Irresponsible Economic Policies Have Left Argentina at Risk of Hyper Inflation

On Monday, NIC Argentina, the office responsible for operating the .ar country code top-level domain, announced that those registering a domain name in Argentina will be required to …

Alejandro Bianchi, Investment Manager, InvertirOnline

On Monday, NIC Argentina, the office responsible for operating the .ar country code top-level domain, announced that those registering a domain name in Argentina will be required to pay an annual fee as of next week.

The same day, Nextel sent out telegrams to 150 employees informing them of their dismissal, calling the move the result of an organizational change and insisting it still plans to stick around. And on Thursday, the AFIP – the Argentine tax bureau – closed down Despegar.com’s local offices over allegations that it uses its U.S. offices to avoid paying taxes in Argentina.

The writing on the wall isn’t hard to decipher: something’s up in Argentina, and it’s taking an increasingly obvious toll.

“Argentina’s situation has worsened at a very slow rate but for a long time. That is why, for many people, how we arrived at this situation was imperceptible. Others, including government officials, simply didn’t want to see or recognize it,” explained Alejandro Bianchi, Financial Analyst and Investment Manager at InvertirOnline.com.

 A Gathering Storm

Argentina has never been the picture of economic stability (this Economist article lays the historic context out well, as does this New York Times opinion piece). But now, it seems to be approaching a boiling point and is letting the cracks in the system show. The government finally acknowledged the country’s extremely high inflation rates just two weeks ago, after months of putting out impossible and unrealistic numbers. The fact that officials are finally addressing the problem is a step in the right direction, but is it too little, too late?

The Argentine government first detected the inflation problem around 2007, but thanks to the global economic crisis that ensued in 2008, it was able to defer the issue for a couple of years. Guillermo Moreno, then Secretary of Domestic Trade, led the way in laying out a number of heterodox economic policies that, in the best cases, proved ineffective and, in the worst, made the situation even more precarious.

The government increased the speed at which it was printing currency and at the same time took a series of measures to close the country off. Commercial and fiscal surpluses dwindled, and when the consequences started to be felt, the officials looked the other way. What’s more, they took to lying about statistics – going so far as to catch the attention of the IMF.

Central bank reserves have been cut nearly in half since 2010, and while the peso-dollar exchange rate devaluation averaged 9.4% from 2008 to 2012, it has jumped 28% over the past two years, even with the tough currency controls put in place.

“As the government has a big deficit from subsidizing utilities and has no international financing capability because of holdouts, its capacity to print at a lower rate is limited, and as the government uses central bank reserves to pay for the performing debt, the draw is increasing the risk of default,” Bianchi outlined. “In the last month, the government has decided upon a more orthodox approach. The central bank increased its borrowing rates to 30%, and there are rumors of a possible increase in utility prices. This could cool the demand for dollars, but it also has the capability of cooling the economy even more.”

Official sources acknowledged a January inflation rate of 3.7% (still lower than the rate calculated by private firms), meaning 54% annual inflation. This, coupled with last month’s 20% currency devaluation, was meant to improve the trade balance. However, it has also caused strife with unions, which are requesting salary increases of upwards of 60%. Should organized workers succeed in getting a pay hike, any effects on trade will be canceled out, as Argentine goods won’t become cheaper internationally.

“The lack of official statistics, plus heterodox economic measures and the increase in rule changes has created international distrust in the country,” Bianchi remarked. “With that prospect, many investors decide to avoid Argentina as a destination for investment until the government changes.”

Chickens Coming Home to Roost

All of this has had major ramifications in Argentina and all over the world, in both public and private sectors alike. The country has lost whatever competitive advantage it gained with the devaluation of 2001 and continues to subsidize services for which it cannot pay.

The scenario has many multinationals fleeing (for example, luxury brands Calvin Klein and Ralph Lauren left in 2012), and investors are steering clear of Argentina until the rules and regulations are more stable and defined. Those who have not fled are struggling with ways of getting their revenues into the matrix.

The landscape does pose an interesting advantage to those in the business of exporting services – especially companies that earn in dollars and/or are able to keep their money abroad. While this week’s AFIP attack on Despegar.com isn’t heartening in that sense, it is worth noting that certain types of businesses have a distinct advantage in coping, especially in comparison with product exporters and those who deal in physical goods.

Another Argentine-born tech giant possibly being affected by the country’s economic downturn is Globant, which has slated an IPO for this year. Bianchi, however, downplayed Argentina’s influence on the company’s success. “I think Globant has managed to establish a proven business model despite the volatility of its country of origin,” he said. “The price may be affected a little, because it has turned into a global company quickly, and investors will be paying for the expectations of it becoming more and more global. But, of course, it presents some extra risks for being in Argentina.”

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So what’s ahead for Argentina? Frankly, it’s hard to tell. The current model in place is one that ends with hyper-inflation. The government and new Minister of the Economy Axel Kicillof have begun to implement more mainstream economic methods, and if they are honest in addressing the problems at hand and how to fix them, their efforts may work. How Argentina’s GDP fares in Q2 and Q3 will be important an important indicator on that front.

Inflation, however, remains the issue of the day, as does how much the Argentine peso is actually worth. The official exchange rate puts one dollar at AR$7.8, while the black market (“dólar blue”) has it set at upwards of AR$11.50. The stock market rate (“dólar bolsa”), the only free and legal way to exchange currency in Argentina right now, fluctuates between a rate of AR$10.50 and AR$10.70 per dollar.

Yes, something is certainly up in Argentina. The question is if and when it will all come tumbling down.

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