Tue | Feb 18, 2020

Argentina: Darkest before the dawn

Published:Friday | March 15, 2019 | 1:40 AM

Times are tough in Argentina.

Automobile production is at a 15-year low. The last time the sector produced such few cars was when the country was in the midst of the depression that followed the 2001 devaluation and default.

Many Argentines are complaining that crime is up, but the situation would be worse if the government had cut the various social programmes that were introduced by the last administration.

The Argentine economy shrank 2.6 per cent y/y in 2018, which was slightly less than the 2.8 per cent drop in economic activity that was forecasted. Not surprisingly, the private sector lost 191,300 jobs last year.

However, this was what was supposed to happen. The standby agreement signed with the International Monetary Fund, IMF, called for a severe fiscal adjustment, along with a draconian tightening of monetary policy. This was engineered to bring the inflation rate down and stabilise the currency.

The problem is that, as John Maynard Keynes pointed out a century ago, prices are “sticky” and they tend to be slow when adjusting down. In other words, producers and employees are reluctant to reduce prices or wages, unless they absolutely have to. This lengthens the period of adjustment.

Argentina has been undergoing the adjustment process for less than half a year, and it still needs more pain in order to force prices to fully stabilise.

Brazil’s adjustment period lasted four years. Therefore, investors are being impatient that the inflation is not stabilising. Last week, they ran out on the peso after the central bank published the consensus inflation report.

The report, which aggregates the inflation forecasts of local and international analysts, showed a marked increase from the previous month. This was why investors panicked.

Nevertheless, prices will stabilise. Inflation is purely a monetary phenomenon and the draconian monetary policy will result in lower inflation numbers. The day after the run, the central bank hiked rates, and the currency market calmed down.

It always seems to be darkest before the dawn.

The good news is that the external adjustment is occurring much quicker than many analysts expected. The trade balance in December was a US$1.4-billion surplus. This was after posting a US$1-billion surplus in November.

The interesting thing was that the harvest numbers will begin to appear in the first quarter, as farmers begin to send their soybeans and grains abroad. Despite heavy rains in 2018, the country is expected to post a bumper crop.

The economy ministry reported that the soybean harvest is going to be up 45 per cent y/y, to a record 54 million metric tonnes. The change in relative prices, due to last year’s devaluation, was a huge incentive for farmers to increase their crop production.

Not surprisingly, international reserves have been on the rise – suggesting that the country can reduce its dependence on external support to meet its external obligations.

Political environment

The political environment is another issue that is bothering investors. President Mauricio Macri’s support numbers have been falling, while former President Cristina Fernández de Kirchner’s numbers have been inching higher.

This is not so surprising, given the brutal adjustment that the economy is suffering. Many voters harken back to the Kirchner era, when things did not seem to be as austere. Little do they realise that the reason they are suffering such a brutal adjustment is due to the economic mismanagement that occurred under the previous administration.

Moreover, former President Cristina Fernández de Kirchner is reaching her ceiling. She has such high rejection numbers that it is impossible to garner more support.

The ongoing nightmare in Venezuela acts as a stark reminder to Argentines of what would happen if her populist policies were allowed to run their full course. More interestingly, a new political actor has come on the scene. Former Economy Minister Roberto Lavagna appears to be preparing a run for the presidency.

Lavagna is well respected domestically and abroad. A picture of discipline and rectitude, he would mark a new chapter in Argentine politics. At the time, he is gathering support from the non-Cristina-aligned Peronist politicians, also known as the Federal Peronists. His support levels are much higher than Macri or Fernández de Kirchner, and he would be a welcomed improvement.

The arrival of Lavagna on the political scene is great news for investors. Assuming that Fernández de Kirchner polls at 40 per cent, which she is not, it would mean that 60 per cent of the electorate is in favour of a pro-market candidate. The line-up will be finalised during the primaries, which are slated for August 11.

This is why there is no reason to panic. On the contrary, the situation is good – and getting better. While it may be darkest before dawn, the good thing is that, as we pass through the blackest moment, we are really on the cusp of a new day.

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