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Argentina - Economy

Why is Argentina perpetually subject to crises? The country of 43.4 million people has a literacy rate of over 98 percent, enormous natural resources, a vibrant export-oriented agricultural sector and a diversified industrial base. Yet it has defaulted on sovereign debt eight times, experienced a massive economic depression from 1998 to 2002 and weathered repeated monetary crises. The country has gone through boom periods as well. It rebounded from its most recent crisis in 2002 - which resulted in an $82 billion (72 billion euros) sovereign debt default - with six years of growth at an average of 8.5 percent.

"Macroeconomic policy tightening will subdue growth in 2016," according to The Economist Intelligence Unit, an economic think-tank associated with The Economist magazine. "But combined with improvements to the business environment, it should set the stage for higher rates of growth in the medium term of over 3 percent per year." The Economist Intelligence Unit expected inflation to drop from the current 30 percent to below 10 percent over the course of the next couple of years, as Argentina returns to issuing dollar-denominated bonds on global markets. Argentina agreed 18 February 2016 to pay two creditors more than US$1.1 billion to resolve claims over defaulted debt, as part of the country’s efforts to resolve long-running litigation over its 2002 default, court papers filed yesterday showed. Billionaire investor Kenneth Dart’s EM would receive US$849.2 million, after agreeing to participate in Argentina’s proposal to resolve the litigation for US$6.5 billion. Montreux Partners LP, which along with EM Ltd was among six leading bondholders at the centre of efforts by Argentina to settle the legal battle, will be paid nearly US$298.7 million.

The offer represents a 27.5 percent to 30 percent discount for creditors who filed claims of about US$9 billion. The settlements were conditioned on the approval of the Argentine Congress — which has to lift the Padlock Law and the Sovereign Payment Law — and the lifting of injunctions in the litigation by US courts. While the offer was accepted by EM and Montreux, four other leading creditors including Elliott Management’s NML Capital and Aurelius Capital Management had not accepted the offer yet.

On March 31, 2016 Argentine lawmakers approved a deal that would repay billions of dollars to the country's foreign creditors, ending a 15-year legal battle that had made the South American country a global financial pariah. The Senate approved the plan by a vote of 54-16 after 14 hours of debate. The deal calls for Buenos Aires to pay nearly $5 billion to resolve claims made by a group of US-based creditors that held billions of dollars in Argentine government bonds, which the nation defaulted on in 2001.

By 2015 Argentina's economy, Latin America's third largest, stalled. Argentina’s economy had not grown for the past three years. Inflation was around 30 percent, gross domestic product growth was just above zero and many private economists warned that the Fernandez administration's spending was not sustainable.

Luis Caputo, Finances Secretary, announced that a plan to to resolve the country's legal dispute with US creditors over unpaid debt would be submitted on 25 January 2016. He made the statements 13 January 2016 in New York, after holding the first meeting with representatives of vulture funds, over the settlement of defaulted debt.

In connection with the holdouts, who won a trial in New York over papers defaulted in 2001, Finances Minister Alfonso Prat Gay gave a press conference in Buenos Aires today, and said the total debt climbs to almost 10 billion dollars. He blamed the previous administration for letting that figure to balloon up, because of a refusal to negotiate with holders of defaulted bonds, who stayed out of the 2005 and 2010 debt swaps accepted by more than 93% of creditors.

According to a report from CTA economist Claudio Lozano at the Ipypp public policy institute, unemployment was likely to rise above 10 percent in 2016, following dismissals both at the public and private sectors. That number would be markedly above the last official unemployment figures released by INDEC, although those numbers were highly questioned even by economists close to the government. INDEC said in November 2015 unemployment stood at a record-low of 5.9 percent, the best mark since 1987, despite four years of little or no economic growth. Economists have repeatedly spoken of hard-to-explain plunges in the official number of people actively looking for a job, which are the only ones who count as unemployed. Private analysts said unemployment could be at eight to nine percent by late 2015.

According to the Consumidores Libres NGO, basic foodstuffs were up by 1.62 percent in the first 15 days of 2016. The NGO led by former lawmaker Héctor Polino said the product that rose the most in his basket was minced meat at 15.5 percent, followed by cooking oil (10.5 percent), chicken (7.6 percent) and coffee (7.4 percent). Some prices did go down, although most of them were fruits and vegetabes, which are subject to big price swings due to seasonal variations. The symbolic kg. of asado was also 2.8 percent down after bouncing back from massive hikes at the end of 2015. Overall, food prices could end gaining around three percent in January 2016 if the trend continued. That would be slower than December 2015, when the basic food basket was up by 4.7 percent, but would still represent hikes comfortably above the inflation targets set by the government.

Foreign exchange restrictions had propped up the official value of the peso since 2011. The exchange controls were hurting exporters, denting productivity and distorting the economy. The restrictions were enacted by previous left-wing leader Cristina Kirchner to combat tax evasion and stop capital flight, but resulted in a considerable gap between official and "black market" exchange rates.

At the end of 2015 the dollar was worth less than 10 Argentine pesos at the official rate, but nearly 15 pesos on the black market. The most realistic exchange rate at the moment was the "blue-chip swap" rate, used to buy Argentine assets traded abroad, which was around 14.2 pesos per dollar, compared with the official exchange rate of 9.8275.

Macri promised to immediately lift unpopular controls on the purchase of US dollars and thus eliminate a booming black market for currency exchange. Doing that would likely lead to a sharp devaluation of the peso, with serious social impact. Inflation could soar and the purchasing power of wages could be destroyed. On 17 December 2015 the official exchange rate in Argentina rose more than 40%, from USD/ARS 9.80 to 14.00.

Inflation expectations had already pushed prices, some say, about 40 percent higher in the last couple of weeks of 2015. Supermarket prices shot up in early December in anticipation of the devaluation.

Macri, who won the backing of the farm lobby with a broad free-market platform, has promised to eliminate corn and wheat export taxes and ditch the quota system that controls international shipments of both crops, reports Reuters. The move would eliminate export taxes put in place to ensure domestic food supplies at cheap prices.

At the time of the Great War, Argentina was one of the world’s richest countries, with an income per person higher than France, Germany, or Sweden. Today it is a poor country. Argentina has experienced long-term economic growth, but it has been sluggish.

Following the failure of last-ditch talks between Argentina and holdout hedge funds on 30 July 2014, Argentina’s economic minister said his country would "imminently be in default" of its debt. Argentina continued to owe debt to private bondholders. Ninety-two percent of the defaulted USD 82 billion of private debt had been swapped for a mix of new bonds with a substantial loss in net present value. These creditors agreed in 2005 and 2010 to write off 70 percent of the money they were owed. Some hedge fund bondholders, known as the “holdouts,” did not participate in the swaps and continued to pressure Argentina via the US courts to settle its outstanding debt for the actual amount they are owed plus interest.

By July 2014 Argentina said it would make another effort to reach a deal with a group of US creditors to avoid a possible default on its debt, the second in 13 years. A US federal judge did not allow Argentina to make a scheduled payment to those bond holders unless it paid the hedge fund creditors as well. Argentina was in a bind because it could not pay some bondholders different amounts without getting sued.

It was not immediately clear how the default would affect the Argentine economy, already in a recession and with one of the world's highest inflation rates. The US credit ratings agency Standard & Poor's downgraded Argentina's long- and short-term foreign currency credit rating to so-called "selective default" Wednesday. Selective default acknowledges that Argentina is current on payments to some creditors and is probably able to make some payments on the debt it had defaulted on.

By 2014 Argentine President Cristina Fernandez's government was struggling with high inflation, anemic economic growth and falling central bank reserves. Argentina’s economy slid into contraction in the January to March quarterfor the first time in nearly two years as the country faced high inflation as well as weak exports to neighboring Brazil. Consumer prices climbed by 12.9 percent in the January to May period of 2014, while Argentina’s international reserves shrank by 25 percent in the previous year to $28.9bn. Argentina's inflation rate was estimated by many private-sector economists to be around 30% a year.

In January 2014 the US Federal Reserve began scaling back monetary stimulus, and investments began flowing back into advanced economies as interest rates began to rise. Argentina’s central bank chose not to intervene - resulting in the Argentine peso’s biggest depreciation in more than a decade. The contagion spread quickly to other emerging markets, leading some economists to call it the "biggest sell off in emerging market currencies since 2009." Argentina had domestic inflation that was running very high and was disguised by the official figures. By mid-2013 consumer prices in Argentina were rising by about 25 percent annually, while the peso currency's black market rate was 48 percent weaker than the official rate.

After several years of publishing non-credible statistics, Argentina’s official statistics agency (INDEC) released substantially revised inflation and GDP growth data that were closer in line with private estimates. The IMF had formally censured Argentina in February 2013 because of manipulation of inflation and GDP data. As of mid-2014, the IMF had not yet released its conclusions regarding its review of Argentina’s new data.

Argentina faced obstacles to growth in a number of other areas. The obstacles are well known inside and outside Argentina, and all have been the subject of extensive study.

  • Rule of law. Safeguards against takings of private property by the government are weak. The judicial system has a reputation for inefficiency and corruption. Violent crime became a big problem when the recession became a depression.
  • Tax strategy. Combining tax cuts with tax simplification and greater efficiency by the tax bureaucracy, Argentina could bring much of the underground economy above ground. It could change from a country that imposes high tax rates on a relatively narrow tax base to one that imposes lower rates on a broader base.
  • Federal-provincial financial relations. Federal revenue sharing weakens the link between the taxes provinces levy and the revenues they spend. The federal government had not been willing to get tough with provinces that are essentially bankrupt. As a result, the provinces face weak financial discipline.
  • Government spending. Spending on pensions and salaries of government employees, including superfluous employees, comprises a larger part of the budget than is desirable for a country at Argentina’s level of economic development. Many expenditures lack transparency.
  • Labor. Inflexible labor laws contribute to a high unemployment rate. Employers must pay heavy severance charges to fire employees, so they are less likely than employers in the United States to take a chance on hiring employees who may not work out. Argentina’s statistical agency estimates that 40 percent of wage earners work in the underground economy. (Many of these people have first or second jobs in the above-ground economy.)

Background

Argentina benefits from rich natural resources, a highly educated population, a globally competitive agricultural sector, and a diversified industrial base. Nearly 500 U.S. companies are currently operating in Argentina, employing over 155,000 Argentine workers. U.S. investment in Argentina is concentrated in the manufacturing, information, and financial sectors.

Argentina has a history of chronic economic, monetary and political problems. After achieving independence from Spain in a war that began in 1810, Argentina’s provinces fought among themselves for many years, and no stable nationwide government existed until 1862. Until the late 1800s the provinces and the national government often financed budget deficits by printing money. The results were persistent inflation and low economic growth.

In the late 1800s and early 1900s, Argentina enjoyed rapid economic growth founded on rising exports of beef and wheat to Europe, made possible by the new technologies of railroads and refrigerator ships. During the 1930s, when important trading partners discriminated against Argentine exports, Argentina responded by beginning a switch to “import substitution”—a largely closed, self-sufficient economy, with high tariffs and extensive government direction. The result was low growth and frequent inflation. Inflation was typically in triple digits from 1975 onward.

In 1989, Carlos Menem became president. After some fumbling, he adopted a free-market approach that reduced the burden of government by privatizing, deregulating, cutting some tax rates, and reforming the state. The centerpiece of Menem’s policies was the Convertibility Law, which took effect on April 1, 1991. It ended the hyperinflation by establishing a pegged exchange rate with the U.S. dollar and backed money issued by the central bank substantially with dollars.

The East Asian currency crisis of 1997-98 and the Russian currency crisis of August 1998 made investors in developed countries much more cautious about investing in developing countries generally. Brazil, Argentina’s largest trading partner, experienced a currency crisis from August to October 1998. After years of gains, Argentine-Brazilian trade was flat in 1998 and shrank in 1999. In 1998, Argentina entered what turned out to be a four-year depression, during which its economy shrank 28 percent. Argentina’s experience has been cited as an example of the failure of free markets and fixed exchange rates, among other things. The evidence does not support those views. Rather, bad economic policies converted an ordinary recession into a depression. Three big tax increases in 2000-2001 discouraged growth, and meddling with the monetary system in mid 2001 created fear of currency devaluation. As a result, confidence in Argentina’s government finances evaporated.

In a series of blunders that made matters even worse, from December 2001 to early 2002, succeeding governments undermined property rights by freezing bank deposits; defaulting on the government’s foreign debt in a thoughtless manner; ending the Argentine peso’s longstanding link to the dollar; forcibly converting dollar deposits and loans into Argentine pesos at unfavorable rates; and voiding contracts.

Since about August 2002 the economy recovered. The exchange rate stabilized and even appreciated. Unlike the last severe bout of currency depreciation, in 1989, inflation did not spin out of control; the consumer price index rose 41 percent in 2002 and inflation may be in single digits in 2003. Production bottomed out, some export sectors began to expand, and by mid 2003 the recovery had become pronounced.

The move after the 2001-2002 crisis to a more flexible exchange rate regime, along with sustained global and regional growth, a boost in domestic aggregate demand via monetary, fiscal, and income distribution policies, and favorable international commodity prices and interest rate trends were catalytic factors in supporting 5 consecutive years of greater than 8% annual GDP growth between 2003 and 2007.

In March 2008, the federal government introduced a new tariff regime, which effectively set a maximum price for crops. This sparked widespread strikes and protests by farmers, including a 21-day strike in which, among other things, roadblocks were set up throughout the country, triggering Argentina’s most significant political crisis in five years. As a consequence of the protests and the subsequent lack of support in the Senate for the tariff, the federal government abrogated the regime of sliding-scale export tariffs.

In December 2008, the Argentine government transferred the approximately U.S.$29.3 billion in assets held by the country’s 10 private pension fund management companies (Administradoras de Fondos de Jubilaciones y Pensiones, or AFJPs) to the Government-run social security agency, or ANSES. AFJPs were the largest participants in the country’s local capital market. With the nationalization of their assets, the local capital market in Argentina diminished in size and is now concentrated in the hands of the government. In addition, the government became a significant shareholder in many of the country’s private companies. The nationalization of the AFJPs has adversely affected investor confidence in Argentina.

Economic recovery enabled the government to accumulate substantial official reserves (over $51 billion as of late August 2010). The reserves, combined with the absence of fresh borrowing from the international capital markets, helped insulate the economy from external shocks. A higher tax burden, improved tax collection efforts, and the recovery's strong impact on tax revenues supported the government's successful efforts to maintain primary fiscal surpluses since 2003.

Global financial turmoil and rapid declines in world commodity prices and economic growth during 2008 and 2009 resulted in diminished domestic growth in 2008 and a mild recession in 2009. These factors as well as some changes in trade policy in late 2008 and in 2009 had an impact on foreign trade, with imports and exports falling 32% and 20% annually, respectively, in 2009. While the economic downturn was less severe in Argentina than elsewhere, the deterioration of both domestic and international demand complicated the fiscal situations of both the federal government and the provinces. The global economy’s current recovery is helping to ameliorate some of those pressures.

Official figures show that Argentine GDP reached U.S. $380 billion in 2010, approximately U.S. $9,400 per capita, with investment increasing an estimated 10% for the year and representing approximately 22% of GDP. Analysts estimate that 2010 GDP growth was 7.5%. Government of Argentina statistics showed unemployment was 9.7% in 2010. Poverty dropped in the aftermath of the economic crisis of 2001-2002, after it reached a record high of over 50%. In 2010, the official poverty level was 12%. Some unofficial estimates suggest that unemployment and poverty levels may be higher.

Foreign trade was approximately 31% of GDP in 2009 (up from only 10% in 1990) and played an increasingly important role in Argentina's economic development. Exports totaled approximately 18% of GDP in 2009 (up from 15% in 2002), and key export markets included Brazil (18.78%), EU (17.7%), China (9.26%), U.S. (6.38%), and Chile (7.11%). Two-way trade in goods with the U.S. in 2009 totaled about $9.4 billion according to the U.S. International Trade Commission. Total two-way trade in services in 2009 was $5.1 billion (according to the Bureau of Economic Analysis, U.S. Department of Commerce). The production of grains, cattle, and other agricultural goods continues to be the backbone of Argentina's export economy. High-technology goods and services are emerging as significant export sectors.

Continuing Argentine arrears to international creditors and a large number of arbitration claims filed by foreign companies are legacies of the 2001-2002 economic crisis that remained to be resolved. Outstanding external debts included over $6.3 billion (not including interest and penalties) owed to official creditors according to Government of Argentina statistics, including about $500 million owed to the United States. 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, leaving approximately $6 billion in private default claims still outstanding.

Between 2003 and 2012, GDP doubled, with an average annual economic growth rate close to 7.2 percent, which constituted the highest average growth rate achieved in the country’s economic history for such a long period. More importantly, this unparalleled economic growth wasn socially inclusive, reflected in a clear reduction in poverty, unemployment, and inequality, making Argentina’s GDP PPP per capita one of the highest in Latin America.

Between 2003 and 2012, Argentina's government strongly believed that equality was an important ingredient in promoting and sustaining growth. Since 2003, key components of Argentina’s growth model were the creation of quality jobs, the progressive reduction of inequality, social inclusion and better income distribution. During this period, 64 percent of new firms were set up; that is, almost 200,000 firms in industry, commerce and other services. Around 500,000 new jobs were created each year, and unemployment thus was reduced by 67 percent, decreasing from 18 percent in 2Q 2002 to 6.9 percent in 4Q 2012, with a strong increase in employment formalization.

The number of workers with a formal job paying social security contributions grew by 92 percent during this ten-year period and the minimum wage grew to be the largest in Latin America. In turn, the average real wage increased by more than 37 percent and, as a consequence, the participation of wages in total income which was on average 40.2 percent in the period 1993-2001, increased to 54 percent in 2012. The end-result was a historic increase in living standards, which is reflected in the doubling of the middle-class between 2003 and 2009, as found by a report by the World Bank. The report shows that in 2003, only 24 percent of the population, that is 9.3 million inhabitants, were part of the middle class, whereas in 2009, the middle class increased to 46 percent of the population, which is 18.6 million inhabitants.

Argentina's exchange rate policy was based on a managed float, with an average exchange rate of 3.89 pesos per dollar in 2010. The rate in early June 2011 was 4.10 pesos per dollar. According to market analysts, the peso's real exchange rate has been undervalued in previous years, which, when combined with high global commodity prices, helped lift export volumes and values to record levels. Argentina had a $1.82 billion trade surplus in early 2011.

After a 9.2 percent growth rate in 2010, and 8.9 percent in 2011, in 2012 the economy only grew by 1.9 percent in a context of a persistent drought that impacted heavily on agricultural output. Strong economic activity recovered in 2013 presenting for the seven first month of the year a 5.7 percent growth rate year-on-year, fueled by the construction and industrial sectors, a good harvest and growing exports. Exports grew by 5 percent during the first 6 months of 2013 compared with the same period of 2012, while imports grew by 11.3 percent, the trade surplus accounted for almost US$ 5 billon.

By late 2013 inflation was estimated by private economists at around 25 percent, while foreign exchange controls had cut access to US dollars, Argentina's traditional currency of choice for savers. The peso currency's black market rate is about 50 percent weaker than the official rate. Import controls made it hard for some businesses to get basic supplies needed for production. President Cristina Fernandez increased the role of the state in Latin America's No. 3 economy and is roundly criticized by business for imposing heavy trade and foreign currency market regulations that hurt investor confidence.





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