|Lack of investment has been the key problem to the success of Mauricio|
Macri’s economic plan
President Mauricio Macri is pushing ahead with his attempts to reform the Argentine economy after his strong performance in the country’s mid-term elections.
The government’s proposed tax reform is the central policy driver for this economic improvement and, while analysts say it could invigorate growth, it could also complicate his finance team’s attempts to shrink the fiscal budget.
It also has some negative impacts for the profitability of Argentina’s banks.
The main change includes a gradual reduction in the corporate tax rate to 25% from 35% over four years and the lowering of employer social security contributions, as well as the introduction of new taxes on investment income for individual investors and on corporate dividends.
These reforms could lower tax receipts in the short term, although if they spark investment and economic growth the negative impact could be short lived – especially as the law also aims to improve the efficiency of the revenue service.
Lack of investment – particularly foreign direct investment – has been the key problem to the success of Macri’s economic plan. The main thrust of these reforms is to incentivize greater investment and more sustainable economic growth.
The government’s own figures suggest that the net impact on the tax cuts will be a loss of revenue in the first year worth 0.3% – and that figure includes projections for increased growth sparked by the tax cuts. Without higher growth, the new tax law would lead to a fall in tax receipts equal to 1.5% of the economy, clearly complicating the government’s target to reduce the primary deficit to 3.2% of GDP this year and to 2.2% in 2019.
UBS’s Argentina economist Rafael de la Fuente believes that fiscal deficit remains the government’s Achilles heel, saying: “If the authorities want to reduce interest rates and prevent further peso appreciation, while at the same time reducing inflation, we believe the central bank will need help from the fiscal side [and a] more rapid fiscal consolidation will have to be on the table.”
The government has already walked back its inflation targeting plan in the face of stubborn inflation and the necessity for high interest rates than the original targets implied – which were frustrating GDP growth and investment.
The central bank announced an increase in the 2018 target to 15% from 10% with a two percentage point band. The central bank then duly cut its main rate to 27.25% – a 75 basis point cut while the market was expecting 150bp.
A report by rating agency Moody’s articulates this problem, but sides with the government’s pro-growth agenda.
“Although government revenue will slip modestly as a result of the tax changes, which will complicate Argentina’s fiscal situation further, looking more broadly the reforms will increase the country’s competitiveness and stimulate investment, which are credit positive for the sovereign,” it states.
Meanwhile, Moody’s claims that the impact of the tax reform for the banking sector is negative. The most direct impact is a new investment income tax on interest earnings from individuals’ term deposits, which is negative for banks’ funding costs.
|Bank deposit breakdown as of October 2017|
As of October 2017, individuals’ term deposits accounted for 20% of Argentine banking system deposits and this tax will push up interest rates on those deposits, as well as slowing deposit growth as savers demand that banks offset the impact of the tax. These increased costs could reduce bank profitability and drive up lending rates.
Although the elimination of the tax exemption only applies to deposits from individuals, it will have a large impact as individual deposits make up 70% of total private-sector term deposits and 30% of total private-sector bank deposits in Argentina.
Moreover, individual deposits have driven term deposit growth in the past year, growing by 24% over the 12 months ended in October. Corporate term deposits grew 10% during the same period and institutional term deposits fell 27%. As a result, the total term deposit base grew only 17%, even as loans grew 51%.
“With loan demand likely to increase as the economy grows and inflation falls, banks’ ability to increase the volume and tenor of their term deposits will be an important means to limit their reliance on market funding,” says the Moody’s report, which also points out that this change comes at a time when the banking system is already struggling to increase its deposit base to fund rising loan demand as the economy continues to expand. Term deposits represent almost 30% of banks’ total funding.
However, the reduction of the corporate income tax rate coupled with the introduction of an offsetting tax on dividends could have an indirect positive impact on banks – in addition to the direct implications for banks’ own tax liabilities. Because these changes are positive for corporate profitability, they should improve the quality of banks’ loan portfolios and increase credit demand more generally.
This increase in credit demand might be tempered at the margin by a tax on dividends that will make earnings reinvestment more attractive relative to debt issuance and bank borrowing, which could lead to less demand for corporate bank loans.
Meanwhile, a new capital markets law is expected to be published in March that could have a bigger impact on the funding costs for bank – as well as creating new revenue opportunities.