Positive vibes in short-term outlook are beginning to emanate from Argentina. Inflation in May was lower than expected, bringing a long awaited positive dynamic, while the economic recovery is gradually but persistently consolidating, driven initially by construction and the agricultural sector, and now also by manufacturing and retail. At the same time, employment has been growing for 12 consecutive months, financing costs are lower than year ago and global interest rates remain subdued, and it is increasingly likely that the government will meet the fiscal targets for this year.
While inflation increased again in July, due to adjustments in some regulated prices, it is clear that inflation is dropping and at the end of the year it will squeeze down to 22%, the lowest figure in almost ten years (leaving aside the 2009 recession associated with the Lehman crisis). In 2018 inflation it is forecast to drop another 5-6%. Economic activity is currently growing, 4% up year-on-year, likely to accumulate growth of around 3% for the whole year.
Certainly, these are positive stories, though the overall economic situation is not yet strong enough to generate overwhelming enthusiasm - or to be an asset for the government in the midterm elections. Investors are wondering why the FDI flows into the country are still subdued, especially after all the policy changes that took place and the positive image that the government has cultivated.
The answer, probably, is that investment decisions take time; they may be in the pipeline, but are still difficult to turn into a trend, while the economy is just beginning to grow and there are still questions about the sustainability of the new policies. Perhaps capital flows will increase if recovery signals become more pronounced, and the mid-term elections go in the government’s favour. Still, FDI is growing 30% in relation to last year and is expected to top US$10bn this year, significantly above last year’s figure (US$5.8bn), although still short of its potential.
Although they are not very popular, the medium and long-term reforms will in fact be the most important ones once the recovery of economic activity becomes more apparent and noise from the midterms passes. These challenges are the key for sustained high growth rates, which would allow the government to fight poverty and improve the living standards in the long run.
In my opinion, there are four main topics that will, to a large extent, define whether Argentina in the years to come will become more competitive and attractive to investors, emerging as a country with social equality and a macroeconomic framework that promotes growth and reduces external vulnerabilities.
Fiscal consolidation is one: it is essential to carry out a steady reduction of the fiscal deficit and to meet the fiscal goals, which means a target equivalent to 1% of GDP per year that the government set for 2017-2019. This is necessary in order to stabilize the net debt-to-GDP ratio at levels around 35% and to ensure that the country will improve its credit rating, with the aim of increasing it from the current B to BBB level.
If that is achieved, Argentina would recover the investment grade rating that it lost more than 70 years ago. Even though reducing the fiscal deficit is challenging and subsidy cuts may interfere with the inflation targets, it should still remain the utmost priority. The fact that the Government increased utility tariffs early this year despite still being far from the midterms, is an encouraging sign of its commitment to fulfil the fiscal targets for this and the coming years.
Capital market development is another key theme: one of the country’s major weaknesses remains its dependency on international financial markets to obtain long-term financing for the nation, the provinces, and the private sector. After the retirement and pension funds companies (AFJPs) were nationalized, Argentina lost local institutional investors that made long term investments. This made the country vulnerable to the volatilise in global financial markets that, once in a while, may lead to a crisis.
Lowering inflation will definitely help to promote the deepening of the local financial market, and although a new capital market law with many positive changes is in the pipeline, without a strong foundation of a new voluntary retirement savings scheme, it is difficult to think that this longer-term vulnerability will be fully resolved.
Reduction in costs is another factor: Argentina has one of the most insular economies in the world, with low productivity among several sectors, a rigid labour market, a heavy tax burden, and high logistics costs. These issues cannot be dealt with overnight. As long as there is no certainty on how or when the economy will open up to greater external competition, or on what the new tax structure will be at a national, provincial, and municipal levels, it is extremely difficult for investment to arrive.
The government has tried to tackled this problem with special or individual frameworks (such as the one on oil), but the case-by-case approach is not advisable in the long run. It is far more important to move forward quickly in drafting the long-term policies of economic openness, economic deregulation, investment incentives, and changes in the tax structure.
Finally, reform in the social security system is essential: retirement costs are not far from representing 10% of GDP and this is presents a heavy fiscal burden today. Although the deficits in social security accounts are a widespread issue, the imbalance in Argentina is huge due to the high level of informality in the labour market, in addition to the fact that the country has a universal pension fund.
This has led to a disbalance between those who contribute to the system and retirees, now estimated to be at a ratio of 1.5 (9 million vs 6 million), making the system structurally deficient. This disbalance is reflected on the fiscal side, as the tax receipts from personal and employer contributions represent 6.5% of GDP, while pensions reach 10%. This is a discussion that will eventually need to happen, as it is right now in Brazil.
