Sat | Dec 14, 2019

Commentary: Argentina: A moment of sobriety

Published:Friday | May 15, 2015 | 12:00 AM
Casa Rosada, the Presidential Office Building, in Plaza de Mayo.

THE MARKET is delirious about Argentina. Companies that can't make payroll have seen their share prices soar since the start of the year. Defaulted government bonds are trading above par and non-emerging market hedge funds are pouring billions of dollars into the country.

Scores of high-yield investors have deplaned at Ezeiza looking for opportunities. Brokers and investment banks that couldn't say anything positive about Argentina for years have it as their top pick.

Yet, the country faces serious challenges. On the surface, the situation is relatively easy to fix. The main problem is the energy subsidies, which the government finances through monetary expansion.

With a fiscal deficit that will top seven per cent of GDP in 2015, this is what is fuelling the massive inflation rate. Although the official inflation estimate remains low, consumer prices are roaring ahead at a pace of almost 40 per cent y/y. This is wreaking havoc with the exchange rate, destroying the country's competitiveness and forcing the central bank to resort to capital controls. It seems that solving the subsidy issue addresses everything. Yet, it won't be so easy.

The energy subsidies are the product of the maxi-devaluation of 2002. Under the privatisation scheme, the utility companies were allowed to set their tariffs in dollars. This was not an issue at the time because the country was using the Convertibility Plan that basically dollarised the Argentine economy.

Unfortunately, the sovereign default and the maxi-devaluation in 2002 sent the exchange rate to 4:1. This would have quadrupled electricity rates in the midst of a massive recession and ignited social unrest. The government decided to break the privatisation contracts and freeze electricity tariffs. It was only a matter of time until the utilities became insolvent. It also decided to keep them afloat through a series of subsidies.

The main target of the subsidies was the working poor of the greater Buenos Aires metropolitan area. They are the core electoral base of the Peronist party. This is why the government was always loath to remove the price supports. Today, most of these households have taken for granted that energy is virtually free.

Some foreign analysts believe that the incoming administration will eliminate the subsidies with a stroke of the pen, remove the exchange rate controls overnight and negotiate with the holdouts in less than a week. But, it won't be so simple. Two of the leading presidential candidates are Peronists. Therefore, how can they expect to implement a reform that will cripple their core constituency and expect to win the race?

Moreover, such a scenario would send the economy into shock and trigger a deep recession. The man on the street will see his utility bills multiply tenfold, while a US hedge fund enjoys a windfall of a similar magnitude. The result will be riots in the street. Argentine investors understand this dilemma very well, and they use it to temper their optimism.

what will trump what?

The question is, what will trump what? Will the economic and political realities trump the tidal wave of money that will fly into the country? Or will the capital inflows wait for the economic and political challenges to play out? This is clearly a market that wants to believe in Argentina.

People are tired of Brazil, and they want something new. People are, similarly, jaded with Chile, Peru and Colombia. Chile has become a cesspool of petty corruption that has tainted the reputation of its most trusted companies and industrial families.

Overnight, the market realised that Chile was just as Latin as all of its neighbours. Investors are also saturated with Peruvian names. A surge of new corporate issuers hit the market over the last year, and it will take some time to digest.

Last of all, everyone knows that Colombia is a consumer credit time bomb that will soon explode. Therefore, Argentina's low corporate and sovereign leverage is very attractive.

The dearth of investment over the past decade means that there is an infinite array of opportunities. A look at the Buenos Aires skyline says it all. While the cityscapes of S„o Paulo, Mexico City, Santiago and Panama reveal the gleaming glass and steel edifices that define the 21st century, Buenos Aires is a motley collection of the architectural styles of the 1970s. Property developers will descend in hoards to rip down entire neighbourhoods and erect new temples to finance, industry and technology.

There is a good chance that the tidal wave of capital inflows may be enough to offset the country's challenges. Perhaps the government may be able to delay the energy reforms with the inflows that will arrive, and the influx could also stabilise the currency as the central bank lifts its controls. This, in turn, would temper the inflation rate.

Of course, such a scenario is a postponement of the inevitable, and it would not address the economy's major flaws. However, it may be a sobering view of what lies ahead.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.