Argentina's GDP, trade and credit improve in an increasingly liberalised economy

Following the inauguration of President Mauricio Macri’s centre-right government in December 2015, the Argentine economy has embarked on a period of structural change propelled by increasingly liberalised policies. Under this leadership, the authorities have been rolling out various reforms to bring the country back onto the global stage, step up international competitiveness and accelerate GDP growth.

However, the nation has faced a number of obstacles, including a recession in 2016, when there was a sharp reduction in investment and production, further depreciation of the currency, and a drop in imports and exports. That year was also a tumultuous one for Brazil – Argentina’s largest neighbour and primary trade partner – which further contributed to these challenges. Nevertheless, the government pushed forward with a series of reforms, which helped bring about a rebound in 2017 and positive outlook for 2018.

GDP Performance

After the 1.8% contraction in 2016, Argentina’s GDP expanded by 2.9% in 2017. Growth continued to accelerate in the first quarter of 2018 at a rate of 3.6% year-on-year (y-o-y), according to the National Institute of Statistics and Census (Instituto Nacional de Estadística y Censos, INDEC). These figures position Argentina as the third-largest economy in Latin America, worth AR2.91trn ($150bn) in constant 2004 peso terms in 2017 – behind Brazil and Mexico, but ahead of Colombia. Meanwhile, IMF figures show that the country had the eighth-highest GDP per capita in the region, at $19,015 that year. This places the country in the top third of the regional spectrum, between Uruguay ($20,377) and Mexico ($18,129).

Sector Breakdown

INDEC figures show that manufacturing comprised the plurality of the country’s gross added value in 2017, with 20.2% of the total. This was followed by retail and wholesale trade (15.6%); real estate, business and rental activities (12.3%); transport and communication (9.8%); and agriculture and livestock (8.2%). These top contributors all posted growth in 2017, with the only contractions seen by mining and quarrying, utilities and private households with domestic service.

Fisheries and construction experienced the fastest expansion, with 14.3% and 10.3%, respectively. In the first quarter of 2018 growth was more evenly distributed, though these two remained at the top, with a 9.7% y-o-y increase in construction and 6.2% in fisheries. Construction is expected to remain a top performer throughout 2018, supported by the government’s prioritisation of infrastructure projects and a continued increase in mortgage lending.

Background

The 2001 collapse of the economy – known locally as el corralito – saw Argentina’s GDP drop by 10.9% in one year, resulting in a crash of the financial sector and outbreaks of violence. While the economy and society were able to bounce back, citizens maintained a negative perception of liberal policies, such as those supported by right-wing President Carlos Menem, in power from 1989 to 1999. Locals blamed this laissez faire-style government for destabilising the country, which resulted in the election of both leftist President Néstor Carlos Kirchner in 2003 and his wife, President Cristina Elisabet Fernández de Kirchner, in 2007 and 2011.

Both of these administrations introduced interventionist measures that reached their peak during then-President Cristina de Kirchner’s second term. Among these policies were strong currency controls, taxes on exports, import regulations and fixed prices on certain goods. Given the government’s aggressive stance against foreign influence – especially due to its unwillingness to service its external debt – the economy retracted. The state mainly sourced funds from within its borders, and companies serviced the internal market. This resulted in a decline in Argentina’s position in global markets, which hampered the competitiveness of domestic companies. Despite this, businesses were able to stay afloat due to the government’s protectionist measures.

The government of President Macri is seeking to help Argentina reopen its borders and regain its global position. However, rolling back policies from the years of “Kirchnerism” has proven difficult. Despite the victory of President Macri’s coalition during the 2017 legislative elections – allowing it to pass landmark reforms and provide greater assurance to international investors – public opinion remains divided on how the country should further develop. “The government has done an important job of fostering greater transparency, but this not yet enough,” Daniel Melhem, managing partner at Knightsbridge Partners and president of the Argentina Investment Council, told OBG. Therefore, the success of the push towards a more liberalised economy will largely depend on whether the leadership can deliver better results than its predecessors.

Historical Growth

These varied approaches have been accompanied by asymmetrical economic development, with sharp drops and quick rebounds. After hitting a peak rate of 10.5% in 1991, GDP progressively decelerated until 1995, when it recorded a 2.8% contraction, before expanding by 8.1% in 1997. GDP declined steadily through to the largest crash in the country’s history: a 10.9% drop in 2002. The 2003-07 period saw stable growth of 8-9%, but the 2007-08 financial crisis hit the country harder than most other emerging markets, leading to a 5.9% contraction in 2009, although this was followed by rises of 10.1% and 6% in 2010 and 2011, respectively. The 2012-16 period brought alternating years of moderate expansion and recession, believed to be in part due to the interventionist measures of Presidents Kirchner and de Kirchner, resulting in a relatively flat average contraction of 0.05%.

Trade

Recession in 2016 led to a sharp drop in imports, which caused a $1.97bn trade surplus that year. Conversely, the subsequent economic rebound in 2017 brought about one of the largest trade deficits in Argentina’s history, worth $8.52bn. This has both positive and negative implications: while it reflects the more favourable position of consumption and openness of the market to international influence, it also indicates a lack of competitiveness of Argentina’s exportable goods.

The deficit continued to widen in the first five months of 2018, with imports rising by 17.9% y-o-y, outpacing export growth of 7.1%, to reach a negative balance of $4.69bn by the end of May 2018. The number of domestic companies that export goods has been persistently low, but the period since the 2007-08 global financial crisis has seen this figure dip further from a peak of 15,100 in 2006 to 9700 in 2016 (see Trade & Investment chapter).

Default

The 2001 financial crisis led to the largest sovereign debt default in history up to that point – for $102.6bn, composed of $81.8bn face value and $20.8bn of past-due interest – and caused the country to be barred from international finance for 15 years. The restructuring of the debt was undertaken in several stages, with President Macri striking the final deal in 2016 after years of legal battles.

The first restructuring came in 2005 after negotiations hit at an impasse. Argentina made a unilateral offer to creditors on relatively unfavourable terms, resulting in $62.3bn, or 72.2% of the face-value debt, exchanged for $35.2bn. In 2006 the government repaid its $9.5bn debt to the IMF to free itself of the fund’s policy constraints, and in 2010 a second bond exchange was concluded with some $12.4bn of the $18.4bn issued. The 2005 and 2010 restructuring efforts collectively covered 91.3% of the debt.

However, ongoing litigation from holdouts pushing for full repayment prevented Argentina from participating in international credit markets, with one hedge fund going so far as to seize the country’s assets. A US court ruling barred any bank operating in the US to participate in debt restructuring before holdouts were paid in full, which resulted in a so-called selective default in 2014.

After assuming office in late 2015, President Macri’s government settled agreements with Italian and US holdouts in February 2016. It made final remunerations with a $475m payment in November 2016, thus settling all outstanding debt.

External Debt

Argentina’s rekindled openness and development plans have caused external debt growth. This has risen from $170bn in the fourth quarter of 2015 to $233bn two years later – a 37% increase. At the end of December 2017 the government accounted for 61% of this, while the Central Bank of Argentina (Banco Central de la República Argentina, BCRA) held 8%, deposit-taking corporations 3%, other financial institutions 1% and other sectors 27%. The authorities still face substantial external financing needs, so debt will likely continue to rise, albeit at a slower pace, in the coming years.

Public Finances

In early 2018 the government reported that it exceeded expectations in lowering the fiscal deficit for 2017, reaching 3.9% of GDP instead of the initial forecast of 4.2%. This represents a notable drop from 2015 and 2016, when the deficit reached 5.4% and 4.6% of GDP, respectively.

Although the IMF projects that the primary deficit will decline to 2% of GDP by 2019, it expects the current account deficit to increase to 4.4% of GDP by then. This contradicts the state’s goal to reduce the fiscal deficit to 2.7% in 2018 and 2.2% by 2019. The government is reducing spending on wages, pensions and social welfare – key expenditure recipients under Presidents Kirchner and de Kirchner – and encourage greater private sector participation in these. While these moves are crucial to rebalance the budget, they are likely to be met with strong opposition by the populace, especially the most vulnerable segments.

Foreign Exchange

Argentine policymakers have a strong history of controlling the local currency. Between 1992 and 2001 the peso was pegged to the dollar at AR1:$1. After the 2001 crash, however, it started to depreciate, reaching AR2.95:$1 in 2002 and AR9.66:$1 in November 2015. During the administrations of Presidents Kirchner and de Kirchner the BCRA kept a firm grip on the peso as part of efforts to keep a lid on inflation, which resulted in a wide variation between the blue-chip – or informal exchange – rate, the exchange rate for those travelling abroad and the one for bond purchases.

The government of President Macri liberated the exchange rate, bringing it closer to the blue-chip rate. These rates had previously deviated significantly from one another, with the official rate at AR9.19:$1 and the blue-chip rate at AR14.95:$1 in July 2015. After the government allowed it to float, the local currency officially depreciated by approximately 30% to AR12.90:$1 by the end of that year. The BCRA has since regulated this, selling dollars in the market to further depreciate the currency and thus control inflation. However, this has also put pressure on the bank’s foreign reserves: by March 2018 the BCRA had intervened five times, collectively costing $4bn of foreign reserves. While this contradicts the government’s plans to allow the currency to float freely, the state considers it necessary to protect against hyperinflation.

Inflation & Monetary Policy

Argentina has long faced difficulties with inflation, seeing historic highs of more than 3000% in 1990 as well as periods of deflation between 1999 and 2001. A sharp increase in 2007 led to government intervention in INDEC operations. The then-executive branch tampered with the institute’s inflation data, thus discrediting its findings until President Macri restructured the body in late 2015. Inflation declined from 40.3% in 2016 to 24.8% in 2017, which was considered a major achievement of the administration.

In an effort to continue moderating inflation, the BCRA increased its key interest rate from 24.75% in 2016 to 28.75% in December 2017. Over two weeks in late April and early May 2018 the bank hiked this rate by 13 points to 40%, on the back of declining investor confidence resulting from a large sell-off of pesos. With credit as percentage of GDP remaining low, the BCRA is facing the challenge of keeping inflation in check while incentivising credit growth. The first half of 2018 saw cumulative inflation of 16%, already higher than the government’s 15% goal for the year. Throughout the first half of the year these higher-than-anticipated figures caused industry specialists to revise their inflation expectations for the year upward, to 27% in July 2018.

Rating

The successful implementation of various reforms and improving macroeconomic fundamentals have caused international rating agencies to improve Argentina’s sovereign credit rating. In October 2017 Standard & Poor’s raised this from “B” to “B+”. Moody’s subsequently upgraded the country from “B3” to “B2” in November 2017, and Fitch has maintained its rating of “B” since May 2016. While the outlook has improved, rating agencies point to key challenges facing the country, especially the fiscal deficit and vulnerability to exogenous pressures.

Private Debt

Credit was once seen in a much less favourable light. In the lead-up to 2015 very little was done to incentivise banks to participate in the economy, and the 2001 financial crisis – which saw the freezing of most accounts – severely eroded trust in financial institutions. These factors contributed to a credit-to-GDP ratio of 11.8% in 2016, one of the lowest in Latin America and down from 25% in the 1990s. However, accelerating economic growth and liberal policies have contributed to a rise in credit, spearheaded by mortgages, a previously non-existent segment (see Banking chapter).

Amnesty

The relative success of a tax amnesty law – which brought in $117bn of offshore funds in March 2018 – is seen as a sign of rising investor confidence. The law offers attractive terms to help repatriate the estimated $400bn of assets held by Argentines outside the country. The move brought in AR148.6bn in taxes and fees to help bridge the fiscal deficit for the year. “While increased confidence can be a factor behind the relative success of the amnesty law, we must not overlook the global change in consciousness with regards to international capital flows – some countries have become less lenient with matters such as tax evasion and sources of funds,” Diego Finchelstein, professor of business at the Universidad de San Andrés, told OBG “I believe both factors are important to consider.”

Development Plan

In further support of economic targets, in 2016 the government launched the National Productive Plan (Plan Nacional Productivo, PNP) to increase production, attract investment and boost employment across key sectors. The initiative comprises eight pillars, aiming to lower the cost of capital; enhance human capital and labour productivity by strengthening vocational training, promoting employment, formalising labour, and reducing absenteeism and labour litigations; develop infrastructure to bring down logistics and energy costs; expand investment in research and development to 1.5% of GDP; support fiscal sustainability through a policy that aims to facilitate growth, decrease informality and increase investment in production; defend free competition and market transparency by favouring new entrants, lowering input costs and protecting consumers; reintegrate the country into global supply chains and boost exports; and facilitate and de-bureaucratise administrative procedures. Smaller reforms have been passed in support of the broader goals of the PNP, including infrastructure initiatives in various stages of development. For example, the Biotechnology Law was passed in January 2018 to incentivise investment and innovation in biotech, but others are still being discussed.

Human Capital

The human development and labour productivity pillar of the PNP addresses an important gap – the World Economic Forum (WEF) ranked Argentina 52nd out of 130 countries with regards to human capital development in its “Global Human Capital Report 2017”. While this only places it in the upper half of global economies, it was the top performer in Latin America, ahead of Chile (53rd), Peru (66th), Colombia (68th), Brazil (69th) and Mexico (77th). This top regional position was due to Argentina’s relatively large, young and skilled population, with 40.6% of its 44.5m residents below the age of 25 in 2018. However, the WEF reports that ascending the global ranking would require stepping up the quality of the education system, as well as reducing unemployment and underemployment, which are all priorities of the PNP.

Social Pressures

Although President Macri’s Cambiemos (Let’s Change) coalition has implemented landmark reforms across a variety of sectors – including sensitive issues such as pensions – it faced resistance from certain segments of the population and opposition lawmakers (see analysis). There have been several general strikes across the country since 2015, both before and after President Macri assumed office. The transport unions – among the largest and most powerful in the country – went on strike twice in 2015 before the general election, resulting in an estimated $100m in daily losses.

The General Labour Confederation, teachers, bankers, health care workers and other unions have also taken to the streets on various occasions, typically demanding salary increases due to the sharp depreciation of the peso and high inflationary pressures. The 2017 pension reform similarly resulted in widespread protests and a general strike. Domestic labour unions are well organised and play a pivotal role in policy-making. Therefore, the government, aiming to liberalise the economy and reduce the role of the public sector, will inevitably face an uphill battle in implementing its planned reforms.

Outlook

Increasingly liberal policies since 2015 are considered to have resulted in growth in investor confidence and improving macroeconomic indicators. However, challenges remain: to simultaneously lower inflation, improve competitiveness and maintain purchasing power, the government will need to continuously adapt its policies to changing market trends. Although many of President Macri’s policies have been met with opposition, the majority of the population supports these efforts, as evidenced by the Cambiemos coalition’s win during the October 2017 legislative elections. With now-unified executive and legislative branches, the government will need to undertake fiscal consolidation without negatively affecting the most vulnerable populations.

The IMF anticipates a gradual reduction in the primary account deficit in the coming years, with inflation subsiding and GDP growth. This should be supported by private consumption, which is expected to increase following the 2016 decline.