Argentina’s Untamed Inflation Eats into Business Models of Outsourcers

There is a growing consensus among international economists that Argentina’s decade-long economic boom is rapidly becoming an out-of-control inflationary spiral. Real inflation has grown at 20+% annually for …


There is a growing consensus among international economists that Argentina’s decade-long economic boom is rapidly becoming an out-of-control inflationary spiral. Real inflation has grown at 20+% annually for over three years, and the Argentine government is clearly in denial or even cover-up mode regarding the situation.

Many businesses in Argentina are already struggling from the double-digit inflation, especially industries like outsourcing that rely largely on income from outside of Argentina, and things are only going to get worse as most sources expect Argentina’s inflation rate to approach 25% in 2012.

Like many Latin American countries, Argentina has a long history of economic ups and downs. The most recent major economic bust occurred just a little over a decade ago, as Argentine unemployment hit 21% and 60% of the population fell below the poverty line in 2002 just before Nestor Kirchner and the Peronist party came to power. However, the resulting devaluation of the currency, and the default/renegotiation of national debt under very favorable terms as well as the expansionary monetary policies promulgated by Kirchner and the Peronists (led by Kirchner’s wife and protege President Cristina Fernandez today), has created a multi-year boom in the Argentine economy.

It is a basic law of macroeconomics that expansionary economic policies cannot continue indefinitely without causing an economy to over-expand and leading to inflationary pressures, and the evidence is mounting that Argentina is no exception to the rule. The bad news is that the current Argentine government is showing no signs of changing its expansionary policies, and worse yet has responded to criticism by resorting to intentionally misrepresenting the official inflation figures and instituting price controls as well as protectionist policies in a number of industries (including effectively nationalizing the Argentine operations of the Spanish oil company REPSOL on April 17).

The official Argentine inflation index listed inflation as ranging between 8.5-10.9% in the period from 2007 to 2011, whereas a wide range of private sources all calculated inflation at rates ranging from 16-27% during that same time span. The official inflation rate was 9.5% in 2011, as compared to 22.8% estimated on average by half a dozen private sources. Furthermore, there is no evidence that the inflationary pressures are easing. A number of economists have forecast that real inflation in Argentina will exceed 25% in 2012.

Cesar DOnofrio, CEO of MakingSense, a software development company with offices in Argentina, says that everybody knows that inflation is really 20+%. “Everyone knows the government inflation index is not correct. If you bought one pound of meat for 20 pesos in 2010 and you are paying 40 pesos today, it is obvious.”

However, the Argentine government has ramped up the programs in its social safety net significantly over the last few years, and is providing a generous inflation-pegged stipend to many lower income families. According to DOnofrio, this means that it is not the poor, but the middle class that is really getting squeezed in the current inflationary economy.

Wage inflation has become a huge problem for businesses in Argentina. Argentina is a highly unionized country, and the unions have contracts with annual wage increases tied to the inflation rate (based on private source figures, not the government inflation index). Furthermore, most non-union businesses (including the outsourcing industry) peg their wage increases to those of the unions. This has resulted in wages in Argentina doubling in the last three or four years in many cases.

DOnofrio reports that at MakingSense they gave employees 25% annual raises in 2010 and 30% annual raises in 2011, and that was just enough to keep them competitive in the industry. DOnofrio also mentioned the inflation-related phenomenon of “rotation” that is actually working to his benefit right now, as he has recently hired a couple of top-line, highly experienced software engineers who formerly worked for larger outsourcing firms whose corporate policies did allow them the flexibility to increase wages fast enough to keep up with inflation.

DOnofrio continued on the subject of inflation in 2012. “I have spoken to several people in the government off the record, and they all agree that the annual inflation rate is likely to remain close to 25% in 2012.”

Maintaining Margins in an Inflationary Environment

It is not easy to run a business when you have to deal with 20%+ inflation. While there are obviously a number of steps you can take to reduce costs and keep overhead down, margins inevitably get squeezed when wages double in three or four years. There is only so much you can save on the overhead side of the balance sheet, and businesses have to start thinking strategically.

DOnofrio emphasized that businesses, smaller businesses in particular, have to be nimble and seize opportunities to scale up business whenever they present themselves. It boils down to expanding revenues sufficiently so that you can survive on lower margins.

Another strategy DOnofrio discussed was adding more value to your products and services so that clients are willing to pay more. “At Making Sense, we are adding more value to our services by developing expertise in specialized areas like agile development and improving user experience, areas not yet dominated by the bigger outsourcing firms.”

DOnofrio concluded with the thought that undertaking this specialized value-added niche strategy is obviously easier said than done, and it requires long-term planning, but that creating value for your clients is almost always a win-win situation.

Effect on Argentine IT Industry

The Argentine IT/software development industry entered a rapid growth phase in 2003 as the country began to emerge from the economic chaos of the previous three or four years, and has grown at a 15-20% clip ever since. In fact, Argentina, along with Mexico, has become one of the largest software outsourcing destination in Latin America today. However, the IT and software development industries are certainly not immune to the out-of-control inflation that is driving up the cost of all businesses in Argentina, and DOnofrio commented that he has seen signs of a slow down in the industry already. And beyond that, many of the more savvy human capital providers have focused their sales efforts on still-growing local Argentina markets as an inflation hedge.