The Promise of Argentina’s Economic Transition

August 03, 2016

Neil Brown

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At a time when populist politics are driving many countries away from investment-friendly policies, Argentina is quickly moving in the opposite direction. Latin America’s fourth-largest economy is starting to reopen for business. In trips we at KKR have made this year, we’ve seen small things — like not needing a fistful of U.S. dollars to manage a dual exchange rate, running into U.S. President Barack Obama’s entourage on the street in Buenos Aires and seeing the evident optimism in local businessmen — that indicate how much change is afoot.

It is still early days in President Mauricio Macri’s tenure. So far we have been impressed by his team’s clear focus on normalizing Argentina’s economy and reintegrating into the global system. Prior to the country’s general election last October and runoff in November, people were wondering whether meaningful reform would happen at all. That question has been answered: Macri has decisively turned away from the economic policies of former president Cristina Fernández de Kirchner. Now the questions are how deep the reforms will be and whether they will provoke a popular backlash.

Achieving normality is an ambitious vision for Argentina’s economy. The Macri government and the country will undoubtedly have setbacks, and there is no guarantee of success. Nonetheless, we believe the door is now open for long-term investors to consider Argentina.

The core economic policy challenge facing the Macri government is to instill macroeconomic discipline while delivering on private sector–led job creation and improving productivity. These are no small tasks for an administration that inherited a state-led, closed economy in recession, with a 30 percent poverty rate and woeful productivity, and at a time of economic havoc in its largest trading partner, Brazil.

Soon after taking office in December, Macri swept away barriers to entry for private investors, such as capital controls and trade restrictions. Early fiscal adjustments to reduce the comparatively high tax burden and adjust subsidies were put in motion. On monetary policy, the peso printing presses finally slowed, and the currency was floated. Early shock therapy was unexpectedly successful: Exports responded quickly, showing a 25 percent year-over-year increase in February.

The hard work of planning and implementing fiscal adjustment, taming inflation and encouraging private investment is under way. Contrary to the argument of some analysts in favor of a quick rollback of subsidies, we think the government’s more deliberate approach is necessary to avoid stoking social unrest. Unlike its subsidy-laden emerging-markets peers, Argentina has a low debt-to-GDP ratio that will allow it to finance its fiscal adjustment in the near term through issuance of debt — now possible with resolution of the foreign debt holdout situation — and the financial repatriation program now under way. Fiscal tightening is ultimately necessary, although we think a focus on a more productive use of spending in the near term will have a strong impact on growth.

For potential private investments, we are looking to see changes in the operating environment: improved judicial independence, a reduction in bureaucratic and regulatory impediments, better service delivery and an embrace of international anticorruption norms.

Nevertheless, having met with a number of local companies and funds, we found a great deal of local optimism — an encouraging change from our preelection conversations over the past two years. Most economists project that the economy will turn the corner to growth by the end of the year, and businesses have new liquidity from peso devaluation and export opportunities. A number of relatively unlevered Argentinean companies have already been upgraded, and we expect them to easily raise foreign capital. Smaller companies, however, will need the development of local capital markets.

More than a decade of devastating state intervention has left businesses, with the possible exception of oil and gas, in survival, rather than value-creation, mode and deeply eroded the industrial base. Although that narrows the opportunity set for large foreign investors, we think Macri’s reforms will produce companies interested in financial partners that also bring expertise for growth.

Making political and economic reform sustainable will be the defining challenge of Macri’s tenure. Argentineans by and large did not grasp the depth of their country’s economic misfortune or its true causes. Macri was elected with a clear mandate for political reform. While in office, he must continue to educate the populace and communicate his economic reforms to build popular credibility and support. The government will rely heavily on direct infrastructure spending via public-private partnerships and on attracting private investment in key sectors such as energy and agriculture. Making real progress in taming inflation will be a key test.

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