but Nestor was the one who suffered the most. After gaining control of the Peronists, he now finds his party divided. Eleven senators defected during the showdown. Governors from the most important provinces were in open opposition, and rivals, such as Duhalde, Schiaretti and Scioli, threatened his leadership of the party.

It is clear that Nestor must regroup and develop a new strategy. In the meantime, Cristina will employ a more consensual approach. Nevertheless, she needs to find new sources of income. Government expenses are soaring, rising at a pace of 40 percent y/y—thanks to the soaring inflation rate. Fuel subsidies, higher wages and infrastructure costs are digging into the fiscal accounts. Unfortunately, revenues are increasing at a more moderate pace of 30 percent y/y. Hence, the government is being left short.

The Ministry of the Economy recently pruned transfers to the provinces. Not surprisingly, Mendoza and Buenos Aires suffered the most, given that their governors were in open opposition to the export tariffs. Local analysts believe that the central government’s primary surplus dropped to 3.1 percent of GDP during the first half of the year, and it could fall to 2 percent of GDP by year end. With very little access to the international capital markets, Argentina has no other choice but to adjust expenses.

OVERHAUL TAX SYSTEM

Therefore, the government needs to respond. Instead of penalizing a single sector, the government should overhaul the tax system in order to take advantage of the windfall that is boosting the economy.

Yet, the Kirchners will be out for revenge, and there is a good chance that a stronger currency may be the measure that best fits their needs. An appreciation of the peso would help stabilize consumer prices, thus reducing expenditures. At the same time, a stronger peso would squeeze profit margins for agro exporters—thus penalizing them for their petulance. This could make peso-denominated instruments some of the most of attractive assets in Argentina.

STRONG FUNDAMENTALS

Fortunately, the end of the agro-crisis allows us to refocus our attention on the country’s fundamentals. As one of the biggest grain producers in the world, Argentina is well positioned to take advantage of the trends that are transforming the global economy. This is the reason why industrial production remained strong, expanding 6.9 percent  y/y in May. Even with a GDP growth rate of only 7 percent y/y in 2008, the warrants should pay out 3.17 at the end of next year. This means that the accumulated payout for the next 17 months will be 5.48—versus a current price of 9.75.

The problem is that investors will be reticent about jumping too fast onto the Argentine bandwagon. The Kirchners are out for vengeance, and they will take their time playing their hand. Therefore, don’t be surprised by the market’s lethargic reaction to the good news. We can’t forget that revenge is a dish best served cold.  

Walter Molano is head of research at BCP Securities.  

 

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