Latin America Short Read

Recession: Made In Argentina

President Macri started his time in office with a mountain to climb. Almost three years on, it has not got any easier.

Argentina has had quite a year so far. Mauricio Macri, the Argentinian President, confessed on September 3rd that: “these were the worst 5 months of my life since my kidnapping”. In 1991 Macri was kidnapped, thrown into a coffin and taken to a safehouse for 2 weeks until his family agreed paid his $6m ransom. It caused Macri to abandon a career in Business and instead focus on politics. Far from being a less traumatic career, President Macri is now staring down the barrel of a second recession since taking office.

Indeed 2018 has been quite a fall from grace for Mr Macri. Near the beginning of the year a second term in office was looking assured as he quickly dealt with the economic issues left by his predecessor Ms Fernández. The government raised interest rates to combat the 25% inflation rate, implemented widespread spending cuts, removed export taxes and lifted currency controls. Following a sharp recession in 2016, the economy rebounded in 2017 and grew by 2.9%.

However, Argentina’s fiscal and current account, along with vast amounts of debt, meant that the economic recovery was never destined to be a brief one. In May this year Argentina raised interest rates to 40% in order to combat its dangerously high inflation rate and also to provide support for the Peso, which has dramatically fallen 52% against the dollar this year. In August, the bank had to hike rates up to 60% as the Peso continue to slump.

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Peso vs Dollar; Source: XE

So why is this happening?
The Central Bank of Argentina said in a statement at the beginning of the year that it would use “all the tools at its disposal” to slow inflation to 15%, having been at 25% throughout 2017, the highest inflation rate in Latin America bar Venezuela. This contractionary policy from the Argentine Government is used as the main tool to combat the dangerous level of inflation in the country. Increasing the interest rate increases the consumers’ propensity to save and therefore less money is being spent in the economy. Reducing spending is important during inflation, because it helps halt economic growth and, in turn, the rate of inflation.

The hike in interest rates also helps to solve the problem of the weak Peso. The Peso, which before Argentina’s economic meltdown in 2001-02 was fixed by law to the US dollar, has weakened even more in recent months as the US dollar has grown stronger and foreign capital has been withdrawn. This has been accelerated as investors begin to see their returns vaporized by the fall of the Peso against the dollar.

This was then compounded by the introduction of an income tax on foreign investors, causing even more investors to head for the exit. According to Win Thin Global Head of Emerging Markets Strategy at Brown Brothers Harriman: “Investors are moving out of emerging markets, frontier economies, and other risky assets and so countries like Argentina remain at heightened risk”. The weakening of the Peso against the dollar caused the Argentinian Government to sell $1.5 Bn of its national reserves in just one day in a desperate attempt to bolster the Peso.

IMF to the rescue?
In June, President Macri was able to secure the largest loan from the IMF in history at over $50bn. The president said that the financial backing would: “strengthen our programme of growth and development”. This has been a controversial decision amongst the Argentinian population given the country’s turbulent relationship with the IMF.

A large proportion of people in Argentina still blame the IMF for the policies that caused the financial crisis in 2001, eventually leading to the country having to default on $80bn of sovereign debt making it the biggest default by a country in history. Mr Macri has already begun a new round of negotiations with the IMF in order to generate more capital for the country. The Central Bank stated that: “A new agreement with the International Monetary Fund will re-establish confidence in the fiscal, financial, monetary and exchange rate situation of the economy”.

From bad to worse
The head of Argentina’s central bank has resigned amid reports of a row over policies to restore confidence in the Argentina’s economy, causing a further 4% fall in the peso, while the country’s main share market fell more than 5% at the open, accompanied by a steep fall in exports. It follows an announcement from the Government that Argentina’s economy shrank by 4.2% in the second quarter, its sharpest quarterly contraction since 2014.

Questions are also being raised about lack of leadership within the country – Mr Macri has been criticised for announcing the IMF deal on television last month before it was actually negotiated in Washington. His opposition is already gathering support in the streets for a 24-hour strike. It could be just a taste of what lies ahead for Argentina.

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