Populist Policies Threaten Argentina's Economy

(International Relations and Security Network, 23/09/2005)

 

Argentine President Nestor Kirchner said 16 September at the United Nations General Assembly in New York that International Monetary Fund (IMF) policies have failed Argentina. His tough stance against the world's last resort lender is popular at home, where millions of Argentines lost at least a third of their life savings when the economy imploded some four years ago after the IMF cut them off.

 

That said, what millions of Argentines fail to realize, and what Kirchner continues to ignore, is that the current success of the Argentine economy is skin deep. His search for political stability at the expense of sound economic strategy may cost him a real mandate for the presidential post in the upcoming elections and earn him the blame for leading Argentina back into recession.

 

After nearly a decade of prosperity, Argentina's economy began to slip into recession in the late 1990s. Global market malaise in 1998-1999, the Brazilian devaluation of the real in 1999, a strong dollar, and low prices for Argentine farm exports contributed to the recession.

 

The government's currency board at that time presided over a fixed exchange rate that locked the peso to the dollar, effectively removing exchange-rate policy and monetary policy - both of which are important tools for managing external shock on the national economy.

 

Economic meltdown

 

The fixed peg had worked for years, but in 1999 it was beginning to prove too inflexible to react to global economic events. Fernando de la Rua assumed the presidency in December 1999 with a popular mandate to stick to the peg and improve Argentina's economy. He was the first president to take power after ten years of rule by Carlos Menem, and wanted to prove that his party could govern better than the Peronists - a position that put him at odds with the country's traditional political powerhouse that after ten years of rule found itself in opposition.

 

De la Rua's administration was plagued from the start. His attempts at austere fiscal policies, which were designed to align government spending with tax revenues, were never accepted by the Peronists without serious bickering, infighting, and deal-making. As the Argentine deficit grew and global economic pressures forced the Argentine economy deeper into recession, de la Rua was forced to turn to the IMF to help serve Argentina's growing deficit. In March, 2000, de la Rua signed a US$7.4 billion program with the IMF.

 

De la Rua's biggest challenge in the wake of the IMF agreement was to convince provincial governors to accept a cap on federal tax transfers, which the Senate would need to approve. But his party took losses in the October 2000 congressional elections, leaving him in a difficult negotiation position with the Peronists. By December 2000, de la Rua was in a tight spot. His vice president had resigned and he found himself again turning to the IMF for help.

 

The IMF agreed to a US$6.3 billion program in January 2001, which helped the Argentine economy limp along a little longer. Total loans from the IMF to Argentina during de la Rua's term in office alone had accumulated to US$13.7 billion. The Argentine economy was quickly becoming a money pit. Spending was still not under control and Argentines, wary of an impending economic collapse, began losing confidence in the country's banking system.

 

The IMF agreed to give Argentina another US$8 billion in August 2001, US$5 billion of which was intended to bolster central bank reserves. As the year wore on, de la Rua was unable to reach an agreement that would cap federal tax transfers to the provinces, so spending continued to out-pace earnings, which continued to increase the government deficit and erode domestic and international confidence in the Argentine economy.

 

Banks began to suffer as the rate of personal withdrawals accelerated against deposits. The government responded by limiting access to personal bank accounts. It was the beginning of the end for Argentina's economy and its fixed exchange rate.

 

By December 2001, after another year of deep recession, the IMF finally decided not to give Argentina more money, effectively cutting the country off from its only economic lifeline. The Argentine economy had not improved as de la Rua promised it would when he entered office. A widely unpopular partial freeze on bank accounts pushed Argentines to the end of their tether. Supermarkets were raided by the hungry poor in Buenos Aires and provincial capital cities. Unemployment was near 20 per cent.

 

De la Rua and his ministers were soon forced into resignation. And in December 2001, the Argentine government defaulted on tens of billions in international debt, including billions worth of IMF loans. It seemed no one wanted the only job available in Argentina, that of president.

 

A shaky recovery, enter Kirchner

 

After de la Rua's demise and a quick succession of "presidents of the week", the Argentine Congress put Peronist Eduardo Duhalde in the president's seat. The middle class was in the streets, bank accounts were frozen, and the Argentine economy was in a shambles.

 

Duhalde had to take action. He devalued the peso at a controlled rate and did his best to keep local and international banks happy while working to manage Argentina's poverty and unemployment problems that had been exacerbated by the economic collapse. By June 2002, some 58 per cent of Argentines lived below the official poverty line, and unemployment had reached some 25 per cent.

 

On his way out, Duhalde hand-picked Nestor Kirchner as his presidential candidate. Largely unknown, Kirchner won 22 per cent of the vote in the first round of elections in 2002. He won by default when his second round opponent, Carlos Menem, withdrew from fears of a landslide defeat. When Kirchner entered office on 25 May 2003, he did so without a popular mandate and an economy that had shrunk by 11 per cent 2002.

 

Kirchner moved quickly to win popularity by taking the IMF head on. Knowing he had an upcoming debt payment of US$2.9 billion on 9 September 2003, Kirchner began a campaign of stubborn bickering behind doors and public demonization of the IMF to his people. He blamed the IMF for a decade of poor policy and IMF officers for giving extremely bad advice.

The public pressure worked, and a day after Argentina missed a US$2.9 billion payment to the IMF, Kirchner strong-armed the IMF into an extremely lenient, long-term debt program on 10 September 2003. The program restructured Argentina's debts in a way that put less pressure on the fragile economy.

 

His measures were very popular, as his approval ratings hovered near 80 per cent during the first months of his term. With a new deal in place, Kirchner could focus on improving his country's economy by stimulating jobs and spending money on growth programs without worrying about financing enormous debt. The peso's devaluation eventually increased exports. Jobs rebounded, and by June 2004 unemployment had fallen to 13 per cent and poverty to 40 per cent.

 

Many of the recovered jobs were in the informal sector, however. Argentina, in 2004, had roughly the same number of formal-sector employees as it did in 1980. At the same time, the richest 10 per cent of Argentines earned 33 times more than the poorest 10 per cent, compared to 26 times in 1999, the Economist reported on 21 July 2004.

 

Since late 2001, poor Argentines have not seen any change in their lives other than an increase in inequality.

 

The public sector is larger than ever, which means that more Argentines rely on government wages to pay the bills. Of the top 25 employers in Argentina, 23 are run by the state, yet real wages remain some 25 per cent lower than pre-crisis levels - a point Argentine workers are happy to protest on a weekly basis.

 

Meanwhile, increased prices in commodities such as soy, corn, and oil have contributed to a surplus in Argentine state coffers, despite a lack of investment from both domestic and foreign investors. Argentina's economy grew 9 per cent in the first half of 2005, according to the National Statistics and Census Institute. Economic growth here has hovered around 8 per cent for the past two years, but the country is still climbing out of a hole that was dug by spending outpacing revenue and flat foreign investment.

 

Myth and reality

 

Most of domestic investment now is in construction, and foreign direct investment is extremely low. What the Argentine economy needs for real growth is foreign direct investment in its industries and utilities, which will allow for increased production without inflation, argue independent Argentine economists Dr. Agustin Monteverde and Gustavo Lazzari.

 

A principle with the Massot, Monteverde & Associates independent consulting firm, Dr. Monteverde pointed out that most of the domestic investment here went to construction and products such as cell phones.

 

"These types of investment are non-productive and do not help the economy," he told ISN Security Watch, adding, "both international and domestic investment is weak."

 

There is little credit to go around, and banks permit only short-term loans, but few are borrowing. Most new companies last less than a year. The fact that there are some US$120 billion in savings held abroad by Argentines belies the low level of confidence locals here have in their country's banking system.

 

"In the first trimester, Argentine foreign direct investment reached some US$588 million, compared to some US$2 billion alone for the month of July in Brazil," Monteverde said.

"There is literally no investment in local industry; plants are producing at a maximum in the face of increased demand, which forces them to raise prices, contributing to the growing inflation problem."

 

Lazzari, an economist with Argentina's Atlas Foundation, agrees that investment in key sectors is lacking, but he also points out a problem with fixed tariffs for the price of public utilities.

 

"Investment in private industries [such as] ports, trucking, trains, electric energy, and gas and oil [infrastructure] is paralyzed because tariffs are frozen," Lazzari told ISN Security Watch.

 

He pointed out that the utilities sector, the one most in need of investment, was the least likely to receive it because of the constricted environment in which they work.

 

"The government does not create an attractive environment for investment because it has frozen tariffs and is hostile at the time of contract renegotiation," he said.

 

But frozen tariffs keep prices for water, gas, and oil at levels that are popular with Kirchner's supporters.

 

Argentina has a history of nasty levels of inflation, and it is on the rise again. It was the fixed exchange rate - when Menem pegged the peso to the dollar - that finally curbed inflation in the early 1990s. Inflation now is not at those levels, but it is on the rise, and Kirchner is doing little to stop it.

 

Prices have increased by 12 to 15 per cent in 2005, according to Lazzari. They show signs of rising higher, and many here agree that as political elections are around the corner, Kirchner will do little to disrupt his strategy that has thus far worked well.

 

Populist policies not good for economy

 

Coming into office with out a popular mandate is a difficult situation for any politician. Kirchner quickly won popularity and still maintains a certain level of popularity due to populist measures like price controls and job creation. But his populist policies have begun to take their toll on the Argentine economy. It is clear he is unlikely to make any dramatic changes in policy with two major elections in the near future. It is just as clear that poverty and unemployment remain giant challenges ahead of the next presidential elections in 2006.

 

Congressional midterm elections are coming up in October, and Kirchner has put his wife, Cristina, up for an influential senate seat in the Buenos Aires province. Next year, presidential elections will put Kirchner in a tough spot as he runs on a re-election platform built with populist planks while maintaining the illusion of a healthy economy. In both elections, his decisions as president will affect outcomes.

 

Kirchner has sacrificed economic stability to win political stability for himself and his tight group of supporters. From now until the end of his current term, Kirchner has less incentive to implement changes that will help control inflation and improve the country's investment climate.

 

If he is unable to increase foreign direct investment or control inflation, Kirchner may well find himself out of the presidential chair and holding the blame for overseeing a short recovery that failed to hoist Argentina's economy out of a pit followed by another recession that may drive it to new depths.

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