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Saturday, April 13, 2024
CEOWORLD magazine - Insights - Argentina

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Argentina

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GDP: USD632.8bn
Population: 46.2mn
Form of state: Presidential republic
Head of government: Javier Milei (President)

Strengths:

• Rich natural resources (notably oil & gas)
• Highly literate population
• Diversified industrial base and services sector
• Major agricultural exporter – notably soya and wheat
• Large economy and domestic market, one of G-20 major economies
• Has made significant progress towards a digital transformation

Weaknesses:

• Structurally high, skyrocketing inflation
• Macroeconomic imbalances and weakened institutional framework
• Nine sovereign defaults, two in the past 20 years
• Capital controls in a context of recurring FX shortages
• Weak currency
• Political instability

Argentina has a troubled history of political and economic instability. In recent years, the country has undergone significant policy changes, resulting in macroeconomic stability. However, it is still characterized by high economic and currency volatility, recurrent debt default crises, and social tensions. During the pandemic, Argentina experienced a deep recession and a debt default. But with strong base effects, a recovery in agricultural exports, and a gradual reopening of the economy, Argentina saw a significant rebound in 2021 with a growth rate of 10.3%. In 2022, the growth rate reached 5.0%, driven by a strong performance in services.

The stimulus measures introduced after the pandemic gave significant support to the tourism and transport sectors. However, in 2023, due to an unprecedented drought and macroeconomic imbalances, the country is predicted to enter a recession. The situation is likely to continue in 2024 with a contraction of 2%, caused by the government’s measures to rebalance the macroeconomic picture, including fiscal cuts and currency devaluation. In the long run, the growth could be fueled by a more competitive business environment and increased investment encouraged by the fiscal consolidation wall. However, the uncertainties are still high, and we expect an average economic growth of 2.5% in 2025.

Argentina is also struggling with inflation, which has been rising since mid-2022 and has surged from an average of 48.1% yoy in 2021 to 211% yoy in 2023. The country is facing extremely low international reserves, and the public debt is still being financed by the Banco Central de Républica Argentina (BCRA). Additionally, the spread between the official and parallel exchange rates (e.g., the Blue Rate) remains high, exacerbating the situation.

The official exchange rate of USD to ARS has doubled since the beginning of 2023. However, it has been fixed at a rate of AR350 per USD since mid-August 2023, until it was devalued by the new administration to ARS800 per USD. This has resulted in a boost in currency competitiveness because the currency depreciation has exceeded inflation. Javier Milei is likely to favor keeping the peso weak as part of his plan to improve competitiveness. The inflation situation is uncertain, but it is predicted to worsen before it gets better, and it is expected to exceed 250% in H124. Further depreciation of the peso, along with government disengagement, particularly subsidy cuts, are likely to add to inflationary pressures before orthodox economic policies start to weigh on inflation. It will take several years for inflation to stabilize at lower levels, with a prediction of 70.0% yoy by the end of 2025 and 40.0% yoy by the end of 2026.

Javier Milei’s administration is attempting to address Argentina’s chronic fiscal imbalances by implementing fiscal austerity measures and improving the country’s external position. In line with Mr. Milei’s libertarian beliefs, subsidies to the public sector, public employment, and public investment should be reduced, along with a reduction in tax revenue, including income tax and VAT. The IMF, which reached an agreement with Argentina in 2020, should view fiscal consolidation positively. Following the Milei administration’s initial announcements, the IMF praised the “bold initial actions” and stated that “the new package provides a solid foundation for further discussions to bring the existing program back on track.”

Despite the restructuring of market debt in 2020, debt levels remain high and have increased significantly in the last two years, from 80.8% of GDP in 2021 to 89.5% of GDP in 2023. Argentina’s sovereign debt is particularly vulnerable to fluctuations in foreign exchange rates, as a large portion of the debt is denominated in foreign currency. Repaying the debt will continue to be a challenge in the medium-term due to limited access to capital markets, high yields, and an uncertain relationship with official creditors.

Recent data shows that Argentina’s trade balance has worsened, with a deficit of -0.59% of GDP recorded in Q1 2023 and a larger deficit of -3.27% in Q2 2023, in seasonally adjusted terms. The El Nino weather phenomenon has had a negative impact on the country’s production of agricultural products. However, it is expected that the current account will return to a surplus in 2024 (1.2% of GDP) after a -0.6% deficit in 2023. The proposed “fiscal shock” by Milei could help improve internal macroeconomic indicators, while the speculated end of the El Nino phenomenon may support the country’s current account through a rebound in agricultural exports.

It is important to note that Argentina’s current and capital accounts are highly distorted by various controls, including trade, financial, capital, price, and foreign exchange controls. Therefore, the stability of the balance of payments is largely relative, as these restrictions and extensive financial repression create significant limitations.

The business environment in Argentina is unfavorable due to strict capital controls that are highly sensitive to the country’s external position and history of expropriation. Although the current risks are lower, Argentina ranks poorly in the 2022 Heritage Foundation Index of Economic Freedom’s survey, ranking 144 out of 177 worldwide and 27 regionally. The country has low rankings in terms of property rights and monetary freedom, and even its strengths are comparatively poor. The 2022 Worldwide Governance Indicators survey highlights a decline in the country’s position, particularly in control of corruption and regulatory quality.

The recent rise of Javier Milei, who has an ultra-liberal stance and favors fiscal consolidation and privatization, could attract investors and potentially improve the situation. However, there are still weaknesses in Argentina’s sustainability, such as its low recycling rate and renewable electricity output, which are highlighted in our proprietary Environmental Sustainability Indicators of 2023. Although the country is not particularly vulnerable to climate change, it is poorly positioned in the race for the green transition, ranking 105 out of 202 for sustainability overall, supported by its low water stress levels.

Political tensions reached their peak as the economic situation worsened in 2023, leading to the rise of Milei to power on December 10th. Milei advocates for significant cost-cutting measures (-15% of GDP), the privatization of the healthcare and education systems, and a redesign of more than half of the ministries. He also supports the gradual dollarization of the economy and the abolition of the BCRA. Whether Milei will implement these “shock therapy” measures strictly is yet to be determined, as he enjoys relatively low support in both the lower house of Argentina (38/257 seats) and the upper house (7/72 seats). Additionally, popular opposition to his anti-social reforms is likely to be high, which could lead to risks to the country’s governability as time passes and Milei’s political capital fades. During the campaign, Milei stood out as anti-system, but he now has to prove himself if he wants to consolidate his position in the 2025 mid-term legislative elections.

CEOWORLD magazine - Insights - Argentina