Argentina is a country with plentiful natural resources, a well-educated labor force, and some of the highest income levels in Latin America. It has a rich, diverse culture and heritage, as well as a very turbulent past. Argentina's story essentially centers on the questions of "what" and "why." The former is less contentious, while the latter remains quite vexing. In terms of the "what," we know that from an economic standpoint, Argentina provides a rare example for the world's intellectuals of a country that has, over the course of a century, gone from being considered among the most developed to being categorized as a developing or emerging country. The investment community largely categorizes this as a frontier market, and it is also sometimes referred to as a pre-emerging market, along with the likes of Bangladesh, Pakistan, Nigeria, and Vietnam. It is probably safe to say that this group is not the company with which Argentines of 100 years ago would have aspired to be categorized.
The "why" part of Argentina's story is more hotly debated. Many in the academic world have spilled a great deal of ink attempting to explain the country's relative decline in living standards. Reasons offered include political instability and military coups, populism by successive governments, corruption, weak institutions, and inequality. The reality is that all of these factors most likely played a part in Argentina's relative stagnation and institutional weakness in recent decades. Identifying the cause and effect of the above factors is difficult, given the chicken-and-egg issues that arise and the confusion between correlation and causation. For example, did inequality lead to political instability, or was it the other way around? The waters only get muddier, and the tendency to conflate socioeconomic issues only increases as those with skin in the game attempt to weave a narrative that confirms their various agendas. Moreover, any relative analysis between countries over such a long period runs the risk of ignoring important idiosyncratic advantages enjoyed by leading countries over time. Among developed countries, these include the geographic and natural resource advantages enjoyed by the United States and the Marshall Plan that boosted Europe after World War II.
We also have some sympathy for the idea that, in general, Latin America's resource bounty has caused it to lag many Asian emerging markets in terms of market-friendly reforms and the development of human capital. While Argentina's level of education is much better than that of its neighbors, the resource cushion has made for a less competitive region overall, where successive governments have been more concerned with divvying up the resource spoils than thinking about ways to grow the economic pie through moving up the value chain.
We admit it is somewhat difficult to pin down the precise historical causes of Argentina's relative decline, but what has occurred in the past decade is less perplexing. The policies enacted in modern times, specifically during the 12 years under the Frente para la Victoria (FpV) led by Cristina Fernandez de Kirchner (and previously by her late husband Nestor Kirchner), have entailed a relentless march toward interventionism, economic unorthodoxy, and a general hostility toward business and foreign investors. We have witnessed the methodical rise of the government's share of the economy and its scope in terms of hindering the functioning of market forces, as well as the proportion of people who work for, and thus depend on, the government. The unorthodox policy prescription has included currency controls and trade restrictions, distortive subsidies for electricity, and large, monetary-financed fiscal deficits. Very predictably, this has led to weak exports, underinvestment in power infrastructure, worsening fiscal accounts, and, perhaps most painful for the average Argentine, rampant inflation. The response has been (again, quite predictably) for the government to resort to populist demagoguery, blaming poor economic outcomes on business and those infamous foreign devils known as speculators. The situation has gone far beyond bully pulpit rhetoric to events ranging from the seemingly desperate to the downright bizarre. The government has engaged in the nationalization and expropriation of foreign assets, an outright purge at the government statistics office, and even fines and the persecution of independent economists for publishing their own estimates of inflation if they differed from the government's numbers. The government's failure to make good on foreign debt payments even resulted in a distressed debt investor arranging for a court detention of an Argentine naval ship in a port in Ghana. It certainly goes without saying that all of these shenanigans are not conducive to economic confidence and entrepreneurialism within Argentina.
Fortunately, the country's voters have recently spoken. After successive rounds of voting, opposition candidate Mauricio Macri was elected president. Since taking office in December, Macri has lived up to his promise of economic reform and a return to orthodox policies. Due to the unusual degree of power that is vested in the presidency, the new president has come out swinging, surprising even some of the most optimistic observers with a flurry of important reforms. In fact, there are few places one can point to where reforms are being implemented with such vigor. This includes countries where we have seen positive election outcomes in recent years, such as India and Indonesia, where Prime Minister Narendra Modi and President Joko Widodo, respectively, have experienced varying degrees of resistance and obstructionism in their legislatures.
Macri has lifted currency controls, allowed the currency to float freely and devalue, and scrapped export taxes on many agricultural products and reduced them on others. As a result of these moves, agricultural exporters have stopped hording inventories, and foreign exchange reserves have been replenished. Furthermore, wasteful subsidies for energy consumption have been cut, which is an important first step toward fiscal consolidation and ending the feedback loop between growing deficits and inflation.
The resolution of the longstanding impasse with foreign creditors, allowing the country to regain access to foreign markets, has perhaps been Macri's most important move. While in theory it would be nice to see just one country not grow its economy via perpetual debt buildup (with perhaps the exception of Singapore), the reality is that myopic government leaders can still run deficits without borrowing. Argentina has proven this in recent years, and regaining access to foreign credit markets means that less of the deficit will need to be financed through monetization, which has been a critical component of the painful and unrelenting inflation the country has experienced.
With the milestone of resolving the holdout issue behind us, the two things that matter most going forward will be the evolution of fiscal consolidation and inflation, with the former a pre-condition for the latter, given that excessive monetization and large deficits fuel inflation. The types of reforms being implemented will be painful. The cutting of subsidies will hit consumers in their wallets and add to inflation, at least initially. Another potential flashpoint that could worsen the outlook for inflation is ongoing wage negotiations between the government and Argentina's powerful unions. Unions are demanding wage hikes in excess of inflation, while the government must argue that such wage hikes only add to overall demand and inflation. This chicken-and-egg issue is complicated by the fact that nobody can say for sure what inflation really is, since the statistics agency is being revamped and has yet to release a new consumer price index indicator. The central bank has hiked interest rates aggressively in an orthodox fashion, but the economic outlook remains challenging.
Social unrest that could result from a failure to tame inflation or the economic adjustment in general is also a notable risk. Macri won the election by a small margin, and even though other candidates also spoke of the need for various policy adjustments and reforms, there is still a sizeable portion of the electorate that preferred the populist handouts of the previous government. Moreover, Macri's allies lack a majority in each house of the legislature.
Not only are the reforms likely to bring more pain, but unfortunately, they are being attempted at a time when the external sector is not likely to act as a relief valve. Brazil, by far Argentina's most important trading partner, is going through a painful adjustment of its own after years of excess. This all but assures that Argentina's adjustment will be challenging and protracted. On the other hand, markets are made on the margin, and it is the rate of change which matters most. From a policy standpoint, the compan's transition is coming at a time when Brazil is starting to pay a heavy price after years of its policy moving in the wrong direction. From a relative standpoint, Argentina is one of the few positive reform stories out there, and investors are starting to have another option in the region besides the political rat's nest of Brazil and the hard commodity-reliant economies of Chile, Colombia, and Peru.
While Argentina's transition from relative basket case back to an investible country will undoubtedly be difficult, we believe the trend of improvement is undeniable. Macri has done a great deal of heavy lifting, which we believe will pave the way for an eventual robust economic expansion led by investment-foreign direct investment in particular - as the more predictable and less burdensome policy orientation should lead to an improvement in business confidence. We expect the external adjustment to continue as the current account deficit narrows, with the fiscal adjustment program weighing on imports, and the weaker peso and lower taxes acting as a tailwind to exports.
It is likely that the pace of reform will moderate somewhat, given the lack of a majority for the government, but the wind should remain at investors' backs in terms of an improving operating environment. We would argue that the government has shown the ability to build consensus across party lines, as demonstrated by their gathering of support to pass bills associated with ending the holdout standoff. We would eventually like to see labor market reforms and further fiscal consolidation, though the government is expected to continue to tread carefully given the scale of the task at hand. We will continue to monitor carefully various private estimates of inflation, but barring a major political upheaval or exogenous global shock, our view is that the Argentine train has left the station. As the country marches toward a more investor-friendly and prosperous future, we will continue to look for opportunities to increase exposure to one of the most promising macro stories out there. While the ride will not always be smooth, we look forward to watching the comeback story as the country works to regain its emerging market status. With the right policies and a little bit of luck, Argentina will likely begin to restore some of its former glory on the global stage.
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