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Feb 10, 2017 | 09:15 GMT

The Uphill Battle to Turn Argentina's Economy Around

The Uphill Battle To Turn Argentina's Economy Around
(EITAN ABRAMOVICH/AFP/Getty Images)
Forecast Highlights

  • Argentina's natural limitations, including its isolation from major markets, will continue to deter investment.
  • The government will nonetheless try to attract investment by lifting regulatory restrictions, by seeking suitors for the Vaca Muerta shale play and by maintaining high domestic natural gas prices.
  • Whether Argentina's pro-business turn continues after 2019 will depend on whether President Mauricio Macri is re-elected. If a leftist administration succeeds his, regulatory attempts to benefit investors or raise utility burdens on consumers could be rescinded.

A little more than a year ago, Mauricio Macri was elected president of Argentina in large part on the strength of promises he made to jump-start the country's declining economy. But a combination of factors, including shortcomings imposed by Argentina's economic and geographic constraints, has limited the effectiveness of his ambitious reform agenda. His administration's initial optimism about improving the country's business climate to attract more foreign investment has been blunted by the magnitude of the problems its economy faces.

When Macri entered office in December 2015, he inherited an economy mired in recession, plagued by an inflation rate of around 30 percent and still hamstrung by the government's 2001 default on foreign debt. His first order of business was to reach a deal with creditors demanding payments on that debt so Argentina could regain access to international credit markets. The government also instituted policies that slashed energy subsidies and attempted to curb the influence of national labor unions.

Isolation

But progress toward economic revival has been slow. Geography and trade patterns tend to isolate the Argentine economy from the rest of South America's economies. Its agriculture production is underpinned by Chinese demand for commodities, especially soybeans — China accounts for around 20 percent of all Argentine exports — and the country's industrial base relies heavily on domestic consumption and exports to neighboring Brazil, which is just emerging from its own recession. Any efforts by the government in Buenos Aires to boost Argentina's economic growth by expanding its export markets face the limits imposed by its membership in the Common Market of the South, or Mercosur. Free trade deals made by any bloc member must first be approved by all other members.

Macri's administration is attempting to work within those constraints by focusing on making certain sectors of the economy, including oil and natural gas, infrastructure construction and agribusiness, more attractive to foreign investment. It also is working to overcome the budget deficit left by his predecessor (4.6 percent of gross domestic product in 2016). But economic growth is the standard by which Argentine voters will measure the success of a Macri administration — both in midterm elections in October and in the presidential election in 2019. His administration will most likely overcome some hurdles to growth by sealing agreements with labor unions to increase worker efficiency and with various companies to make investments in oil and gas or the automotive industry more attractive. But Macri will not be able to overcome all the limits on Argentine growth — even if he manages to win re-election in 2019.

The country's highly protected, somewhat secluded and relatively uncompetitive manufacturing sector is going to limit its ability to attract a sustained wave of investment. Argentina is not an export powerhouse for value-added products, nor is it likely to become one. It is isolated by its distance from major global markets, and none of the countries nearby possess completely developed economies.

Its Greatest Potential

Given the lack of available markets and the institutional constraints limiting freer trade, Argentina's greatest potential for sustained growth lies in its agriculture and its oil and gas sectors. For instance, the Vaca Muerta shale play in Neuquen province has attracted interest from foreign companies. Between 2012 and 2015, firms drilling in the Vaca Muerta region increased the number of exploratory and production wells there nearly fivefold. If oil prices continue to rise (Vaca Muerta's break-even price has been estimated at between $70 and $85 per barrel), the Vaca Muerta shale will eventually attract significant capital and become a key source of domestic natural gas production.

Efforts by the Macri administration to raise the price of natural gas, both at the wellhead and for consumers (however unpopular among potential voters) will provide an added incentive for private companies to invest with an eye on supplying the domestic market. An agreement reached earlier in the year with Neuquen's oil and gas labor unions to reduce labor costs and improve productivity will also act as an incentive for investment there, although it is unclear whether the government can reach similar agreements elsewhere in the country. In the case of Neuquen's energy unions, the opportunity to help attract investment to ensure future employment motivated them to accept the government's deal.

Separately, the Argentine government is attempting to negotiate a deal with labor unions in the auto industry to make that sector more attractive to foreign capital. However, investor interest could be blunted by the relative strength of Argentina's autoworker unions and the limited opportunities that industry has to expand, given that the majority of Argentine auto production effectively supplies only two markets.

Agriculture, already an important component of Argentina's export picture, was strengthened by the administration's reduction of export taxes in 2016, which will drive more export growth and investment in agricultural commodities, particularly soybeans, in the coming years. Agriculture exports currently make up about half the country's total exports, and that figure is likely to remain robust, given the strong incentives provided by the tax cut.

But Macri's piecemeal attempts to attract investment will work only if the next presidential administration continues them. After enduring several years of increases in the prices of natural gas, electricity and fuel, it is possible that voters in 2019 will elect a Peronist — a candidate who is more receptive to reviving populist measures. While it is unlikely that a Peronist government would undo some of the Macri government's more beneficial reforms (such as lifting currency controls and removing heavy utility subsidies), it likely would limit or reverse attempts to reform labor regulations in favor of employers and could be tempted to cap future utility price increases. While it is too soon to say with certainty that Macri will lose the election, such a scenario is worth considering, given that the ascension of a Peronist government would cause some foreign companies to rethink investing in Argentina.

In the near term, the Macri government will remove some of the barriers to foreign investment in Argentina. But the weight of the country's geographic, institutional and economic challenges works against economic growth. Despite initial excitement about what the Macri government could accomplish, it is becoming clear that even though his administration will begin to address Argentina's economic issues, the economy's historical limitations will keep continue to limit the effectiveness of its policies.

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