Walter Molano | Argentina: Seasonal woes for grain and growth
Published:Thursday | March 8, 2018 | 12:00 AM
Climate change is wreaking havoc all over the planet. Inordinate levels of precipitation have fallen across much of North America. Ice and snow have blanketed Europe and Central Asia, while drought conditions have gripped much of the Southern Hemisphere.
Cape Town in South Africa is less than a month away from running out of water. Likewise, a four-month-long drought is devastating Argentina's agricultural sector.
As the third-largest grain exporter in the world, the Argentine drought is pushing global grain prices higher, but the benefits will be felt elsewhere. Argentina's agricultural sector represents about seven per cent of the country's economic output, and it has been hit so hard that some economists are expecting that the drought will reduce the country's GDP growth rate in 2018 by 0.5 per cent year-on-year.
The government was shooting for a GDP growth rate of 3.5 per cent year-on-year, this year. We were more conservative, expecting an economic expansion of three per cent year-on-year in 2018.
Nevertheless, the drought will most likely put the growth rate well below the three per cent year-on-year mark. This situation will cause a great deal of consternation, particularly in hard-hit rural areas, but it will not lead to many tears in the economic team. Any growth rate above three per cent year-on-year will trigger the payment of the GDP warrants, which could be costly.
The recent index of monthly economic activity published by the National Statistics Agency, or INDEC, reported that the Argentine economy grew two per cent year-on-year in December, bringing the annual GDP growth rate to 2.8 per cent year-on-year. As a result, the polemic issue of the GDP warrants was delayed. However, it will need to be addressed at some point in time.
The issue at hand is what will be the base year that will be used to calculate the parameters for the GDP warrant payments. The prospectus used the 1993 GDP national income accounts as the base year. However, governments revise their national income accounts periodically, typically every decade, to take into account new products or services that have been introduced since the last survey.
Conditions to be met
In 2004, the Argentine government revised its national income accounts, and in 2012, it published its first GDP numbers using the revised series. Under the GDP warrants prospectus, three conditions must be met in order to trigger payment. The first is a GDP growth rate of three per cent year-on-year or more.
The second condition is that the level of actual GDP must be above the baseline GDP that was established in the prospectus, and the third is that no more than 48 cents can be disbursed. Since 2011, the Argentine economy has not grown more than three per cent year-on-year. Therefore, the first condition for the payment has not been met. However, the introduction of the new GDP series from 2004 raised the issue of what were the baseline assumptions.
The prospectus is pretty clear. It contemplates changes in GDP series, and it says that the baseline needs to be adjusted by the ratio between the old and new GDP series. In the case of the 2004 GDP series, the ratio differential was 1.7. This meant that the baseline had to be multiplied by 1.7 from what was published in the prospectus.
However, given that the first year that the INDEC published the 2004 GDP series was in 2012, then the ratio of the first published GDP number was different. It was only 1.5. This meant that warrant payments using 2004 as the reference for the baseline would be much lower than those using 2012.
Indeed, if the Argentine economy grew three per cent year-on-year in 2018, the payment would be almost six cents, using the 2012 assumption, but there would be no payment if it used the 2004 assumption. In fact, we estimate that the economy would need to grow 15 per cent in order to move above the baseline, and the payment would be less than one cent.
Unfortunately, the government has not shed any light on this issue. There are even rumours that the government may even introduce a different base year, which would add new complications.
The news on the agricultural front added other problems for the Argentine government. First, the drought is going to add to the country's inflationary woes. Food is an important component of any inflation index, and the drought will push prices higher. This will complicate things on the exchange rate front.
The devaluation of the peso in January helped realign relative prices, and we believe that the overvaluation of the currency is now in the 10 per cent to 15 per cent range. Nevertheless, the drought in the pampas will be another blow for the external accounts. Argentina's current account deficit was 4.1 per cent of GDP in 2017, but some economists are worried that a combination of factors could push it up to five per cent of GDP in 2018.
So far, international investors have been more than willing to finance Argentina's external needs. However, the steady rise in US interest rates will make it more difficult. That is why climate change may be pushing global grain prices higher, but it is creating other woes for Argentina.
- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.