July 18, 2011 9:39 pm

Argentina: A high-risk recovery

By Jude Webber

Ever higher: performers in Buenos Aires celebrate the 1810 revolution that preceded political independence; some say the 2001 default ushered in an era of economic independence

Learn from experience might be a useful maxim. But what if the lesson is default and the experience is Argentina’s?
As Greece lurches closer to the brink, Irish and Portuguese debt is demoted to junk status, and the D word rears its head in the US, Argentine officials smugly point to their own sustained high growth. It proves, they say, not only that there is life after the world’s biggest sovereign default but that it can be a party, too.

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“Conventional wisdom has failed,” said Mercedes Marcó del Pont, Argentina’s central bank chief in a recent television interview, referring to the debt-plus-austerity recipes dished out to Greece. “Let’s stop the ball and look at what’s happened to the economy on a global scale. 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.”
Paul Krugman, a Nobel Prize-winning economist, recently made the same point. Doing the “right” thing went badly wrong for Argentina in the late 1990s; and, though default triggered a savage downturn, it soon gave way to a speedy and lengthy recovery. “Surely the Argentine example suggests that default is a great idea,” he argued in a New York Times blog post last month.
Certainly, before Argentina’s 2001 default on $100bn of sovereign debt, the idea had appeared all but unthinkable. The country was then the region’s exemplar for liberal economic policies. But as one international rescue package followed another, the debt burden only grew. At the same time, social protests increased as the country’s fixed exchange rate system forced deflation upon an increasingly uncompetitive economy. (To anyone following events in Greece, this might all seem very familiar – at least, at first glance.)

OIL AND GAS

‘The energy economy has been totally altered by bad state intervention’If there is one obvious Achilles heel in the Argentine government’s “model” – an economic mix based on trade and fiscal surpluses and a competitive currency – it is energy policy.
Even as Buenos Aires boasts of its booming economy, factories are forced to scramble each winter for the gas they need to keep producing. In the agriculture sector, crucial to the economy, it is not uncommon for diesel supplies to run low at the height of the harvest.
In effect, industry is kept on short rations to avoid the politically unpalatable prospect of restricting supplies to residential customers. They have grown used in the 10 years since the default to paying heavily subsidised prices and see no incentive to reduce consumption. “Argentina’s energy economy has been totally altered by bad state intervention,” said Francisco Mezzadri, an energy analyst.
Despite sitting on large reserves of oil and gas, including reserves of hard-to-extract shale and tight gas thought to be among the world’s biggest, Argentina has become a net energy importer. While neighbouring Brazil has invested heavily to develop its massive offshore discoveries, Argentina last month signed a 20-year deal to buy liquefied natural gas from Qatar at an undisclosed price – an agreement unlikely to be the last of its kind.
Argentina’s tightly regulated energy market has also failed to attract the investment needed to increase refining capacity enough to keep pace with domestic demand.
Though the government denies there is an energy problem, this month it had to scramble to find an extra $1.5bn to fund its subsidies for the sector, having run through the money it had allocated halfway through the year. If high growth continues, meaning industry requires more fuel, energy will continue to be a burden on finances in a nation where public spending grew 34.5 per cent year-on-year in May.
Meanwhile, maturing oil and gas fields with lower productivity and a lack of investment in exploration, as well as increasing subsidies of tariffs and prices in the sector ($6.3bn last year), have led to plummeting output and reserves. The industry is also in the red.
“Argentina, [which] had an energy trade surplus of $5.6bn in 2006, will end 2011 with an estimated deficit of $3bn,” said eight former energy secretaries this month in a document designed to act as a wake-up call on energy fragility ahead of October’s presidential election.
It will not be easy to raise energy tariffs at a time of high inflation. The alternative is to continue subsidising energy consumption with state funds that could be used to make structural changes to reduce poverty.
If Cristina Fernández is re-elected as president, as expected, she will have to make changes, says Mr Mezzadri – “or this policy will end up turning Argentina into a country that swaps soya [its biggest export earner] for energy”.

Today, Argentina shows a country can turn its back on the international consensus, by defaulting and breaking an “unbreakable” currency peg, and live to tell the tale. Yet the end result is not quite as attractive or as clean-cut as some of its proponents suggest.
The recovery has been impressive – the economy expanded 65 per cent from 2002 until the world financial crisis broke in 2008; its 2011 growth forecast has just been lifted to 8.2 per cent. But the government has not yet been able to lift the stain of default from Argentina’s reputation, nor convince the world crowd-pleasing populist measures that defy accepted economic orthodoxy offer a sustainable recipe for running a country.
“The model”, as President Cristina Fernández calls the country’s policy mix, has worked for longer and far better than many thought possible. Because the country remains cut off from international capital markets, it fights to run twin trade and fiscal surpluses. Keeping the exchange rate competitive is central to this approach as it helps generate a balance of payments surplus while also boosting exporters. That option is not open to Greek policymakers as long as their currency remains in the eurozone.
Another critical feature was the rigid commitment to fiscal discipline pursued by Néstor Kirchner, Ms Fernández’s micromanagerial husband, who as president from 2003 to 2007 kept an eagle eye on tax revenues. But since 2007 that discipline has relaxed and inflation has risen as the government has turned to the printing press to meet some of its financing needs. Private estimates suggest that Argentina is heading for an inflation rate of 25 per cent or more this year, the fifth straight year in double digits. For its part, the government says inflation is running at 9.7 per cent.
Other warning lights are flashing. Public spending is outpacing tax revenues. Hefty energy and transport subsidies look increasingly untenable. Presidential elections in October, in which Ms Fernández is on course to win a second term, mean an early end to such largesse is unlikely.
All this undermines Argentina’s image at the very time the government believes the country – proud of having joined the Group of 20 leading economies – has valuable wider lessons to offer.
To Ms Fernández, who has been steering the country solo since her husband’s sudden death last October, the injustice of this is palpable. In her view the International Monetary Fund, which shaped policy in the pre-default years, got Argentina wrong, prescribing ruinous neo-liberal policies. More recently, she believes, the rating agencies got the financial crisis wrong. And yet the world is still reluctant to recognise Argentina’s recovery or take it seriously.
One reason is that, beyond the stellar growth numbers, the picture is mixed. To start with, the boom owes much to global factors. Amid a surge in global prices, Argentina is a leading food commodities producer, with agriculture making up 35 per cent of foreign sales. Furthermore, not only is China clamouring for Argentina’s natural resources, but the middle class in neighbouring Brazil – its main trading partner – are also avidly buying cars, its biggest manufacturing export.
“The terms of trade are now at a historic high. This is the best possible world for Argentina,” says Lucio Castro of Cippec, a Buenos Aires-based think-tank. “But take out the natural-resource intensive sectors and productivity in the rest of the economy is bad and informality extremely high.”
Unemployment, at 7.4 per cent in the first quarter, is low, but investment is lacklustre – 19.4 cent of gross domestic product. Meanwhile, productivity is “not bad, it’s dismal”, says Mr Castro.
Moreover, following years of underfunding, the country’s once admired education system is a shadow of its former self. The same, critics claim, can be said for the state statistics office, which has come under greater government influence, leading many to believe that figures for inflation, poverty and growth have been presented in too rosy a light.
. . .
Argentina’s foreign debt-to-GDP ratio is an enviable 35 per cent, but Claudio Loser, the most senior IMF official for Latin America at the time of the default, reckons it still owes as much as $16bn to holders of defaulted bonds when interest is included. That is despite two tough bond swaps that restructured 92.4 per cent of the defaulted debt. Argentina also owes $7bn to western governments; and, though widely seen as willing to pay, it is not generally perceived to be willing to do so on any terms but its own.
Though no default is seen on the horizon, there could be turbulence ahead. Mark Weisbrot of the Center for Economic and Policy Research in Washington, who sees more merit in the government’s strategies than many economic analysts, acknowledges that: “No economic model works 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.”
Proof, though, that it can not pin everything on a booming economy is that – aside from the Chinese who sealed three multibillion-dollar energy deals last year – investors are not making a beeline for Argentina.
Inflation, labour unrest, an energy crisis and unpredictable economic policy from an interventionist government which, for example, nationalised private pension funds in 2008 can make doing business difficult, to say the least. Meanwhile, capital flight has reached an estimated $60bn or more in the past four years and is accelerating, dwarfing the $26bn that the UN’s Economic Commission for Latin America and the Caribbean calculates has flowed in as foreign direct investment since 2007.
Furthermore, the government has fallen into contradiction on a key article of faith – fighting poverty. A child benefit scheme has proved highly popular, but inflation has eroded an estimated 30 per cent of its real value. One new study also found 50 per cent of the population was poor or at risk of becoming so, though official data show a poverty rate of just under 10 per cent. Roberto Lavagna, who as economy minister from 2002 to 2005 helped engineer Argentina’s recovery, calls this “an insuperable contradiction for a government which has a progressive and populist discourse”.
Meanwhile, institutions have been eroded and state interference has increased. Newspaper kiosks were temporarily shut for selling Clarín, the top-circulation daily and a fierce critic. The government has fined private consultancies over inflation data deemed misleading, and has even begun criminal proceedings against one. Never mind that analysts say the official inflation rate has enabled it to make vast savings on payments from its inflation-linked bonds.

. . .
So where is Argentina now? Despite bouncing back exceptionally from the default, Mr Loser says his homeland is “becoming irrelevant”. One of the world’s most affluent countries a century ago, Argentina still has the region’s highest per capita income on a purchasing power parity basis. But its relative importance has “declined precipitously”, its economy just a sixth of the size of Brazil’s and a third of Mexico’s. “The country that is going to surpass Argentina soon if it’s not careful is Colombia. It is growing nicely and in a much more rational fashion,” he says.
The result is that Argentina looks isolated, a bit player in the G20, outpaced by emerging market darlings. International engagement appears limited to rallying support for negotiations with the UK over the disputed Falkland Islands.
While talk of cooling the economy is taboo, analysts say the government needs to start managing inflation and stabilising the real exchange rate, which makes some devaluation likely after the election. The peso has shed nearly 8 per cent versus the dollar in the past 18 months.
“The government has a pro-inflationary monetary and fiscal policy which is inconsistent with the exchange rate policy,” says Martín Redrado, ousted as central bank chief last year in a battle over the use of reserves to pay off debt. “Sooner or later, they will collide.”
That doesn’t mean an old-style bust. “Argentina isn’t going to explode as it did before,” Mr Redrado adds. “But it is heading into the path of a storm.”
The government prides itself on the fact that doom-mongers have been wrong before – and for now, soya is the saviour. While capital flight has accelerated, nearly $100bn in agricultural revenues have flowed into Argentina in the past four years and unless commodities prices or weather conditions falter, Argentina may be sitting pretty.
Even so, it risks continuing to be a model of what not to do, rather than a promising model of what to do.
“In 20 years, history will ask us: ‘What did you do with the [commodities] bonanza?’ Was there an increase in consumption, public companies and wages or investment in infrastructure, health, education and saving for a rainy day?” says Mr Castro. “We are not doing our homework and becoming a developed country.”

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