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Global Economic Outlook
Argentina: Q2 2010 Outlook
By Bertrand Delgado
- Despite its low popularity, the Kirchner administration still has the upper hand over a fragmented opposition in a turbulent political environment.
- Argentina’s economy is growing at a faster-than-expected pace at the beginning of 2010, and in the absence of solid macroeconomic management, inflation is dangerously close to moving above 30%.
- Sharp deterioration in the political scene and deep worsening of the inflation outlook are the main risks to our scenario.
Outlook Update: Political Tension and Macroeconomic Mismanagement
The political environment remains tense as the government and the opposition fought over the transfer of central bank reserves to the treasury in order to pay debt, and each side struggled to build up its political power in congress. On the latter, the administration is winning. Despite the administration’s low popularity and its losing the absolute majority in congress, the opposition remains divided. Meanwhile, a debt swap is likely to take place by mid-April as the SEC gave the green light, easing market concerns about a credit event in Argentina. Needless to say, economic policy remains uncertain and unfriendly to markets, while macroeconomic mismanagement persists, producing strong inflationary pressures. Although still too early to call, some market participants are betting on a regime change in the October 2011 presidential elections.
RGE is revising up GDP growth to 4.4% y/y from 3.8% y/y previously (4% y/y to 5% y/y range), supported by solid growth in Brazil and China. Strong growth in domestic demand, in particular consumption, as a result of high fiscal spending, together with a solid recovery in the agricultural sector and a low base, will support growth this year. Moreover, a loose monetary policy stance should add to growth momentum. Industrial production is growing faster than expected at the beginning of 2010, while the construction and retail sectors are showing positive dynamics. Investment will likely be limited by the uncertain economic policy framework.
Figure 1: GDP and Domestic Demand (y/y %)
Source: INDEC and RGE, Forecast in Box
Non-official inflation is approaching Venezuela’s inflation rates at around 30%. Inflation expectation reports from reliable local think tanks and the Universidad Torcuato Di Tella suggest that actual inflation is over 30% y/y. In RGE’s view, strong domestic demand, a weak currency and loose fiscal and monetary policies are responsible for high inflation and should keep inflation pressures elevated. Moreover, high inflation expectations and sharp increases in wages of around 25% should keep inflation dynamics pushing prices upward. Unfortunately, these dynamics are unlikely to change much next year because of the electoral cycle and unwillingness on the part of the government to tackle the problem. In the eyes of the administration, the inflation problem is related to structural bottlenecks rather than unsustainable macroeconomic policy.
Figure 2: Official Inflation vs. Non-Official Inflation Expectations
Source: CB, UTDT and RGE, Forecast in Box
Given that the government would prefer to keep a relatively weak peso in place to maintain competitiveness (especially since inflation is surging) and to boost fiscal accounts (exports revenues and central bank transfers in domestic currency), RGE maintains the view that the local currency will likely be around ARS4.2 per USD by the end of 2010. However, we see some strengthening pressures in the upcoming months as farmers unload U.S. dollar revenues in the local markets, and some Argentinean corporates and provinces likely obtain access the international markets.
How Do We Differ from Consensus: Above the Average Survey
Our growth survey indicates that Argentina will likely expand 4% y/y on average in 2010 with a range of 1.4% to 5.6%. RGE’s 4.4% GDP growth projection is above our survey’s average; however, we see those results moving higher as they were taken before better-than-expected data were released. Overall, we see somewhat more robust private and public consumption in 2010 driven by high fiscal spending.
Risks to Our Forecast: Political Deterioration
Sharp deterioration in the political scene and further worsening of the inflation outlook represent the main risks to our benign domestic demand dynamics. On the positive side, this might create or cement the conditions for a regime change.
Policy Implications: A Small Fiscal Surplus and Loose Monetary Policy
For fiscal policy, fiscal accounts should benefit from the economic recovery, improved global backdrop and high inflation, but the government’s low popularity and the pre-electoral cycle should keep spending high. In Q1 2010, tax revenues increased 23% y/y, though in this instance they were boosted by extraordinary transfers from the central bank. Spending grew above 33% y/y, thus shrinking the fiscal surplus rapidly to 1.6% of GDP from 2.7% in Q1 2009. We anticipate this dynamic will persist in 2010 and 2011, with the risk that spending grows even higher in H2 2010 and especially in H1 2011, given the October 2011 presidential elections. Therefore, RGE maintains its primary fiscal surplus forecast at about 1.1% of GDP for 2010, which accounts for a total of ARS25 billion in transfers from the central government during the year. RGE foresees a 0.5% of GDP surplus for 2011. The government expects a 2.3% of GDP primary surplus in 2010.
Monetary policy will remain loose as the new central bank management and the executive branch prioritize growth over fighting inflation. The government and the central bank consider inflation problems in Argentina to be based on structural bottlenecks that limit supply of goods, so their solution is to keep credit and monetary conditions loose to support investment. Moreover, the central bank is likely to increase the pace of intervention in the upcoming months to defuse strong appreciating pressures on the currency stemming from large agricultural export proceeds. It remains to be seen how much of the large increase in money supply will be sterilized by the central bank. Meanwhile, the central bank will keep financing the treasury to support the government’s spending spree.