By Tim Umberger, Senior Advisor, East Capital
For macroeconomists and investors, Argentina is not only associated great wine, tasty meat and great football but also with the history of volatile economic cycles and one of the largest debt defaults in history back in 2001.
In October when we went to visit Buenos Aires, we immediately got very mixed feelings about the situation there: on one hand, a fantastic city with remarkable architecture of old, but also very modern buildings. On the other hand, a sense of sadness and depression as the country lost a decade and is running not only significantly below its potential, but even towards a collapse.
Electricity outages in the very center of the city are a rule rather than an exception, and are a consequence of close to zero investments over the past decade. We quickly understood that Argentina is at the cross roads again ahead of the second run of presidential elections on November 22.
The elections will mark the end of Kirchnerism – an era that started with Nestor Kirchner, who was appointed president in 2003 (in the first elections after the 2001 default) and followed by his wife, Kristina Nestor, appointed president in 2007 and 2011.
In the mid-term elections in 2013 Mrs Kirchner wanted to change the constitution to allow her to run for the third mandate in 2015; but this failed at the end. This event marked the start of the rally on the equity markets as it became clear that Mrs Kirchner will be leaving in 2015, giving hope for policy normalisation and economic recovery thereafter.
The 2015 elections are coming in very difficult times though. The USD 500bn, relatively close economy, declined by around -3% last year and is expected to continue its stagnation this year. 2016 is a big unknown: with the austerity it could be negative in the short run before improving in 2017.
Inflation is running at 27% in 2015 and will probably rise to 35% in 2016 due to devaluation. Capital controls were introduced immediately after the elections in 2011. Since then, we are speaking about a transactional economy where almost everything is expressed in USD, but de facto done in Pesos.
The official ARS/USD rate of 9.5 versus the “blue rate” of 15, indicates that the currency is significantly overvalued, putting an additional drag on the economy whereby all neighbours including Brazil have depreciated significantly.
The budget deficit is running at 7% due to subsidies (estimated at 5% of GDP) and is financed directly from the central bank, inevitably causing inflation. The central bank reserves are low and will, according to some estimates, be completely depleted early next year.
The current account deficit is widening due to low soft commodity prices and problems in Brazil, and has turned negative in 2014. On a slightly positive side, the government debt is at around 30% of GDP, and private debt is very low, especially on the retail side where it practically doesn’t exists. The total private loans/GDP are standing at mere 15%. Hence, in a case of normalisation, there is significant scope to drive the economy by simply adding leverage.