RISK ASSESSMENTS

One Year Ahead Five Years Ahead
Risk Category Year Ago Current 11/10 Worst Case Best Case Worst Case Best Case
Political Risk 64.0 64.5 59.0 68.5 57.5 75.5
Financial Risk 36.0 41.0 37.0 41.0 30.5 42.0
Economic Risk 32.0 41.5 38.5 41.0 32.0 42.5
Composite Risk 66.0 73.5 67.3 75.3 60.0 80.0
Risk Band Mod. Low Mod. Low High V. Low

POLITICS

Government Stability
Addition by Subtraction

The death of former President Nestor Kirchner, who suffered a fatal heart attack on October 27, has significantly altered the outlook for next year’s presidential and legislative elections.  Kirchner was widely expected to stand as the presidential candidate of the incumbent Front for Victory (FPV) faction of the Justicialist Party (PJ), in keeping with his plan to control the presidency indefinitely by alternating in the office with his wife, Cristina Fernández, who succeeded her husband as the country’s leader in 2007.  Although Fernández is eligible to stand for re-election in 2011, it is unclear at this point whether she has any desire to do so.

But the impact of Kirchner’s death goes far beyond injecting uncertainty into the process of identifying the top contenders for the presidency.  Kirchner was a source of division within the PJ—the FPV has for all intents and purposes functioned as a party unto itself since 2003—and his departure from the scene could create an opportunity to reunite the competing factions of the party.  Noteworthy in that regard is the fact that Kirchner was the leader of the PJ, and his death will necessitate an internal election that could provide the catalyst for such a development.

Just as significant, Kirchner’s absence from the 2011 campaign will deny the fragmented opposition a common enemy against whom they might have been able to forge a united front.  Even if Fernández stands for re-election, her candidacy is unlikely to generate the same level of unifying hostility among the opposition without the looming presence of her husband, who was widely perceived to be the architect of the current administration’s policies and the director of its heavy-handed governing style.

Finally, there is the sympathy factor.  The dynastic ambitions of the first couple appeared to be in jeopardy following a stinging defeat for the FPV at mid-term elections held in June 2009.  The clear rebuke of Kirchner’s unorthodox economic strategy and authoritarian leadership style, and a sharp decline in Fernández’s popularity, raised serious doubts about the ability of either to win the 2011 presidential election.

Fernández’s approval rating had been trending upward since mid-year, boosted by a strong economic turnaround.  However, it surged immediately following Kirchner’s death, amid a wave of public sympathy.  A poll conducted by Ibarometro on October 28 put support for the president at 68.5%, a 20-point increase on her standing just 10 days earlier.  Moreover, 45% of poll respondents stated that they would back Fernández for a second term in 2011.  Her nearest competitors—Vice President Julio Cobos, who had a falling out with the Kirchners in 2008, and Buenos Aires Mayor Mauricio Macri—trailed far behind, with 11.8% and 10.1%, respectively.

Highly Unorthodox

Key allies of the Kirchners have already issued public calls for Fernández to stand for re-election in 2011, but it will probably be some time yet before she gives a clear indication of her intentions.  In any case, the FPV will no doubt ride the crest of sympathy as far as it can.  Consequently, there is little reason to expect any significant deviation from the policy course set by the tragically departed leader, a central feature of which is the implementation of unorthodox economic policies that have contributed to strong growth, but also fueled inflation and raised concerns about medium-term fiscal stability.

The government has attempted to limit the negative consequences of its economic policies by resorting to protectionism, price controls, and the use of central bank reserves to make payments on foreign debt.  Its efforts have met with only partial success, as was made evident at the 2009 elections.  But rather than changing direction, the Kirchners instead pursued a strategy of silencing dissent, through the assertion of executive control over independent state institutions and what appears to be a campaign of harassment against its critics in the media.

Earlier this year, Fernández caused a stir when she demanded that the central bank transfer its “excess reserves” to a fund established for debt repayment.  Central Bank Gov. Martin Redrado refused, forcing a showdown that was ultimately won by the president.  Redrado’s replacement, Mercedes Marco del Pont, a Yale-educated economist, has cooperated fully with Fernández, in the process eliminating any pretense of independence.

Monetary policy is being implemented at the direction of the government, resulting in moves that are clearly aimed at fulfilling political objectives, rather than adhering to sound economic principles.  In August, the country exceeded its monetary targets for the first time since 2003, and the central bank responded by raising the ceiling from 18% to 30%, with no apparent regard for the potentially disastrous inflationary consequences.

Of course, inflation is not a serious problem in Argentina, at least not according to the official government figures produced by the national statistics agency, INDEC.  However, it is widely accepted that INDEC’s data, particularly with regard to prices, is completely unreliable.  The most recent official figures put inflation at slightly more than 11%; private economists estimate that the actual number is closer to 30%.

INDEC’s loss of credibility began in 2007, when then-President Kírchner, displeased by evidence of runaway inflation, replaced key personnel at INDEC with hand-picked supporters, resulting in the subsequent release of far more favorable inflation data.  At the time, the FPV enjoyed a strong position in Congress.

However, the administration’s opponents won majorities in both chambers of Congress at elections held in mid-2009, and the Senate has managed to push through a reform bill aimed at restoring INDEC’s independence.  The prospects for passage in the lower house are unclear, but the stakes are high enough that Fernández might veto the measure if it is approved.

Even if the president manages to keep trusted allies in key positions at INDEC, it could become more difficult to fudge the price data.  Local sources report that the government is working to reach a deal with Paris Club creditors, the lone remaining group of holders of defaulted Argentine debt that has not reached a settlement with the government.  It is expected that the Paris Club will condition an agreement on Argentina’s willingness to open its books to IMF scrutiny.

President Kírchner blamed the IMF and international lenders for the economic crisis that erupted in late 2001, and in a blatantly populist gesture, he paid Argentina’s outstanding debt to the IMF in full in January 2006, declaring at the time that the country would never again put itself in the position of having its economic policies dictated by a foreign entity.  However, the lack of the IMF’s stamp of approval has proven to be an obstacle to securing investment, an impediment that the government is keen to eliminate as it seeks to limit the degree to which the pace of economic growth decelerates ahead of next year’s elections.

Given the recent surge in her popularity, Fernández might be willing to risk allowing the IMF to confirm that the official inflation data has been manipulated for political ends.  Indeed, it could well be that the fallout would be minimal, as just about anyone with an interest in such matters is already operating on the assumption that such is the case.

One possible result could be an escalation of the government’s battle with the media, which has focused on Grupo Clarín, the country’s largest media group, and an outspoken critic of the administration.  In August, the government revoked Grupo Clarín’s Internet license and ordered the closure of its Internet arm, Fibertel, on the grounds that Fibertel’s merger with Cablevision, another company owned by Grupo Clarín, breached regulations for the communications sector.

The government then seized the country’s main newsprint provider, Papel Prensa, on the grounds that Clarín purchased its 49% share in the company in 1972 with the help of the military dictatorship, which used torture and intimidate to facilitate the sale.  The administration further contends that Clarín has used its interest in Papel Prensa to thwart the emergence of competing newspapers.

Clarín insist that its purchase of Papel Prensa, which it co-owns with another newspaper, La Nacion, and the government, was completely legitimate, and that the government is abusing its authority to punish a prominent critic.  That interpretation of events is shared by defenders of press freedom and leaders of the opposition, including Elisa Carrio, who has warned that the government is “pushing the boundary between democracy and authoritarianism.”

ECONOMY
Spending Competition Will Stoke Inflation

While the opposition has bemoaned the potentially destabilizing effects of the government’s full-throttle economic strategy, it seems that no one in a position to influence policy is prepared to even lightly tap the brakes ahead of the 2011 elections.  Indeed, the government and the opposition have become engaged in a competition to see who can spend more.

The opposition’s opening bid was a proposal to increase the minimum pension payment by 37%, a figure that Economy Minister Amado Boudou stated would bankrupt the pension system.  However, the government dispelled any illusions that it had suddenly recognized the virtues of fiscal orthodoxy by concluding an agreement with the unions to hike the minimum wage by 23%.  The administration also increased the minimum pension benefit by 17% (effective September 1), bringing the total hike since the beginning of the year to 26.5%.

Analysts took note of the fact that the increases in both the minimum wage and pension payments were more than double the official inflation rate, and, curiously enough, near the mid-range of private estimates of actual inflation.  As such, the increases perhaps provide a gauge of the government’s true understanding of what is happening to price levels.

The government’s generosity has been made possible by a strong economic rebound that resulted in real GDP growth of 11.3% (year-on-year) in the April–June 2010 period, generating a 30% increase in tax receipts.  The economic revival reflects a combination of factors, among them the similarly strong recovery in neighboring Brazil, the country’s top trade partner, which is generating robust investment and employment growth in the export sector.  But while Brazil’s robust revival is a testament to the solid macroeconomic foundation built by that country’s government over the last eight years, the strength of Argentina’s rebound is also a reflection of fiscal and monetary policies that are designed to maximize growth, even at the cost of overheating and a dangerous upward spiral of inflation.

The second-quarter performance reflects in part a surge in major purchases by households anticipating a continued rise in prices, which is expected to make less of a contribution to growth over the coming months.  However, healthy demand for exports will continue to encourage business investment that in combination with robust state spending will produce annual real GDP growth of 8% in 2010.  Assuming the government continues to spend freely in the run up to next year’s elections, persistent high inflation will dampen household spending, and the political uncertainty surrounding the elections will incline businesses to adopt a more cautious approach to investment, resulting in a deceleration of growth to about 4.7% in 2011.

Even the highly suspect inflation data indicates that consumer prices are rising at a double-digit pace, largely owing to demand pressures generated by loose fiscal and monetary policies.  Barring a change of course in macroeconomic policy, which is highly unlikely before 2012, the government will have little choice but to continue using trade restrictions, price caps, and similar measures to contain inflation, with limited success.  Based on the official data, inflation is forecast to average 11.1% in 2010, and will rise above 13% next year, although actual price increases will be substantially higher.

The trade surplus totaled a record $18.5 billion in 2009, as weaker domestic demand, lower commodities prices, a depreciation of the peso, and import licensing requirements imposed by the government contributed to a steeper fall in imports than exports.  However, imports are growing more rapidly than exports in 2010, reflecting both higher prices for fuel and other commodities and robust demand generated by healthy government spending.  A smaller trade surplus will contribute to a narrowing of the current account surplus, which is forecast to shrink to $6.8 billion, or somewhat less than 2% of GDP, in 2010.  A sustained revival of external demand will keep the current account balance in surplus beyond 2010, but moderate growth of the domestic economy will underpin fairly strong domestic demand, resulting in healthy growth of imports that will contributed to the further narrowing of surpluses going forward.