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Macroeconomic Outlook - Argentina

An overview of Argentina’s economic fundamentals and the drivers of growth going forward

Oct 28, 2016 // 2:11PM

How is the current GDP performance of Argentina looking? How strong is its growth outlook and what factors could affect this?

The current outlook on Argentine GDP performance is not particularly positive. According to research from Capital Economics, the economy is contracting by 2-3% year-on-year at present, and this recession is likely to continue for the next few quarters.

Both interest rates and inflation are high, with the main policy rate currently at 27.75%. This means that policy tightening will wait on consumer and domestic demand over the coming quarters.

However, the outlook for the medium-term is more positive. Macri has implemented a number of economic reforms, which included devaluing the peso so that the currency is now free-floating. Macri has also pared back capital controls and controls on imports, and has cut various tariffs within the export sector such as agricultural tariffs, which should lead to a pick-up in export revenues over the coming years, as well as an increase in investment.

Looking ahead, lower inflation, higher levels of investment and a cheaper currency should lay the foundations for stronger economic growth from 2018 onwards.

Which areas of the country’s economy have a strong outlook? Which have a negative performance outlook going forwards?

Sector wise, the export-led sectors are expected to do well, such as manufacturing and agriculture. These areas of the Argentine economy suffered heavily over the past decade under the previous Kirchner government, from policies it implemented that included high taxes on commodities such as soy beans and grains.

These taxes have however since been lifted and therefore it is expected that such sectors will begin to perform increasingly well, particularly now that the country’s currency is much more competitive.

Consumer-facing sectors are likely to perform less well. In the past, consumer spending had been incredibly strong, and had been one of the key drivers of the country’s economy. Under the previous government, fiscal and monetary policy was overly-loose, and was partly why Argentina developed its current problem with inflation.

Consumers are now likely to be under continued pressure primarily because economic policy such as fiscal and monetary policy will have to be much tighter than in the past, particularly if inflation falls, meaning that consumers and consumer facing sectors, although having boomed over the last decade, are unlikely to be the key drivers of the recovery.

What risks are currently affecting Argentina’s economy, what hurdles could the economy face in the near future?

The big risk for Argentina going forward is the country’s fiscal position. At present, President Macri and Finance Minister Alfonso Prat-Gay have started a process of fiscal consolidation, meaning that spending has been cut modestly. However, progress has been slower than expected.

Macri had also announced utility subsidy cuts earlier in the year, primarily to gas and electricity tariffs. These had encountered a lot of opposition, and some of them have been overturned by the country’s Supreme Court because of various protests by consumers, and by the fact that these consumers were not properly consulted before the cuts.

As a result, the subsidy cuts have been delayed until later in the year. Although the fiscal impact of the suspension of these cuts is not likely to be hugely significant, it does demonstrate that Macri’s fiscal agenda is facing political hurdles.

There is an additional risk that Macri’s fiscal agenda could be watered-down further, which would lead to difficulties in implementing a number of other measures aimed at substantially cutting government spending to bring the budget deficit down.

If the budget deficit remains high, it will be a big concern for investors, particularly with mid-term elections coming up next year. There will be a lot of pressure on Macri to hold onto his support base, and pressures may mount to loosen the purse strings next year.

What are the main drivers of the Argentine economy? Are there any new drivers that could come into effect going forward?

In the past, under the Kirchner government, the two main drivers of the economy were private consumer spending following an extremely loose fiscal policy and government spending. The latter of these two has been particularly strong, and state spending as a share of GDP has risen very quickly.

The strength of these drivers has been at the expense of other factors such as net trade under the Kirchner government, and net trade has been a drag on growth in the sense that exports have performed poorly and strong domestic demand had also caused imports to rise.

Overall, despite the fact the economy is in recession, the large drivers of the economy are expected to be export led sectors such as agriculture and manufacturing, whilst other, previously strong drivers, such as government spending and private consumption will take more of a back seat in terms of driving growth going forward.

What is the outlook for the performance of the Argentine peso going forward? What will influence it? How is monetary policy likely to play out in the coming months?

The Argentine peso was devalued in December and since then it has depreciated slightly, but has remained relatively stable and has broadly traded in line with sentiments regarding other emerging market currencies, even appreciating slightly over the last couple of months.

However, over the next few years it is expected that the Argentine peso will depreciate further, mainly because high inflation will mean that the nominal exchange rate has to weaken just to maintain its external competitiveness against its trading partners.

The currency is expected however to make a general recovery in 2018, as investment begins to pick-up and the outlook on the country’s economy improves, which will support the peso over the medium-term.

Although the big moves in the currency have now happened, including the 35% drop against the dollar in December, any future moves are expected to be slight. The peso is expected to fall by around 5-10% over the next year, and then appreciate by about 5% in 2018.

To what extent could political factors and legislation impact the country’s economy?

Political factors have a significant potential to hamper the country’s recovery process. The deep recession is also only going to exacerbate the problems the country faces. Macri has enjoyed some support in Congress, but that could begin to wane with elections on the horizon, and the recession has already dented Macri’s popularity amongst the electorate.

The main way this will impact policy is through the fiscal position. The big outstanding reforms for Macri are fiscal-related ones, and he needs Congressional support for them.

Although Macri is able to devalue the peso through allies in the Central Bank who could lift capital controls and export tariffs, without Congressional approval cutting government spending and raising gas tariffs will not be possible, and these are the reforms that are currently in gridlock.

How are current levels of corporate and sovereign debt leverage looking? How is this likely to change in the future?

The fact that the sovereign has effectively been locked out of the international capital markets for the past 15 years means that debt levels are relatively low, particularly regarding the country’s FX debt. Although the sovereign’s US$16.5bn issuance in April amounted to 3% of GDP, the government’s dollar-denominated debt is still low, with the majority being denominated in local currency.

However, the local currency debt owed by the government could still be of concern if the fiscal position does not change. Unless government spending is cut substantially and the fiscal deficit falls, total government or public sector debt could continue to rise on an unsustainable path.

Unless the government deficit falls, public sector debt will continue to rise, reinforcing concerns over the country’s fiscal position. However, regarding the corporate space, debt levels, and particularly dollar-denominated debt levels, are relatively low.

To what extent has the depreciation of the peso impacted the country’s ability to repay its dollar-denominated debts?

In theory the depreciation of the peso would make repayments of dollar-denominated debt more expensive, and any entities owning dollar debts before the peso’s depreciation will have seen their repayment costs increase by about a third.

However, the devaluation was well signalled to the extent that any entities with outstanding dollar-denominated debts would have been able to pay-down any such debts they had before the peso’s devaluation. Furthermore, any entities with a revenue stream in dollars, such as export companies, mitigate the risk of their dollar-denominated liabilities through a natural hedge.

Overall, although the depreciation could cause NPLs to spike, but there has not yet been any noticeable change on this front.

Americas Macro Argentina

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