An investor might wonder why would the 8th largest nation in the world with abundant natural resources and a well educated populace, continues to lurch from one economic crisis to the other. The nation of Argentina has been mismanaged since independence over 200 years ago. In keeping with that tradition, the country defaulted on its debt for the second time in 13 years in July 2014.
Of course according to the government of Argentina, it was the result of some bond holders who refused a deal of partial payment once again. Argentina needs a deal in order to have access to new cash to pay for necessary imports. Indeed, the lower world prices for commodities have severely impacted the economy of Argentina and the pitiful government continues to ruin it.
A 2012 court ruling in the United States ruled that Argentina would have to pay in full, the small minority of debt holders who refused to take the deal offered by the government. This had put Argentina in a quandary because according to the deal struck with bondholders in 2001 as a way of encouraging them to reinvest, an offer made to one group of investors needed to be offered to all of them. This article known as Rights Upon Future Offers (RUFO) expired at the end of 2014. In theory, this would now allow Argentina to settle with the remaining creditors and become eligible for new financing.
What is the holdup in this logical solution? The same it has always been. The obstinate government of the country, at present under the control of Cristina Fernandez de Kirchner. The default engineered last summer by her government, forced the country to restrict imports even further in the second half of 2014.
This had become necessary since foreign exchange reserves had shrunk to less than $30 billion USD (United States Dollar). This sum in reality, would not even pay for 6 months of the country’s imports.
The limitations on imports has lead to a shortage of some consumer goods, but more importantly a deficit in needed supplies to numerous factories. This is why economists have forecast that the economy in Argentina will shrink by at least another 1% in 2015. Worse yet, roughly 40% of all international reserves this year will be used to pay debt already owed. This issue continues to plague the economy of the country.
In response last December, the government offered bondholders due payment, new securities that would mature in 2024. Less than 5% of creditors went for the deal. As to be expected, most of them prefer to be paid now.
Many investors in Argentine debt, have become as stubborn as President Fernandez de Kirchner. After being referred to as vultures and being held responsible for the sufferings of the Argentine people by the President, they are less inclined to be sympathetic now. Furthermore, it would now be embarrassing for the government of Argentina to pay these holdouts what they are owed.
It is questionable that a settlement will change the reality of the situation anyway. Given the past record of repayment, it is unlikely that investors will want to buy any new debt issued from Argentina in the near future.
It is much more likely that President Fernandez will save face and not settle. Term limited and with new elections due in October, she is most apt to hand off this financial fiasco to her successor. A deal now would not really benefit her much politically, so in her mind the economy can continue to take the hit.
Foreign companies in Argentina have scaled back operations in the country, some have simply cut their losses and abandoned their investment altogether. These foreign enterprises were used to the inefficiency, corruption and the unending cycles of inflation. Many business executives have accepted as have many Argentinians, that the country will have a major economic, fiscal and monetary dislocation every 10 to 12 years.
However, what they did not plan for, was the downright hostility of the present government headed by President Fernandez. The list of her targets continues to grow and includes such notable firms as American Airlines, HSBC, Proctor & Gamble and Shell. Besides the rhetoric, there has been a series of tax raids against a number of companies. The aim of authorities in Argentina is not just to collect owed taxes, but to ensure that any foreign currency particularly dollars is not able to leave the country.
Since 2011, President Fernandez has prohibited foreign companies from sending their profits abroad. Coupled with strict currency control, her objective was to prevent any capital flight from the country, as economic conditions continued to worsen for Argentina. To make matters worse, she has forced firms that wish to import needed commodities or merchandise to export something else of similar value. The most famous example of this was having the German automobile firm BMW export rice, so they would be permitted to import cars.
The attempt by the government to prevent capital flight has overall failed, if one considers the amount of currency reserves available. They have fallen from over $50 billion USD when the new restrictions were enacted in 2011, to less than $20 billion USD now, as earlier indicated. The other monetary schemes put into place by President Fernandez which include multiple exchange rates, have basically destroyed the Argentine peso. As a result inflation is now galloping at an annual rate exceeding 40%, far above the 28% reported a year ago.
The end result has made Argentine one of the least competitive countries in the world and one of the worst places to open and maintain a business. Foreign investment has gone from billions on the plus side to negative amounts, as more firms slow down operations or divest holdings. The largest example of the latter was Vale, a giant Brazilian mining firm. It totally abandoned a $6 billion USD project and has totally left the Argentine market. For most firms remaining in the country, their hope is that a new president and government at the end of the year, will finally bring some sanity to the present chaos.
President Fernandez has been using the Argentine economy as a political tool in maintaining power for years. She seems to have little regard to the long term damage that her meddling is doing to the country’s economic prospects.
The government has resorted to traditional populist practices to hold on to power. These activities usually involve government payments to various blocs of the voting public. These costs can only be paid for by printing more money. It is what is helping to contribute to the runaway inflation rate the country is now experiencing.
Unemployment was reported at 6.8% towards the end of in 2013 and 7.5% in 2014. Once again, the real rate is estimated to be higher by at least 2%. Even those Argentinians who are holding hobs are now feeling the financial pain. Salaries which were raised in 2012 and 2013 in response to inflation, are no longer keeping pace.
Living standards are declining, which is evidenced by the drop in spending at supermarkets throughout the country. There is some economists that claim it had dropped by 5% in the last year alone. More discretionary spending has dropped even further. Car sales for example, have dropped by more than a third in the past year. They are expected to fall even further in 2015.
An additional problem is getting accurate information on what is occurring with the economy in Argentina. The IMF (International Monetary Fund) continues to accuse the Argentinian government as have other institutions of manipulating rates of inflation, unemployment and GDP (Gross Domestic Product). It has been going on since at least 2007. Threats of financial sanctions and additional punitive actions, have still not been effective in making the government in Argentina report figures in an accurate manner.
Foolishly the government attempts to combat the problem of unemployment by expanding government sponsored jobs. State employment went up over 4% in 2014 and may rise even higher this year. Of course, the resulting deficits are financed by printing ever more pesos, which leads to more inflation as aforementioned. It has now become a vicious and destructive spiral.
Protests are rising especially since the recent scandal involving the murder of Alberto Nisman a federal prosecutor. He died hours before he was to give evidence for obstruction of justice in action against the President. More troubling for President Rodriguez is the indictment he had already drawn up against her.
The presidential response to the tragedy, was to replace top officials in the intelligence service with loyalists. She has also eagerly endorsed the idea of a suicide, but the public is having a hard time accepting that as the cause of death. Her actions will likely ensure that there will be no resolution to the case, as long as she remains president.
There is no hope for a viable alternative to President Fernandez, given the cloud of suspicion that surrounds her administration in general. The vice-president Amado Boudou for example, was indicted twice in 2014, once for corruption the other time for fraud, yet he remains in office.
The people of Argentina have finally caught on somewhat, to what is happening to the economy and who might be responsible. Presidential approval ratings are now in the low 30’s by some estimates. However, she has been president since 2007 and will most likely cling to power until the end of the year. Most Argentinians and foreign investors have resigned themselves to this reality. The larger question is, have the people of Argentina had enough of this type of government?
Although the era of the Kirchner’s as president which began with her late husband in 2003 is drawing to a close, is the electorate really ready for a change, not only in style but in actual substance? Will they base electoral choices on merit, rather than personality and bombastic rhetoric? The investment world for now, will need to wait for the answer.