By Daniel Kerner
Argentina is once again rattling the nerves of foreign investors. The country that has been struggling to move on after its 2001 default and checkered economic history has recently nationalized the country’s largest private company, Repsol’s YPF, without any signs of providing compensation. Additionally, there have been growing rumors and divergent signals that the government might “pesify” its debt obligations — in other words, convert dollar-denominated debt into the less valuable local currency — to contain the outflow of dollars.
Government officials have denied such rumors, knowing that debt is a very sensitive issue for its own voters. Indeed, the near-term probability of debt pesification seems low given that the government is, in part, imposing tough foreign exchange restrictions so that it has enough reserves to meet debt payments. That being said, the risk will probably increase over time. Economic dynamics will likely worsen in the next few months, and the government is likely to double down on interventionist measures even as economic distortions grow.
Argentina has experienced high rates of economic growth since 2003 (with the exception of 2009), but in a context of growing macroeconomic problems. Now, with economic growth faltering, and the central bank increasingly financing the treasury, Argentina seems to be headed toward a negative equilibrium of low growth and high inflation. But fear of following more orthodox policy prescriptions that, in the government’s view, caused the last crisis (and Europe’s recent troubles), may be generating the next economic crisis.
Financial investors clearly have a reason to be concerned. Argentina still has debt in default and has been tweaking official statistics in part to pay less debt. The paradox, however, is that the government is imposing trade and foreign exchange restrictions precisely to have enough dollars to meet its debt obligations. To some extent, this is because the effects and memory of the 2001 debt default are still alive. Fernandez de Kirchner’s government is a product of the economic crisis, and during her presidency and that of her husband, the late Nestor Kirchner (2003-2005), the government was willing to take interventionist actions to service the debt for fear that financial troubles could cause them political troubles, even if these measures are now generating inflation and a sharp economic slowdown. In fact, the memory of the crisis can also be seen in the government’s obsession with maximizing short-term growth and consumption, and in its reluctance to implement needed macroeconomic adjustments (especially if they are seen as orthodox measures).
At the center of the problems is rising inflation. Official inflation is at 9.9 percent, but the credibility of those figures has been questioned since 2007 (private estimates put inflation above 25 percent). Inflation first picked up following Argentina’s 2002 devaluation and has been rising over the past few years due to expansionary fiscal and monetary policies. In contrast to most of its neighbors where independent central banks actively fight inflation, the government has been increasingly relying on the central bank to finance the treasury, and even reformed the bank’s charter earlier this year to gain further support.
High inflation, and the government’s reluctance to let the currency depreciate substantially, has led to a rapid increase in imports and capital flight ($21 billion in 2011), all of which have put pressure on the currency. Low investment in the energy sector, a result of low prices and interventionist policies, has led to ballooning energy imports (which increased by 113 percent in 2011). The government responded to the deterioration in the external accounts by restricting purchases of dollars, limiting imports substantially, and nationalizing the largest energy company, all measures that have aggravated the country’s problems.
Argentina seems to be caught in economic limbo. It is aware that making its debt payments is of paramount importance, but is unwilling to adopt the economic policies that would make it easier to do so without causing more economic damage. Foreign investors are right to be experiencing flashbacks.
Daniel Kerner is an analyst in Eurasia Group’s Latin America practice.