When Mauricio Macri became president in December 2015, Argentina had already had four years of little economic growth and the country had remained largely isolated due to capital controls and an artificially strong currency. Inflation was out of control since the government financed large budget deficits by printing money.
From an economic perspective, the situation could hardly be worse. Yet here we are, almost one and a half years later, and a huge change begins to occur. Macri can be considered as the first non-populist president of Argentina since the 40s of the last century. Technocrats are holding key positions in all major ministries and in the central bank. Just a few months after its installation, the new government had already removed the barriers on foreign exchange businesses, eliminated or reduced the most distortive taxes, and resolved the long-standing conflict with foreign creditors.
Macri also acknowledges the social cost of reforms, which is extraordinary and certainly not a matter of course in a Latin American context. This explains the careful attempts to cover the budget deficit. Instead of shock therapy, the president pursues a more gradual path to change. Subsidies are being reduced, but only gradually and with compensation for the lowest income groups, which has so far prevented social unrest in the country.
The downside of this cautious approach is that the budget deficit has barely narrowed. On an annual basis, there is still a 6% gap that needs to be financed. As Argentina’s capital market has little depth – significant reforms in this area still have to be approved by Congress – its funding largely depends on foreign flows. The country’s high interest rates attract many foreign investors, so it is not hard to place bonds. However, it increases the inflow of hard currencies into the country, and the now very strong peso has a negative impact on domestic consumption and investment.
This is Macri’s main concern. Economic growth is slightly picking up, but it remains low. It is too low to allow for a faster reduction of the budget deficit. Moreover, as monetary financing (printing money) is reduced only gradually, inflation is still high. Consequently, interest rates cannot decline quickly, and investment growth is barely picking up. The country is clearly moving in the right direction though. We believe that this year, public investments in infrastructure will increase significantly, as well as Argentina’s business confidence and the interest of foreign investors to participate in the energy, agricultural and construction sectors. Besides, slightly positive real wage growth figures bode well for a pick-up in consumption. Overall, the economy is expected to grow by about 3% this year.
There are other emerging markets with a positive reform momentum - Brazil, India and Indonesia are also on the right track - but Argentina clearly has much more room for improvement in the economy as well as equity returns. The path of reform may be cautious, but the turnaround is complete.