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Taming the Twin Headaches of Argentina's Economy

7 MINS READApr 26, 2018 | 16:54 GMT
Activists in Buenos Aires, Argentina, protest at a government news conference in June 2016 on the release of inflation figures.
(JUAN MABROMATA/AFP/Getty Images)

Activists in Buenos Aires, Argentina, protest at a government news conference on the release of inflation figures on June 15, 2016. It was the first official release of those numbers since the inauguration of President Mauricio Macri in December 2015. Argentina had halted the release for six months, and Macri said the numbers are the first honest estimate in years.

Highlights
  • To limit popular backlash, Argentine President Mauricio Macri has adopted a gradual approach to economic reform and trade liberalization, but it has generated weak results.
  • While the economy recovered last year from a deep recession, a growing trade deficit and high inflation could put those improvements at risk ahead of Argentina's 2019 presidential election.
  • Macri's chances for re-election could be severely undermined if his reforms don't start generating more visible economic results.

In Argentina, the political pendulum swings between economic reform and state intervention. Since taking office in December 2015, President Mauricio Macri has enacted numerous economic improvements and trade liberalizations to ease inflation and improve growth. However, those changes may not be enough, and his time is running short. The next presidential election will be in November 2019, and the reduced but still high inflation, along with a trade deficit, could pinch voters and lead to a populist backlash, bringing the return of greater government restrictions and regulations.

The Big Picture

Argentina has a history of cycling between global integration and national isolation. The government is now on the path of reforming the economy and opening up trade. However, high inflation and the trade deficit could halt this trend.

Lessons in Reform, Populism and Voter Pain

When Macri was elected in 2015, he emphasized the need to go slowly in liberalizing Argentina's economy. Previous reform attempts had been met with extensive opposition and a populist resistance, so the government had to find a way to balance economic reform against the amount of pain those changes caused voters.

In the 1990s, economic liberalization ended with a major financial crisis in 2001, which eventually led to the election of populist leader Nestor Kirchner as president in 2003. The reforms had kept inflation down, but they had also led to high unemployment. The 2001 financial crisis had been partly caused by the government's insistence that the Argentine peso be pegged to the U.S. dollar. The country had been running large trade and fiscal deficits and had financed them through the issuance of debt in foreign currency. That debt eventually reached unsustainable levels, and Argentina defaulted on the debt and devalued its currency.

The crisis so traumatized Argentine society that the election of Kirchner also paved the way for a return of the populist agenda of the Peronist party. Kirchner and later his wife, Cristina Fernandez de Kirchner, who ruled after him from 2007 to 2015, nationalized the country's major companies such as airline Aerolineas Argentinas and oil company YPF. Additionally, Argentina imposed strict foreign currency controls, provided heavy energy and transportation subsidies to keep its political base happy, and tried to force reindustrialization through import restrictions and export taxes on raw materials. However, these policies led to out-of-control inflation and failed to promote the reindustrialization envisioned by Kirchner and his spouse.

A chart showing inflation and the value of imports and exports for Argentina.

Eventually, their tight government control over the economy reached its limit, and liberalization returned with Macri. He reached an agreement with the holders of Argentina's defaulted debt and lifted foreign currency controls. A reduction in import restrictions and energy price controls followed. Additionally, the government was able to approve tax and pension reforms and reduce taxation on the export of raw materials such as leather and grains. It also cut public spending and led the Common Market of the South (Mercosur) in beginning free trade negotiations with several countries and economic blocs. Furthermore, Macri is expected to send a labor reform proposal to Congress this year. However, he has avoided, so far, the unpopular move of privatizing the major state-owned companies, including the airline and oil company.

Macri has implemented his reforms gradually, especially the reduction in energy and transportation subsidies. Lifting these subsidies all at once could have generated strong opposition. And there was indeed strong opposition, but not enough to seriously affect the government's economic reforms. In fact, Macri's ruling coalition, Cambiemos, performed well in last year's legislative election and increased its number of seats in both houses of Congress. That performance was an important indicator, showing that his economic and trade policies still resonate with a good portion of Argentina's people.

The Twin Headaches 

Despite Macri's economic successes, consistently high inflation and a large trade deficit still threaten his reform agenda. Annual inflation has fallen since 2017, but the pace of the decline is short of the government's goal. A cut in public spending was not enough to tame inflation, which increased from over 30 percent in 2015 to more than 40 percent in 2016, before it dropped to 24 percent in 2017. However, that drop failed to hit the government target of 18 percent.

Macri had expected inflation to increase during his first year in office, despite the cut to public spending, and to start dropping at a much faster pace in 2017. The government's decision to lift energy and transportation price controls was blamed for the failure to hit that target. Additionally, labor unions have used the energy and transportation price hikes, which in some cases were over 100 percent, to negotiate big wage increases.

As for 2018, signs already indicate that the government will miss the target of 15 percent, and inflation will likely be over 20 percent. High inflation could cause voters to alter the country's political and economic direction next year. According to a report from the Argentine newspaper Clarin this month, about a dozen polls by different consulting firms showed that high inflation is a top concern. The country's economy grew almost 3 percent last year after a deep contraction in 2016, and high inflation continues to cast a shadow over Argentina's recovery.

Meanwhile, as a temporary side effect of efforts to open up international commerce, the country's trade deficit hasn't stopped growing. That deficit, though not as politically sensitive as high inflation, is another factor that jeopardizes the effort to open up the country. Macri has been trying to diversify Argentina's trade partners by pushing Mercosur to advance free trade negotiations with members of the Pacific Alliance bloc, the European Union, Canada, South Korea, China and Japan, among others.

In 2017, Argentina's trade deficit hit a record because it had lifted foreign currency and trade restrictions and because Brazil, its main trade partner, had seen its currency depreciate during the past three years. In 2016, Argentina had a trade surplus of almost $2 billion, but the next year it reported a deficit of $8.7 billion, and Brazil accounted for more than $8 billion of it. And, in fact, that figure is expected to climb, to $11 billion. A severe drought has cut the production of soybeans, the country's main export product, by about 20 percent, and the U.S. Department of Agriculture is projecting that Argentina's soybean exports will be the lowest in nearly 20 years.

In 2016, Argentina had a trade surplus of almost $2 billion, but the next year it reported a deficit of $8.7 billion, and Brazil accounted for more than $8 billion of it.

Despite the growing deficit, the government is unlikely to impose severe foreign currency and trade restrictions this year. The government will probably cover the deficit by issuing debt in foreign currency, but supporters of more import restrictions, especially from the industrial sector, could become more vocal next year during the presidential election. A Peronist victory could lead to attempts to reduce the deficit through selective import controls, such as altering the import license status of some products. This would slow the importation of goods without imposing high tariffs and could lead to trade spats with other countries.

Election Year Uncertainty

Macri's gradualist approach has been partly successful at preventing the opposition from blocking the approval of his reforms. Nevertheless, those measures must start generating more visible economic results for the people this year and next, or Macri, who is expected to run again, will be facing an uphill reelection battle.

The political opposition, especially the Peronist party, will be looking to take advantage of any shortcomings, and high inflation and a growing trade deficit could become its weapons. Macri's pledge to reintegrate Argentina into the global economy could die, along with trade reform and economic liberalization. And the effects could be felt outside the country, because the government in Buenos Aires has the power to veto Mercosur's free trade agreement negotiations. A more protectionist Argentina could also jeopardize the trade bloc's move toward greater liberalization.

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