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Argentina Prepares for a New Phase, Again

9 MINS READMar 12, 2015 | 09:23 GMT
Argentina Prepares for a New Economic and Political Phase
(JUAN MABROMATA/AFP/Getty Images)
Argentine representatives discuss the approval of the bill on sovereign payment of the debt submitted by Argentine President Cristina Fernandez de Kirchner.
Summary

The transition to a new but familiar phase in Argentina's political and economic cycle is beginning. In October, Argentina will hold elections to determine the successor to President Cristina Fernandez de Kirchner, who has reached her term limit. Argentina has enough financial leeway to delay a settlement for its 2014 technical default with holdout lenders until after the end of the Fernandez presidency. However, the state-centric economic model used to recover from the 2002 crisis is struggling. The major presidential candidates are known for their ideological flexibility. Ultimately, the next president will be guided by necessity rather than ideology in resolving Argentina's debt burden and attracting new investment, especially in the energy sector.

Fundamental to understanding Argentine political development are the political and economic cycles it has faced roughly every decade throughout its modern history. From the mid-20th century onward, the populist politics of Juan Peron and periodic reactions against them have dominated the country. In the 1940s, Peron brought labor and women into the political system and established social programs for the working class. Peron's rule ended in the 1950s in a military coup, which reversed the populist economic model. When Peronist rule returned in the 1970s, it was again disrupted by a military dictatorship that introduced economic liberalism, leading to economic decline. The dictatorship collapsed in 1983 after the Falklands War. A center-left government replaced the military and returned to policies of state intervention and protectionism, only to collapse in the face of hyperinflation and violence in 1989.

In the 1990s, President Carlos Menem pursued privatization and market liberalization in a model that collapsed in 2001. Fernandez's predecessor and husband, Nestor Kirchner, returned the state to the center of the economy in the mid-2000s, and Fernandez has continued along this track. As in other eras, the flaws in this model of economic governance have manifested as inflation, unemployment and violence. The next president will inherit Argentina at a time when the pendulum of national economic history suggests a swing toward economic liberalization and pro-business policies to address the problems caused by state management of the economy.

Peronist Politics and the Next Election

The Peronist identity is central to Argentine politics, but it is a contradictory identity. Peron unified leftist labor and rightist nationalists through patronage rather than economic ideology. Patronage and ideological flexibility are keystones of party politics in Argentina. Both the neoliberal Menem and the redistributionist Kirchners identify as Peronist. The contemporary party exists in many factions. Of the three front-runners in the presidential race, two represent competing Peronist factions: the Front for Victory, from which Fernandez hails, and the dissident Renewal Front.

Daniel Scioli, governor of Buenos Aires province, is the head of the Front for Victory. Though he belongs to the same faction as Fernandez, Scioli has criticized her policies at times, creating friction between the two. Scioli reportedly is seen as being supportive enough of Fernandez to compete for her supporters in the election but different enough to be a credible messenger of change. However, his Front for Victory candidacy is not guaranteed; Minister of the Interior and Transport Florencio Randazzo identifies more closely with Fernandez and seeks to take up her mantle in the race. Candidates vying for the Front for Victory nomination will also be competing for the support of the Kirchner youth organization, La Campora.

The Renewal Front is a creation of Sergio Massa, a former member of Fernandez's Cabinet who broke away from the Front for Victory in 2013. Massa has promised central bank independence and advocates reducing the state's role in the economy, including reforming the Supply Law that has allowed the government to set profit margins for private companies operating in the country.

Outside of these Peronist factions is the center-right Republican Proposal. Mauricio Macri, mayor of the city of Buenos Aires, leads this party. Macri is considered the most business-friendly of the three major candidates and the one most associated with renewed efforts to improve policing and reduce crime. At the Expoagro in Buenos Aires, both Massa and Macri promised, if elected, to end the Fernandez administration's restrictions on the agricultural sector that have been a source of conflict between the provinces and the national government during her presidency.

The fluid nature of party alliances in Argentina ensures that the next few months will see presidential contenders negotiate their electoral partnerships and parties lock in their candidates by August. Scioli, Massa and others will each be competing for the Peronist brand. Scioli's and Massa's success will depend more on how much of the party machine will support them than on their ideological claims — though the Peronist label is still so central to Argentine politics that even Macri declared his belief in "Peronist ideals." Massa and Macri are both reportedly seeking to pair with the Radical Party. Macri has strong support in Buenos Aires, but his Republican Proposal party lacks an established political machine in the provinces. The Radical Party faces the inverse situation, making the two potential allies. Such partnerships have already begun to form, but they will proceed slowly; Argentine parties vary from one province to another, requiring negotiations at this level rather than a blanket agreement from central party leaders.

Argentina's Economic Struggle

Whoever wins Argentina's presidential election, the next administration will be conditioned by Argentina's debt burden and energy needs. Repairing its standing in international financial markets has been important for Argentina for more than a decade. However, dwindling cash reserves and a return to default in 2014 because of extended litigation with holdout lenders has added urgency to the matter.

The populist policies of the Kirchner era were a response to the 2001-2002 financial crisis, in which the economy contracted by nearly 6 percent, millions lost their jobs, and half the population fell below the poverty line. The Kirchner administration (2003-2007) brought the country back from recession, reduced unemployment significantly, grew the economy by an average of 8 percent a year and left central bank reserves at $41 billion. By 2010, however, economic growth had brought with it 30 percent annual inflation, and government spending on industrial and public subsidies was proving difficult to sustain. Overall public spending as a percentage of gross domestic product was estimated at above 40 percent in 2014, with GDP still shrinking. The job market has been stagnant for the last two years, with unemployment at 7 percent and underemployment at 9 percent. The economy lost 200,000 jobs in 2014.

Argentina's unresolved debt issue has exacerbated capital constraints. The country largely has been locked out of international capital markets since the 2001 default, preventing Argentina from issuing new bonds. Since 2012, the country has been paying off debt with its foreign currency reserves, which have fallen to approximately $31 billion as of February. The government can access only $15 billion of these reserves immediately in liquid cash because Argentina is reporting currency set aside for debt payments as part of its freely usable reserves. The money is still in the central bank, but its use is already accounted for in upcoming debt payments. Lower foreign currency reserves also make it harder to defend the value of the peso and prevent capital flight.

Despite Argentina's declining stock of dollars, the government has enough cash flow for the remainder of Fernandez's term to allow her to delay making any deals with the holdout lenders. Maintaining a hard line against the "vulture funds" has been a hallmark of the Fernandez administration, and despite renewed negotiations between Argentina and the holdouts, the task of finding a solution is expected to fall to the next president. The debt situation is not an immediate crisis requiring resolution before the election, but with Argentina's reserves declining, it is unsustainable.

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The amounts of public debt due in the next three years — $11.8 billion this year, another $7.3 billion maturing in 2016 and a further $12 billion in 2017 — suggest that the next president's best play will be to make an agreement with the holdout lenders to schedule payment for 2016, when its debt obligation is at its lowest. Such an agreement would rectify Argentina's standing in international markets. 

The Potential for Investment

Settling its unstructured debt is essential to normalize Argentina's status in international markets, issuing new bonds at favorable rates and attracting new investment. Argentina is one of the most resource-rich countries in the world, and the country presents great potential for investment if it can finally put its debt default behind it.

The shale oil and natural gas reserves of the Vaca Muerta formation in Neuquen province provide an opportunity for Argentina to further develop its energy sector and to overcome the country's energy deficit. All three of the presidential front-runners have been vocal about increasing oil and natural gas production. Falling domestic energy production and increased domestic consumption caused Argentina, once a net exporter of energy, to become a net importer in 2010.

Fernandez put the country on the path toward increased energy investment with the passage of the hydrocarbon reform bill in October 2014. The reform creates clearer rules for investment by standardizing taxes and royalties and eliminating exclusive areas for provincial companies. However, there are still obstacles to investment, such as the government-set price for oil, high export taxes and a complex exchange rate regime.

The next president can work to repair the country's financial reputation by addressing the debt default and restoring confidence in government institutions responsible for financial management and economic reporting. Fernandez leaves behind a government statistical bureau — the National Institute of Statistics and Census of Argentina — whose reporting has been manipulated at times to mask negative economic indicators. After a censuring by the International Monetary Fund in 2013, the bureau improved its reporting standards, but as La Nacion recently reported, private economists are once again finding that the bureau may have inflated trade numbers to give the impression of a stronger trade surplus than actually exists. A new president will have the ability to address the statistical bureau's reporting as one measure to restore investor confidence.

Similarly, Fernandez has eroded central bank independence during her presidency. Among the three leading presidential candidates, the Renewal Front's Massa has been most vocal on the need to re-establish Argentina's financial credibility by allowing the central bank to operate without interference from the executive. The risk associated with investing in Argentina means that the government will make concessions to attract early investors, as Fernandez did for Chevron in 2014 by offering 20 percent tax-free exports. As the investment climate improves and Argentina becomes more attractive, such concessions are likely to be scaled back.

The next four years will be a transitional period for Argentina as it moves from the state-centric economic model of the Kirchner era to the next phase of national development based on more liberal economic policy. The 2014 technical default, paired with declining foreign currency reserves and a mandate to increase domestic energy production, has brought the country to the point that the next president will have to resolve the standoff with holdout lenders and restore access to international capital markets.

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