Fair winds for Argentina

When you invest in an emerging country as an outsider you always have to bear in mind that you are an easy target for populist politicians. Why should they pay you rather than their supporters, the poor, pensioners or whoever else they want to encourage to vote for them?

Argentina is a country that demonstrates just how important political risk can be to an investor. It has a murky history of terrible political decisions and is a good example of the havoc that socialist-populist and interventionist economic policy can wreak.

It is astonishing how far Argentina has fallen. In the early twentieth century the economy was flourishing. It was one of the most prosperous countries in the world, with per capita income at 80% of that of the US and almost on a par with Britain. But this is all just a distant memory in today’s Argentina. Years of political populism, military coups, media control, an isolationist approach to trade and a lack of interest in foreign policy have made the country a shadow of its former self. The country’s urbanized and well-educated population has seen its relative wealth decline over decades of political instability and periods of hyperinflation.

The numbers reflect this. The Argentine economy has seen pretty dismal growth over the last 35 years. While the country’s GDP has grown by 1.88% on average, annual per capita GDP has increased by only 0.62%. The relatively low level of the growth itself is less of an issue than the fact that since 2003 it has come largely from public spending on for instance, social security, rather than productivity or development of competitive industry.

Productivity is poor and Argentina historically lags its Latin American peers in this area. Doing business there is also difficult. In the World Bank’s ‘ease of doing business’ ranking, Argentina (116) still trails Mexico (47), Peru (54) and Chile (57), but has now overtaken Brazil (123) and is way ahead of Venezuela (187). It ranks 104 in the World Economic Forum’s Global Competitiveness Index – also way behind Colombia (61), Peru (67), Uruguay (73), Brazil (81) and Ecuador (91).

Wind of change

But a wind of change is blowing in the second largest and third most populous country in South America. This started with the election of business and market friendly president Mauricio Macri in 2015.

Do not expect Argentina to be able to extricate itself from populism and recession within a heartbeat, but the building blocks are there. Besides the new government that has rekindled hope for Argentina, the country has a rich supply of fertile land for soya, grain and beef and plentiful natural resources in the form of metals and minerals. Its shale oil and gas reserves are the third largest in the world and its long coastline provides access to rich fishing grounds.

Latin America seems to be witnessing the rise and fall of populism. Countries such as Argentina, Brazil and Venezuela have all been held back by populist regimes. But the trend appears to have been reversed in the first two of these countries.

Turbulent political history

Political influences seem to have had a stronger impact on the economy in Argentina than in many other emerging countries. Post-colonial politics in Argentina are characterized by military coups and alternating civilian and military governments. Successive and often widely divergent regimes resulted in huge policy swings – from protectionist to free trade and back again.

Peronism, named after Juan Domingo Perón who became president in 1946, is still an important force in Argentina’s political and economic landscape today. The major legacies of this populist ideology, which can be described as ‘right-wing socialism’ or ‘corporate socialism’, include nationalization and powerful labor unions.

Twelve years of ‘Kirchnerism’ brought Argentina to a standstill. This political ‘-ism’ refers to Néstor Kirchner and his brand of Peronism. He was president from 2003 to 2007 and his wife Cristina Kirchner completed two further presidential terms from 2007 to 2015 (with a still influential Néstor behind the scenes until his death in 2010). Economic policy failures by the Kirchners brought the economy to its knees and scared investors away.

Kirchnerism had two main effects on the economy – its interventionist policies dampened import and export levels and it boosted government consumption as a proportion of GDP. The regime’s approach to trade was protectionist, characterised by strained economic relations with the US and high export tariffs.

The Kirchners aimed to address poverty and income inequality by allowing high wage growth and large social welfare benefits as well as maintaining substantial energy subsidies. Economic figures were manipulated while the central bank, Banco Central de la República Argentina (BCRA), supposedly an independent institution, engaged in deficit financing and foreign exchange intervention to the point that the country’s foreign exchange reserves were nearly exhausted.

The Kirchners also steadfastly refused to settle with US ‘vulture funds’ over the country’s 2001 sovereign default. The unwillingness to service debt meant that debt-rating agencies considered Argentina in default, severely limiting the access of both the federal and provincial governments to the global capital markets.

Another legacy of the country’s past political regimes is corruption. It is rife at all levels of Argentine society. The judicial system also appears to be entangled in politics in contrast to, for example, Brazil. Crime will be a difficult problem to eradicate, particularly as Macri’s vows to fight the Narcos might require a level of police violence that the average Argentinian has so far resisted.

The age of the technocrat

A combination of factors came together at the end of 2015, resulting in the fall of the Kirchner regime. There was growing public discontent, a failing economy, corruption allegations and polarization within the Peronist movement as the government came to the end of its second consecutive – and strictly speaking – last term. The controversy surrounding the Kirchners’ leftist policies caused the main Peronist party Partido Justicalista (PJ) to go through a divisive ideological split into pro- and anti-Kirchnerists (with most pro-Kirchnerists uniting under the Frente para la Victoria (Front for Victory party).

This fragmentation gave the center-right Macri and his followers a window of opportunity. Since he took over in late 2015, he has surrounded himself with a new breed of politician. The old political class is no longer in charge. Many of the people in government now are young, have worked overseas, have an international mindset – they are not homegrown politicians. Even established parties like the Peronists now have a generation of new politicians who are willing to support change. This is really important in terms of political stability.

This new group includes technocrats like energy minister Juan José Aranguren, a former CEO of Shell Argentina and central bank chairman Federico Sturzenegger, who has a PhD in Economics from MIT, which is rather reassuring. The new administration is more business oriented, which will also encourage talented and internationally experienced Argentinians to return to a country that may now allow them to put their skills and expertise to some use. Macri’s tax amnesty plan is also helping to encourage repatriation of some of the Argentine assets stashed overseas. At the end of 2016, Argentines declared $97.8bn of previously-undeclared wealth and the government announced that tax revenue for the year was up 35% year on year. According to Morgan Stanley, the government has collected extraordinary taxes relating to the amnesty that account for over 1% of GDP. These inflows of both money and talent could really help Argentina to get back on the right track.

There is a belief in both corporate and government circles that the new reform-minded political class has staying power. The skepticism that often surrounds change in emerging markets – that feeling of ‘We’ve seen it all before’ seemed profoundly absent this time in Argentina. Both Argentina-based companies and foreign firms with operations there are hopeful that the Macri administration will have a positive impact.

A daunting task

According to the World Economic Forum, inflation, foreign currency regulations and access to financing are the top three factors that detract from a country’s competitiveness. The World Bank cites construction permits, paying taxes, starting a business, trading across borders, and registering property as issues that hamper the ease of doing business in Argentina. These issues along with promoting economic growth are all items on the government’s long to-do list. The Macri government is well aware of these weaknesses and is addressing them.

One of Macri’s first actions after taking office in December 2015 was to suspend the capital controls – El Cepo or ‘the clamp’ with the US dollar that had been put in place by the previous administration – and allow the Argentine peso (ARS) to find its own level, which led to an immediate 26% devaluation that same month. This move was soon followed by proactive engagement with holders of defaulted Argentine debt who were still holding out, with the aim of reaching a settlement as soon as possible. These first actions of Macri spoke louder than any flowery policy speeches and showed the world that ensuring that Argentina regains access to global capital markets is a top priority.

The Argentine economy may now also finally be coming out of recession. Although the economy contracted by 2.3% in 2016, recent figures confirm that GDP grew by 0.5% in the last quarter of 2016 and seasonally-adjusted third quarter figures were revised up to +0.1%. Expectations for GDP growth in 2017 currently range between 2.5% and 3.5%. This growth is expected to come from the expansion of agribusiness, infrastructure and energy as well as an increase in consumption. But the weak link in the government’s expectation for GDP growth is the consumption pick up. With high inflation and a barely-stabilized economy, it is no surprise that consumer confidence has been declining. And with higher energy bills on the horizon – when subsidies are reduced – a pick-up in disposable income is far from a certainty.

Argentina could also benefit from an improved outlook for the region. Brazil is an important export market for Argentina, in automobile parts, for example. But more importantly, Argentina will need to promote capital-intensive sectors to achieve its target growth level and ensure this is sustainable. Argentina’s labor productivity growth has, however, been especially disappointing since 2000. Research indicates that the majority of GDP growth in Argentina over the past 50 years has come from capital accumulation. This is somewhat typical for a developing economy but the lack of meaningful productivity expansion is worrying.

Inflation has also been a recurring thorn in Argentina’s side. But with the assistance of a now independent central bank the stubbornly high level of inflation is starting to come down. The central bank has been cutting rates as inflation falls, trying to achieve a balancing act between a further reduction in inflation and a stabilization of the financial system while kick-starting the economy. The inflation target of 12% to 17% for the end of 2017 is widely thought to be unrealistic – it’s unlikely to fall below 20%, especially as rising energy tariffs will probably increase annualized inflation by 2% in 2017. The long-term target (by 2019) is 5%.

Reining in inflation will also have a positive effect on the Argentine peso which could be a drawback for foreign investors. But the central bank is sending out a strong message on targeting inflation. Many Argentinians also apparently shop over the border in Chile to take advantage of prices that are almost half what they are at home. These sales represent as much as 10% of the total revenues of Chilean department stores but this could move back to Argentina if the pricing environment normalises.

 

Fabiana Fedeli is senior portfolio manager, Emerging Markets, and Paul Murray-John is portfolio manager, Robeco Emerging Debt

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