MACROECONOMICS

Macroeconomic Analysis of Argentina

Faculty: Prof. Jaydeep Mukherjee

Group 7
Abhilash K. (01)
Anant Bibhore (08)
LamzoulianVaiphei (30)
Prasanna Nakka (41)
Ranjit Ram (49)
Supratik Saha (61)

IIM Raipur Batch – 1 PGP 2010-12

Argentina -- A socio-political-economic Overview

Pre – Independence: Argentina is the eight largest country of the world spread
over an area of almost 28 lakh square Km. Inhabited from almost 11,000 BC the
country was relatively sparsely populated until the arrival of the Europeans in the
16th century. Juan Diaz de Solis is credited to have been the first European to visit
the area presently known as Argentina. The Spanish established a colony in
Argentina around 1580. Napoleon’s Spanish conquest triggered a revolution in
Argentina in May 1810, popularly known as the May revolution. Argentina made a
formal declaration of independence in the year 1816. 85% of modern Argentina is
inhabited by the descendants of immigrants from Europe, the remaining being
Mestizos, indigenous Americans and others.

Golden Age: Soon after the declaration of independence, a civil war wrecked the
country and Paraguay, Bolivia and Uruguay seceded to form separate nations.
Political instability continued till the formation of the constitution in 1853. A
national unified government was established in 1861. Post-unification, Argentina
witnessed a developmental spree and emerged as one of the ten wealthiest
countries of the world by 1929. This period in the twentieth century is referred to
as the ‘Golden Age’ of the Argentine economy. GDP growth averaged around 5%
during this period. This economic prosperity of the country could be attributed to
the following key reasons:

a) Rich Natural resources

b) Introduction of modern agricultural techniques
c) Integration of the country into the world economy
d) Investment flowing in from Europe and
e) The labour put in by the huge numbers of migrant workers largely from
Europe

Great Depression and the Downfall: The country witnessed a rapid economic
downturn after the effects of the Great Depression hit the country. This process
of downturn continued as the country witnessed decline in status and prestige,
although it possessed abundant resources. For much of this period to the 1970’s
political power was held alternately by military and civil governments. Though
there are multiple theories which try to explain this downfall of the Argentinean
economy no consensus exists. But the major reasons and effects include:

a) Huge foreign debt

b) Excessive regulation
c) Weak rule of law
d) Barriers to free trade
e) Persistent fiscal and current account deficits
f) Consistent High Inflation

Dirty War in the 1970’s: During the 1970’s the country witnessed the ‘Dirty
War’ after the military seized power from the widow of Juan Peron, who had
started the Partido Unico de la Revolucion popularly known as the Peronist. From
1976 to 1983 Argentina remained under a military dictatorship and in attempt to
curb the extremists the military took very harsh measures. Large numbers of
deaths and disappearances were reported during this period and the economy
remained in chaos. Serious economic problems, mounting charges of corruption,
public revulsion in the face of human rights abuses and, finally, the country's
1982 defeat by the United Kingdom in an unsuccessful attempt to seize the
Falklands/Malvinas Islands all combined to discredit the Argentine military
regime.

Return to Democracy in the 1980’s and the hyperinflation: Democracy

returned to the country and the process of political reforms was started.
Democratic institutions were consolidated and a civilian control over the armed
forces was imposed. But the economical conditions worsened. GDP growth
averaged at a negative throughout the 1980’s at an average rate of -0.5%. A
deep recession brought in hyperinflation and the process of production and
circulation of goods ceased to function in a regular manner. The government lost
popularity and after the election in 1989 Saul Menem of the Peronist Party came
to power.

The Menem Magic in the 90’s: Menem along with noted economist of the
period, Domingo Cavallo initiated imposed peso-dollar parity in 1992. This meant
that the peso was fixed vis-à-vis the US dollar on a one-to-one basis and this
convertibility was backed by codified law and a promise by the central
government to furnish dollars to anyone who wanted to exchange pesos. This
created an atmosphere of credibility in the steps taken by the government to
curb inflation. In addition to this the government took steps to promote
liberalisation, deregulation and privatization of the Argentinean economy. Soon,
inflation came down to single digit figures and in the period from 1990 to 1997,
the GDP of Argentina grew on average by 6% per year. By the end of the decade

The Argentinean Default: But, this peso dollar parity meant that the monetary
base had to be completely backed by foreign currency reserves. This effectively
disabled Argentina’s monetary policy. Also, the exports became less competitive
and vis-a-vis important trading competitors. As a result, Argentina’s ability to
earn hard currency was damaged. Argentina started borrowing heavily to finance
deficits. The global slowdown in 2001 hit the country and market confidence
deteriorated. The government was starved of foreign reserves and despite IMF’s
bailout attempts the Argentinean economy collapsed into default in 2001. The
political situation was thrown into turmoil as one president after another
assumed office and stepped down. The one-to-one pegging with the US dollar
had to end and 60% of the Argentines were left below poverty line.

The Aftermath: Things started improving again in 2003 when President

Kirchner assumed office. Expansionary monetary and fiscal policies and
rejuvenated exports triggered a rebound in GDP. Real GDP grew at an average of
8.5% annually from 2002 to 2007. However inflation continued to increase and
starting 2007 government started to understate inflationary data. Cristina
Kirchner succeeded her husband as President in late 2007, and this is when the
global recession hit the country. Though the recession was less severe in
Argentina, but GDP growth slowed to almost 0.8% in 2009. A high GDP growth
has resumed since 2010 and the economy is expanding by 8.5%.

GDP Growth Rate 1980-2011 (Data Source: International Monetary Fund, World Economic
Outlook Database)

Macroeconomic Performance of Argentina in the last 3 years

GDP in 2008-2009: Amid global recession in 2008 both domestic and

international demand plummeted and resulted in diminished growth in 2008
followed by a mild recession in 2009. Economic performance was also hit by a
severe drought during the agricultural season of 2008-2009. This complicated the
fiscal situations for both the central and provincial governments. In 2009
investments fell by 11% and private consumption fell by 0.3%. However, nominal
GDP of the country was about 320 billion US dollars in 2009. This resulted in per
Capita income in 2009 to be USD 7969. This makes Argentina an upper middle
class economy by World Bank standards.

GDP in 2010: Improved weather conditions favouring agriculture, global

recovery from recession and the continuing expansionary fiscal and monetary
policies taken by the government have helped to the rise in GDP in 2010. GDP
was supposed to have grown at about 7 to 8 % in 2010. Since 2006, investment
growth has been low as government interventions in the economy have led to a
policy uncertainty. Investment represented about 20% of GDP after increasing
about 10% in 2009.

Sectoral Allocation of GDP: Argentina has a diversified agricultural sector

which contributes to about 9% of the nation’s GDP while employing only 7% of
the labour force. This has been possible due to use of technology and favourable
farming conditions. Manufacturing accounts for one-third of the country’s exports
and thus projects a developed industrial sector. Industrial production accounts for
35% of the GDP and employs about 13% of the working populace. The country’s
infrastructure is developed and facilitates trade. Services account for the
remaining 55% of the GDP. It employs nearly 75% of the workforce.

Unemployment and Poverty levels: Data put forth by the Government shows
unemployment to be at 8.4% in 2009. Poverty has significantly dropped from the record high of 60%
during the crisis in 2001-02. But recent years has seen a rising trend in unemployment which has risen
to 13.2% in 2009. Some unofficial estimates suggest that unemployment and poverty levels may be
higher.

Unemployment Rate 2003-2010 (Data Source: International Monetary Fund, World Economic
Outlook Database)
Inflation: Official Inflation figures are very unreliable as the government has
tried to supress inflationary data. Officially customer prices have increased by
6.3% in 2009. Unofficial figures however have put the inflation of last year at
15%. Coupled with the recessionary pressures of the past year this is an
extremely high figure. Officially 2010 was an even more difficult year for
consumers as officially inflation was supposed to rise at 10%. Unofficial
calculations report the price increase to be at a whooping rate of 25% in 2010.
High inflation will have a toll on the real GDP increase in the coming years.

Inflation 2008-2011 (Data Source: International Monetary Fund, World Economic Outlook
Database)

Balance of Payments: The recession hit the Argentinean trade in 2009 as

exports fell drastically. There was a decrease in both the volume and prices of
trade and exports of goods fell by 19% last year. On the import side, high import
restrictions imposed by the government, depreciation of the national currency
and the weakened economy pulled down imports by about 34%. This higher
decrease in imports caused the trade surplus to rise. Current account balance
increased from 4.8 billion USD in 2008 to 6.1 billion USD in 2009. However with
decreasing exports and current account balance is expected to go down further
in 2011.
Decrease in FDI inflows was reported from USD 8.3bn in 2008 to USD 2.3bn in
2009. This was because a tendency of risk aversion among foreign investors and
uncertainty regarding future government policies. FII’s also decreased due to
similar reasons, shifting to a net outflow of USD 7.3bn in 2008. Debt inflows also
diminished in 2008 and 2009, mainly due to lower trade related short-term debt
inflows.

Current Account Balance 2008-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)

Exchange Rate: The Central Bank of the country intervenes in the exchange
rate even now though peso is no longer pegged at one-to-one to dollar and the
exchange rates are supposed to be floating. But, in reality the exchange rate is
determined by a managed float system. Average exchange rate in 2009 was 3.73
pesos per dollar. In September 2010 the rate was 3.94 pesos per dollar. The
peso's real exchange rate had been undervalued in earlier years, which, along
with historically high global commodity prices, helped lift export volumes and
values to record levels.

Debt Levels: The economic crisis of 2001-02 is still haunting the country in the
form of huge debts which are yet to be paid back. Debts in Argentinean Peso
have increased from 615 billion in 2008 to 675 billion in 2009. Estimated value of
debts in 2010 was a high 774 billion peso. It owes about 8 billion USD to official
creditors. International Capital Markets have been closed for Argentina since its
debt crisis. From May to June 2010, the Government of Argentina offered a debt
restructuring for private holders of defaulted bonds. Two-thirds of the private
bondholders participated. This has resulted in about USD 6 billion in private
default claims which is yet to be paid back.

General government gross debt 2008-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)
Fiscal and Monetary Policy: The Central Bank governor Martín Redrado was
removed by the government on his refused to transfer USD 6.6billion of foreign
exchange-reserves for public debt payments. The new Governor, Mercedes Marcó
del Pont, is a close ally of the government. So, it is expected that the Central
Bank will continue with its lose monetary policy instead of moves to tighten
liquidity. Also, the Central Bank might continue financing the fiscal deficit of the
government as and when necessary.
The government is following an expansionary fiscal policy with heavy
government spending. The expenditures are targeted at keeping the growth
rates high and close the average of 9%. The combined effect of expansionary
fiscal and monetary policies is bearing down on the prices which are on an ever
increasing trend.

Budgetary Deficits: As the government is following an expansionary fiscal it is

continually increasing spending and has increased expenditure by around 30% in
2008 followed by an additional increase of 10% in 2009. But, the tax revenues
have not increased proportionately as the recession slowed the growth in 2008
and 2009. In fact revenue increased only by 0.5% in 2009.This has resulted in the
constant decrease in the fiscal accounts. The government was successful in
clocking a budgetary surplus of 1.5% of GDP in 2008 merely due to the additional
revenues coming in like contributions for the pension funds and profit transfers
from agencies owned by the government. In fact in 2009 the budgetary deficit of
0.6% of GDP has been clocked.

Problems that the Argentinean economy will face in the next 3

years

1) High Inflation:

High inflation is a problem that the Argentine economy has been troubled
with from a long time and is likely to be a big problem for the economy in the
coming years. The central government has been reporting inflation rates at
around 9% on an average since 2006. But, private estimates put this number at
around 20%. So, it is a well-known fact in the global financial markets that the
government is underreporting the inflationary figures.

The steps taken by the government to control inflation have clearly not
been enough. Neither the fiscal policy undertaken by the government, nor the
monetary nor the managed float policy for exchange rates have done anything to
instil belief in the consumers and the industries that inflation is going to come
down in the coming future. On the contrary, inflation is following an increasing
trend and seems to growing at a year-on-year basis.

Such high inflationary figures are proving to be discouraging for investors

to pursue long term projects which would have otherwise provided long term
growth perspectives for the country. A lower inflation rate would have had
stimulated those long term investments, as investors would have perceived
better rates of return on those projects. As a result, currently investment in
Argentina is happening on a short term basis.

Needless to say, high inflation is hurting the poor in Argentina as food

prices and energy prices are growing exorbitantly and these are the purchases
necessary for survival. As a result there is a growing rift in income distribution
among the richer and the poorer sections of the society.

A proof of high inflation is seen in the wage revision demands voiced by

official government unions who are pitching for wage hikes in the range of 30%
and above. This solidifies claims by private agencies that actual inflation is much
higher than reported rates. Another indicative of disproportionate inflationary
rates is seen in the fact that the unions have demanded wage revisions every 6
months proving that food and energy prices are rising.

These demands put forward by the official unions are indicative of the
following problems:

1) Purchasing power of the Peso is reducing fast as the wage increments are
not being able to keep up with the price rise

2) Real GDP growth is slowing down as the prices of commodities keep

increasing thus hurting economic growth

3) A negative expectation is setting in the market regarding inflationary

figures which is pushing up inflation even further thus aggravating the
problem
 4) Markets and manufacturers are factoring their high inflationary
expectations into future prices and thereby driving prices even higher

2) Artificially undervalued currency

Though as a stated policy the exchange rate for the Peso is floating, in reality the
Central Bank is following a policy of managed float. So, whenever the currency tends to
appreciate due to a current account surplus the Central Bank buys dollars thereby
increasing supply of the peso. This is artificially making the current account surplus seem
reasonable.

The additional liquidity created in the market by supplying domestic currency is

pushing inflation even higher which was already a big problem in the recent times. This
aggravates problems as imports are becoming more and more expensive making life
difficult for the domestic industries.

To sterilise the injected liquidity the Central Bank is attempting to sterilise by

selling bonds to commercial banks. This is resulting in rising interest rates. High interest
rates are hurting the investment prospects and thereby bringing down the GDP growth.
So, the Central Bank’s exchange rate policy is working against one of its major objectives
– to bring down inflation. Again, the interest rates going higher is creating an interest rate
differential with the rest of the world thus attracting short term portfolio investments
which is tending to appreciate the currency even further. Thus, the primary objective of
the Central Bank in keeping the currency devalued by injecting liquidity is working
against itself aggravating the problem and is process is building up inflationary pressures.

Also, as the currency is tending to appreciate even further the competitiveness of

Argentine goods is decreasing in the global market vis-a-vis its competitors. This is
resulting in the exports getting hurt. This will result in the fiscal balance decrease in a
time when it has just started improving after the global recession.

Another policy followed by the government to manipulate the exchange rates has
been by taxing exports massively. The government is even banning exports in certain
cases and there are no guarantees that when international prices go down such bans are
likely to be lifted as the policy of taxing exports is not based on a particular rule. The
result is that it seems to the people that teher is no benefit in investing in agriculture or
agribusiness which forma bulk of the exports. Thus the government is hurting itself by
curbing future revenue prospects.
3) Huge Foreign debts

Argentine Government had borrowed heavily in the crisis period in 2001 to

finance the twin deficit. But, once it surfaced that the twin deficit may be come
unsustainable the investors quit along with their money. This resulted in foreign
debt which was almost 50% of the GDP in 2001.

This huge burden of debt has been a cause of concern on the Argentine
government ever since. The debt restructuring policy followed by the
government in the recent years has resulted in paying back of USD 100 billion of
debt. But, there a long way to go before the problem can be alleviated. The debt
in terms of domestic currency is on a rising trend even now. The country ows
about USD 6.3 billion to official creditors in different nations who are collectively
called the Paris club. The international capital markets are also closed to
Argentina before it can repay back a substantial amount of these debt
obligations.

But, as the government has rescheduled debt with the official creditors this
normally means that the government has to register for an economic program
with the international Monetary Fund. But, this will again prove to be a major
setback for the government which had recently in 2006 succeeded in paying
back USD 9.8 billion of IMF credit. If the government has to enter into a renewed
agreement with the IMF it has to go back on its previously announced victory
against the IMF. The Argentine government had only succeeded in repaying IMF’s
money as the Venezuelan president Hugo Chavez had stepped in to help.
Venezuela poured in the money earned from oil exports in bailing out Argentina
against the IMF. Venezuela also assisted Argentina to access the foreign financial
markets by underwriting USD 4 billion for Argentina through bonds. But, it would
be able to continue doing so if the oil prices fall in the near future.

Due to this very reason Argentina needs to improve its image with its
creditors. The country needs more funds than Venezuela has underwritten it for.
This can only be received once investor confidence is rejuvenated. But, the
history of default and consequent devaluation of the domestic currency is still
fresh in the memories of Wall Street and the other investors. This has severely
deteriorated the credit rating of the country and increased country risk. As a
result, Argentina has to pay much higher interest rates in international markets
and is expected to do so in the near future.

Also, the country has a recurrent problem in the form that many creditors
had held out against the debt restructuring scheme of the government. This is
because these creditors felt that the terms of the negotiation were tilted against
them. These creditors are constantly demanding that the government negotiate
a restructuring with better terms. So, all in all the debt crisis is harming the GDP
of the country as the investment required cannot be generated. So, it is in
Argentina’s interest to come to terms with all of its creditors and repay the
mounting debt as soon as possible.

Bibilography

1. Wikipedia - http://en.wikipedia.org/wiki/Argentina
2. World Economic Outlook Database, October 2010
3. Argentina Country Report 2006 by The Economist Intelligence United Ltd
4. U.S. Department of State Background Note on Argentina
-http://www.state.gov/r/pa/ei/bgn/26516.htm
5. Central Intelligence Agency - The World Fact book -
https://www.cia.gov/library/publications/the-world-factbook/geos/ar.html
6. Argentine Financial Crisis: Lessons Learned - INTERNATIONAL JOURNAL OF
BUSINESS RESEARCH, Volume 9, Number 5, 2009
7. Radobank Country Report Argentina -
http://overons.rabobank.com/content/images/Argentina-201004_tcm64-85825.pdf
8. Argentina - Macroeconomic issues -
http://globotrends.pbworks.com/w/page/14807636/Argentina%20-
%20Macroeconomic%20issues