Argentina is entering president Macri’s third year in office: it appears it will be in tune with the end of the previous year, with the economy growing at a rate of 3%, with somewhat lower inflation (close to 19%) and gradual reforms. Risks may grow in the second half of the year as the Federal Reserve tightens monetary policy which may lead to a correction in bond and equity markets. Historically, this policy change had a negative impact on emerging markets.
President Macri will continue its efforts in reforming the economy slowly but surely.
Being the first review of the year, we can make a quick assessment of the situation in Argentina. In its first two years, Macri’s government undoubtedly made some progress: he made a U-turn in foreign policy, seeking closer ties with US and Europe; it lifted FX restrictions (“cepo”) without generating hyperinflation; and it recovered international credit paying to the holdouts; gradually improved the international trade, removing barriers and lowering some tariffs, notably for computers (from 35% to 0%), and partially lowering withholding taxes to agricultural exports. Also, the situation of the judiciary was improved.
However, Argentina continues to have one of the most restrictive and repressed economies on the planet, with very high and inefficient public spending. It still ranks among the twelve countries with the highest tax burden. It ranks 156 out of 180 in the ranking of economic freedoms, together with countries like Iran, Maldives, Mozambique and Haiti. According to Standard & Poor’s, Argentina remains one of the five weakest emerging market economies. In short, we have improved but there is still a long road ahead. At the current rate, it would take at least two full mandates to reach the level of Chile, if everything goes well.
Source: Marcos Hilding Ohlsson
LyP researcher, based on Heritage Foundation data.
During 2017, the economy grew at an annual rate close to 3%, all sectors experienced growth, including construction and trade, except for the textile industry. Some had very important jumps such as the motorcycle market that went up 60%. While unemployment rate continued to decline reaching 8.5%.
But at 24.5%, the inflation rate remained well above the Central Bank’s target of 17%. That means Argentina is still among the ten countries with the highest inflation on the planet. The government admitted the failure of its anti-inflationary strategy which in essence combined a restrictive monetary policy and an expansive fiscal policy. Or monetary shock with fiscal gradualism. This is a combination that never worked in Argentina. The decision to change the inflation target was announced by the Minister of Finance, undermining the authority and independence of Governor of the Central Bank, Federico Sturzenegger.
Logically, this generated a bit of uncertainty about interest rates in pesos that finally fell in nominal terms, from 28,75% to 28% in the first week of 2018. Economists on average expected an inflation of 16.6% for this year but now is closer to 19%, even above the new inflation target of 15% (previously established at 12%). The government’s idea to relax the inflation target was to decrease interest rates, but with inflation expectations rising, Federico Sturzenegger had little room for maneuver. Now the Treasury should make a greater effort in decreasing public expenditures. And also, announced it will decrease the amount of bonds placed in foreign markets, replacing the domestic market, (which would allow the Central Bank to buy fewer reserves) to temper inflation pressures.
As for the exchange rate, it closed the year at 19 Argentine pesos per US Dollar, significantly below inflation. This, coupled with high real interest rates, has put increasing pressures on producers of tradeable goods. The current account deficit is estimated to be US$ 9.000 million for 2017.
With the new monetary policy, we expect, in principle, an inflation of around 19% for 2018, interest rates averaging 24%, and the exchange rate depreciating in sync with inflation. However, we recognize greater uncertainties than last year. It will be necessary to monitor if the changes in policy do not lower the demand for money. If they do, it could unleash a race between the dollar, interest rates, and inflation.
In 2017, the BCRA (Argentina’s Central Bank) bought US$ 16,000 million in cash reserves, which at year-end reached US$ 55 billion. This gives the monetary authority a lot of short-term power to stabilize the markets, but not so much if we think about the long run.
In terms of fiscal policy, the president has publicly admitted that Argentina has a very big government, with the huge bureaucracy, taxes are extremely high and public debt is rising at an unsustainable rate. Macri has urged public officials to decrease expenditures and in December sent a tax reform to Congress.
But on the other hand, public spending and tax pressure continue to grow, albeit at a slower rate than in the last 15 years. Although that President Macri has said that “Taxes are killing us”, tax revenues increased 29.2% in 2017 (in the Province of Buenos Aires they increased 37%). High taxes are one of the main factors that discourage a large inflow of private investment, both domestic and foreign. Total public expenditure rose by 26.5%. If we compare these indicators against an annual average inflation of 25.7%, we observe that in real terms: national taxes grew 2.8%, those of the Province of Buenos Aires at 9.4% and public expenditures at 0.6% respectively.
But, total spending was reduced in terms of GDP because the economy grew close to 3%. Primary spending grew somewhat less than inflation, 22.1%. Subsidies to the private sector fell 17.9%, due to the increase in public services’ tariffs and other expenses. On the other hand, retirement spending rose strongly by 37.7%, as did social spending in 31.2%; but the biggest increase is shown in interests paid on public debt: 72%. The cost of wages also rose, albeit slightly, above inflation: 27%.
Hence, the primary deficit of 2017 will be somewhat lower than the target of 4.2%, but remember that this deficit does not incorporate interest payments on public debt, which rose 72% during the year. Total borrowing requirements were probably closer to 7% of GDP.
Between the President’s rhetoric and reality, there is an insurmountable gap. Macri seems to be betting that economic growth at 3.5% per year is achievable. Therefore, freezing public spending in real terms would lead to a lower fiscal deficit and would allow a gradual reduction in taxes.
The promised reduction in public employment is being delayed. However, we know that in the month of December, President Macri insisted on accelerating reforms in all sectors to reach 35.000 layoffs in the next few months. We have yet to see any tangible results.
The Achilles heel of the current program is that total public debt is close to US$ 313 billion, or about 54% of GDP and rising rapidly. With another 30.8 billion from the provinces, gross public debt would exceed 60% by the end of this year (although net debt owed to private creditors is closer to 25% of GDP). The government managed to place US$ 9 billion in the first week of 2018 at rates lower than those of a year ago and received offers for US$ 21 billion. The 30-year rate was 6.95%, the 10-year rate was 6% and the 5-year rate was 4.625%. We do not see important short-term risks, nor do we worry about the volatility of the US dollar in the very short term.
However, we consider that the program remains inconsistent in the medium or long-term and is very vulnerable to a disruption in international financial markets.
In summary, the government has made some progress in the reforms towards an open market economy and will continue in the same direction during 2018 at a gradual pace. October elections gave him a big victory that should encourage public officials to speed up the reforms. However, the Cambiemos coalition still doesn’t have a majority in Congress and needs to negotiate any major legislative initiative. Argentina seems on the right track but is not yet out of the woods, either politically or economically.
By Agustín Etchebarne (DG from Libertad y Progreso)