Are we about to see a new Argentina?

Key Strengths and Vulnerabilities as of December 2022

Argentina began the 20th century as one of the wealthiest and most economically stable countries in the world. During the first three decades of the 20th century, Argentina outgrew Canada and Australia in population, total income, and per capita income[1]. In the 10 years following 1900, Argentina had the highest immigration to population ratio in the world. By 1913, Argentina was the world's 10th wealthiest state per capita[2]. In the 1930s, however, Argentina’s economy began to deteriorate rapidly due to political instability. Successive governments have failed to encourage strategic investments, such as in agricultural production - one of Argentina’s most valuable assets.?????????????????? ?????????????????

Key Strengths

Argentina is often in the news for its rampant inflation (140%+ this year) and economic troubles. However, the country has meaningful strengths.

• Internal demand: With a population of over 46 million, Argentina is a large economy with a robust domestic market relative to other developing countries.
• Comparative advantages in agriculture and cattle raising: The country has extensive fertile land. It is the 3rd largest exporter of soybeans (after the US and Brazil), the 4th largest exporter of corn, the 6th largest producer and 5th largest exporter of meat, and it is among the 10th largest exporters of wheat in the world.
• Oil & gas reserves: Argentina’s Vaca Muerta holds the 4th largest reserves of shale oil in the world and the 2nd largest for shale gas.?
• Mining potential: Argentina has vast lithium reserves[3], which is becoming an advantage given increasing global demand and price – last year the price of lithium doubled[4].?Argentina’s lithium production accounts for 16% of the overall global lithium production.
• Talent pool: Argentina has a high level of education, both in absolute terms (99% of literacy rate) and compared to several neighboring countries (Chile and Brazil, for example). The big talent pool has been cited as a reason for the country’s special ability to create unicorn startups (e.g., Uala, Mercado Libre, etc).?

Key Vulnerabilities

Argentina's long-run economic performance has been disappointing, and the country presently shows many vulnerabilities across key indicators.

• Inflation: In recent years Argentina’s economic situation has deteriorated sharply, with inflation reaching rates not seen in 30+ years[5]. Consumer Price Index increased by 94.8% in 2022, after increasing 36.1% in 2020 and 50.9% in 2021. In 2023, September’s inflation was 12.7%, which is a 21 year record (Appendix 1). Moreover, the year-on-year inflation (the inflation accumulated over the last 12 months) stands at 142.7%, a record since 1991.
• Exchange Rate: In 2022, the currency in Argentina devalued 70% with reference to the dollar, which has led to even higher inflation and to social unrest. The exchange rate regime in Argentina has changed in recent decades but has mostly remained as a very dirty float. There is a huge gap between the black market rate (often called “the blue dollar”) and the official rate (Appendix 2). In 2022 the peso depreciation in the blue market was 66%. This has only accelerated YTD: so far in 2023, the official exchange rate has gone up by 99.46%, the black market exchange rate by 180.35% and the gap stands at 163.23%[6]. While the numbers in Appendix 3 show real exchange rate appreciation, all official figures and macroeconomic data when expressed in dollar terms are considered at the official exchange rate.
• Unemployment: Although the unemployment numbers seem encouraging at first, having decreased from 11.5% to 6.5% in 2020-2022 (Appendix 3), these numbers are likely misleading. A large percentage of the population receives government subsidies called “plans”. This number increased from 44.7% of the population in 2021 to 51.7% in 2022[7]. At the same time, the percentage of the population living below the poverty line was 37.3% in 2021 and reached 39.2% in 2022[8]. The fact that these subsidies have been going on for so long is an important anchor to government spending and one of the reasons why achieving a balanced budget is so difficult.
• Strength of financial sector: The financial sector is relatively small (assets lower than 50% of GDP) and has strong capital buffers and low NPLs. As of December 2022, the capital to risk adjusted assets of banks was 29.7% and non-performing loans were approximately 3% of total loans (Appendix 3). However, as we saw in 2001, some runs on currency can transform into runs on banks. There is a high exposure of banks to government debt, especially given the high probability of government default. The ratio of public sector exposure to total assets rose from 35.2% to 44.3% between 2021 and 2022.
• GDP Evolution: Although GDP numbers appear strong with 2021 growth of 10.4% and 2022 growth of 5.2% (Appendix 3), most of this is due to a post-pandemic rebound. When looking at the fourth quarter of 2022, GDP grew only 1.9% relative to the same prior year period. If we look at the seasonally adjusted fourth quarter over third quarter growth, it was -1.5%. Therefore, the economy continues to show macroeconomic imbalances that limit the sustainability of its economic growth.
• Balance of Payments: The trade balance has been deteriorating continuously given the exchange rate problems mentioned above. Trade balance to GDP went from 3.1% in 2021 to 0.87% in 2022. Likewise, the current account to GDP ratio went from 1.4% of GDP in 2021 to -0.7% in 2022 (Appendix 3).?As for the financial account, it is no surprise that FDI is negative and portfolio investment is positive while the overall balance is negative. The investor sentiment towards the country is negative and the only positive flows are “hot money”. During 2020 and 2021 the country lost reserves and although it appears that at the end of 2022 it gained reserves, there is a lot of debate as to whether there is some “creative accounting” (Appendix 3). In any case, during the first 5 months of 2023 Argentina had already lost a quarter of the 2022 EoY balance.
• Reserves: The lack of reserves is an issue that is talked about continuously in the media and street. The average Argentine knows that the country has a problem with its international reserves. At the end of 2022, reserves stood at 53% of short-term debt, therefore the government cannot cover the full amount of short-term liabilities. Also, the December 2022 reserves level covered only 5 months of imports (Appendix 3). Although this number is close to the limit considered safe, reserves are very volatile and have already been reduced YTD (as mentioned above).
• Government Balance: there have been continuous government budget deficits, with a high proportion of these deficits lying in social plans, subsidies, and interest payments. At the end of 2022, the deficit stood at 3.9% of GDP, government gross debt was 84.5% of GDP and foreign-currency-denominated liabilities were 66.9% of total liabilities. This makes it very difficult to argue for a devaluation of the currency since the debt burden could become unbearable (see Appendix 3).??

Summary of Vulnerabilities

Argentina seems to check all the statistics associated with high vulnerability. The fact that the world is undergoing some difficulties with interest rates going up, inflation increasing, a flight to quality because of increased risk aversion, the potential for energy prices increases, and tightening of financing will all contribute negatively to an already wounded (and on-the-brink-of-an-abyss) country. We have to remember that Argentina is presently the largest IMF creditor in the world with $46BN of debt (30% of the IMF′s total outstanding credit) so anything that affects the willingness or flexibility of the IMF could potentially accelerate problems for the country. In addition, we can look at country risk (expressed in basis points) to get a sense of investor sentiment towards the country: J.P. Morgan's EMBI (Emerging Markets Bond Index) was 1368, 1688, and 2213 for the years 2020, 2021 and 2022 respectively.

For all the above, the expectations for 2023 are for a deteriorating scenario and the country is very ill-positioned to manage a worsening worldwide environment, especially since it is largely dependent on external financing and capital flows.

Longer-term recommendations

What Argentina needs to do right now is not rocket science but is difficult to implement. The issues that need to be addressed are the same whether there are some global imminent risks or not, and whether those fears are materialized or not. The policies that the country needs to put in place are all common sense; the problem is that the outcome is going to be painful for a lot of people for quite some time.

As already stressed, Argentina has a billionaire debt with the IMF; the IMF-supported program provides Argentina with balance of payments and budget support that is linked to the steadfast continued implementation of program policies aimed at strengthening public finances, tackling persistent high inflation, boosting reserve accumulation, and setting the basis for sustained and inclusive economic growth[9].

This is one of the many arguments that support the belief that Argentina should first focus on balancing its fiscal policy. The country will most probably continue to depend on external financing (IMF and other official creditors) because the local currency debt market is small, the CB financing ought to start decreasing and access to global capital markets has been impaired, but if fiscal balance is sought, this need will be smaller. If the country keeps its pronounced economic imbalances (including high/rising inflation, foreign exchange controls, and a low level of international reserves), a moderate pace of planned fiscal consolidation, and volatile global economic conditions, it will definitely face increased challenges in securing new deficit financing and smooth rollovers in the small peso-debt market[10].???????????????????

Argentina needs to focus on lowering inflation, develop political stability, and gain investor credibility, to attract investments and be able to repay current debt. This is why articulating a fiscal and monetary policy to stabilize inflation and exchange rate dynamics is key for the country to achieve economic growth. Expenditure controls and reduction are key as well as increased efficiency of subsidies and social spending, which in turn would create space for critical energy infrastructure projects and targeted assistance to the vulnerable.

More consistent and resolute application of the enhanced monetary and FX policy framework is needed to deliver sustained positive real interest rates, supporting a gradual moderation in inflation, increasing demand for peso assets, and reducing reliance on CB financing. Stronger efforts are also needed on the structural agenda to strengthen public financial management, combat tax evasion and money laundering (supported by international exchange of information agreements), implement a comprehensive labor reform that increases flexibility when hiring and firing people, and develop the net export potential of strategic sectors.?????????????????????????????????

On a positive note, there is no reason why Argentina could not come back as one of the leading economies in the world. The path is not easy and many difficult measures will have to be taken at the same time. The road will indeed be bumpy and an initial tough period will be unavoidable, but the medium to long-term benefits will surely outweigh the pain that Argentines need to go through sooner or later, whether from active policies or because of the explosion of the many variables they are trying to control and defy.

APPENDICES

APPENDIX 1 - Consumer Price Index (monthly evolution November 2022-September 2023)

APPENDIX 2 - Foreign Exchange Gap

APPENDIX 3 - Evolution of Macroeconomic Variables (2020-2022)

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[1] Mundlak, Yair, et al. Agriculture and Economic Growth in Argentina, 1913-84. International Food Policy Research Institute, 1989

[2] Eiras, Ana, and Brett Schaefer. “Argentina's Economic Crisis: An ‘Absence of Capitalism.’” The Heritage Foundation, 19 Apr. 2001, https://www.heritage.org/research/reports/2001/04/argentinas-economic-crisis-an-absence-of-capitalism/

[3] “Argentina Overview.” World Bank, 3 Oct. 2022, https://www.worldbank.org/en/country/argentina/overview

[4] Mulvihill, Clara. “Lithium Mining in Argentina.” Borgen Magazine, 19 Oct. 2022, https://www.borgenmagazine.com/lithium-mining-in-argentina/

[5] Larsson, Naomi. “How Much?! the Absurdity of Inflation in Argentina.” The Guardian, 8 Oct. 2022, https://www.theguardian.com/artanddesign/2022/oct/08/argentina-100-per-cent-inflation-photo-essay-irina -werning

[6] https://www.cotizacion-dolar.com.ar/cotizaciones-dolar-historico.php

[7] “La Nacion” (2022), https://www.lanacion.com.ar/economia/mas-dinero-y-mas-pobreza-el-517-de-los-argentinos-ya-recibe-algun-tipo-de-ayuda-social-nid26122022/#:~:text=Hace%20un%20a%C3%B1o%2C%20el%2044,al%20actual%2051%2C7%25.

[8] National Institute of Statistics and Census (2022), https://www.indec.gob.ar/indec/web/Nivel3-Tema-4-46#:~:text=INDEC%3A%20Instituto%20Nacional%20de%20Estad%C3%ADstica%20y%20Censos%20de%20la%20Rep%C3%BAblica%20Argentina&text=Los%20resultados%20del%20segundo%20semestre,%2C2%25%20de%20las%20personas.

[9] “Argentina: Second Review.” IMF Country Report, No. 22/322, October 2022, https://www.imf.org/-/media/Files/Publications/CR/2022/English/1ARGEA2022003.ashx

[10] Schnieller, Liza and Sebastian Briozzo. “Argentina.” S&P Global Ratings, 12 May 2022,https://www.argentina.gob.ar/sites/default/files/rating_sp_mayo2022.pdf