Argentina’s corporate beef
Argentina’s current hard times, though in keeping with a well-established pattern of recurring economic crises, are among the worst in the country’s history.
Henry Ford’s decision to build an automobile plant in the port of La Boca outside Buenos Aires in 1918 was a significant vote of confidence in Argentina. But it was not a surprise. At the time, the country was a burgeoning industrial power, the world’s seventh-largest economy and the generator of 7 percent of all global commerce. Its GNP per capita nominally made Argentineans richer than the French, the Italians and the Spanish, and left them not far behind the Americans. The showroom that Ford Motor Co. had opened on Buenos Aires’ bustling Calle Lavalle five years earlier was flourishing. The La Boca factory was only Ford’s third foreign plant, after facilities in Manchester and Bordeaux, and it was soon supplanted by even bigger Argentinean plants. By 1926 Ford had assembled 100,000 cars in Argentina.
Eighty-four years later - this past January - Ford froze auto production in Argentina and halted exports. The cost of buying foreign currency to pay for imported parts had soared to prohibitive levels; in any case, potential car buyers could not obtain credit. By mid-February the automaker was contemplating slashing its remaining workforce of 2,900 by one fifth. But perhaps mindful of its long history in Argentina, the company took out a full-page ad in the Buenos Aires Econ¢mico to reassure Argentineans of its commitment to their troubled country: “You can insult us, you can understand us, but you will never be able to say that in hard times Ford didn’t show its face.”
Argentina’s current hard times, though in keeping with a well-established pattern of recurring economic crises, are among the worst in the country’s history. On December 23 the government halted payment on a portion of its $141 billion of foreign obligations, chiefly government bonds; it has been forced to sever a decade-old, one-to-one tie between the dollar and the peso. First, Buenos Aires devalued the peso, and then it allowed it to float freely. The Argentinean currency was worth about 49 U.S. cents late last month.
Abruptly ending peso-dollar convertibility was so wrenching, says former Argentinean Treasury secretary Daniel Artana, that it will be much harder for Argentina to rebound than it was for Brazil after its 1999 devaluation (see story, page 53) or for Mexico following its 1994 peso crisis.
“Argentina was practically dollarized,” says Artana, currently the Bueno Aires-based chief economist of the Fundación de Investigaciones Económicas Latinoamericanas. “Now the rug has been pulled out from under it. That credit was so heavily dollarized should have been taken more into account by economists pressuring for a devaluation. For whatever the benefits, you have to look at the toll of what is destroyed: a financial system that took years to develop and gain confidence in. The country has zero credibility.”
By the most optimistic estimate - that of the government - the economy will shrink a further 4.9 percent in 2002, its fifth straight year of contraction. Private forecasters put the decline at 7 percent or more. The country’s share of global trade today is a meager 0.4 percent. And Argentina’s GNP per capita - $7,500 in 2000, before the devaluation - is now 50 percent lower than Spain’s and 70 percent lower than France’s.
Faced with another year of deepening recession and virtually no access to credit, companies have gone into survival mode. Desperate for cash flow, manufacturers are dumping inventory, closing assembly lines and sending workers home. The great hope is that this government - or a new one - can create a stable currency regime. Only then, say businesspeople, will companies be able to take advantage of whatever competitive edge the cheaper peso gives them.
Some foreign enterprises, like FleetBoston Financial Corp., have publicly contemplated beating a strategic retreat. The Boston-based bank, lured to Argentina in 1917 to finance the wool trade, has already written off $538 million of its local assets, contributing to the bank’s $507 million loss for the quarter. “For us to continue to operate in Argentina, it will be necessary to have a political and economic framework that’s conducive to profitable operations,” warns Fleet spokesperson James Mahoney. “In the absence of that, we would reevaluate our commitment.”
Argentinean Treasury Secretary Oscar Lamberto, a longtime Per¢nist legislator who was named to his post in January by President Eduardo Duhalde, responds that FleetBoston’s departure “would be unfortunate, but those are the risks.”
Like rival Ford, Fiat has temporarily stopped production in Argentina, after winding down from making a peak 95,000 cars in 1998 to just 31,600 last year. “I’m not sure what we Argentineans have done to this country,” laments Fiat Auto Argentina president Cristiano Rattazzi, a Harvard Business School graduate. “The situation is that it has become next to impossible to operate.”
For precisely that reason, many foreign companies that bet big on the country in better days are licking their wounds and reevaluating their allegiance to Argentina. The list of prominent multinationals doing substantial business in the country - some, like YPF parent Repsol, because they bought Argentinean companies - reads like a corporate Who’s Who: AES Corp., BellSouth Corp., Exxon Mobil Corp., France Télécom, Liberty Media Corp., Motorola, Repsol YPF, Royal Dutch/Shell Group of Cos., Telecom Italia, Spain’s Telef¢nica and Verizon Communications. Major foreign banks with a sizable stake in Argentina include Banco Bilbao Vizcaya Argentaria, Banco Santander Central Hispano, Citigroup and HSBC Holdings. Several, including the big Spanish banks and Repsol, have publicly affirmed their commitment to Argentina.
The plight of corporations might not seem particularly heartrending beside that of Argentina’s poor or even that of its middle class, who’ve lost precious savings because of the peso devaluation and a freeze on bank deposits. But the fact is that companies are more critical this time than ever to the country’s recovery.
“There’s no way to make it without companies,” says Bernard Sheahan, global director of operational strategy for the World Bank Group’s International Finance Corp., which has a $1.2 billion loan portfolio in Argentina. “If you look back, where did Argentina get any growth at all in the last decade? It was private money.” Unlike the U.S., Argentina can’t count on an army of free-spending consumers to revive growth.
Private investment has actually almost doubled as a contributor to Argentina’s economy over the past decade and now accounts for nearly one fifth of GDP. Foreign companies alone pumped more than $55 billion into the country during the mid-1990s, energizing the economy during its most recent heyday. At the same time, the government’s contribution has dwindled by half, to less than 2 percent of GDP. Buenos Aires is not only broke but also fresh out of state assets to sell, having privatized everything from the national oil company to the post office. “What this administration wants is for foreign companies to make investments here,” says Treasury Secretary Lamberto. “We want companies to root themselves in the economy and create employment.”
Perversely, however, a string of government measures aimed at righting the economy has all but paralyzed the very companies that could lead a rebound. Last month confusion still reigned about even the most basic business transactions, from the proper procedures for importing goods to the validity of predevaluation supply contracts. “There’s not much anyone can do in this climate,” says José Giraudo, finance director of Acindar Industria Argentina de Aceros, the country’s largest producer of nonflat steel. “We need to hold off until we have some idea of the future.”
Immense damage has been done to the business sector already. The sundering of the dollar-peso link and the ensuing plunge in the Argentinean currency’s relative value immediately caused companies’ assets to depreciate by a still-undeterminable amount, while sending their debts surging in peso terms (see box). Bankers had actually encouraged companies to borrow in dollars rather than pesos, by demanding a premium on peso loans as compensation for the risk that Argentina might someday devalue.
Companies got caught in a currency squeeze. Take Autopistas del Sol, formed by Italy’s Impregilo, Spain’s Grupo Dragados and local investors to buy a concession to operate the Panamericana highway as a toll road. The devaluation slashed Autopistas’ dollar income by half after the government froze tolls in peso terms (reneging on a contract that indexed tolls to dollars, the company says.) Faced with interest payments of $18.7 million due February 1, Autopistas defaulted. “We still don’t have any inclination of how prices will be set in the future,” the company’s finance director, Matias Sejhezzo, said before the default. “Our balance sheet has been thrown out of whack to the point where it’s impossible to get our arms around it.”
Banks, however, not corporations, bore the brunt of the currency blow. For loans, banks must honor the preexisting rate of one peso to one dollar; for deposits, though, they must pay out 1.4 pesos for each dollar. This alone threatens them with a $16 billion loss, estimates Standard & Poor’s banking analyst Carina López. To compensate banks for this glaring discrepancy, the government plans to give them government bonds, but, as López notes, the bonds’ real value is “dubious, given the indebtedness of the defaulted issuer.” Making matters worse, banks already own $30 billion of government bonds worth pennies on the dollar.
Treasury Secretary Lamberto acknowledges that “of course, we understand the importance of the role of the banks. Obviously, without banks there’s no economy.” He notes that the administration is conducting an “ongoing dialogue” with banks. But he also observes that “it hasn’t gone that bad for the banks in Argentina - there have been plenty of profits. What’s happening is shared by everyone.”
The government’s emergency restrictions on bank withdrawals and on foreign transfers for repatriating profits or paying debts have precipitated a wave of defaults among corporations. Marta Castelli, a director at S&P, reports that the rating agency has put more than 35 companies in “selective default"- signifying that S&P doesn’t expect them to be able to pay all of their debts - because of the way the dollar-denominated payments on their foreign debt have ballooned in pesos. The list includes some of the country’s biggest names: Telefónica de Argentina and Telecom Argentina Stet-France Telecom, owned by Spain’s Telefónica and France Télécom; BP’s Pan American Energy; and CTI Holdings, part-owned by Verizon.
What companies need most from the government now, after so much turmoil, executives say, is a stable operating environment. Given that, they maintain, Argentinean companies are fully prepared to compete anywhere. Indeed, businesspeople contend that in spite of, or maybe because of, all the years of being hamstrung by an overvalued peso, a crippling recession and a welter of government taxes and regulations, their companies have emerged with drastically improved efficiency. The former state oil company, YPF, for example, once employed 45,000 workers and throughout the late 1980s lost roughly $300 million a year. Today, after being privatized and acquired by Spain’s Repsol, the company employs 8,600 people and earned $1 billion in 2001.
But to achieve the kind of economic stability that will allow companies to flourish, the government will have to muster the discipline to provide two key things for a sustained period: a responsible monetary policy and reduced deficit spending. And the record is not reassuring on that score. What makes Argentina’s predicament so painful, and poignant, is that it is the bitter sequel to a remarkable success story.
Desperate to tame inflation that had reached the vertiginous height of 5,000 percent a year in the 1980s, Argentina’s then-Economy minister, Domingo Cavallo, pegged the country’s currency firmly to the dollar in 1991. The so-called convertibility rule - one peso equaled exactly one dollar - was written into the constitution. Buenos Aires could no longer blithely print pesos to fund politically inspired projects.
Inflation dropped dramatically, to mere double-digit figures, and foreign money came pouring back into the country. Argentina’s educated workforce and comparatively well-off middle class added to the country’s appeal to investors. By 1994 prices were rising at an average annual rate of just 4.2 percent, while the economy was growing at a 5.8 percent annual clip, the fastest in years.
The next year, however, Mexico’s disastrous devaluation caused investors to pull back from Latin America, and although Argentina soon recovered from that setback, the Asia crisis began in 1997. This time Argentinean companies had to contend with a more severe credit crunch. And things grew even worse in January 1999, when Brazil devalued its real, putting Argentinean companies at a huge trading disadvantage because of the overpriced peso. Argentina slipped deeper into recession. Meanwhile, the government continued to overspend recklessly, despite the discipline of convertibility.
Between 1997 and 2000 government spending increased 6 percent while revenues rose just 2 percent. This imbalance necessitated more borrowing even as interest rates climbed, pushing up the national debt by 30 percent in four years. Annual payments on interest doubled, to $12 billion. Then late last year Buenos Aires overshot an IMF target for its budget deficit of 2.3 percent of GDP.
On December 5 the IMF confirmed that it would withhold a $1.26 billion installment of a $40 billion loan. During the last week of November, rumors that the IMF would delay the payment and that Argentina’s central bank would impose withdrawal restrictions prompted a bank run: Anxious investors pulled $1.5 billion out of the banking system, almost all of it on a single Friday, just before withdrawal restrictions were announced. The financial crisis that would soon trigger default was thus set in motion.
Few businesspeople believe that President Duhalde can impose the fiscal austerity needed to win the IMF’s blessing - and cash. As governor of Buenos Aires province, he increased public debt by 70 percent in one year, purportedly to fund public works projects, during his failed 1999 bid for the presidency. Nobody’s first choice for president, Duhalde got the job on January 2 with the backing of the Perónist and Unión Cívica Radical parties, only after violent protests over economic chaos had ousted four presidents in two weeks and left 27 civilians dead.
The 60-year-old Duhalde and his 53-year-old Economy minister, Jorge Remes Lenicov, a Perónist of the old school, have enacted emergency measures that some say are doing more harm than good. In addition to dismantling the currency peg, Buenos Aires has rescinded dozens of government concession contracts to run things like highways and airports and reneged on a promise to repay small depositors in dollars. In late February the government imposed a 20 percent tax on crude oil exports to fund public spending, over oil companies’ strenuous objections. It did, however, promise to review Argentina’s corporate tax code: Companies have complained bitterly about tariffs on debt interest payments and financial transactions. Buenos Aires also plans to put a still-undetermined cap on interest rates, which have hit 40 percent for some companies.
The administration promises to take up companies’ gripes on a case-by-case basis after the new budget is written, talks with the IMF for a fresh loan are well under way, and exchange controls on the peso are lifted. Companies’ wish lists are bound to be lengthy, ranging from carmakers’ desire for looser trade quotas with Brazil to the ailing construction industry’s call for massive public works projects.
The current chaos is an unavoidable but temporary bump on the road to recovery, contends the Duhalde administration, which has promised an independent monetary policy presided over by the central bank, as well as the lifting of bank controls.
Buenos Aires may see a brighter future, but companies are clamoring for more reassurance - and not without reason. The auto industry alone lost $600 million in each of the past two years. Manufacturers’ sales of cars to local dealers have plummeted from 40,000 a month in 1998 to about 2,000 today.
“Many investments will be maintained, because these factories don’t have legs and you can’t just take them to another country,” says Rattazzi of Fiat Argentina, which opened a $600 million plant in 1996. “But let’s just say that new money will be slow in coming. Then, maybe down the line, if things are put on track, we’ll see.”
Companies may be critical to Argentina’s recovery (story), but Buenos Aires hasn’t gone out of its way to allay businesspeople’s concerns or clarify currency laws and other rules by which companies live or die. Here’s how three quite different enterprises are seeking to cope with uncertainty: Steelmaker Acindar Industria Argentina de Aceros was one of the great success stories of Argentina’s convertibility era. The advent of the peso-dollar peg in 1991 gave Acindar access to foreign capital to convert onerous short-term credits run up in the chaotic 1980s into longer-term bonds and loans. With its finances in order, the company was able to invest $200 million in plant modernization between 1996 and 1998, boosting capacity by 30 percent.
Unfortunately, the timing was off. Although the company prospered at first, it was soon staggered by the one-two punch of the Asia crisis and neighboring Brazil’s devaluation. For three straight years, starting in 1999, Acindar’s most important customer - the domestic construction industry - shrank by an average of 10 percent a year, while the company’s borrowing costs rose.
As sales dropped by 30 percent, Acindar cut its workforce by half, to 3,000. It sought to offset the weak home market by selling more steel abroad: 40 percent of its production is now exported, compared with 15 percent in 1997. But the margins on raw steel - Acindar’s main export - are lower than those on higher-value-added local products. In December Acindar said it could no longer meet payments on its $400 million debt, $250 million of which is foreign.
For the time being, says finance director José Giraudo, the company is in a holding pattern as it awaits government ground rules for companies. Talks with foreign creditors probably won’t take shape, he adds, until Acindar can draft a convincing recovery plan, which will be contingent on its ability to predict exchange rates, economic growth, interest rates and the value of the company’s debts in pesos. In the meantime, the company is holding off importing iron ore, graphite and spare machine parts.
Claudia Biasotti, chief financial officer of Capex, a thermal energy generator partly owned by El Paso Energy International of Texas, fondly remembers a time when fund managers from Morgan Stanley & Co. and J.P. Morgan trekked to her office in suburban Buenos Aires.
Capex had a compelling story to tell. Once convertibility was in place, Biasotti was able to tap the international debt markets and even launch a public stock offering in 1994. The money mainly went to construct a gas-separation plant in 1996 and to upgrade an existing plant, boosting Capex’s capacity by 70 percent.
Sales for the fiscal year ending last April were nearly double those of fiscal 1998, the year the upgraded plant came on line, and one third higher than just two years ago. But Capex’s profits have plummeted by almost half since then, to 13.4 million pesos ($13.4 million, at the predevaluation exchange rate), while the company’s interest payments have nearly doubled, to 33 million pesos. The company’s debt load has roughly tripled since 1996, to more than $300 million.
When the outside bond market began closing to Argentinean companies in the late 1990s, Biasotti turned to a group of banks led by Citibank, Banco Santander Central Hispano’s Banco Río de la Plata, and BankBoston to set up a series of shorter-term syndicated loans to sustain expansion. Now Capex faces $72 million in debt coming due this May, but Biasotti isn’t worried that she’ll have any problem extending it.
Nevertheless, Standard & Poor’s analyst Sergio Fuentes has placed Capex on the agency’s “selective default” list. He warns that Argentina’s energy suppliers are at the mercy of a still-unreleased government pricing plan. The Duhalde administration is expected to come out with a pricing strategy for distributors, which in turn will be passed on to suppliers like Capex, says Fuentes. He predicts that power prices, which fell two thirds over the past decade, reflecting fierce postregulation competition, will remain flat in real terms for the near future. The analyst calculates that Capex’s ratio of earnings before interest, taxes, depreciation and amortization to interest expenses - one measure of its ability to pay debts - will fall from 1.7 to 0.6 percent this year.
But, Biasotti insists, “we’re in a great position within the market and in great standing with our bankers.” She expects Capex’s sales and earnings to rise in keeping with the devaluation, as renewed economic activity revives demand for energy. “When a company like Capex can’t get credit,” she contends, “then the country really will be in dire straits.”
Traditional manufacturing industries that were hammered by Argentina’s embrace of free trade may stand to gain the most from devaluation. For the better part of the 20th century, Alpargatas thrived making cotton and leather goods, principally shoes. But in the early 1990s, Argentinean president Carlos Saúl Menem drastically lowered long-standing trade barriers. For Alpargatas - suddenly contending with an overvalued peso, labor costs that were 15 percent higher than in neighboring Brazil and operations that were inefficient after years of protection - the competition was overwhelming. Sales plunged from 423 million pesos in 1992 to 108 million pesos by 2000, and the payroll shrank from 15,000 to 2,000. Despite funding from the World Bank’s private sector arm and U.S. private equity fund Newbridge Latin America, Alpargatas defaulted on its debts in 1998 and finally sought legal protection from creditors in December.
The company now requires wholesalers to pay cash up front; there’s no longer a grace period. Sales have plunged 60 percent in just the past two months, and inventory has begun to pile up. Alpargatas has had to close six of its eight plants.
Despite all this, the company’s president, Guillermo Gotelli, is counting on the weaker peso to put the company back on a level playing field with foreign competitors. Indeed, he forecasts a 30 percent increase in sales this year, led by exports to Brazil, Spain and the U.S.
“We have the raw materials, we have the best designers and the best engineers,” declares Gotelli. “There’s no reason we shouldn’t be able to offer the best products and services. The cost of capital is still a problem, but I’m optimistic.” Right now such stubborn optimism may the most critical raw material of all for Argentinean companies.