Cry for me, Argentina

Argentina’s latest attempt to get its hands on more cash through the desperate measure of purloining Central Bank reserves and firing its president has both emasculated the bank and further alienated investors. The move may provide a little more stability and provide coherence to economic policies, point out diehard optimists. However, it removes a vital check on the government’s fiscally expansionary policies and underlines the ever-more erratic decision-making style of president Christina Kirchner, who continues to alienate Argentina from the mainstream. The government is likely to blow the money by distributing largesse on popular measures and as giveaways to obedient provinces ahead of next October’s presidential elections.

The bungled firing of Brazil’s ex-central bank chief Martín Redrado and his replacement by Mercedes Marcó del Pont was initiated in January and only completed in February. The saga seemed to unfold in slow motion. Kirchner’s decision to remove Redrado from the post came after he declined to implement her decision to take $6.5bn from the central bank’s $48bn reserves to create a new fund, the Bicentennial Fund. It is widely seen as a piggy bank to ensure the government can up its spending while meeting debt obligations.

Redrado’s dismissal was the death of thousand cuts. He was fired by decree on January 7th this year, but swiftly reinstated by court order, which pointed out that a special congressional committee should have been convened to ratify the presidential decision.

Redrado’s vice-president Miguel Pesce became interim president after January 24th when the government physically prevented Redrado from re-entering his offices, leading to a furious war of words. The committee that was cobbled together from congress and the senate was headed by the vice-president Julio Cobos and finally voted by a majority of two to one to support Redrado’s dismissal.

The new central bank president, formerly the president of the state-owned Banco de la Nación, is an altogether more pliable figure and has been making all the right, emollient sounds. Del Pont pays lip service to independence but has stated that the central bank needs to follow the government’s domestic agenda and although the bank might have operational autonomy, it could not operate independently of the nation’s economic policies. She added that the bank would need to take a softer line with inflation, spooking local economists and analysts.

Policy shift

Local analysts have been scouring her past to make predictions about the likely policy shift at the bank. In her time in the lower house of congress, del Pont supported a number of suggested changes to the central bank, including the idea that it should not merely target inflation but alter its charter to actively support generating jobs and sustaining growth. One economist wryly noted: “She believes the central bank should be more of a development bank.” Del Pont has also in the past argued for a devaluation of the peso to ensure competitiveness in the economy.

Del Pont was quick to add that she did not intend to change radically the foreign exchange policy in order to assuage markets. Although the peso did fall, the move was muted as jaded markets increasingly take the twists and turns of the Kirchner government for granted and the only investors in debt markets are deep discount and vulture buyers.

The Bicentennial Fund now needs to garner the support of congress. To drum up that support, the government has been negotiating with cash-strapped provinces. A “yes” vote will therefore likely be sealed only after further financial goodies are lined up for the regions.

Since his ousting, Redrado has been sniping from the sidelines, warning of “the government's hunger for raising expenditure” and revealing that the central bank stopped paying heed to national inflation statistics prepared by Indec two years ago, saying that there was an extremely significant credibility gap in the data.

Macro story

A host of other issues continue to dog the economy as well and could be worsened by the new appointee and changes in policy direction. The latest manoeuvres come at a time of recovery in Argentina, although growth predictions for this year are anaemic. GDP growth was a negative 2.52% last year and is predicted to reach a sluggish positive 1.5% growth this year, according to the International Monetary Fund (IMF).

Argentina’s numbers compare poorly with other key economies in Latin America, which are also more investor friendly. Peru is predicted to grow at a healthy clip of 5.8%; Chile at 4%; Brazil at 3.5%; and Colombia at 2.5% by the IMF. Of the larger Latin economies, only Venezuela will do worse, with expected negative GDP of 0.4%. There are growing concerns, too, that the government’s voracious spending appetite will further unleash inflation, which is already the highest in the region outside of Venezuela. Meantime, the controversy over unreliable inflation data has been given fresh support by Redrado’s statements.

It’s not as if the official numbers on inflation are flattering. They are acceptable, if poor. Official data claim that consumer prices rose 7.7% in 2009, itself an increase from the year before at 7.2%. This year’s budget makes predictions that inflation will decline to 6.1% this year. The central bank has already been proving more mealy-mouthed. The latest inflation report under interim president Pesce was slimmed down, confining its statements on inflation to a one-page summary.

Economists already found the official data risible. Private-sector economists say inflation has been close to 20% for the past four years. This year has not started well either, with inflation estimated by independent economists at 2% in January alone. Economists fear the appointment of del Pont at the bank will stoke further inflationary pressures.

The government has been increasing its inflation-adjusted spending by 15% per year, notes economist Miguel Ángel Broda. Its primary surplus has been shrinking fast as increased tax collection is not keeping up with spending plans. Some local analysts believe that growth in government spending could spike to 30% this year as elections draw near.

Unions already sense more spending leeway and are pressing the government to increase salaries of public employees. The teachers’ union has been pushing for an increase of some 25% and has been threatening to strike.

These additional spending pressures come as the country’s finances are deteriorating. The total for the primary surplus came in at 17.27bn pesos ($4.49bn) in 2009, down significantly from 32.5bn pesos ($8.45bn) a year earlier. The overall fiscal deficit after interest payments was 7.1bn pesos ($1.85bn).

Moreover, last year’s figures were flattering, showing the impact of both payments that will not be repeated as well as the effects of nationalisation. The government counted not only a one-off payment from the IMF but also investment profits from the social security agency ANSES and counted contributions to the social security system, which when combined, total $5.85bn.

Senior Argentine economists have lined up to condemn the government’s spending plans, according to local media. Claudio Loser, ex-director of the IMF, called the government’s action very myopic, adding that it was spending the family jewels. His interpretation of the creation of the Bicentennial Fund was that the government was looking for more resources to spend as the budget had already included provisions for the payment of bondholder debt, he said.

Former economy minister Roberto Lavagna added that the possible creation of the fund added to measures taken in the previous three months were leading to higher indebtedness, more public spending and higher inflation. Since 2006, the government had spent its entire fiscal surplus and continued to be in the red. With the elections, it would enter into a new cycle of debt, he noted.

Another issue is the policy direction that the central bank will take on the exchange rate. A central bank report issued under Pesce’s interim management displayed only one, slightly controversial aspect. It said that it “wouldn't be advisable to use the exchange rate as the only tool against inflation”, fearing that such a move would negatively affect competitiveness.

The likelihood of a policy of lower interest rates could both exacerbate inflation as well as weaken the peso. “The perception that interest rates are going down and inflation up is worrying. This positions the dollar as an alternative,” says Ricardo Delgado, director of the consulting firm Analytica. The peso tumbled 9.2% over the 12 months to the end of January and some analysts see the currency falling to 4.2 to the dollar by year-end. It was worth 3.84 to the dollar in early February.

Foreign Debts

The impact of the policy twists and turns on Argentina’s ability to pay back foreign debtors is still murky. Argentina is left owing some $7bn to the Paris Club, a group of 19 creditor nations, and some $20bn to hold-out private sector bondholders after its default in 2001 and a restructuring that was accepted only by some bondholders. In 2006, the country paid off its entire $9.5bn debt to the IMF, but an attempt last year to reschedule with the Paris Club failed.

While its overall deficit is small, especially when compared to the huge deficits run up by developed markets, the argy-bargy with bondholders has prevented the country from tapping international credit markets, creating rigidity in its spending. If Argentina could issue debt again, the government would be able to spend tomorrow’s money today.

Indeed, since 2006, the government has had an on-off policy of engaging with bondholders. It reopened negotiations in 2008 and hired Barclays, Citigroup and Deutsche Bank to hammer out details of a plan, but as yet few details are available on the shape of any possible offer.

Furthermore, the effort may be stillborn thanks to weak global markets. The motivation for the government to settle with bondholders is to be able to issue debt; if global markets continue to shun risk, it may not benefit Argentina to cough up.

Local analysts say that the government believes it only makes sense to pay bondholders if it is able to issue in international markets with a single digit interest rate. They agree that current market conditions are unlikely to permit that and suggest that is why Kirchner has turned to central bank reserves. New York-based NML Capital is the largest hold-out bondholder.

Already Kirchner has met stiff resistance in her plan to set up the Bicentennial Fund with the reserves. Her attempt to move the funds to the Treasury by decree was blocked by the courts, which ruled that the opposition-controlled congress must approve the move once it reconvenes after the summer recess.

Unfortunately perhaps, sleaze and arbitrariness continues to be the order of the day in Argentina. The sad truth is that Argentina continues to grow ever more irrelevant to investors as its neighbour Brazil flexes its economic muscles and as Peru and Colombia, which have pursued with determination more investor-friendly policies, reap the rewards of a return of investor interest in South America.

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