After one year of lifting trade and capital controls, marking a turning point in Argentina away from the previous administration’s interventionist policies, President Mauricio Macri is now focusing government efforts on prioritizing economic growth and lowering inflation. While keeping the balance to achieve both will be difficult, the Argentine government has set a clear plan of action to achieve those goals in 2017.
Fiscal policy and growth
Progress in boosting economic growth while reducing fiscal deficits should continue at a pace consistent with the need to minimize the impact on the most vulnerable social classes. Although a more frontloaded fiscal adjustment would allow Argentina’s Central Bank to lower interest rates at a faster pace, ease pressures on the currency, and reduce the risk associated with a strong reliance on external financing, Argentina’s current social and political constraints justify a softer fiscal tightening cycle over the next couple of years.
Despite Macri’s initial promise to be more fiscally conservative, his administration has now decided to soften its austerity measures through an increase of 22.1% in government spending in 2017 (2.6% in real terms). With mid-term legislative elections approaching soon in the second half of 2017, Macri has decided to increase spending mainly with two objectives in mind: First, to secure the support of key labor unions, while minimizing potential social unrest; and second, to revive consumer confidence and therefore consumer spending.
In order to achieve both objectives, the government has significantly expanded the budget for social security initiatives to almost US$ 70 billion (31.1% YOY growth in nominal terms or 11% in real terms), mainly to provide cash transfers to vulnerable segments of the Argentine population. Additionally, key economic sectors for employment creation such as transport and infrastructure, and science and technology will receive a boost of 21.5% and 24.7% in their 2017 budget (2.1% and 4.8% in real terms, respectively).
If the two objectives are reached, by the end of 2017 Macri will have potentially recovered control over the Argentine congress, and most importantly, GDP will have grown by 3% according to recent government numbers (though FSG expects a GDP growth rate closer to 2%). However, as a counterfactual to the positive impact of higher government spending, Argentina would run a primary fiscal deficit of 4.2% of GDP in 2017, significantly wider than the 3.3% deficit the government initially proposed earlier this year.
Despite the relatively large fiscal deficit, Argentina is indeed progressively reducing this number. That is what investors have been following since April and May, where three of the largest credit agencies upgraded Argentina’s credit ratings and outlook.
Monetary policy and inflation
As with fiscal policy, Argentina’s Central Bank has recently adopted a more dovish stance towards monetary policy, as it tries to strike the right balance between lowering inflation and not cooling consumption and investment too much.
According to recent Central Bank estimates, annual inflation is expected to slow to the range of 12% to 17% in 2017, down from a high of 47% in the capital city of Buenos Aires and a 38% at a national level. However, FSG estimates a more conservative inflation of 22%, mainly as a result of the progressive elimination of subsidies in electricity, gas, and transportation and the increase in cash transfers, the latter of which will foster until-now subdued domestic demand and push prices up.
Softening of monetary policy should, at some point, translate into lower interest rates for consumers and businesses. However, Argentina’s Central Bank’s decisions will be constrained by monetary policy in the US throughout the next 12 months. Recently in December, the US Federal Reserve decided to increase the benchmark policy rate by 25 basis points. Additionally, there is a high probability of seeing two or three additional hikes in 2017, which will put extra pressure on the Argentine peso to depreciate, potentially leading to higher inflation expectations. This means that the Argentine Central Bank will most likely have to maintain the LEBAC rate at its current level of 24.75%, or potentially resort to even higher interest rates if inflation pressures are not contained.
After one year in power, the Argentine government has proven to be making the right decisions to put their economy back on track. However, it is clear that keeping the balance between policies that will boost consumption, investment, and growth while keeping inflation in check will prove even more challenging next year.
While having lower interest rates in 2017 is highly unlikely, inflation is expected to lower and consumer spending to recover. The combination of these factors will help Argentina offer a more favorable business environment for companies interested in medium-term ROI investments or for multinationals interested in gaining market share quickly through strategic acquisitions. So far, investment commitments made in 2016 reached US$ 45 billion, a number that is expected to be much higher in 2017.