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Rising inflation in Argentina has encouraged the government to adopt unorthodox means of tackling the problem, including price freezes and controversial recalculation of figures. Uncertainty over the government’s commitment to economic probity and orthodox management will act as a disincentive to investment.

Issue

Official figures for 2007 inflation have come in well below consensus estimates, leading to concerns that the government is intervening in the activities of the National Institute of Statistics and Census (INDEC):

  • In April 2007 INDEC announced the preliminary March 2007 figure for price increases in a basket of basic foods as 3.6% month-on-month;
  • Shortly afterwards INDEC revised its figures to announce a 0.2% contraction. This brings annualised inflation to 8.9% according to national statistics.

Such a difference has decreased confidence in official statistics. Rising inflation is a warning sign that the economy may be overheating, which will make investors wary about investing.

Importance

Inflation is traditionally viewed as a barometer of Argentina’s economic health following hyperinflation in the 1980s and inflation of over 25% following the economic crash in 2001. Via measures such as price freezes for basic foodstuffs and massaging of data, the government hopes to allay fears about mounting inflation:

  • Presidential elections in October 2007 make inflation a political issue;
  • Rising inflation would force the government to allow the peso to appreciate, reducing export competitiveness. Exports rose 11% year-on-year to US$11.0 million in Q1 2007, from US$9.9 in Q1 2006;
  • The government has issued a large number of inflation-linked bonds, such as the Global 2033, with a 5.83% coupon. If inflation rises, the government’s servicing commitments will also increase. This will put pressure on government finances and reduce state investment, limiting economic output, which is already operating at only an estimated 74% of potential.

Rising inflation would result in a more uncertain business environment, with price increases making operating in Argentina more expensive. Long-term government financial constraints stemming from inflation-related pressures will reduce key investments into making Argentina’s business environment more attractive.

Implications

Growing distrust of inflation figures will cause domestic expectations to rise and act as a disincentive to foreign direct investment:

  • The government is trying to cap wage increases at 15% in an effort to curb inflationary pressures. Concerns that inflation is rising more than reported will encourage unions to press for higher salary increases in order to maintain consumer purchasing power. In current negotiations, the teachers’ union is pressing for a rise of 20% after six unions won an increase of 16.5% in April;
  • If wage increases do not keep pace with inflation, this will result in a reduction of consumer purchasing power;
  • Rising prices will lead investors to fear the imposition of price freezes on export goods, which would decrease net profits. FDI is vital to underpin Argentina’s economic recovery and increase ability to meet current levels of domestic demand. By 2006 FDI was beginning to decline, to US$3.3 billion, after recovering to US$4.7 billion after the US$1.7 billion registered in 2003 after the economic crisis;
  • Argentina is attractive to investors following its strong economic growth and cheap operating environment after the 2001 economic crash. Rising inflation will make the business environment more expensive. This could encourage businesses to shift operations to countries that are currently more expensive but economically stable, such as Chile and Brazil;
  • A major factor deterring investors will be the government’s tendency to intervene in the business environment. For example, setting limits on beef exports has reduced the sector’s export and revenue potential. Similar moves in other sectors would encourage businesses to move out of Argentina.

Future scenarios

Strong GDP growth (expected at 7.5% in 2007) will maintain steady levels of FDI. However, the rate of FDI growth will continue to slow as businesses become wary about investing in Argentina. This will have a knock-on effect on both consumer confidence and spending power, as less FDI leads to a long-term moderation in economic activity, with negative impacts on wage and unemployment growth:

  • Inflation is forecast to decline only slightly in 2007, to 10.3%, before surging to 12.7% in 2008 as the effect of pre-election spending feeds through to increase price pressures. By contrast, the government is targeting a 7.0-11.0% range;
  • The government has refused to admit that inflation is a problem, since this would fuel domestic concerns. Its strategy seems to be to control inflation via price freezes on basic goods and attempting to hold down wage pressures. However, this cannot be sustained in the long term, especially since businesses negatively affected by the price freezes are using campaigning for the October 2007 elections as a way of pressing for the government to remove these measures;
  • Price caps on fuel and utilities will discourage investment in these industries. The prospect of more power shortages will reduce investment further;
  • The government’s ability to finance its high spending (ARS115.7 billion in 2006, up from ARS96.4 billion in 2005) will be limited by falling demand for inflation-linked debt, as this becomes increasingly perceived as unreliable.

The business environment in Argentina will continue to decline as rising inflation and subsequent upward pressures on wages erode Argentina’s attractiveness as a relatively low-cost operating environment.

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