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MACROECONOMICS

Macroeconomic Analysis of Argentina


Faculty: Prof. Jaydeep Mukherjee

Group 7
Abhilash K. (01)
Anant Bibhore (08)
LamzoulianVaiphei (30)
Prasanna Nakka (41)
Ranjit Ram (49)
Supratik Saha (61)

IIM Raipur Batch – 1 PGP 2010-12


Table of Contents
Argentina -- A socio-political-economic Overview.....................................................................................................3

Macroeconomic Performance of Argentina in the last 3 years..................................................................................5

Problems that the Argentinean economy will face in the next 3 years......................................................................8

1) High Inflation:....................................................................................................................................................8

2) Managed Exchange Rate:..............................................................................................................................10

3) Huge Foreign debts:........................................................................................................................................11

Remedies to the problems that the Argentinean economy will face in the next 3 years..........................................12

1) High Inflation:..................................................................................................................................................12

2) Artificially undervalued currency:...................................................................................................................13

3) Huge Foreign debts:........................................................................................................................................14

Bibilography.............................................................................................................................................................15
Argentina -- A socio-political-economic Overview
Pre – Independence: Argentina is the eight largest country of the world
spread over an area of almost 28 lakh square Km. Inhabited from almost 11,000
BC the country was relatively sparsely populated until the arrival of the
Europeans in the 16th century. Juan Diaz de Solis is credited to have been the first
European to visit the area presently known as Argentina. The Spanish established
a colony in Argentina around 1580. Napoleon’s Spanish conquest triggered a
revolution in Argentina in May 1810, popularly known as the May revolution.
Argentina made a formal declaration of independence in the year 1816. 85% of
modern Argentina is inhabited by the descendants of immigrants from Europe,
the remaining being Mestizos, indigenous Americans and others.

Golden Age: Soon after the declaration of independence, a civil war wrecked
the country and Paraguay, Bolivia and Uruguay seceded to form separate
nations. Political instability continued till the formation of the constitution in
1853. A national unified government was established in 1861. Post-unification,
Argentina witnessed a developmental spree and emerged as one of the ten
wealthiest countries of the world by 1929. This period in the twentieth century is
referred to as the ‘Golden Age’ of the Argentine economy. GDP growth averaged
around 5% during this period. This economic prosperity of the country could be
attributed to the following key reasons:

a) Rich Natural resources


b) Introduction of modern agricultural techniques
c) Integration of the country into the world economy
d) Investment flowing in from Europe and
e) The labour put in by the huge numbers of migrant workers largely from
Europe

Great Depression and the Downfall: The country witnessed a rapid


economic downturn after the effects of the Great Depression hit the country. This
process of downturn continued as the country witnessed decline in status and
prestige, although it possessed abundant resources. For much of this period to
the 1970’s political power was held alternately by military and civil governments.
Though there are multiple theories which try to explain this downfall of the
Argentinean economy no consensus exists. But the major reasons and effects
include:

a) Huge foreign debt


b) Excessive regulation
c) Weak rule of law
d) Barriers to free trade
e) Persistent fiscal and current account deficits
f) Consistent High Inflation

Dirty War in the 1970’s: During the 1970’s the country witnessed the ‘Dirty
War’ after the military seized power from the widow of Juan Peron, who had
started the Partido Unico de la Revolucion popularly known as the Peronist. From
1976 to 1983 Argentina remained under a military dictatorship and in attempt to
curb the extremists the military took very harsh measures. Large numbers of
deaths and disappearances were reported during this period and the economy
remained in chaos. Serious economic problems, mounting charges of corruption,
public revulsion in the face of human rights abuses and, finally, the country's
1982 defeat by the United Kingdom in an unsuccessful attempt to seize the
Falklands/Malvinas Islands all combined to discredit the Argentine military
regime.

Return to Democracy in the 1980’s and the hyperinflation:


Democracy returned to the country and the process of political reforms was
started. Democratic institutions were consolidated and a civilian control over the
armed forces was imposed. But the economic conditions worsened. GDP growth
averaged at a negative throughout the 1980’s at an average rate of -0.5%. A
deep recession brought in hyperinflation and the process of production and
circulation of goods ceased to function in a regular manner. The government lost
popularity and after the election in 1989 Saul Menem of the Peronist Party came
to power.

The Menem Magic in the 90’s: Menem along with noted economist of the
period, Domingo Cavallo initiated imposed peso-dollar parity in 1992. This meant
that the peso was fixed vis-à-vis the US dollar on a one-to-one basis and this
convertibility was backed by codified law and a promise by the central
government to furnish dollars to anyone who wanted to exchange pesos. This
created an atmosphere of credibility in the steps taken by the government to
curb inflation. In addition to this the government took steps to promote
liberalisation, deregulation and privatization of the Argentinean economy. Soon,
inflation came down to single digit figures and in the period from 1990 to 1997,
the GDP of Argentina grew on average by 6% per year. By the end of the decade

The Argentinean Default: But, this peso dollar parity meant that the
monetary base had to be completely backed by foreign currency reserves. This
effectively disabled Argentina’s monetary policy. Also, the exports became less
competitive and vis-a-vis important trading competitors. As a result, Argentina’s
ability to earn hard currency was damaged. Argentina started borrowing heavily
to finance deficits. The global slowdown in 2001 hit the country and market
confidence deteriorated. The government was starved of foreign reserves and
despite IMF’s bailout attempts the Argentinean economy collapsed into default in
2001. The political situation was thrown into turmoil as one president after
another assumed office and stepped down. The one-to-one pegging with the US
dollar had to end and 60% of the Argentines were left below poverty line.

The Aftermath: Things started improving again in 2003 when President


Kirchner assumed office. Expansionary monetary and fiscal policies and
rejuvenated exports triggered a rebound in GDP. Real GDP grew at an average of
8.5% annually from 2002 to 2007. However inflation continued to increase and
starting 2007 government started to understate inflationary data. Cristina
Kirchner succeeded her husband as President in late 2007, and this is when the
global recession hit the country. Though the recession was less severe in
Argentina, but GDP growth slowed to almost 0.8% in 2009. A high GDP growth
has resumed since 2010 and the economy is expanding by 8.5%.

Chart: GDP Growth Rate 1980-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)

Macroeconomic Performance of Argentina in the


last 3 years
GDP in 2008-2009: Amid global recession in 2008 both domestic and
international demand plummeted and resulted in diminished growth in 2008
followed by a mild recession in 2009. Economic performance was also hit by a
severe drought during the agricultural season of 2008-2009. This complicated the
fiscal situations for both the central and provincial governments. In 2009
investments fell by 11% and private consumption fell by 0.3%. However, nominal
GDP of the country was about 320 billion US dollars in 2009. This resulted in per
Capita income in 2009 to be USD 7969. This makes Argentina an upper middle
class economy by World Bank standards.

GDP in 2010: Improved weather conditions favouring agriculture, global


recovery from recession and the continuing expansionary fiscal and monetary
policies taken by the government have helped to the rise in GDP in 2010. GDP
was supposed to have grown at about 7 to 8 % in 2010. Since 2006, investment
growth has been low as government interventions in the economy have led to a
policy uncertainty. Investment represented about 20% of GDP after increasing
about 10% in 2009.

Sectoral Allocation of GDP: Argentina has a diversified agricultural sector


which contributes to about 9% of the nation’s GDP while employing only 7% of
the labour force. This has been possible due to use of technology and favourable
farming conditions. Manufacturing accounts for one-third of the country’s exports
and thus projects a developed industrial sector. Industrial production accounts for
35% of the GDP and employs about 13% of the working populace. The country’s
infrastructure is developed and facilitates trade. Services account for the
remaining 55% of the GDP. It employs nearly 75% of the workforce.

Unemployment and Poverty levels: Data put forth by the Government


shows unemployment to be at 8.4% in 2009. Poverty has significantly dropped
from the record high of 60% during the crisis in 2001-02. But recent years has
seen a rising trend in unemployment which has risen to 13.2% in 2009. Some
unofficial estimates suggest that unemployment and poverty levels may be
higher.

Chart: Unemployment Rate 2003-2010 (Data Source: International Monetary Fund, World
Economic Outlook Database)

Inflation: Official Inflation figures are very unreliable as the government has
tried to supress inflationary data. Officially customer prices have increased by
6.3% in 2009. Unofficial figures however have put the inflation of last year at
15%. Coupled with the recessionary pressures of the past year this is an
extremely high figure. Officially 2010 was an even more difficult year for
consumers as officially inflation was supposed to rise at 10%. Unofficial
calculations report the price increase to be at a whooping rate of 25% in 2010.
High inflation will have a toll on the real GDP increase in the coming years.

Chart: Inflation 2008-2011 (Data Source: International Monetary Fund, World Economic Outlook
Database)

Balance of Payments: The recession hit the Argentinean trade in 2009 as


exports fell drastically. There was a decrease in both the volume and prices of
trade and exports of goods fell by 19% last year. On the import side, high import
restrictions imposed by the government, depreciation of the national currency
and the weakened economy pulled down imports by about 34%. This higher
decrease in imports caused the trade surplus to rise. Current account balance
increased from 4.8 billion USD in 2008 to 6.1 billion USD in 2009. However with
decreasing exports and current account balance is expected to go down further
in 2011.
Decrease in FDI inflows was reported from USD 8.3bn in 2008 to USD 2.3bn in
2009. This was because a tendency of risk aversion among foreign investors and
uncertainty regarding future government policies. FII’s also decreased due to
similar reasons, shifting to a net outflow of USD 7.3bn in 2008. Debt inflows also
diminished in 2008 and 2009, mainly due to lower trade related short-term debt
inflows.

Chart: Current Account Balance 2008-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)

Exchange Rate: The Central Bank of the country intervenes in the exchange
rate even now though peso is no longer pegged at one-to-one to dollar and the
exchange rates are supposed to be floating. But, in reality the exchange rate is
determined by a managed float system. Average exchange rate in 2009 was 3.73
pesos per dollar. In September 2010 the rate was 3.94 pesos per dollar. The
peso's real exchange rate had been undervalued in earlier years, which, along
with historically high global commodity prices, helped lift export volumes and
values to record levels.

Debt Levels: The economic crisis of 2001-02 is still haunting the country in the
form of huge debts which are yet to be paid back. Debts in Argentinean Peso
have increased from 615 billion in 2008 to 675 billion in 2009. Estimated value of
debts in 2010 was a high 774 billion peso. It owes about 8 billion USD to official
creditors. International Capital Markets have been closed for Argentina since its
debt crisis. From May to June 2010, the Government of Argentina offered a debt
restructuring for private holders of defaulted bonds. Two-thirds of the private
bondholders participated. This has resulted in about USD 6 billion in private
default claims which is yet to be paid back.

Chart: General government gross debt 2008-2011 (Data Source: International Monetary
Fund, World Economic Outlook Database)
Fiscal and Monetary Policy: The Central Bank governor Martín Redrado was
removed by the government on his refused to transfer USD 6.6billion of foreign
exchange-reserves for public debt payments. The new Governor, Mercedes Marcó
del Pont, is a close ally of the government. So, it is expected that the Central
Bank will continue with it’s lose monetary policy instead of moves to tighten
liquidity. Also, the Central Bank might continue financing the fiscal deficit of the
government as and when necessary.
The government is following an expansionary fiscal policy with heavy
government spending. The expenditures are targeted at keeping the growth
rates high and close the average of 9%. The combined effect of expansionary
fiscal and monetary policies is bearing down on the prices which are on an ever
increasing trend.

Budgetary Deficits: As the government is following an expansionary fiscal it


is continually increasing spending and has increased expenditure by around 30%
in 2008 followed by an additional increase of 10% in 2009. But, the tax revenues
have not increased proportionately as the recession slowed the growth in 2008
and 2009. In fact revenue increased only by 0.5% in 2009.This has resulted in the
constant decrease in the fiscal accounts. The government was successful in
clocking a budgetary surplus of 1.5% of GDP in 2008 merely due to the additional
revenues coming in like contributions for the pension funds and profit transfers
from agencies owned by the government. In fact in 2009 the budgetary deficit of
0.6% of GDP has been clocked.

Problems that the Argentinean economy will face


in the next 3 years

1) High Inflation:
High inflation is a problem that the Argentine economy has been troubled
with from a long time and is likely to be a big problem for the economy in the
coming years. The central government has been reporting inflation rates at
around 9% on an average since 2006. But, private estimates put this number at
around 20%. So, it is a well-known fact in the global financial markets that the
government is underreporting the inflationary figures.

The steps taken by the government to control inflation have clearly not
been enough. Neither the fiscal policy undertaken by the government, nor the
monetary nor the managed float policy for exchange rates have done anything to
instil belief in the consumers and the industries that inflation is going to come
down in the coming future. On the contrary, inflation is following an increasing
trend and seems to growing at a year-on-year basis.

Such high inflationary figures are proving to be discouraging for investors


to pursue long term projects which would have otherwise provided long term
growth perspectives for the country. A lower inflation rate would have had
stimulated those long term investments, as investors would have perceived
better rates of return on those projects. As a result, currently investment in
Argentina is happening on a short term basis.

Needless to say, high inflation is hurting the poor in Argentina as food


prices and energy prices are growing exorbitantly and these are the purchases
necessary for survival. As a result there is a growing rift in income distribution
among the richer and the poorer sections of the society.

A proof of high inflation is seen in the wage revision demands voiced by


official government unions who are pitching for wage hikes in the range of 30%
and above. This solidifies claims by private agencies that actual inflation is much
higher than reported rates. Another indicative of disproportionate inflationary
rates is seen in the fact that the unions have demanded wage revisions every 6
months proving that food and energy prices are rising.

These demands put forward by the official unions are indicative of the
following problems:

1. Purchasing power of the Peso is reducing fast as the wage increments are
not being able to keep up with the price rise

2. Real GDP growth is slowing down as the prices of commodities keep


increasing thus hurting economic growth

3. A negative expectation is setting in the market regarding inflationary


figures which is pushing up inflation even further thus aggravating the
problem

4. Markets and manufacturers are factoring their high inflationary


expectations into future prices and thereby driving prices even higher
2) Managed Exchange Rate:
Though as a stated policy the exchange rate for the Peso is floating, in
reality the Central Bank is following a policy of managed float. So, whenever the
currency tends to appreciate due to a current account surplus the Central Bank
buys dollars thereby increasing supply of the peso. This is artificially making the
current account surplus seem reasonable.

The additional liquidity created in the market by supplying domestic


currency is pushing inflation even higher which was already a big problem in the
recent times. This aggravates problems as imports are becoming more and more
expensive making life difficult for the domestic industries.

To sterilise the injected liquidity the Central Bank is attempting to sterilise


by selling bonds to commercial banks. This is resulting in rising interest rates.
High interest rates are hurting the investment prospects and thereby bringing
down the GDP growth. So, the Central Bank’s exchange rate policy is working
against one of its major objectives – to bring down inflation. Again, the interest
rates going higher is creating an interest rate differential with the rest of the
world thus attracting short term portfolio investments which is tending to
appreciate the currency even further. Thus, the primary objective of the Central
Bank in keeping the currency devalued by injecting liquidity is working against
itself aggravating the problem and is process is building up inflationary
pressures.

Also, as the currency is tending to appreciate even further the


competitiveness of Argentine goods is decreasing in the global market vis-a-vis
its competitors. This is resulting in the exports getting hurt. This will result in the
fiscal balance decrease in a time when it has just started improving after the
global recession.

Another policy followed by the government to manipulate the exchange


rates has been by taxing exports massively. The government is even banning
exports in certain cases and there are no guarantees that when international
prices go down such bans are likely to be lifted as the policy of taxing exports is
not based on a particular rule. The result is that it seems to the people that there
is no benefit in investing in agriculture or agribusiness which forma bulk of the
exports. Thus the government is hurting itself by curbing future revenue
prospects.
3) Huge Foreign debts:
Argentine Government had borrowed heavily in the crisis period in 2001 to
finance the twin deficit. But, once it surfaced that the twin deficit may be come
unsustainable the investors quit along with their money. This resulted in foreign
debt which was almost 50% of the GDP in 2001.

This huge burden of debt has been a cause of concern on the Argentine
government ever since. The debt restructuring policy followed by the
government in the recent years has resulted in paying back of USD 100 billion of
debt. But, there a long way to go before the problem can be alleviated. The debt
in terms of domestic currency is on a rising trend even now. The country ows
about USD 6.3 billion to official creditors in different nations who are collectively
called the Paris club. The international capital markets are also closed to
Argentina before it can repay back a substantial amount of these debt
obligations.

But, as the government has rescheduled debt with the official creditors this
normally means that the government has to register for an economic program
with the international Monetary Fund. But, this will again prove to be a major
setback for the government which had recently in 2006 succeeded in paying
back USD 9.8 billion of IMF credit. If the government has to enter into a renewed
agreement with the IMF it has to go back on its previously announced victory
against the IMF. The Argentine government had only succeeded in repaying IMF’s
money as the Venezuelan president Hugo Chavez had stepped in to help.
Venezuela poured in the money earned from oil exports in bailing out Argentina
against the IMF. Venezuela also assisted Argentina to access the foreign financial
markets by underwriting USD 4 billion for Argentina through bonds. But, it would
be able to continue doing so if the oil prices fall in the near future.

Due to this very reason Argentina needs to improve its image with its
creditors. The country needs more funds than Venezuela has underwritten it for.
This can only be received once investor confidence is rejuvenated. But, the
history of default and consequent devaluation of the domestic currency is still
fresh in the memories of Wall Street and the other investors. This has severely
deteriorated the credit rating of the country and increased country risk. As a
result, Argentina has to pay much higher interest rates in international markets
and is expected to do so in the near future.

Also, the country has a recurrent problem in the form that many creditors
had held out against the debt restructuring scheme of the government. This is
because these creditors felt that the terms of the negotiation were tilted against
them. These creditors are constantly demanding that the government negotiate
a restructuring with better terms. So, all in all the debt crisis is harming the GDP
of the country as the investment required cannot be generated. So, it is in
Argentina’s interest to come to terms with all of its creditors and repay the
mounting debt as soon as possible.

Remedies to the problems that the Argentinean


economy will face in the next 3 years

1) High Inflation:

As the Argentine economy is in a growth spurt, after the recession in 2008-2009


so, it would be better to hurt GDP growth as less as possible while trying to bring
down inflation. The best way to pursue this would be a two-fold mechanism. The
crux of this scheme should be such that one end of it the Central bank should be
allowed to follow a contractionary monetary policy to suck away the excessive
liquidity prevailing in the market. The present government intervention with the
Central Bank’s policies is the reason why the Central Bank has not been able to
take this measure.

The contractionary monetary policy would ensure that there is less supply
of money in the market. This will result in higher interest rates, which will be
reflected in lower investment over times. As, the investment component will fall,
so would the aggregate demand. With the fall in aggregate demand prices should
fall bringing down inflation.

But, in order to lower the negative effect on growth ushered by the


contractionary monetary policy at the other end the Government must continue
with its expansionary fiscal policy. This can be ensured by a mixture of
government spending and tax cuts. This would in turn be reflected in higher
levels of planned expenditure. Thus with planned expenditure increase the
output of the economy would also increase thereby not pulling down the growth
of the economy. One effect of this combination of contractionary monetary and
expansionary fiscal would be however reflected in higher interest rates.

r LM2

LM1
r3
r2
r1 IS2
IS1
Y1 Y2 Y
Graph: Using IS-LM Curve to depict the fiscal and monetary policy outcomes

2) Artificially undervalued currency:

The two bigger economies of Latin America viz. Brazil and Argentina have
both experienced an average increase in GDP in the past 5 years barring the two
year period of recession in 2008-2009. Both of these economies have exports as
a key part of their GDP. But, the differentiating factor in Brazil’s success and
Argentina’s dubious financial situation has been in the exchange rate policy
followed by the central Banks of the two countries.

Brazil has not tinkered much with the exchange rate of its domestic
currency and has let it float relatively freely. This has resulted in the Brazilian
currency, the Real appreciating against other major currencies in the last 5 years.
But, Argentina had taken the just opposite approach.

Argentina’s Central bank has intervened constantly in the currency’s


exchange rate thereby following a managed float and maintaining the currency
at a low level by undervaluing it. Doing this the Central Bank had added to the
inflationary pressures on the economy. The pretext of this policy has been to
boost exports. But, when we look at Brazil we find that it has done pretty well in
maintaining and increasing their exports in the last 5 years in spite of an
appreciating Real.

So, taking a cue from Brazil, the Central Bank of Argentina should stop
interfering aggressively with the exchange rate of the Peso. This would be
beneficial in three ways:

Firstly, it would release the pressure on imports. As, the currency appreciates
imports would be less costly and the import intensive industries would do better.

Secondly, such a policy would lower inflation and even more importantly when
the Central bank announces such a policy the expectation of the people
regarding inflation is going to come down. This would be beneficial in bringing
down the price levels which are astronomically high and are ever increasing at a
fast pace.

Thirdly, it would be beneficial in terms of increasing the foreign reserves of


Argentina. Much of the foreign reserves presently are borrowed. As, Argentina
has a current account surplus so, by not selling its foreign reserves to undervalue
its currency Argentina can built up its own reserves and return the borrowed
foreign reserves they had accumulated with help of Venezuela.

3) Huge Foreign debts:

Argentina has a huge burden of debt and it is high time that the
Government to allocates a higher part of its budget in paying back the
accumulated credits from foreign investors. The debt restructuring had helped
but as a lot of creditors had not accepted the terms, the government has to
renegotiate with these creditors to include them in the debt restructuring
scheme. This would ease the burden somewhat. But, the essence in doing so is
time as the accumulated debt is increasing every year.

Argentina is need of foreign investment in the form of long-term


investment. But, the country’s relation with its creditors needs to improve and
the inflationary pressures have to come down to foster confidence in the
investor’s mind sets to bring in those much needed long term investments into
Argentina. So, this is another area where paying back of the debts would help.

The credit rating of Argentina had gone down hugely after the default in
2001-2002. The debt pay back would help in recovering that tarnished image and
open up the global capital markets for Argentina which at present is quite closed
for them.

Though Argentina seems to have learnt its lesson against huge borrowings
but, the recent borrowings from Venezuela is an area where it should tread more
carefully. Argentina would better not repeat the mistake it made in the start of
the last decade.

The Argentine economy is starting to show signs of recovery. The GDP


growth is high. So, this is the time the Government with the central Bank takes
the necessary measures to ensure that this growth can be sustained in a long
term timespan than looking at short term measures. Bringing down inflation, pay
back of debts and lesser intervention in the exchange rates are the three
pronged approach the policy makers should take to nurse the health of this
recovering economy.
Bibilography

1. Wikipedia - http://en.wikipedia.org/wiki/Argentina
2. World Economic Outlook Database, October 2010
3. Argentina Country Report 2006 by The Economist Intelligence United Ltd
4. U.S. Department of State Background Note on Argentina
-http://www.state.gov/r/pa/ei/bgn/26516.htm
5. Central Intelligence Agency - The World Fact book -
https://www.cia.gov/library/publications/the-world-factbook/geos/ar.html
6. Argentine Financial Crisis: Lessons Learned - INTERNATIONAL JOURNAL OF
BUSINESS RESEARCH, Volume 9, Number 5, 2009
7. Radobank Country Report Argentina -
http://overons.rabobank.com/content/images/Argentina-201004_tcm64-
85825.pdf
8. Argentina - Macroeconomic issues -
http://globotrends.pbworks.com/w/page/14807636/Argentina%20-
%20Macroeconomic%20issues

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