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Ten years on from its debt default, the Argentine economy is booming: since 2001, GDP has grown by 79.5%, and the government forecasts further growth of 8.2% in 2011. But some are wondering whether this stellar growth seen in Argentina, and in other dynamic emerging economies, is sustainable.
The Economist recently published a study rating all countries on a number of criteria – including inflation, unemployment, GDP growth, excess credit, real interest rates and forecast change in current account balance – to test for signs of overheating. Argentina received a score of 100%, putting the country top of the list, and above other ‘high-risk’ nations such as Indonesia, Vietnam and Egypt. Are the good times coming to an end?
Argentina’s decade of strong growth is mainly due to two factors. Firstly, the resource-based economy has benefited hugely from high commodity prices – especially in agriculture, where Argentina is among the most developed in the world, and has taken advantage of soya prices tripling since 2002. The country is now the world’s largest exporter of soybean oil, and the third largest exporter of soya beans.
Secondly, it has been helped by the growing economies of its two main export partners: China and Brazil. China is the destination for 90% of the Argentine soya crop, and is set to invest US$1.5bn in agricultural sector infrastructure in Argentina over the next ten years. Brazilian growth, meanwhile, has underpinned demand for Argentine cars and manufactured goods.
Export growth has been critical to Argentina and years of trade surplus (US$11.4bn in the 12 months ending March 2011) have allowed the country to accrue substantial cash reserves. This, combined with its current isolation from global debt markets, helped to shield it from the 2008 financial crisis (GDP growth only slowed to 0.8% in 2009 and sharply recovered to 9.2% in 2010).
Revenues from export taxes have also enabled the government to increase its spending on social and welfare programmes. Government spending (as a percentage of GDP) has risen by 6.9% in the last three years.
Subsidies, for example, are an integral part of government policy and are implemented in the energy, transport, rural, agriculture and some industrial sectors. According to ASAP, a government spending watchdog, subsidies during the first half of 2011 totalled $32.4bn – a 73% increase on the same period in 2010. Some 59.5% of this is spent on energy – specifically gas, diesel and electricity – which is expensively sourced from Bolivia, Qatar and, most recently, from Uruguay – creating an imbalance.
Cracks in the Model
As with any economic model, however, there are problems.
Much discredited government figures state an average inflation rate 8.6% over the past four years, whereas a consensus of private think-tank opinions suggest an average rate of 22.2%.
But the government denies inflation is a issue, claiming it is a media phenomenon whilst focusing on maintaining the high growth rate.
Herwin Loman, a South America economist from Rabobank, suggests the government may actually benefit from the current situation: “by having high inflation, and underreporting the inflation rate at the same time, the government can decrease the amount in real terms it has to pay on bonds on which the interest rate is linked to the (official) inflation rate.”
It is also estimated the government raised US$6bn through inflation in 2010 – essentially a cheap form of financing.
But the social effects of this policy are alarming. According to Bret Rosen of Standard Chartered: “It essentially acts as a tax on the lower income classes as well as informal sector that can not necessarily secure wage increases in the same way that organised labour can.” It also encourages consumption rather than saving, harms access to credit, and does little to encourage investment.
The peso exchange rate is also affected. Although it has devalued against the US dollar by 5.0% in the last 12 months, Loman explains that “the high inflation coupled with a moderate fall of the peso have resulted in the erosion of the competitiveness that the economy gained when the currency board was ended almost ten years ago.” Taking this into account, the ‘real’ value of the peso has increased, making imports cheaper for Argentines and thus reducing the trade surplus.
Indeed, the trade surplus is estimated to decline 29.8% in 2011 to US$8bn. With less money flowing into the country and access to foreign debt hindered since the 2001 default, there are growing concerns the government will not be able to maintain its spending without causing inflation to spiral upwards.
Protecting the Model
“The economy is overheating right now,” says Loman, “9% growth is unsustainable, even as the official figures are likely to overstate growth. Before, rapid growth was primarily driven by foreign demand, right now it is more and more driven by domestic demand. As a result you see high inflation and a deterioration of the trade balance…as the current policy mix is unsustainable, a hard landing (but probably not a 2001 style crisis) seems more and more likely.”
Loman suggests major changes are required: “Policies need to become predictable and transparent. Erratic policies and the high inflation rate make it risky for businesses to invest. And the low quality of government institutions is a problem. The structure of spending also needs to be addressed—the government has rapidly increased wages and subsidies, instead of improving Argentina’s infrastructure, education and health.”
However, policies that have been introduced so far aim to ensure the longer term maintenance of the trade surplus, and therefore the status quo.
For example, a policy introduced earlier this year requires car manufacturers to export goods equal (or higher) in value to the value of goods the company imports. This is contradictory to the rules of regional trade bloc Mercusor, and the policy attracted serious rebuttal from Brazil. At one point, it was reported that 40,000 cars were held by customs at the border for days before they were allowed into the country.
And, while the government claims this $1:$1 policy will increase the trade balance in the sector by $4bn in 2012, companies seem to be taking obscure routes to meet the requirements that ultimately defeat its aim. Car companies make agreements with soya, wine or biodiesel companies to export their raw product through the car company’s books, and thus plug their trade deficit gap.
Claudio Loser, an Argentine who was managing director of Western Hemisphere Department at the IMF from 1994 to 2002, wrote last month: “[Argentina has] introduced 110 restrictive measures since 2009, affecting 174 countries, more than any other country.”
Another measure, import substitution – replacing an imported good with a domestically-produced version – has been in place on a small scale for years and was extended in July to approximately 4,000 finished goods, ranging from electronics to furniture.
President Fernández de Kirchner rebuffs criticism of these measures. She said in February: “In no country in the world is the free market applied in the way they teach us in the central countries.” She views these measures as defending the economy rather than protectionism.
Overheating and Sustainability
The president’s response to warnings of overheating is also clear. In July she commented: “It is not a matter of cooling the economy, it is of reheating investment.” But recent data suggest this will be no easy task.
According to the central bank, $9.8bn in the first half of 2011 has been sent overseas compared to $11.4bn during the whole of 2010, claiming that “it reflects the usual behaviour of the private sector during pre-election times”. However, data from UN’s Economic Commission for Latin America and the Caribbean suggests that the situation is more serious: while US$26bn has been invested in Argentina from abroad since 2007, over US$60bn has been lost due to capital flight.
Moreover, heavy government subsidising of energy removes both the incentive for domestic investment in the sector and also the reason for consumers to reduce consumption. Long term underinvestment in the domestic energy sector will, according to the Financial Times, turn a 2006 energy positive trade balance of $5.6bn into deficit of $3bn by the end of 2011.
High levels of unpredictable government intervention – through subsidies, regulation, high inflation and foreign trade tariffs – reduces Argentina’s attractiveness as a place to conduct business.
Despite these problems, Marc Weisbrot, of the Center for Economic and Policy Research in Washington, does not foresee another crisis on the horizon. “No economic model lasts forever. The biggest problem Argentina faces is that its inflation is higher than that of its trading partners, so the currency begins to appreciate in real terms…but Argentina’s not sitting on the edge of a precipice.”
The Argentine economy immediately prior to the 2001 default – where the peso was drastically overvalued due to its peg with the US dollar, was in the midst of a recession, and was forced to borrow at increasing interest rates to support its huge foreign debt burden – is very different from today’s.
Unlike mainstream commentators, Weisbrot does not view current growth as unsustainable. “Argentina is not running into large trade imbalances and currently has a strong buffer against a global downturn. And a crash in the price of soya is not going to sink the economy…the economy is sustainable over the long term as long as inflation is reduced.”
And, indeed, there are other avenues to increase investment in the country. Weisbrot suggests “settling with the Paris Club [on US$7.5bn of outstanding debt] would help open up some export markets and probably increase foreign direct investment.” Economy minister, and now the president’s candidate for vice president, Amado Boudou has pledged to find an agreement by the end of 2011.
Local think-tanks also suggest access to foreign bond markets could help ease inflation.
The appointment of an ex-economics minister as presidential running mate suggests economic policy will play a major post-election role should Fernández de Kirchner win in October, as current polls suggest she will.
To make clear the country is not preoccupied with external criticism of their policies, the president’s comments this weekend (“In a world which appears to be collapsing into universal default, our debt-to-GDP ratio puts us among the top countries”) are echoed by Mercedes Marcó del Pont, the Argentine central bank chief.
“Conventional wisdom has failed,” she says. “Let’s learn from what happened in lots of developing countries, like Argentina, which did things that absolutely flew in the face of conventional wisdom and that have turned out very well for us.”
Whatever new measures are implemented, Loman says they must be enacted quickly to be successful: “Now is the time for reform because the economy is growing strongly.”
Difficult decisions are currently being made in Europe and the US in response to debt problems. Argentina now appears to be well-placed to make big decisions to sustain its growth.