Argentina to use central bank reserves to pay off debt

In May 2010, the Argentine legislature passed a law approving the use of central bank foreign currency reserves to pay down the country’s debt. This politically controversial move may ease fiscal pressures in the short term, in the longer term it will reduce business confidence in Argentina as an investment destination, worsening the business environment and undermining economic growth.

  • On 5 May 2010 the Argentine Senate approved a bill allowing the transfer of US$4.3 billion in central bank foreign currency reserves to the government. The government plans to use these funds to meet the country’s 2010 debt repayments, which total approximately US$15 billion over the course of the year;
  • The approval of this controversial measure will allow the government to meet its debt repayments but indicates that it is under fiscal pressure. The Argentine government has been unable to borrow money from the international capital markets following its sovereign debt default in early 2002, during a major economic crisis. Argentina is therefore determined to meet its 2010 debt repayments in order to prove that it can be trusted to tap international financing again;
  • Meanwhile, Argentina’s economy slowed sharply during the 2008-2009 economic slowdown, registering annual real GDP growth of only 0.9% in 2009, after experiencing annual growth rates of above 6.0% since 2003. Foreign direct investment (FDI) inflows fell 10.8% year-on-year to US$7.9 billion in 2009, exacerbating the effect of the economic downturn.
FDI inflows and real GDP growth in Argentina: 2004-2009
US$ billion; annual % change

Source: Euromonitor International from the IMF, UNCTAD and national statisticsNote: 2009 FDI figures are preliminary.

Implications

  • Taking money from the supposedly independent central bank will raise questions about the government’s willingness to respect business regulations. Argentina’s business environment is already weak. In the World Bank’s Ease of Doing Business Report 2010, it was ranked 118th out of 183 countries, down from 112th in 2009;
  • Foreign direct investment had been rebounding from the 2001-2002 economic crisis, reaching 2.7% of total GDP in 2008, from 0.8% of GDP in 2001. Yet preliminary reports indicate that foreign investment slumped by 10.8% annually in 2009, to approximately US$7.9 billion. Declining investor confidence in the Argentine business environment will act as a further disincentive for investment, with an ongoing decline in foreign investment acting as a drag on economic growth;
  • The government has tried to compensate for slowing economic activity and investment by increasing spending, particularly on social programmes. Budget expenditure rose by 1.2% annually in real terms in 2009, at a time when budget revenue fell by 0.6% annually in real terms;
Argentina’s budget expenditure and revenue: 2004-2009
ARS billion (constant 2009)

Source: Euromonitor International from IMF/International Financial Statistics.

  • Increased spending has contributed to rising inflation. Although government statistics estimate annual inflation at 9.7% in March 2010, independent estimates put the figure at just over 20.0%, representing a significant erosion of consumer spending power.

Prospects

Argentina’s economic recovery in 2010 will be hindered by ongoing uncertainty regarding government financing and rising inflation:

  • The economy is set to grow by 3.5% annually in 2010, largely owing to high global prices for its key export commodities of oil, beef and soya;
  • The business environment will continue to deteriorate, reducing investor confidence. In May 2010 the government banned the importing of foreign goods that could be produced domestically. This protectionism will further undermine investor confidence;
  • Inflation is set to continue rising in 2010. The IMF projected in April 2010 that Argentina’s inflation rate for the whole 2010 will reach 10.1% — a significant upward revision from the forecast of 5.0% it made in October 2009. Argentina’s annual inflation stood at 6.3% in 2009;
  • Although economic growth will recover in 2010, consumers will continue to suffer from the negative impact of high inflation on purchasing power, while longer-term growth prospects will be undermined by declining investor confidence.