Argentina Just Might Get Its Act Together – by Lawrence Goodman

Argentina seems to be on a collision course of its own making.  Inflation is soaring and investment is on the wane.  Despite being the third largest economy in Latin America with abundant resources, Argentina no longer has access to voluntary capital inflows and the growth that funding affords.

The republic faces the threat of a currency crisis that could readily spiral to high double-digit inflation.  In years past, excessive inflation eroded incomes and wiped out the savings of individuals.  Despite intentions to benefit the poor, an unsustainable macro mix, difficult dealings with the private sector, and increasing international isolation promises to again diminish living standards.

Argentina’s foreign exchange policy and breach of international contracts represent obstacles to attracting financing for many worthy projects.  Currency is now rationed by the government.  So, an insufficient supply of available dollars threatens to stymie economic activity in the private and public sectors.  These barriers also incent foreign and local participants to move funds from Buenos Aires toMiami, Zurich or London rather than putting them to work in Argentina.

To circumvent currency limits, the private sector deftly employs a shadow exchange rate called the “blue chip swap.”  Yet, the costs of doing business via the Blue chip exchange rate are high – as securities priced in U.S. dollars must be purchased and exchanged to obtain scarce foreign currency.  In other words, there are two separate exchange rates in Argentina.

Memories of dual or multi-tiered exchange systems are limited, as they are fortunately relics of the distant past.  However, previous experiments – stretching from Argentina (1978-81 and 2001-02),Jamaica (1970-78 and 1987-94), Mexico (1982-85), and Venezuela (1984-89) – all ended poorly with a surge of inflation and shortages of basic goods and necessities.

At present, the “blue chip swap” strongly signals the risk of a roughly 40% devaluation of the peso.  So, this cumbersome and costly exchange rate management system either keeps investors sidelined or requires them to attach a hefty premium to any new undertaking.

Investment confidence is also vitally linked to adherence to the rule of law.  Unfortunately, Argentina has racked up lawsuits by individuals and institutions, and many settlements remain outstanding.  For instance, Argentina has not complied with any judgments brought by ICSID, the World Bank’s arbitral body for settling disputes.  Similarly, Argentina has refused to comply with more than 100 judgments in New York State alone ordering it to pay its creditors – including a high profile dispute with holdout creditors.

Fortunately, the government possesses the power to engineer a dramatic turnaround.

Argentina is rich in human and natural resource. Moreover, it has nurtured human resources by implementing policies dedicated to social inclusion.   It is the sixth most literate nation among the top 24 emerging markets in the world today.  On the financial front, the nation sports a strong balance sheet.  Debt is a scant 40% of GDP, well below the safe threshold of 60%.  Similarly, Argentina has grown the economy by an average 7.7% per year since the 2001/02 crisis, while widening its social safety net.

A reversal of rogue behavior on the legal front would free access to capital and help Argentina lower borrowing costs.  For instance, if Argentina’s perceived adherence to the rule of law converged with Brazil’s, as measured by theCenter for Financial Stability’s Rule of Law Index, Argentina could reduce future borrowing costs by a minimum of 735 basis points per year over ten years and open the nation to new sources of funding and growth.

Given the political will, Argentina can engineer a recovery and regain its prominence as a leading G-20 nation by fortifying its social programs through sound fiscal management; moving away from distortionary exchange rate policies; and honoring contracts.  How the Kirchner administration develops the nation’s human and natural resources will either accelerate its downward descent or set the stage for prosperity.

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