Argentina: Balance of payments crunch?

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This post is a guest contribution by Daniel Volberg of Morgan Stanley.

No sooner had President Cristina Fernandez de Kirchner declared victory in her re-election bid less than a month ago than the challenges for the administration had taken on new urgency. At the time we highlighted that the two most pressing issues for the administration would likely come on the fiscal front where a reduction in energy subsidies was likely and on the currency front. While the authorities have made some initial announcements on the subsidies front, the first moves on the currency front appear to have created an even more challenging environment. The decline in international reserves – which have fallen by $5 billion (just under 10%) since July – has accelerated in the first days of November after having slowed somewhat in October.

A Balance-of-Payments Crisis?

At first glance, the reserve losses suggest that Argentina is suffering a balance-of-payments crisis where an overvalued currency has become unsustainable. Indeed, the view that recent turmoil is driven by an unsustainably overvalued peso appears to be gaining traction. However, we caution that based on Argentina’s fundamentals, there should be no balance-of-payments crisis for two reasons.

First, while the real exchange rate has appreciated in recent years, it is by no means overly stretched. After all, the real effective exchange rate is still below the average of the 1990s. Of course, any conclusions drawn from looking at a long series of the multilateral real exchange rate must be taken with some skepticism. Still, given the terms-of-trade improvement that Argentina has experienced in recent years, it is hard to argue that the peso is dramatically overvalued.

Second, Argentina still has a current account surplus. While the current account has deteriorated, in the first half of the year it still posted a surplus of roughly $800 million. And in the following months the trade balance data have remained supportive, suggesting that the current account should have stabilized in surplus territory.

Expectations Challenge

We suspect that the recent turmoil is largely driven by a question of confidence. Recent policy actions and fundamental dynamics have resulted in deteriorating confidence in the value of Argentina’s currency. We suspect that there are three key elements behind the recent currency turmoil.

First, the status quo does not appear to be sustainable. With annual inflation (near 24% according to our measurement) running well above the current nominal peso depreciation (7-10%), the real exchange rate has been steadily appreciating. Indeed, the deteriorating balance of payments suggests that a decade of an undervalued Argentine peso has come to an end. The status quo – single-digit nominal depreciation and double-digit inflation that result in real appreciation of the peso – does not appear to be sustainable and, if unchecked, seems likely to lead to an overvalued peso in the near term. That, in turn, could spark pressure for more rapid peso depreciation. Thus, some foreign currency demand in recent months may have been driven by the desire to preserve savings (in dollar terms) in light of the concerns that without major adjustments to currency policy, the peso would have to devalue within months.

Second, the tightening of capital controls announced in late October has led some to be concerned that a devaluation may come sooner rather than later. At the end of October the authorities introduced new restrictions on buying foreign currency for individuals and companies. Those buying currency now need prior approval from the tax agency (AFIP). The measures appear to have been prompted by the loss of international reserves and the FATF investigation of Argentina’s anti-money laundering regime. Since the measures have been announced, there has been considerable confusion about the new regulatory landscape. The authorities claim that the measures are largely informational (identifying those who purchase foreign exchange) rather than a more substantial tightening of capital controls. Authorities note that the approval rate for dollar purchases under the new regime is roughly 80%. However, some banks suggest that it may be significantly lower. And while dividend payments by large companies in foreign currency are currently exempt from the AFIP approval requirement, there are concerns that additional measures could be forthcoming that would further restrict access to foreign currency. Our concern is that the authorities have not clearly communicated the logic behind the tightening of capital controls and the result has been an increase in expectations of devaluation and hence increasing demand for hard currency.

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Mobius on Argentina

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The paragraphs below come courtesy of Mark Mobius, emerging markets guru and executive chairman of Templeton Asset Management.

In the search for good investment opportunities around the world, I have made many interesting company visits. This time, I particularly wanted to share some of my noteworthy observations from Argentina, where we had our semi-annual analyst conference earlier this year.

Argentina has been experiencing steady growth throughout the years despite the country’s economic problems, from double-digit inflation to a shrinking trade surplus. We saw one good example of the improvements in the country when we arrived at the Ministro Pistarini International Airport, which, since its privatization, is in much better shape than it was in the past. Besides the bright and airy new wing, the customs and immigration process was quick and efficient. We then checked into a modern hotel in the Puerto Madero area in Buenos Aires, which is another good example ofArgentina’s transformation. Puerto Madero was a rundown port with derelict red-brick warehouses, but thanks to creative entrepreneurs, the warehouses lining the port canal have been transformed into offices, restaurants and apartments. The hip and wealthy have migrated to the area; across the canal are a slew of new high-rise, high-end apartments, and a half hour’s walk from the hotel along the canal is a floating casino that is seeing brisk business.

On our first company visit, we met with executives of a telecommunication services firm. We were told that operational results had been positive as a result of strong consumption growth patterns and a favorable macroeconomic environment. The company has continued to report solid results in both mobile and fixed-line operations, and it has also maintained reasonable EBITDA (earnings before interest, tax, depreciation, and amortization) margins despite the challenging inflationary environment and the fact that mobile and broadband penetration are approaching saturation in the country. Although the company estimates that high usage is likely to keep revenues growing at a healthy pace, it warned that margins could deteriorate moderately on the back of wage pressures. These are some of the factors we take into consideration when we evaluate the attractiveness of a potential investment.

We also visited a leading Latin American producer of crude steel, with production operations in both Argentina and Mexico. What was interesting to us is that the company appeared to have a very attractive cost structure due to its integrated operations, state-of-the-art steel facilities, access to diversified sources of low-cost raw materials and other input and operational efficiencies. The company improved operations in the first quarter of 2011 as a result of solid volumes and better prices, and it indicated that it expected higher product prices and margins in the second quarter as well. However, a key factor that the company has to consider—and that also factors into our evaluation process—is the rising cost of raw materials such as iron ore and coal.

Another interesting visit we made was to an energy-related company, a leading global manufacturer and supplier of pipes and associated services for the oil and gas industry, among others. The company has production, distribution and service capabilities in key markets across South America, North America, Europe and Asia. Management informed us that the oil and gas industry had been witnessing a new cycle of investments and that the company was operationally prepared to service this growing market. Moreover, they pointed out that the sustainability of this cycle is likely to be supported by high oil prices, paving the way for higher drilling activity worldwide.

During our trip, we took one day out to visit the delta of the Rio de la Plata (River of Silver) and the riverside town of Tigre, whose name is derived from “tigres” or jaguars that were hunted there in the past. The delta is a complex of tightly packed canals and islands that reminded me of the Mekong river delta in Vietnam and the Chao Phraya river delta in Bangkok, where you can explore hundreds of winding canals. The Rio Plata delta is a popular summer holiday spot with thousands arriving by car or train from Buenos Aires. The waterways are filled with picturesque summer houses, where the only way to get around is by boat.

All in all, we were very pleased with our trip and the discussions we had with the different companies we visited. We look forward to returning to Argentina for more visits like this.

Source: Mark Mobius, Investment Adventures in Emerging Markets, July 8, 2011.

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Argentina’s pivot point

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This post is a guest contribution by Daniel Volberg of Morgan Stanley.

This year could be pivotal in shaping Argentina’s economy, as well as its political and policy direction. Argentina appears to be at a crossroads: this year’s presidential and congressional elections could determine policy direction in the next few years. But while Argentina watchers are looking closely at any signs of a shift in the policy mix of the current administration and trying to handicap how the political landscape could change ahead of the elections, we would argue that alongside a great deal of political unknowns there are economic known facts about Argentina that may challenge conventional wisdom.

While elections may be the critical element towards understanding Argentina’s dynamics this year and beyond, in the near term the political landscape is likely to remain highly uncertain. Indeed, we suspect that the outlines of the election contest are likely to start taking shape only in March or April. Two points are worth highlighting:

First, we believe it is unlikely that economic policy will change ahead of the elections, given our expectations of persistent political gridlock. The political gridlock may be the result of a tight balance of power between the administration’s party and the opposition in Congress. The administration’s party controls 104 seats in the 257-seat lower house of Congress and 36 seats in the 72-seat Senate. Meanwhile, the opposition block – a loose union of several parties – have an outright majority in the lower house with 131 seats and a minority of 32 seats in the Senate. This tight balance of power, especially in the Senate where no block has a majority, has raised the power of independents and contributed to significant gridlock and uncertainty. We suspect that this political landscape is unlikely to change dramatically until presidential and congressional elections in October 2011 and so we see little chance for a change in economic policy in the interim.

Second, we expect persistent uncertainty in the near term over the presidential contenders, their programs and their electability. There are many politicians tipped to run for the top job, but very few have actually declared their intent to do so. Indeed, only four politicians have declared their intent to fight for the top job – Vice President Julio Cobos, Senator Ernesto Sanz and Senator Ricardo Alfonsin – all from the center-left UCR party – and Senator Elisa Carrio from the opposition ARI block. The three candidates from UCR are expected to first run against each other in a primary scheduled for August, and perhaps also in an earlier primary possibly in April.

In addition to the declared contestants, a key question will be whether the current president will run for reelection. Her approval rating has improved dramatically over the course of last year – from just over 20% at the beginning of 2010 to nearly 60%% by the end of the year, according to polling data from Poliarquia Consultores. That would suggest that her chances at re-election are very strong. However, much of this upturn in popularity – over 20pp – appears to have come in the aftermath of her husband’s sudden death in October last year, and it is uncertain whether it would persist or translate into votes on election day. Despite this caveat, the president’s decision on whether to run for re-election is likely to be an important milestone in defining the political landscape as she remains a strong contender.

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