December 5, 2013
Argentina’s coming economic springtime
Winter is coming for the Kirchner government and Argentina’s economic springtime could be right around the corner. The Argentine economy is like a cork being held underwater by the hand of bad policies. As soon as these policies change, the economy will soar, driven by the unleashed power of investment in agribusiness, energy and mining among other promising sectors.
However, this renewed growth will not happen in the short term. The economy is stagnant: it has only grown an accumulated 3% in the last two years. Growth in the second quarter showed a small spike, with inter-annual growth of 5.5%, but that was mainly due to dubious statistics and a very low benchmark, since the second quarter of 2012 had been especially low. In July, the growth rate went down to 2.2%. This growth was not only anaemic but also selective. Only three sectors grew significantly: agriculture (because last year’s crop was low), finance (mainly fuelled by consumption loans), and the auto industry (driven by demand from Brazil). Manufacturing as a whole fell, excluding the auto industry. As a result of low growth and investment, job creation and real wages have been stagnant in the past two years, contributing to the government’s poor electoral performance in the August primaries.
The causes of this stagnation lie in an inconsistent economic model which has inhibited investment and innovation. Following the 2001-2 crisis, Argentina grew at 9% per year thanks to an ultra-competitive exchange rate (GDP per capita in 2002 was around U$2,500 in current dollars, comparable with a low-income country), high unemployment and unused capital in the industrial sector, and growing commodity prices. However, inflation was left unchecked and public spending and taxation grew to record levels. This meant that competitiveness declined as domestic prices rose faster than the nominal exchange rate, and companies faced an increased tax burden. At the same time, the government chose a populist energy policy of subsidies to residential consumers, which led to a decline in investment and production of oil and gas, and a ballooning subsidy bill currently consuming almost 4% of GDP.
Other policies such as the intervention of the INDEC statistics institute in 2007 and the nationalization of AFJP private pension funds in 2008 deepened the perception of investors that Argentina’s government was not interested in a level playing-field. As a result, capital outflows grew to over US$20 billion in 2011. The government responded by closing imports, stopping companies from transferring profits abroad and severely limiting the purchase of foreign exchange, leading to a black-market exchange rate with a 60% premium over the official rate. Despite these controls, Central Bank reserves are declining due to a rising energy import bill, a drastic reversal in the tourism balance (Argentines travel abroad because they can pay with their credit cards at the overvalued official exchange rate) and a virtual standstill in foreign investment. A notorious case was the decision this year by Brazilian mining giant Vale to discontinue its US$8 billion investment in a potassium mine in Mendoza.
At the same time, the government is covering a growing fiscal deficit (over 4% this year if payments from the pension system are excluded) by printing money, which explains the 25% inflation rate and devaluation expectations despite slow growth. The current scenario is thus very unfavourable for investment, and since the tail-winds of growing commodity prices and high world growth are gone, the economy has stagnated, with no sign of improving in the short run.
This bleak scenario can rapidly turn into an economic springtime with a new, credible government in 2015. For starters, Argentina is a confirmed natural resource paradise. Vaca Muerta, located in the Pata-gonian province of Neuquén, is the third-largest deposit of shale gas in the world, worth approximately seven GDPs of Argentina in present value. According to private estimates, Vaca Muerta requires an investment of US$140 billion. Chile exports 10 times more minerals than Argentina, despite the fact that we share the same mountain range. Australia proves that with macro-economic stability and investment in infrastructure, it is possible to sustain long-term growth based on vast natural resources in mining and agribusiness, and Argentina’s agriculture production is one of the most efficient and profitable in the world.
However, these opportunities will not be developed unless there is a credible change in the policies described above. For policies to change, there must be a change in government, and following the poor performance by the Kirchner government in the August legislative primaries (they obtained 26% of the vote nationwide with defeats in all major provinces), the chances of a new government taking power after the October 2015 presidential election appear very high.
To take advantage of these opportunities, the next government of Argentina has a two-tiered agenda: in the short run, the country must reduce inflation, free its exchange rate, eliminate arbitrary government interventions in international trade and re-establish normal relations with the international financial community.
In the medium run, Argentina must foster profitability by reducing transport costs, lowering the tax burden and making credit accessible for businesses. Many potential opportunities, for example, agri-business in fringe areas, tourism, specific manufacturing sectors, etc are not developed because profits are just not large enough to encourage investment. One of those obstacles is transport costs. According to World Bank estimates, transport costs in Argentina are up to three times higher as a percentage of export value compared to OECD countries, and higher than other Latin American countries such as Chile, Mexico and Brazil. Much of that comes from the very low utilization of railways (4.4% compared to 56.3% in Canada and 21.9% in Brazil, for example). Investment in infrastructure would foster short-term growth and, at the same time, increasingly make more business plans possible, especially in regions farther from Buenos Aires.
The second obstacle is the tax burden. Since the 2001 crisis, Argentina has deviated from the rest of Latin America in tax burden as a percent of GDP and has reached OECD levels. Public expenditure, including the three levels of government, has grown from 29% in 2003 to 50% in 2012. This high tax burden is of course a drawback for competitive sectors, and is especially negative if we take into account that there has been low and inefficient investment in infrastructure and energy, education and innovation, etc.
Finally, lack of credit also hampers investment. Throughout the country there are hundreds of small firms and entire sectors that could compete globally but who need a technological reconversion and sometimes an increase in scale to do so. These firms need credit, apart from lower transport and tax costs. A financial sector which was already small before the crisis has taken progressive beatings since. Persistent inflation, the nationalization of pension funds and increasingly arbitrary regulations have limited the financial sector essentially to transactional banking, with credit being funnelled almost exclusively to consumption. Credit to the private sector in Argentina was 18.4% of GDP in 2012, compared to 68.4% in Brazil and 73.2% in Chile.
It is the end of a political era, and Argentina’s economic springtime looks ready to bloom in 2015. An economic turnaround would mean phenomenal capital gains for investors who get in early, but of course there is no certainty. Let us hope that the size of the opportunity and the success that other Latin American countries such as Chile, Colombia and Peru have had with reasonable policies are enough to ensure that the next president will seize the chance.
*Miguel Braun is the Executive Director of Fundación Pensar.