Can Mauricio Macri Make Argentina a Market Darling Again?

The president has lifted exchange controls and adopted a growth agenda, but he needs to reach a debt deal and contain deficit to sustain progress.

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Mauricio Macri has a passion for speed. As a young man he loved sports cars and was a regular spectator at races. His first wife, Ivonne Bordeu, was the daughter of Argentinean Formula 1 driver Juan Manuel Bordeu. As mayor of Buenos Aires, Macri brought Formula E racing, a Grand Prix series for electric cars, to the city’s streets in 2015. So when he climbed into the national driver’s seat in December as Argentina’s new president, it was no surprise that he hit the accelerator in introducing market-oriented reforms after 14 years of populist Peronist rule. “Let’s get a move on it, Argentina!” he told the country, with a note of impatience, in his brief inaugural address.

Macri has been true to his word. Just six days after taking office, his conservative government lifted foreign exchange controls — a central campaign pledge that the president hopes will spur foreign investment. Although the peso promptly dropped by more than a third against the dollar, economists and investors hailed the move as a vital break from the interventionist policies of former president Cristina Fernández de Kirchner, and one that could end Argentina’s long isolation from global capital.

“This government has shown a willingness to allow market forces to play more freely,” says Alfredo Coutiño, Moody’s Analytics’ West Chester, Pennsylvania–based director for Latin America. “And that’s exactly the road that investors believe Argentina should follow.”

Macri has empowered his liberal economic team, led by Finance Minister Alfonso Prat-Gay, a former JPMorgan Chase & Co. economist in New York and London, and central bank president Federico Sturzenegger, who earned an economics doctorate from Massachusetts Institute of Technology. The two men have begun dismantling regulations that have stifled banking activity and suppressed credit. Bankers who had seethed over Fernández’s policies are now consulted about how best to revitalize their industry. “We’re working like a team with the new government,” exults Enrique Cristofani, CEO of Banco Santander Río, a subsidiary of Spain’s Banco Santander and the largest private bank in the country.

The new president is also moving to spur agriculture, Argentina’s biggest earner of foreign exchange, by reducing or eliminating export taxes on farm products. “The difference between this government and what came before is like night and day,” says Oscar Moncho, a farmer who in recent years stockpiled much of his produce as a hedge against inflation.

All this amounts to an impressive start. Now comes the hard part. Macri, an athletically trim 57-year-old, must overcome a series of obstacles in his efforts to promote reforms and spur long-term growth. The most important is the need to resolve a long-running dispute with holdout investors, led by Paul Singer’s Elliott Management Corp., that stems from the country’s record debt default in 2001. Macri is eager for a deal, which would allow Argentina to regain access to international capital markets. He moved a step closer to his goal on February 19, when U.S. District Judge Thomas Griesa agreed to lift an injunction that had barred Argentina from tapping markets until it resolved its dispute with the holdouts. Those investors were expected to appeal the latest ruling, though, and Argentina’s Congress may yet balk at the cost of the settling the issue.

Even if Macri and his team can strike a debt deal, Argentina lacks a deep pool of publicly listed assets that could attract foreign money. “There are only a handful of investable equities and in only a few sectors,” says Will Pruett, Boston-based portfolio manager for the Fidelity Latin America Fund. The state owns only two large enterprises that could draw widespread investor interest — Banco de la Nación Argentina, the country’s largest bank, and Yacimientos Petrolíferos Fiscales (YPF), its major oil and gas company — and Macri has said he has no plans to privatize them.

Argentina’s sovereign bonds and some corporate bonds rallied in anticipation of Macri’s election and an early resolution of the debt issue, but to sustain and extend the gains the government will have to bring public spending under control. So far, Prat-Gay has made only tentative progress because an inherited energy subsidy policy is hampering efforts to rein in the budget. “This will be crucial in pricing what government debt should be trading at,” says Axel Christensen, BlackRock’s Santiago, Chile–based investment strategist for Latin America.

Macri seems unlikely to enjoy much of a honeymoon, and the political risks to his program could soon rise. The new president lacks a congressional majority to back his economic policies, and the painful austerity measures needed to get the deficit under control are almost certain to provoke a backlash given the country’s history of populism.

Ever since Juan Domingo Perón rose to power seven decades ago, he and his heirs have dominated the political landscape by championing labor, big spending and a big state role in the economy. Argentina’s rich patrimony of fertile soil and mineral wealth was ripe for the taking, ruling out the need for tough choices. Even when boom times gave way to slow growth or worse, Peronist governments refused belt-tightening.

“We believe we have a right to a middle-class existence — good salaries, services and education,” says Gabriel Kessler, a sociologist who has written extensively on Argentina’s middle class. “It has created a society that always wants more, and quickly, but isn’t always willing to pay for public services or taxes. And this complicates political and economic stability.”

ARGENTINA HAS KNOWN PERIODS OF CONSERVATIVE RULE, most notably by a number of military dictatorships between the mid-1950s and the early ’80s. But the country has habitually returned to populist Peronists when democracy was restored or economic times improved. The last non-Peronist president, Fernando de la Rúa, was hounded out of office in 2001, just two years into his term, by mass protests over the country’s devastating depression at the time. Argentina defaulted on its $95 billion in foreign debt, and it also abandoned its fixed exchange rate against the dollar, which had tanked the economy. Néstor Kirchner rode to power in 2003 on populist anger over the default and reaped the benefits of a rebounding economy and commodities boom.

“These economic and political cycles are part of the history of Argentina since my father’s and grandfather’s time,” says Verena Wachnitz, an Argentinean who manages T. Rowe Price’s Latin America Fund out of London.

Who can blame the Argentineans for believing the dream of immense national wealth for all? With its elegant parks, heroic monuments and tasteful high-rises, Buenos Aires has long been dubbed the Paris of Latin America. At 1.1 million square miles, Argentina is almost the size of India; it has just as much arable land, with only 3 percent of India’s population. Natural harbors abound. Mineral deposits in the Andes are believed to be as abundant as those on the other side of the mountain chain in Chile, the world’s largest copper producer. Only the U.S. and China have greater proven shale oil and gas reserves.

Flush with revenue from the commodities supercycle, Kirchner and his wife and successor, Fernández, showered social and economic benefits on lower-income and middle-class citizens. According to the World Bank, by 2012 more than half of Argentina’s 43 million population had reached middle-class status, defined as people with incomes of $10 to $50 a day. That was a jump from less than a third at the beginning of the new millennium. The country’s per capita income, at $22,302 in terms of purchasing power parity, ranked behind only Chile’s ($23,057) in Latin America, according to International Monetary Fund figures for 2014.

But the good times have come to a crashing halt throughout the region as a result of the collapse of global commodities prices and a massive outflow of capital from emerging markets over the past year. “Tailwinds have suddenly become headwinds,” says Luis Alberto Moreno, president of the Inter-American Development Bank. “It will require a great deal of political dexterity to restore fiscal and external accounts on a sustainable basis.”

Falling export revenue and uncontrolled public spending have left Venezuela, the country with the largest proven reserves of oil in the world, on the verge of bankruptcy. Brazil has been unable to deal with the economic fallout from the crash in commodities prices because a corruption scandal linked to state-owned oil company Petróleo Brasileiro (Petrobras) has paralyzed the government of President Dilma Rousseff.

In Argentina president Fernández staffed the official statistics agency with loyalists to hide the real rate of inflation — believed by private sector economists to have reached 30 percent last year, or double the official rate — and slowing growth (estimated at 1.7 percent by the World Bank for 2015 and half that by some local economists). She also drained foreign reserves to dangerously low levels to help defray costs for social programs.

Fernández had hoped her preferred Peronist, former vice president Daniel Scioli, would succeed her, but a worried electorate was willing to try an alternative. In November, Macri won a runoff election with 51.6 percent of the vote.

MACRI TOOK AN UNLIKELY PATH TO POWER. A wealthy socialite, he was set to succeed his father at the helm of Socma Group, a family-owned enterprise that’s one of Argentina’s largest conglomerates, but his life took a dramatic turn when he was kidnapped in 1991 by a gang of rogue policemen. After a 12-day ordeal that included confinement in a coffin, Macri was released when his father made a reported $6 million ransom payment, but the incident left lasting scars. Convinced that there were more important things in life than wine, women and parties, he began to get serious about his career.

Seeing soccer as a stepping-stone into politics — a reasonable strategy in his soccer-mad country — Macri in 1995 was elected president of Boca Juniors, an iconic team that had fallen on hard times both on the field and in its finances. Macri reversed the team’s fortunes. Boca won two national championships under his aegis, and he gained a strong political base in the capital. He won election as mayor of Buenos Aires, the most high-profile post in the country after the presidency, in 2007 and served two four-year terms. Using the mayoralty as a platform to attack Peronist policies, he built a nationwide conservative alliance under the banner of his Propuesta Republicana party (PRO).

As president, Macri has relied heavily on Prat-Gay to set economic policy. The economist enjoys strong credibility both at home and abroad, based on his experience on Wall Street and his success as president of the Banco Central de la República Argentina. Appointed to the central bank post in 2002, in the wake of the debt default and devaluation, Prat-Gay adopted a floating-peso exchange rate to help stabilize the currency and bring down inflation. He stepped down two years later after refusing to surrender the central bank’s independence, as demanded by Kirchner, but by then the inflation rate had fallen from 40 percent to 5 percent and the economy was growing at a rate of 8 percent.

In 2005, Prat-Gay co-founded Tilton Capital, an asset management company in Buenos Aires. The government promptly launched an investigation of the man and the firm over allegations of facilitating tax evasion and capital flight for clients. Prat-Gay denied any wrongdoing, and the investigation was eventually dropped. He was elected to Congress in 2009 as a member of the center-right Civic Coalition and emerged as a leading opposition voice on economic issues, particularly on the need for reaching a debt agreement with the bond holdouts. His performance impressed Macri, who consulted Prat-Gay regularly on ways to jump-start the economy, including moving to a floating exchange rate and lowering export taxes on farmers.

The sudden freeing of the exchange rate in produced a sharp drop in the peso, but it didn’t send the currency into an uncontrolled tailspin or unleash hyperinflation, as some skeptics had predicted. The peso fell almost immediately to about 13 to the dollar and held steady there for three weeks, then declined steadily to 15.225 on February 22. That represents a decline of nearly 36 percent from the old managed rate and leaves the peso below the black-market rate of almost 15 to the dollar in the waning days of the Fernández government. Thus far, only about half of the devaluation has been reflected in consumer prices. “Many people feared that the pass-through from the exchange rate to prices would cause inflation to jump to over 50 percent,” says Miguel Kiguel, executive director of Econviews, a leading, Buenos Aires–based economic consulting firm. “So inflation is clearly at the lower end of expectations.”

Clearly, the bold move to free the exchange rate and promises to begin cutting public spending have gained the new government credibility among investors and many Argentineans. “Macri and his team are showing conviction and determination and no hesitation,” says Alberto Ramos, Goldman Sachs Group’s New York–based senior Latin American economist. “That creates a lot of confidence in their strategy.”

One measure of that confidence is a growing willingness of Argentineans to pull dollars out from under their mattresses and deposit them in banks. Chronic inflation has always made hidden dollars the main vehicle of savings. It explains Argentina’s startlingly low ratio of credit to GDP: just 15 percent, compared with an average of 36 percent across Latin America.

Over the past four years of sluggish growth, the banking system’s annual return on equity has been only 3 percentage points above inflation, or about half the regionwide median. Besides a lack of deposits, banks found themselves squeezed by a lengthening list of regulations under the previous government. “We weren’t allowed to increase fees or commissions, or raise interest rates on consumer loans,” says Santander Río CEO Cristofani. “And we were required to make loans at subsidized rates to businesses that claimed to be making new investments.”

The Macri government is lifting all those controls. “We’ve got good partners in the Finance Ministry and the central bank,” Cristofani says. His bank is moving to attract new deposits and extend more loans, in both cases denominated in dollars and at elevated interest rates. (Double-digit inflation still scares banks and clients away from peso loans.)

In December alone Santander Río gained $500 million in new retail deposits — three times more than expected — by offering interest rates of 4 to 4.5 percent for periods of 30 to 90 days. On the credit side the bank recently began offering four-year dollar loans at a rate of 8.75 percent to companies in export-earning sectors such as agriculture.

The ample room for credit expansion should make the banks a magnet for investors. “Once inflation declines to normal levels and economic growth resumes, there is no reason why there can’t be years of strong loan growth ahead,” says T. Rowe Price’s Wachnitz. For now, however, investors can choose among only three publicly listed entities: Grupo Financiero Galicia, Banco Macro and BBVA Banco Francés, an arm of Spain’s No. 2 lender, Banco Bilbao Vizcaya Argentaria. Their combined market cap is less than $11 billion.

Because of their export earnings, farmers are the most sought-after banking clients. Last year agriculture accounted for $20 billion of the country’s roughly $60 billion in exports, with soybeans alone bringing in some $15 billion.

In the flat, loamy pampa community of Carmen de Areco, 90 miles west of Buenos Aires, Oscar Moncho has been contacted by four banks since December, including a visit from the manager of the local BBVA Banco Francés. “He was putting together his loan projections for the year and wanted to know if I was planning any investments on my property,” says Moncho, who owns 1,270 acres and rents an additional 3,800 devoted mainly to soybeans. He intended to repair and replace machinery, he told the banker, who immediately offered to raise his lending limit by 20 percent. But Moncho figures he can get a better deal on loans if he waits. “Interest rates are too high at the moment,” he says.

The contrast with the recently ended Peronist era is startling. In recent years farmers staged strikes and withheld an estimated $11.5 billion in produce to protest taxes, which were hiked to 35 percent of export sales for their grains and soybeans.

The Fernández government imposed an export ban on most beef to create a domestic glut and keep meat prices down. It worked for a while but ultimately led farmers to cull their herds. Over the past six years, farmers slaughtered 12 million steers and cows, reducing the national herd by a fifth, to 50 million cattle; they also shifted more land from grazing to cultivation.

Thanks to China’s huge appetite for animal feed, soybeans became Argentina’s dominant national product, accounting for about 50 percent of the country’s 105 million tons of annual crop output. Moncho, who used to divide his holdings more equitably among wheat, corn, soy and cattle, now devotes about 85 percent of his acreage to soybeans.

Soybeans have literally become the currency of agriculture. Even more than dollars under mattresses, soybeans are hoarded, in plastic silo bags, as a hedge against inflation. In legal contracts with suppliers, farmers barter soybeans for machinery, fertilizer and other material and equipment. Moncho talks about his production costs and earnings in terms of quintales — 100 kilograms, or 220 pounds — of soybeans.

Pesos are for speculation. As an example, Moncho cites the moves he and his neighbors made before last year’s presidential election, anticipating that Macri would win and carry out a devaluation. “We took peso loans, knowing we could repay them at lower real rates,” he says, sounding more like a financier than a farmer.

Changing that mentality is at the top of the agenda for Carlos Melconián, the recently appointed chief executive of state-owned Banco de la Nación Argentina, the country’s biggest bank by deposits, loans and branches. During Fernández’s last year in office, many farmers boycotted Banco Nación because it refused to extend loans unless they diversified their crops and released hoarded soybeans. “We hope to encourage farmers to leave finances to bankers and focus again on agriculture and livestock,” Melconián says.

That effort received a big boost only days after Macri took office. The president announced in December that the government would gradually phase out export taxes on soybeans by 2020 and would eliminate them immediately on other grains. Farmers also stand to be among the biggest beneficiaries of the peso devaluation, which suddenly made their dollar-denominated export earnings worth 30 percent more in the national currency. Farmers responded by increasing their foreign crop sales by $2 billion in the last three weeks of 2015, or nearly double the amount of sales for the month of November.

Argentinean farmers are among the most competitive in the world in terms of soil fertility, mechanization and financial savvy. They sound confident even though the price for a metric ton of soybeans has tumbled, from a record high of $623 in August 2012 to $325 in early February. “We can increase production even if commodity prices remain low,” says Alfredo Rodes, executive director of CARBAP, the farm association for the provinces of Buenos Aires and La Pampa, in the soy heartland.

Institutional investors would love to buy farm-related equities — if only they could. “There are only a few companies, but they don’t have a pure Argentinean exposure,” says T. Rowe Price’s Wachnitz. The most prominent, Adecoagro, has the bulk of its operations in Brazil.

Macri’s farm policies helped boost foreign exchange reserves to $29.7 billion in early February from a nine-year low of $25 billion — of which barely $3 billion was liquid — in the last days of the Fernández administration. But the cuts in export taxes will increase the fiscal deficit in the short run. The deficit climbed past 6 percent of GDP at the end of 2015 (precise figures aren’t available) from 2.6 percent in 2013, the last year the IMF accepted the accuracy of Argentinean statistics.

Macri has urged farmers to pay their full income taxes to help cover the shortfall. To some economists that sounds like wishful thinking in a country where tax evasion ranks a close second to soccer as the national sport. “Argentina simply doesn’t have the administrative capacity to monitor and collect personal and corporate income taxes efficiently,” says Estanislao Malic, an economist at Buenos Aires consulting firm CESO. “On the other hand, it would be difficult for a cargo ship of soybeans on the River Plate to slip past tax inspectors.”

Energy spending, about 3 percent of GDP, is the biggest single contributor to the budget deficit. It may be the most daunting economic and political challenge inherited by Macri and his team. The government currently sets the price of domestically produced oil at an average of $67.50 a barrel, double the level of the international benchmark, Brent crude. At the consumption end the government sets the price of electricity — 80 percent of which is generated by oil and gas plants — at some of the lowest rates in the world.

According to a January report by Eurasia Group, a New York–based political-risk consulting firm, electricity subsidies reached $14.5 billion last year, or more than 10 percent of government spending, and they “have been behind the sharp deterioration in the country’s fiscal and external accounts.”

A combination of nationalism and populism under the Kirchners created the energy muddle. A decade ago Argentina was a net exporter of hydrocarbons. But as rising demand for subsidized electricity overtook domestic fuel production, the government has been forced to import ever-higher amounts of oil and gas.

In 2010, Repsol YPF, an arm of Spain’s Repsol, discovered a vast deposit of shale oil and gas, dubbed Vaca Muerta, or “dead cow,” in arid western Patagonia — the largest shale find in Latin America. Two years later the Fernández government expropriated the subsidiary, contending it had failed to keep up production at its other, conventional Patagonian wells.

After bitter recriminations the Spanish parent company agreed to a $5 billion compensation deal in 2014. Vaca Muerta was turned over to the renationalized YPF. Crowds rallied outside the Casa Rosada — the pink presidential palace in downtown Buenos Aires — hoisting banners proclaiming “Vaca Muerta Es Nuestra!” (“Dead Cow Is Ours!”).

The celebrations quickly faded, though, and Argentina has struggled to exploit the giant deposit. According to analysts, it would require capital spending of $20 billion a year for at least three years to fully develop the field. YPF is the largest energy investor in Argentina, but its total capital expenditures, both upstream and downstream, are less than $6 billion a year.

“The Macri government will probably do a good job in making investments in oil and gas more attractive,” says Xavier Olave, New York–based analyst for Fitch Ratings. The government has already indicated it plans to lift restrictions on imports of drilling and production equipment and raise the regulated price of natural gas sold to the electricity grid. “But investors will still have to worry about how long-term energy investment cycles in Argentina have worked in the past,” Olave adds.

Expropriation dangers aside, it makes little sense for multinational energy companies to invest in a high-cost project like Vaca Muerta when global crude prices have plunged from more than $110 a barrel in mid-2014 to less than $35 in mid-February. To persuade subsidiaries of foreign companies — led by Pan American Energy, China Petroleum & Chemical Corp., Petrobras and Chevron Corp. — to maintain production levels in existing fields, the government has kept the domestic oil price artificially high. In the longer term this may encourage energy self-sufficiency; for now, though, it helps stoke the nation’s double-digit inflation.

The electricity sector is mired in an even deeper morass. Forced to charge below-market rates, distributors face negative cash flows and have failed to keep up repairs of the grid. Monthly charges of $10 or less for electricity are common both in poorer and middle-class urban neighborhoods. Brownouts and blackouts are frequent in the southern hemisphere summer. In late January, on a day when temperatures soared to nearly 100 degrees Fahrenheit (38 Celsius), some 800,000 of the 13 million people living in the greater Buenos Aires metropolitan zone were left without electricity for several hours.

Earlier in the month the government had announced a first round of electricity price increases of up to 300 percent. “In some cases the increase will be the equivalent of two pizza pies,” Finance Minister Prat-Gay noted. The new prices won’t be nearly enough to cover the cost of electricity generation or to induce more private investment in the grid, though. Says Fidelity’s Pruett, “it will take a massive increase in tariffs — maybe 1,000 percent — and that’s too big a pill for consumers to swallow.”

Already, the Macri government has its hands full getting labor unions to accept wage increases of less than 25 percent. Meanwhile, car owners will continue to pay some of the highest fuel prices in the world — about $5 a gallon after a 6 percent rise in January. And there’s little relief in sight, as the government intends to keep domestic crude prices high. “We will maintain the internal reference price for a barrel of crude far above the international levels,” Prat-Gay said in announcing the government’s energy policy in January.

So far, Macri has enjoyed a political honeymoon, with one local pollster, Poliarquía Consultores, giving him a 71 percent approval rating in mid-January after his first month in office. To compensate at least temporarily for his lack of a congressional majority, Macri has made a de facto alliance with a Peronist faction led by Sergio Massa, who ran third in the presidential race.

But March will be crucial. Argentineans returning from their summer vacations will face sticker shock in the supermarkets. The canasta alimentaria — an index of 300 food products — rose more than 4 percent in both December and January. Prices for beef have jumped 60 percent since November, according to farmers’ association CARBAP. That will hit consumers hard in a country that leads all nations in beef consumption, at 58 to 62 kilos (128 to 137 pounds) per person.

“Beef prices have gone through the ceiling,” says Claudio Codina, owner of La Raya, one of the leading beef restaurants in Buenos Aires and a gathering place for politicians and soccer stars. “I can’t pass them on to my customers because they’ll run away.”

In the back room of Codina’s restaurant, politicians of every persuasion recently gathered around a table to devour grilled sausages, sweetbreads and steaks. “Here they put their quarrels aside,” Codina says. That may not last much longer. Midterm legislative elections are scheduled for next year, and the possibility that Macri may not gain a congressional majority to press his reforms gives some investors pause.

“It makes it more difficult if you are investing with a long-term horizon like we do,” says Fidelity’s Pruett. “Argentina is one of those show-me markets.”

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