Argentina’s unknown destination

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There’s an old joke about a tourist approaching a local to ask for directions: The local considers, sucks on his teeth for a while and replies “I wouldn’t start off from here if I were you”.

Argentina under president Mauricio Macri feels a little like that. The challenge his administration has had to overcome is one for the economic textbooks. But today, following a collapse in international investors’ confidence, that joke feels even more apposite.

Argentina’s inflation rate is around 25%, and it has no chance of hitting its 15% target for the end of the year. Inflation was already becoming unanchored before the peso fell to 25 to the dollar, and now there are pass-through effects to come.

Meanwhile, interest rates of 40% sit astride a slowing economy. Investment is still to show up in any meaningful way and, with these rates, inflation and a stricken currency, the outlook for the domestic and international capital flows needed to drive GDP growth isn’t good.

Tortuously slow

The so-far tortuously slow fiscal adjustment – just about do-able with 3%-plus GDP growth – will have to be sped up. Macri was desperate to avoid shock treatment in a bid to preserve his political capital. That equation, at least, was working. But now the IMF is back to haunt a country traumatized by its last intervention.

The political fallout from that and the necessary pain from fiscal tightening – cutting subsidies, reducing provincial spending and limiting public wages and pensions at below-inflation rates – creates real risk to his re-election bid next year. Some are predicting recession. The opposition smells blood. It’s an odour that will make international investors nervous, but whose dollars remain crucial to finance the government.

Luis Caputo-160x186

Luis Caputo

If Argentines are to re-elect Macri as their president, they need to see and feel the benefits of their country’s economic experiment by the time they head to the polls in October 2019. 

That means finance minister Luis Caputo and treasury minister Nicolás Dujovne have lots of work to do on the fiscal side to back up the central bank chair Federico Sturzenegger and get inflation down, and then (and only then) interest rates. They then have to hope investment begins to flow in time to get unemployment down and growth and wages up.

In the meantime, they need to find micro-reforms to boost productivity and the economy. There is some good news here in that there are lots of these reforms that can be done. And the interest rate burden at 40% isn’t necessarily a death-knell to the economy; adjusting for inflation it’s ‘only’ around 15%, while credit penetration in the economy is low at about 15.8% and therefore debt servicing costs should not become skewed.

Time – never Argentina’s friend – is now actively an enemy. It is as if the government was trying to dismantle the economic bomb Cristina Kirchner left for them and cut the wrong wire. Rather than being defused, the countdown clock has started to speed up.

It is not certain that the bomb will go off, but Euromoney would rather be watching the disposal team’s efforts from behind barricades than from alongside them.

The really scary point is that if domestic businesses and international investors start to feel that way too, there will be extensive damage.