The state is increasing its control of key sectors.
Cristina Fernandez's landslide victory is likely to be interpreted as mandate to deepen interventionist state policies.
On October 26, 2011, President Cristina Fernandez secured re-election with 53.8 percent of votes against 16.9 percent for her closest rival. This granted her a majority in Congress and the Senate, with the ruling Frente para La Victoria (FPV) and its allies winning 20 of 24 provinces. President Fernandez said the results vindicated her government's economic policies (these policies include negative real interest rates, a weak currency, high public spending, price controls, import constraints, stringent regulation targeted at the private sector and export taxes). The Socialist Party came second in the election and is likely to support more public spending and increased regulation of private business activities. The most pro-business groups, such as the UCR, will struggle to be heard given their poor electoral results and internal rifts.
Highly favourable domestic and global conditions explain the successes of the 'Argentina model', but these conditions are deteriorating.
Since the debt default in 2002, Argentina has averaged 8.2 percent p.a. GDP growth, with declining unemployment and a significant reduction in poverty. Default reduced the debt burden from 160 percent of GDP to 49 percent currently, greatly easing fiscal pressure. Sharp peso devaluation meant manufacturers saw a big drop in their real wage bills. Allied to a freeze in gas and electricity tariffs, this produced a surge in manufacturing companies' profits, investment and exports. Alongside this, the prices of soy and corn, two key exports, hit record levels. The net effect was to push the current account and government budget, two key drivers of default in 2002, into surplus. Added to the above the government engineered a consumer spending boom with a stimulative monetary policy (including an artificially weak peso via Central Bank intervention) and strong growth in public spending.
Cracks in the Model
Argentina's measure of inflation has become highly politically charged since 2007 following the sacking of the head of INDEC, the statistics national agency, and claims that the authorities took control of the agency to massage inflation figures. Indeed, according to official data, inflation in Argentina is about 9-10 percent, while independent economists put it at about 26 percent. In any event, workers are ignoring official inflation figures and typically demanding wage increases of more than 25 percent, which they usually get, with producers passing the costs onto the consumer.
(ii) The government's budget
The fiscal accounts are no longer in surplus; this year the deficit will be around 0.5 percent of GDP and this is expected to widen to 3.5 percent in 2012. A particular area of concern is that of subsidies for gas, electricity and transport, which together account for 4 percent of GDP. There are few indications the government is considering phasing them out. If weaker external demand in 2012 leads to lower prices of soft commodities, this would severely dent tax revenue. Between 2002 and 2010 export tax revenues from grain amounted to $30 billion ($8.2 billion in 2010 alone).
(iii) External balance and capital flight
The trade surplus is now contracting, with import growth exceeding a still robust export performance (about 90 percent of the growth in Argentina's exports in 2010 went to China and Brazil). In the first half of 2011, the current account recorded a small deficit for the first time since 2002. A drop in the price of soft commodity exports, or a sudden slowdown in China, could quickly pose a significant threat to the current account. Ominously, this has been accompanied by an acceleration of capital flight. Argentinians, alarmed by inflation and what this means for the currency, are expected to take about $20 billion out of the country in 2011, nearly double what they took in 2010.
Capital controls are being tightened, with the greatest impact on mining firms.
Larger than expected capital flight is threatening a faster peso depreciation than the government wants given inflationary pressures. The Central Bank has now spent $6 billion of its reserves (they stood at $47 billion in October 2011) slowing the rate of this depreciation and on October 26the government introduced a decree on capital controls. Unless the government introduces exceptions to the decree, mining, energy and insurance companies operating in Argentina must now repatriate their export revenues and sell the dollars to the Central Bank. They will then have to buy the dollars back with pesos to send profits abroad or make other foreign payments. The measures are likely to be more disruptive for mining firms than oil and gas companies which mainly supply the domestic market (energy companies already had to convert 30 percent of their dollar earnings into pesos). The cost for mining firms is estimated at between 2 percent and 5 percent of mining exports.
Mining in Argentina is governed by the Mining Investment Law (MIL), which grants fiscal stability for 30 years including the right to repatriate profits. Speaking anonymously, mining firms have described the decree as a new 'royalty' in disguise that breaches the MIL (they were already expecting royalty and tax increases following the election). Barrick Gold, Argentina's main gold producer, said that the decree will not affect its scheduled investments, but noted that Veladero and Pascua Lama, its two largest projects, have fiscal stability agreements which must be respected. Goldcorp, Xstrata and Anglogold Ashanti are yet to make meaningful public announcements.
In the decree insurance companies were given 50 days to repatriate $1.9 billion held abroad. Controls were also tightened on individuals purchasing dollars (must provide evidence of the source of the funds used and detailed personal information). The new decree states that failure to meet its requirements will result in heavy fines and possible prison sentences.
Protectionism is likely to increase as external balances deteriorate.
The government is expected to make greater use of the so-called 'balanced trade mechanism' adopted in 2008, whereby companies either match imports with exports, invest in local production or agree to withhold remittances to parent companies abroad. This policy, widely known as the 1:1 formula, is based on the introduction of mandatory non-automatic licences (LNAs) for specific imports, which is allowed by the WTO.
Delays in granting LNAs have led to vast build-ups of supplies being retained at customs. To avoid this, several leading auto importers have been forced to agree to 1:1 deals to sell imported brands (20 out 29 brands are now under the scheme). Carmakers have had to export products other than those they import. For example, German firm Porsche has committed itself to exporting wine and olive oil, Italian firm Alfa Romeo to exporting biodiesel, and Chinese firm Chery to exporting pomegranates. About 90 percent of leading brands of Brazilian footwear, which had come to dominate the Argentine market, are now producing locally.
These export constraints are likely to be expanded on the grounds of protecting local production. The adverse policy implications will probably be: more supply delays; lower productivity as firms are forced into non-core activities; higher bribery and corruption involving custom officials; and retaliation by key trade partners such as Brazil and China.
Outright nationalization is unlikely but the state is increasing its control of key sectors, most notably energy.
Following the nationalization of private pension funds in 2008, the government now has a sizeable shareholding in 32 companies spanning the energy, telecommunications and banking sectors. In many of these it now has the right to a quarter or more of the seats on the board. This leaves the government in a strong position to influence company policy, and thus far there is little suggestion of the government nationalizing them.
On the energy front, Argentina has an enormous potential for gas with recent huge discoveries, particularly of unconventional gas, attracting great foreign investor attention. However, a freeze in gas and electricity tariffs has now been in place for eight years (bar a modest increase two years ago), and the authorities are likely to continue resisting any moves towards price liberalisation. This is a major deterrent to foreign investors, in addition to the recent introduction of capital controls.
People close to Cristina Fernandez are talking about the strategic importance of the government being in the driving seat of YPF-Repsol, the country's largest oil company. Spain's Repsol still owns 57.4 percent of the company, but has been reducing its stake under pressure from the Argentine government, in favor of investing in countries with better commercial prospects. The Petersen Group, controlled by the Eskenazi family, now has a 25.5 percent holding and there is a 17.1 percent free float.
The government is likely to target specific groups with forced asset sales or tax arrears payments.
Grupo Clarin, the largest media group in Latin America, has become one of the harshest critics of the government. It is likely to be targeted via a new media law, with Clarin forced to divest many of its holdings in telecoms and TV media in the name of improving the competitive environment.
The government is also likely to put pressure on private groups to contribute more to government funds with tax reviews followed by public announcements designed to make headlines. Companies such as ADM, Cargill and Bunge have already being presented with demands for tax arrears. (Bunge was alleged to have set up an office in the tax free zone of Montevideo to reroute trade, though the export association described this as political posturing by the government).
Sovereign non-payment risk is likely to increase.
Exports are still performing well and capital controls will probably provide a temporary respite for the currency. However, the fact that the government resorted to capital controls as soon as foreign exchange reserves began to fall has seriously damaging its credibility, most obviously with foreign direct investors. The government is likely to use its foreign reserves again in 2012 to pay its obligations, but with reserves now on a declining trend, this option looks increasingly risky.
Negotiations with the Paris Club to settle the outstanding $6.3 billion plus interest of defaulted debt appear to be going nowhere. And heightened risk aversion means the country will struggle to attract investor interest. In early 2011, dollar denominated bond yields fell to 8 percent but the authorities declined to issue, and they have since risen above 10 percent, a rate at which the government has long said it will not consider issuing bonds.
The risk of another default is not immediate, but the country has become more vulnerable to sudden changes for the worse in the global economy, most notably a sharp drop in the prices or volumes of its commodity exports.
This commentary was provided by specialist intelligence company Exclusive Analysis.