It is about a year ago that we wrote a blog about Argentina’s economic prospects under president Mauricio Macri (refer to “Argentina 2.0”). We applauded the vigor with which the new government addressed a number of core issues, amongst them the hold-out debtors, floatation of the peso and reversal of export taxes on agricultural products. However, we also noted that turning around and reforming the economy would be a momentous task and that political capital could evaporate quickly as many people did not suffer from the devastating economic policies of Macri’s predecessor, Cristina Fernández de Kirchner (CFK), a Perónista, whereas the inevitable measures (e.g. abolish unsustainable subsidies on electricity and fuel and reduce unproductive government spending) to steer the economy away from the abyss, of course, would inflict pain on a large number of people. With Macri visiting our Kingdom (reigned by a sparkling Argentine queen, by the way), it seems an opportune moment to reflect on Argentina’s state of play.
Macri takes two to tango…
As expected, Argentina’s economy nosedived last year and contracted by 2.3%. The overdue depreciation of the peso in December of 2015 and the partial reduction of subsidies on electricity and fuel led to high inflation (30-35%) and choked consumer demand, whereas weak demand from Brazil and persistently low soybean prices dented exports. Unemployment increased to almost 9%, partly due to cuts in government headcount, reversing redundant jobs that CFK approved just before the presidential elections. Meanwhile, Macri’s popularity has dropped to (a still respectable) 40%. He is facing a somewhat hostile press, blaming him for his father’s business dealings, and militant trade unions, who threaten to strike unless unrealistic wage demands are allotted (especially the teachers union seems to be empty-headed). In October, legislative elections will be held, the outcome of which will determine the remainder of Macri’s first 4-year term. Important reforms, such as those to the tax system and pensions, most likely only will be presented after these elections have passed as many politicians are preoccupied with their own survival instead of that of their country.
Fortunately, the economy finally seems to turn the corner with GDP growth expected to reach 2-3% this year. Private investments are picking up after years of drought with interesting opportunities arising in agriculture, logistics, (shale) oil & gas and power generation. Another blessing is CFK’s continued presence in the political arena. Although she doesn’t know how to govern, she turns out to excel in dividing her party. Daily headlines about massive corruption that occurred under her watch (and by herself!) provides stark contrast and support for the relatively clean politicians of Cambiemos, Mr. Macri’s coalition. Although Cambiemos cannot win a majority, a good showing in the elections (meaning getting close to 40% of the votes) would secure the coalition’s negotiation power for the remainder of Macri’s term. Such a result may be more likely if and when CFK decides to run for Senate in the province of Buenos Aires as in that case Sergio Massa also will feel the urge to run to protect support from Perónismo, dividing the vote.
Macri’s government does not have much room for error as it needs to rein in inflation as well as reduce the fiscal deficit in order to uphold the credibility of its economic plan. Inflation may not recede if wage negotiations, that the government understandably wants to base on forward-looking inflation estimates, are not successful. The adopted policy of gradually unwinding subsidies, although sensible from a political point of view, is not helpful to manage inflation expectations as in people’s minds they are confronted with continuous price hikes and forget the big picture (gradualism, therefore, also dampens consumer demand). The central bank is targeting an upper limit of 17% by year-end but this may prove to be too ambitious (20% being more likely). On the fiscal front we are more optimistic. The target primary fiscal deficit for this year is 4.2%, which seems achievable as long as growth comes in at around 3% also thanks to revenues from a successful tax amnesty program that allowed the government to prepay some of this year’s expenditures. For 2018-2019 the aim is to reduce the deficit by 1% per year. The risk of not reaching the fiscal target, in our view, may materialize if growth undershoots, most likely because of external factors (another weak year for Brazil’s economy, collapse in commodity prices, Trump enacts global trade barriers, etc.).
Support in unexpected places…
We strongly believe that Macri’s team is implementing the right policies, which eventually will deliver sustainable economic growth. However, the Argentine people have to stomach short-term pain. In October, the Argentines need to show their support for long-term economic prosperity and a corruption-free society or risk falling back in the old ways of politics under Perónismo: it takes two to tango. As a small crowd on Dam Square chanted when Mr. Macri performed a ceremony there: Sí, se puede…*
* Yes, we can