Argentina: The Implications of the Export Tax Failure

In an 18-hour, drama-filled debate session that lasted until the early morning hours of July 17, the Argentine Senate officially rejected a measure designed to raise taxes on agricultural exports by a tie-breaking vote cast by a supposed ally of Argentine President Cristina Fernandez de Kirchner. The vote effectively ends a law that has threatened Argentina's stability, and put its agricultural industry at risk of collapse. It also represents a major defeat for Fernandez, whose control over the South American country never has been weaker. The purpose of the taxes was twofold. First, the government is in dire need of cash. Fernandez's government, like that of her husband before her, relies on populist policies to ensure support from the poor. To win this support, the government must be able to pay for massive subsidies. This results in artificially low prices for basic necessities (food and electricity lead this category), which translates into artificially high demand (and thus an evermore massive subsidy bill for the government). The second reason for the export tax is to keep food at home. To ensure cheap foodstuffs at home, the government long ago imposed domestic price caps on food. This reduced farmers' ability to profit at home, so they began growing crops such as soybeans for the export market. The export taxes were designed to reverse that incentive by making planting soy for export not worth it. Combined with domestic price controls on wheat (among other essential foods), however, the export taxes effectively ended farmers' ability to operate at all. Without the ability to make money abroad or at home, the distinct possibility that the farmers would opt out of the market altogether arose. The resulting food shortage would have been disastrous for Argentina. Fernandez retains the ability to submit a modified tax bill, or resubmit the same bill next year. But with the export tax thoroughly defeated (for now), the future of the farm industry is much brighter. Crises abound on the not-so-distant horizon, however — namely, rising inflation, rising government debt and the energy crisis. Overall, the country as a whole is staring down the barrel of a gun. With Fernandez's apparent loss of control of the legislature, that gun just got a bit closer to firing. Argentina's 2002 debt crisis was caused by an accelerating deterioration of the country's economic situation between 1999 and 2002, which was tripped off by the government's inability to service many of its debts. The resulting instability and insecurity of Argentina's investors led to the flight of investment, massive capital flight and a dearth of new investors. With so much money flowing out of the country, Argentina was unable to maintain its dollar peg. When the peg collapsed, the cost of servicing Argentina's foreign-denominated debt went through the roof, forcing Argentina into a liquidity and inflation crisis. As a result, Argentina chose to restructure debt in 2003, a process that did not end until 2005. The resulting reduction in overall debt equaled about $60 billion. Although the debt picture is markedly better than at the time of the default, debt has begun to rise again. New debt — that is, the total gross public debt accumulated since the restructuring process — currently rests at $144 billion, just higher than gross public debt immediately prior to the debt crisis. Furthermore, current debt accounting excludes the outstanding debt to bondholders, which (although it may never be resolved) hovers around $30 billion. Since the debt restructuring, reliance on deficit spending caused debt to rise to support costly social projects. At the same time that the debt is approaching worrying levels, inflation is yet again an issue. The official numbers show inflation hovering at around 9 percent; however, in reality, it ranges somewhere up to 30 percent. This is not hyperinflation, but it is distinctly bad news. If the situation worsens, it could impact Argentina's ability to service its foreign-denominated debt (which makes up about 37 percent of total debt, or $54.4 billion). With rising inflation and an increasing debt burden, all indications point to Argentina heading down the same bad path as in 2001. Increasing pressures on the government that will translate into increasingly expensive spending programs mean that a big decline in the debt level is unlikely any time soon. The most pressing and expensive issue on the horizon is the energy crisis. Argentina's flip from being a natural gas net exporter to being a net importer has put the government in a bind. With more than 50 percent of the country's electrical generation dependent on natural gas, just keeping the lights on means having to juggle electricity imports from Brazil, liquefied natural gas imports from the world market and beseeching Bolivia to increase its pipeline exports — all of which must be paid for. Luckily, 2008 has seen a mild winter in Argentina. But, in the long term, the government will be increasingly burdened with subsidies for electricity and natural gas — not to mention any attempts to resurrect the energy industry. Fernandez's ability to guarantee government responses to important issues is increasingly suspect. And with the loss of this political battle, Fernandez is now weaker than ever. She stood her ground against the farmers, insisting they could afford the taxes. In the process, however, she has fractured her party. In the short term, she might not even be able to control the loyalties of her own party. In the medium term, she faces losing control of the legislature in the upcoming 2009 midterm elections. The inability of the government to govern has profound implications for Argentina. On one level, it raises the level of risk in the eyes of potential investors. Luckily, regional ally Venezuela has proven willing both to invest directly in Argentina and to purchase and then resell Argentine debt on local Venezuelan markets. Though this may be good for Argentina, it locks Venezuela (which is also increasingly financially unstable) into following Argentina if the latter goes into free fall again — and vice versa. On a more fundamental level, the government's inability to face the rising energy crisis coupled with rising public distrust of the stability of the peso threatens the government's very hold on power. Although there are no indications as of yet that the military would try to take power, Fernandez's decision earlier this month to institute broad-based pay raises for military personnel may be an indication that she is worried about just that. But threats from without are just as powerful. The Argentine penchant for protest is well known, and a wave of rising unrest could force Fernandez to step down like so many Argentine presidents before her.