Argentina’s New Economic Reality

On September 16th, in a speech at a high school in La Plata, Argentine President Cristina Fernández stood at the podium and indicated, in two long-winded but typical run-on sentences, that Argentina would stand athwart the global financial firestorm.

“I think we Argentines are in a moment of profound introspection, watching as that world, the developed world, which had been made out to be a kind of Mecca to which we should strive, is falling apart like a bubble. And here we are, modest and humble, as Argentines, with our national plans, trying to build things on our own, with the accumulation of our (Central Bank) reserves, with the construction of our industrial model, with the accumulation of jobs, of education, here we are, in the middle of the storm, standing firm, like this high school, rebuilt, and ready to continue facing, as always, the present and the future.”

Hidden not-so-subtly in that statement is a tacit jab at the U.S. and the global financial crisis that is unraveling before our eyes. As is often the case with Fernández, her jabs are implicit. But sometimes she is more blunt, as was the case in another speech given nine days later at the Council of the Americas in New York. There, Fernández was asked if her government had a “Plan B”, or a backup strategy, to lead Argentina’s economy forward if the crisis started affecting Argentina. Her response:

…”it seems to me that the first ones who need a Plan B are you guys here in the U.S. and in Europe because our Plan A is working, so it seems to me that those who need a Plan B are you guys.”

To some degree, of course, Fernández was right. After all, at the time of her speech, the U.S. government was just beginning to struggle with what to do about the credit crisis. A prudent person, whether the president of a country or the manager of a family business, surely would be wise to plan for diverse situations and differing financial scenarios.

Leaders, one would think, should think strategically, much like chess players, if they are to successfully deal the with the unpredictable challenges that inevitably arise in life. So it is no doubt true that it would behoove both the U.S. and Europe to have backup plans in case their first responses to the new global crisis fail to contain it.

Even so, it struck many observers as naive and disingenuous for Fernández to imply that Argentina had no need for a backup plan of its own. Fernández insinuated that, regardless of what happens in the U.S. and Europe, Argentina, thanks to her savvy guidance, was already prepared for whatever might come. 

Now, however, a month later, it’s looking like Argentina isn’t standing so firm amid the storm. In her Council of the Americas speech, Fernández said Argentina had no ability to influence financial decisions made by the U.S. or Europe. Such decisions, she said, are “absolutely exogenous,” or beyond her control. Fair enough. But Fernández concluded from this that it means that Argentina does not need a “Plan B” of its own. Her logic: “Because our Plan A is working, it seems to me that it’s you guys who need a Plan B.”

Of course, this logic doesn’t follow. Its foolhardiness is all the more apparent if we look at the argument expressed as a simple syllogism:

Premise 1) The U.S. needs a ”Plan B.”
Premise 2) Argentina’s “Plan A” is working.
Conclusion: Therefore, Argentina does not need a “Plan B.”

Unsound reasoning aside, it seems increasingly apparent that Argentina did in fact need an alternative economic plan. First, despite statements to the contrary, Argentina is not immune to the global credit crunch. It is even less immune to a global economic slowdown. And such a slowdown, which now appears inevitable, at least in larger developed economies, will crimp demand for Argentine goods and make credit even harder to obtain – even for Argentina, which has remained largely isolated from international capital markets since its 2001 default.

Weakened U.S., European and Japanese economies will lead to lower demand for goods produced by Chinese manufacturers. In turn, China’s economy, which has been booming largely because of growth in its export sector, will slow, as acknowledged by Chinese officials. That would mean reduced Chinese demand for Argentine farm products like soybeans. As a result, the price of farm commodities like soybeans will decline at a time when demand if falling, leading to a double whammy for both local farmers and the Argentine government, whose tax revenue depends heavily on taxes on farm exports. This could make it harder for the government to meet its financial obligations next year, when about $20 billion in debt payments come due.

Meanwhile, after expanding at almost 9% annually for the past give years, Argentina’s economic growth is finally slowing. Last week, the national statistics agency, INDEC, said the economy grew 6.4% in August, compared with 9.6% a year ago. Although lower, the August number is still impressive, even if it is inflated because of the way INDEC calculates inflation. But economists expect growth to decline further this and next year. The 2009 federal budget forecasts 4% growth, and economists too are cutting their 2009 forecasts. In doing so, they cite domestic factors (among them, an inflation-inspired decline in consumption) and global factors (such as the expected slowdown in developed economies).

Economists at J.P. Morgan Chase think the U.S. recession could be the worst since World War II, declining by 3% in the last two quarters of 2008. They expect the U.S. recession to last three quarters, followed by three years of slow growth.

There is a great deal of debate among economists over how long and deep the U.S. recession will be, but almost nobody thinks it is avoidable. Given the interwoven nature of the world’s financial architecture and economy, it is highly likely that America and Europe’s problems will be felt in Argentina. In addition to reduced exports, lower domestic consumption and slowed industrial output, tourism could decline too, shrinking another key source of revenue.

As if all of this weren’t enough to spook investors, the government last week rocked the market by announcing it would nationalize Argentina’s 14-year-old private pension system. The news fell like a bomb on the local stock market, causing Merval index to plummet almost 27% in one week. Bond prices tanked, revealing heightened distrust in the government’s ability and will to pay its debt. The news even helped push other indexes down around the world.

The market reacted negatively largely because investors know that pension funds here are the country’s leading source of private liquidity. They invest in local stocks and bonds, and provide billions of dollars in credit used by individuals and institutions. They are the largest single investor in corporate stocks. So if the government takes over the funds, the local capital market, in one fell swoop, could lose its most important participant. This possibility scared many investors and led them to dump Argentine assets at a record pace, fearing that if they didn’t get out of the market now, they might never be able to do so.

All of this exacerbated concern among already-anxious Argentines about the future of the economy. The government’s decision, good or bad, came at an incredibly bad time. In addition, it came devoid of answers to myriad questions about how the government plans to eliminate the pension funds.

Among other things, the government is about to take over around $3 billion worth of stocks in private sector firms, including energy companies like Edenor, telephone companies like Telecom, and even media companies like Grupo Clarín.

Holding stakes in those companies will give the government the right to have its own representatives on corporate boards of directors, giving it more influence on private sector decisions. This raises ethical problems: Will the government try to influence editorial decisions made by the newspaper Clarín? Will it try, as it has repeatedly in the past, to get companies to sell specific goods at specific prices at specific times?

Given the government’s proclivity to influence private sector activity, many analysts say it is highly likely it will use its new-found authority to shape corporate policies in ways that are beneficial to it.

Meanwhile, the government has yet to convince the millions of Argentines who voluntarily paid into private pensions that it is in their best interest to eliminate them. Around 9.5 million Argentines are fund members and 3.6 million are actively contributing to them now. A year ago, the government allowed Argentines to dump their private funds and opt into the government’s public retirement system.

But nine out of 10 Argentines decided to stay in the private system. Many of these individuals are unhappy about the government’s plans.

In addition, it is far from clear what the government plans to do with the $30 billion in assets (55% of which are government bonds) it will obtain by nationalizing the pensions. Skeptics say the government needs the funds desperately to pay down its debt next year.

I asked Argentine Cabinet Chief Sergio Massa (who used to manage the social security agency, ANSES) about this at a press conference last week. He said only that the government wants to improve pension benefits. Though noble, it is clear that many people don’t think that is the real reason for nationalizing the funds. Some 42.5% of people surveyed recently said the government wants those funds “for political activity,” according to a poll by the consulting firm Ibarómetro.

That skepticism amplifies an already-abundant amount of distrust in the government’s motives and its approach to economic policy. The last time the government tried to raid pension funds was in 2001 before it defaulted on its debt. That didn’t turn out too well.

The government’s decision to radically reform the pension system added uncertainty to an already unstable market, diminishing confidence in the economy and in the government’s capacity to implement prudent and predictable policies at a time of perturbation. In a sense, the government took what was already a bad financial climate and made it notably worse.

Argentine investor Eduardo Constantini manages Consultatio, one of Argentina’s leading investment firms. Pension funds hold a combined 27% stake in the firm, meaning the government is set to become a significant shareholder in the company. In a local radio interview, Constantini voiced a kind of concern that is felt widely throughout Argentina’s business community. When asked about the government’s pension fund plan, he had this to say:

“It was a surprise. You have to understand human psychology. People are scared. Investors are scared. Savers are scared. Political analysts are scared. People are scared because they don’t know what the next policy move might be that could surprise them.”

Fear, anxiety and surprise all deter investment. Insofar as this is true, the pension fund plan has fanned the flames of the global financial crisis, reducing even more the likelihood that Argentina will avoid its distasteful ramifications.

But the government’s bet on pension reform could also carry substantial political consequences. The pension plan seems more akin to a Hail Mary gamble than a pragmatic policy proposal. In addition to potentially devastating Argentina’s diminishing capital market, it risks angering the millions of people who put their faith in the pension system.

Many of those people, as evidenced by dozens of emails sent to me in recent days, feel “defrauded” by the government. They will probably make their voices heard in the days and weeks ahead as Congress begins debating the nationalization plan.

The pension system as it currently exists certainly has problems. One of them is that it has been forced into buying Argentine government bonds, which have repeatedly proven to be a losing bet. Even so, as measured in current pesos, the funds have averaged an annual return of almost 14% return since 1994 (or about 7% in real terms). That’s pretty good, especially considering the funds had to invest a huge chunk of their portfolios in bad Argentine debt. But the funds also have another problem: excessively high commissions, which at one point rose to 50%, according to ANSES. In addition, the system has not adequately funded some pensions, ANSES officials say. That means the government has to spend its own money to lift certain pensions to acceptable levels. In any case, critics of the reform plan say, these problems could be addressed without eliminating the entire system.

Government-run social security programs have merit, but are not without problems of their own. Fernández cites the U.S. social security system as a reason why Argentina should nationalize its pension funds. But the U.S. Social Security Trust Fund is set to go bankrupt in 2042, according to the White House Council of Economic Advisors. “If nothing is done to correct this problem, benefit payments would have to be reduced by roughly 27 percent,” the CEA said in a 2005 memo. Moreover, the fund will start losing money in 2018. If the U.S. system can run into trouble, so can Argentina’s.

But perhaps the biggest concern over Argentina’s plan is related to a lack of trust in the people advocating it. Critics say they can no more trust the government with their money than they can trust it to tell the truth about inflation. They also point to some $535 million in taxpayer money that Nestor Kirchner sent abroad when he was governor of Santa Cruz Province. It’s not entirely clear what exactly happened to those funds, or the interest they presumably earned. Kirchner, critics say, has never been fully forthcoming about the subject. 

If the government manages to pass the plan intact, it could anger many people while doing potentially irreversible damage to the capital market. Alternatively, if Congress rejects the plan, this would be a powerful blow to the Kirchners and their grip on the Peronist Party.

After suffering a historic setback in July, when Congress rejected the president’s plan to boost export taxes, the president can scarcely afford a political defeat of similar proportions. Such a blow could cripple the Kirchners’ influence just as the ruling party heads into the 2009 congressional elections.

Meanwhile, the president also faces risks if Congress passes the reform bill but amends it to prevent the government from using the funds to pay its debt. In an interview published Sunday in La Nación, ANSES director Amado Boudou indicated he was opposed to blocking the fund’s use for certain purposes.

But opposition politicians already have said this is necessary to ensure the government uses the funds only to pay retirement benefits. Meanwhile, Nestor Kirchner, who is widely believed to be the mastermind behind the reform plan, is reportedly vehemently opposed to blocking the funds for other uses. If true, this would seem to confirm suspicions that the government wants the reform because it needs money to pay its debt, and not because it simply wants to improve pensions.

So if Congress amends the pension bill and ties the government’s hands, it would represent the worst of both worlds for the Kirchners. First, they would pay a high political price for eliminating a system that many people want to keep. Second, they would do so without getting the additional money needed to avoid defaulting in the near future.

As a result, the reform appears to be a risky gamble, one that is typical of a government which seems to prefer imposing instead of developing them through consensus and collaboration. 

If anecdotal evidence is anything to go by, and often it isn’t, my guess is that the economy will slow much more than expected by economists. And just as most economists failed to forecast the U.S. decline, there seems to be a good chance that those who think Argentina will avoid a recession in 2009 are similarly myopic. Bad news already is appearing in the manufacturing and retail sectors. GM recently tried to let go of around around 500 workers, according to an employees union. And the home supply company EASY tried to lay off as many as 500 workers as it attempts to be profitable amid an expected slowdown. In both cases, the layoffs were avoided, or at least delayed by government action. But companies around the country are already looking to cut costs and spending on the expectation, realistic or not, that times are going to get tough.

British Prime Minister Gordon Brown, himself an experienced economist and policy maker, last week said the new global economic realities will be felt nearly everywhere:

“Having taken action on the banking system, we must now take action on the global financial recession which is likely to cause recession in America, France, Italy, Germany, Japan and – because no country can insulate itself from it – Britain too.”

But while those countries may experience significant recessions, their governments have access to financial tools that Argentina does not. They can all push tax cuts or other recession-taming Keynesian policies by injecting large amounts of capital into the private sector (through infrastructure projects, etc.). They can do this because they have access to credit. Even the U.S., which has spent profligately and is running at least a $500 billion deficit, has ample access to funding.

Argentina, however, has no such access to credit. Therefore, its ability to spend its way out of a recession could be severely limited. Unless, of course, it finds a way to come up with billions of dollars in fresh funds – funds which just happen to be held by private pensions.

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