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CIAO DATE: 2/00
Argentina Alert: Markets Will Remain Skittish until October Elections
Hemisphere Focus: 1998-2000
July 28, 1999
Overview
Presidential politics are aggravating an already weak economic picture in Argentina, a nation in recession and political flux. Despite recent praise from the International Monetary Fund (IMF) that Argentina, with the third largest economy in Latin America, was doing “a spectacular job” in keeping its budget deficit under control during a recession, the economy will remain under intense scrutiny at least until after the October 24 elections. The new wave of currency jitters, which hit Argentina last month after Colombia effectively devalued its peso, is but the latest sign of this increased scrutiny.
Recent recommendations of several Wall Street investment banks to reduce the Argentine share in emerging market investment portfolios reflect serious concern about the current recession and the possible effect of the electoral campaign. “Argentina faces severe challenges as it tries to deal with a strengthening U.S. dollar, weak agricultural commodity prices, and stagnant global export markets,” David Malpass, senior economist at Bear Stearns, wrote recently.
Duhalde and de la Rúa Running Neck and Neck
There is no doubt that electoral issues will dominate the scene until the end of October, especially since the two major candidates, Eduardo Duhalde, the governor of Buenos Aires province from the ruling Peronistas party, and Fernando de la Rúa, long-time Radical party politician and mayor of Buenos Aires from the opposition Alianza, seem to be so evenly matched in the polls. Although de la Rúa has pulled ahead in the most recent ones, most analysts doubt that he can win in the first round.
Former Economy Minister Domingo Cavallo, who is mounting his own challenge to the two leading candidates, but who commands less than ten percent in most polls, commented last month that “to elect de la Rúa is to change from golf to tennis, but it would not signify a major change.” With either candidate, he said, the country would be getting a government “inferior” to President Menem’s because neither has demonstrated the “minimum realism and sense of responsibility” needed to move Argentina ahead in the new century. Cavallo hopes to attract enough votes to be able to play a decisive role should the elections go to a second round.
Country Has Heavy Debt Burden
Duhalde shocked both Argentina’s business sector and foreign investors with recent comments that some interpreted as a call for the country’s foreign debt to be pardoned. “Debt payments are bleeding us,” he said. Most economists dismissed his statements as campaign bravado and Duhalde himself later said he did not mean to imply that the debt not be paid. “It is ridiculous to think I don’t want to pay the debt. Argentina is able to pay everything it owes and much more,” he told reporters. He did say that rich countries should go easy on Argentina to enable it to fight poverty and crime.
Duhalde’s original comments came after de la Rúa was reported to have said he wanted “a political reconsideration” of Argentina’s foreign debt of over $100 billion. The comments of the two candidates prompted the Buenos Aires Stock Exchange to call on them to stop criticizing the level of the country’s foreign debt, saying such comments damages Argentina’s credibility. “Any doubts, however unrealistic they may be, about paying off our commitments would have the most grave consequences for investment, availability of finance, and in turn, for job creation and economic well being,” the exchange said in a statement. Cavallo also criticized both candidates, saying demand for renegotiation of the debt undermined international confidence in Argentina and pushed up the cost of borrowing. In a later speech to the Argentine banking association, de la Rúa said the country would honor all of its debts as well as all commitments under taken with private sector investors.
A large part of Argentina’s total public debt of about $140 billion is with international lenders and countless bondholders with whom it would be impossible to negotiate any deal. At the end of last September gross external debt reached $122.9 billion, a 12 percent increase over 1997 year-end figures. That access to external financing will remain difficult and expensive, and country risk perception will remain high was demonstrated by last month’s spread of Argentine Brady bonds over U.S. treasuries. The spread rose to 870 basis points from 500 points in May—a big jump in perception of risk. After a truckers’ strike early this month highlighted the difficulties of raising additional revenue through increased taxation, spreads on Argentine debt widened another 26 basis points.
Although the Menem government, with the help of the IMF, has managed to sooth market nerves somewhat, fears of a larger government deficit and deeper recession, plus speculation about an Argentine debt default even affected the U.S. stock market earlier this month. There is also a growing impression among investors that President Menem is losing influence in his final months in office.
The Dollarization Question
So far at least, the United States has been lukewarm about Argentina’s request to formally discuss a monetary treaty, which would make the dollar the official Argentine currency and end fears of a devaluation of the peso. The United States has said “technical issues” had to be sorted out before any formal discussions could take place. U.S. officials have also said they are not prepared to make monetary policy concessions or open the Federal Reserve’s discount window to countries that dollarize, nor help supervise their banks.
The Menem government has said that it could simply unilaterally adopt the dollar by swapping all the pesos in circulation for its more than $30 billion in foreign reserves. But it prefers to negotiate an agreement with the United States which it hopes would compensate it for the loss of interest from foreign reserves, estimated at about $700 million, and grant access to the Federal Reserve’s discount lending window.
The Alianza party has said it is firmly opposed to dollarization, but wants to keep the peso pegged one-to-one to the dollar. De la Rúa has accused central bank president Pedro Pou of “conspiring against the peso.” Duhalde has not commented publicly, but some of his aides have said he prefers the peso to the dollar. His chief economic advisor, Jorge Remes Lenicov, says dollarization would eliminate the risk of devaluation, “but not country risk.” In any case, with only five more months in office, Menem is not likely to force the country to take such a big step.
Dollar Deposits Increase
Even though the currency board system adopted in 1991 as the Convertibility Plan is supported by the majority of Argentines, including all of the presidential candidates, there appears to be an increased perception of risk in the system. Peso deposits have fallen and dollar deposits have increased by about a billion dollars since the first of the year. Of the $51.7 billion in total time deposits, such as CDs and similar instruments, nearly 74 percent are denominated in dollars. This increase in dollar deposits, despite their lower yields, indicates that investors do not believe the higher peso rates compensate for the risk of holding local currency.
On the positive side, Argentines are not taking their money out of the banking system or the country. This reflects Argentina’s good record in managing economic contagion. Since the post Mexican devaluation crisis, when the absolute level of deposits in Argentina dropped by 18 percent, the financial system has been strengthened as a result of consolidation, the entry of foreign banks, increased liquidity requirements, and heightened supervision.
Recession Deeper than Expected
Economy Minister Roque Fernandez is sticking with his forecast of only a 1.5 percent contraction of gross domestic product (GDP) this year even though first quarter statistics show a greater than expected decline. The most recent figures show industrial output down by 9.5 percent in the first five months of the year. The biggest decrease was in the automobile industry where May’s output was down by almost 50 percent over a year ago, and about the same for the first five months of the year. Unemployment in May was estimated at about 15 percent, still less than the 1995 recession peak of 18.4 percent, but significantly higher than last October’s 12.4 percent. May’s revenue collection plunged 11.4 percent from the same month a year ago. All of this has led many private economists to predict a 3 to 4 percent decline in GDP this year.
Argentina will pay about $9 billion in interest on its debt in 1999. Total financing needs for the year amount to around $17 billion. Undersecretary of Finance Miguel Kiguel said recently that Argentina still has to raise another $3.2 billion on capital markets this year, but is in no hurry to do so. Argentina plans to raise $2.1 billion in the international markets and $1.1 billion domestically, but depending on market conditions, the mix could change, according to Kiguel’s statement last month in Washington.
Some financial analysts have said that the country may have to investigate alternative sources of financing, and possibly increase reliance on multilateral lending institutions as a deepening economic recession and political uncertainty may limit the country’s access to the international markets. “Our assessment of the outlook for the Argentine economy leads to the conclusion that Argentine credit risk is likely to persist at current high levels for the foreseeable future,” warned a Smith Barney research report issued last month. Other analysts have concluded that financing is manageable for the remainder of the year, but financing needs are the Achilles heel of the economy.
Further complicating the picture, during the last two months several important firms, including the powerful conglomerate, Sociedad Comercial de la Plata, have defaulted on bonds and bank debt forcing them to restructure with their creditors.
Structural Reforms Needed Now
Apart from its heavy debt burden, Argentina has had sound economic fundamentals, a moderate, if growing budget deficit, and a low inflationary environment, and has been blessed with responsible and competent policymakers. However, new structural reforms (labor, social security, and revenue sharing with the provinces) that will result in gains in competition are needed now. Most analysts also point to the need for urgent reform of the judicial system to reassure potential investors that they will get a fair hearing should disputes arise. In a recent article examining Argentina’s credit quality, Standard and Poor’s concluded that the country’s credit worthiness and long-term prospects for maintaining the convertibility regime will depend on:
The markets are likely to remain skeptical until the next government can demonstrate a commitment to back reforms and policies that will shore up the Convertibility Plan. In the meantime, the confidence crisis, stemming from the debt service profile, the elections and change in administrations, the recessions, concern over competitiveness, and a skeptical international environment, is likely to continue.
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