The new government of Mauricio Macri in Argentina had a flying start. After its inauguration in December of last year, the peso was allowed to float freely and FX controls were lifted (resulting in a 30% depreciation of the peso). Overnight, the country became more competitive, although more adjustment is needed in our view. Export taxes on agricultural products were scrapped (with the exception of the all-important soybeans, for which taxes were reduced by 5%), which resulted in farmers releasing inventories, providing the country with much-needed dollars. With the tax distortion largely out of the way, Argentina’s farmers are planting wheat again. The biggest achievement, however, was the government’s deal with holdout creditors. On February 29th, Argentina reached a deal with Elliott and other hedge funds to settle unrestructured sovereign debt for an amount of USD 4.65 billion (25% less than Elliot’s claim). For background, please refer to our earlier blog “Don’t Cry for the Holdouts”. Lawmakers in the lower house of Congress passed a bill (effectively repealing two laws, the padlock law and sovereign payment law, established by Macri’s predecessor Cristina Fernandez de Kirchner, that would prevent paying the holdouts). We expect the Senate to follow through in the coming days as without a deal being approved their provinces will run out of money.

Without belittling the importance of the measures described above, actually this was the easy part. Argentina now has to start to turn around and reform its economy. First of all, the fiscal deficit has to be brought under control. The budget balance for 2015 is estimated at approximately -7% (excluding BCRA profit transfers), down from -4.3% in 2014 and an average of -1.9% in the five years before that. The government targets a deficit of -4.8% for 2016, which seems feasible and not overly ambitious. The government politically has to follow a gradual path. Even though CFK’s legacy is that of a country on the verge of a balance of payment crisis with its reserve coffers emptied, many people on the streets so far have not experienced the devastating economic policies of CFK and only now will be confronted with the impact of these policies in their wallets. Public debt as a percentage of GDP inevitably will rise further before the fiscal tightening has been completed, of course, also because debt will have to be issued to pay the holdouts (about USD 11 billion in total). Public debt as of the end of 2015 stands at about 40% of GDP, of which about one-third is external debt (USD 80 billion). Citigroup expects public debt to rise to 50% by the end of this year.

Inflation has been running at 30% due to the monetization of government debts over the last couple of years. The BCRA aims for an inflation target of 20-25% for 2016. This seems optimistic given the knock-on of the depreciation of the peso against the dollar in terms of prices of imported goods and the required elimination of subsidies on electricity prices (it only costs 125 pesos per month to keep the author’s collection of malbecs nice and cool), amongst others. Also, the indexation of wages to inflation that crept into the system needs to be addressed. The BCRA may need to hike rates to contain inflation and keep real rates positive. Obviously, this will depress already weak domestic demand.

The main challenge is to instill economic growth. In normal times, a currency depreciation should help the country to reinvigorate exports. But Argentina’s most important trading partner, Brazil, is in dire straits (negative for the important automotive sector) and the country’s manufacturing base has weakened over the years due to underinvestment. Agricultural exports, accounting for 60% of total exports, could disappoint due to weather-related issues. Hopes are that foreigners will resume investments into the country after a drought of more than 15 years. We already see some interest in the livestock segment (Minerva, Brasil Foods) but investment flows are still tiny. We believe that the government should liberalize foreign ownership of land as agriculture remains the bright spot in Argentina. Another important area is shale oil and gas but depressed oil prices might deter foreign oil companies to make large commitments (although in Argentina the oil price is a generous USD 60 today, but, of course, this has to change as well). The government aims for economic growth of 1% this year. This probably is too optimistic as domestic demand is cooling and foreign investors will take longer to make commitments to the country. A small contraction this year is more likely but 2017 could be much better (3 to 4% growth).

Argentina for the first time in ages has a very competent, top-notch government that finally could deliver the goodies. However, 2016 will be a decisive year and Macri needs to get the political buy-in from a divided Congress, as his Cambiemos coalition does not have a majority, to turn the economy around, whereas trade unions are already taking to the streets to protest against the new economic policies. It may be helpful to expose the massive corruption under CFK’s regime to remind voters what they are in for if they revert to the old ways of politics in Argentina.