Argentina: Staff Report for the 2005 Article IV Consultation
Author: International Monetary Fund
Publication Date:
18 Jul 2005
eISBN:
9781451801392
Language:
English
Keywords:
ISCR; CR; government; country risk risk premium; government financing; government paper; exchange rate; private sector; central bank; fiscal policy; banking system; Public sector; Global; debt service
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This 2005 Article IV Consultation highlights that Argentina’s economy has rebounded strongly from the financial crisis in late 2001. Reflecting buoyant domestic demand, real GDP grew close to 9 percent in both 2003 and 2004, bringing real output level back to the peak level achieved prior to the crisis. Growth has continued in the first quarter, and consumer and business confidence indicators remain at high levels. Inflation, however, has accelerated amid rising demand, increased capacity constraints, growing wage pressures, and monetary accommodation.

Abstract

This 2005 Article IV Consultation highlights that Argentina’s economy has rebounded strongly from the financial crisis in late 2001. Reflecting buoyant domestic demand, real GDP grew close to 9 percent in both 2003 and 2004, bringing real output level back to the peak level achieved prior to the crisis. Growth has continued in the first quarter, and consumer and business confidence indicators remain at high levels. Inflation, however, has accelerated amid rising demand, increased capacity constraints, growing wage pressures, and monetary accommodation.

I. Background

1. Since the last Article IV consultation in January 2003, Argentina has recovered strongly from the financial crisis that erupted in late 2001 (Figure 1). The crisis imposed severe economic and social costs but, after 2½ years of vigorous growth, real output has reached the peak level achieved prior to the crisis, labor market conditions are improving, financial markets are stable, inroads have been made in reducing poverty, and the authorities have made important progress toward normalizing relations with creditors.

Figure 1.
Figure 1.

Recovery from the Crisis

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

Sources: Central Bank of Argentina; Ministry of Economy; INDEC; and staff estimates.

2. The 2005 Article IV consultation focuses on Argentina’s emergence from crisis and the policy choices to complete this process. Against the background of Argentina’s poor long-term record of economic growth (Text Figure), the clear challenge is to maintain the economy’s current momentum. The discussions, therefore, centered on identifying factors underlying the recovery, addressing key vulnerabilities, and identifying structural reform priorities to sustain growth into the medium term. In this context, there was an intensive discussion of debt sustainability and the experience of the recent debt restructuring process.

A01ufig01

Average Real Per Capita GDP Growth (percent, 1960-2000)

Argentina’s average real per capita GDP growth has lagged behind most other countries

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

II. The Recovery Phase

3. The strength of Argentina’s economic recovery has exceeded expectations but, in many respects, it shares similarities with recovering from other recent crises (Figure 1 and Box 1). From early 2003, confidence rose steadily, and both private consumption and investment rebounded. Reflecting buoyant domestic demand, real GDP grew by almost 9 percent in both 2003 and 2004. Export receipts also increased—initially reflecting higher commodity prices as export volumes responded only slowly to the large depreciation—while imports grew, but remained below pre-crisis levels. International reserves began to recover, and bank deposit and external payments restrictions were progressively dismantled. The robust recovery in money demand, contrary to most expectations, was a key aspect of the recovery. In contrast to some other countries emerging from crisis, inflation—after spiking in 2002—remained very moderate (reaching only 3¾ percent in 2003 and 6 percent in 2004) despite the almost 300 percent depreciation of the currency. In part, this was a result of a freeze on public service prices. Given the softness of labor markets, real wages recovered only slowly and, unlike several other crisis countries, the real exchange rate remained at a highly depreciated level (Text Figure).

A01ufig02

Argentina’s real effective exchange rate has remained highly depreciated following the crisis compared to other countries.

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

Cross-Country Comparison of Recoveries from Capital Account Crises1

The impact of the financial crisis on Argentina’s economy shares similarities with that of other countries that faced large capital account crises in the last decade, although the adjustment path has been different in a few aspects (see Box 1 Figure below):

  • Large exchange rate depreciations, both in nominal and real effective terms. While in most countries the real effective exchange rate recovered gradually the real depreciation in Argentina has proved more persistent. By end-2004, Argentina’s real effective exchange rate was still over 50 percent below its pre-crisis average.

  • Sharp drop in real GDP after the currency crisis, followed by a strong rebound in activity. While the drop in real GDP in Argentina was similar to that in Korea, Thailand and Turkey, its recovery was somewhat slower than in these countries (except Thailand).

  • Sizeable current account corrections. Following the depreciations and the declines in economic activity, imports contracted strongly. In most countries there was also a strong export response, which contributed to large current account reversals and drove the initial stages of the recovery. In Argentina, by contrast, export volume growth has been sluggish, despite the relatively large real exchange rate depreciation, the favorable terms of trade and the strong growth experienced by its trading partners. This reflects Argentina’s lower degree of openness and concentration on commodity and agricultural exports, but also the distortions created by the export taxes.

  • Large fiscal consolidations. In all the countries considered—except Korea and Thailand, where the headline debt-to-GDP ratios were very low prior to the crisis—fiscal policy had to be tightened considerably in the aftermath of the crisis either to correct pre-existing imbalances or to bring down debt ratios following their dramatic increases on the back of large exchange rate depreciations.

  • Banking crises accompanied the currency crises (except in Brazil), as banks carried unhedged foreign exchange exposures to the government or nontradable sectors with local currency earnings.

  • Inflation. Unlike in some other countries emerging from crisis, inflation remained moderate in Argentina after spiking in 2002, despite the almost 300 percent nominal depreciation of the currency.

Box 1. Figure:
Box 1. Figure:

Cross-Country Comparison of Selected Indicators 1/

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

1/ The shaded area represents the range of developments pre and post-crisis for Brazil (1999), Korea (1997), Russia (1998), Thailand (1997), Turkey (2000) and Uruguay (2001).

Argentina’s recovery, in contrast to some other countries, has benefited from strong terms of trade. While the large improvement in the terms of trade in the aftermath of the crisis has helped Argentina to sustain its recovery and strengthen its fiscal position and external balance, other countries’ recoveries took place against weakening terms of trade, with Russia and—to a lesser extent—Uruguay being notable exceptions. The reliance of the recovery on favorable terms of trade underscores the need for Argentina to advance structural reforms which would provide a firmer foundation for continued macroeconomic stability and robust growth and boost external competitiveness, especially in a less supportive external environment.

1 The comparisons are made by focusing on the behavior of selected economic variables around the time of the crises in Argentina, Brazil, Korea, Russia, Thailand, Turkey, and Uruguay. In the figures, time is rescaled by defining year T as the year when the crisis erupted, year T+1 as the first post-crisis year, and so on. The crisis years are 1997 for Korea and Thailand, 1998 for Russia, 1999 for Brazil, 2000 for Turkey, and 2001 for Argentina and Uruguay.

4. The recovery was supported by a combination of political stability, prudent macroeconomic policies, and favorable external conditions. The smooth political transition following the May 2003 presidential elections was critical. President Kirchner, while only receiving 22 percent of the national vote in the first round of the elections, quickly gathered exceptionally high approval ratings and popularity. In his public statements, he gave prominence to the mistakes of the 1990’s, to human rights issues, to denouncing corruption and vested interests, and to the government’s support for labor groups, pensioners, and the unemployed. At the same time, the firm implementation of fiscal and monetary policies was key to rebuilding consumer and business confidence. These helped stabilize financial markets and allowed a steady reduction of interest rates. Domestic confidence was further bolstered by the unwinding of restrictions on bank deposits, the lifting of exchange controls, and the redemption of federal and provincial quasi-monies. Argentina also benefited from a supportive external environment, including an improvement in the terms of trade (by 10 percent during 2002–04) largely reflecting higher prices for key export commodities, robust economic activity in Argentina’s main trading partners (especially Brazil), and low world interest rates. The nominal bilateral exchange rate against the dollar has remained within a 7 percent range since the first quarter of 2003.

5. Social indicators began to improve from end-2002 at a steady, but gradual pace (Box 2). The headline unemployment rate fell to about 13 percent in March 2005 from 17.8 percent in December 2002, though an additional 4.1 percent of the labor force was employed under emergency social assistance programs. The share of the population living in extreme poverty fell to 17 percent in June 2004 (from 24.8 percent two years earlier), while the share of the population below the poverty line declined from a peak of 58 percent to 44 percent in June 2004.

6. The recovery was helped for some time by net financial support from the international community, as well as by nonpayment to private creditors (Table 2). After increasing its exposure to Argentina by almost SDR 8 billion during 2000–01, the Fund agreed to support the authorities’ economic program by approving two arrangements in 2003 that aimed to maintain exposure to the Fund broadly unchanged. The other IFI’s also agreed on the objective of maintaining their exposure. However, since the failure to complete the third review of the three-year Stand-By Arrangement, the authorities have been making sizeable net debt service payments to the Fund. Since 2003, Argentina has made net principal payments to the Fund of SDR 2.4 billion (about US$3.7 billion) and paid charges of SDR 0.9 billion (about US$1.3 billion). In the same period, net debt service to the World Bank and IDB has amounted to US$3.1 billion. In regard to other debt obligations, significant breathing room was provided by the long interruption in payments on private and official bilateral creditors that resulted in an accumulation of arrears of about US$40–45 billion during 2002–04.

Table 1.

Argentina: Selected Economic and Financial Indicators, 2001–2007

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Sources: Ministry of Economy; Central Bank of the Republic of Argentina; and Fund staff estimates.

Poverty data for 2004 Q1.

Includes quasi-monies in circulation.

Excludes interest due on nonperforming debt.

Assumes no disbursements from the Fund in 2005 and 2006

Table 2.

Argentina: External Financing Requirements and Sources, 2001-05

(in billions of U.S. dollars)

article image
Sources: BCRA; and Fund staff estimates.

Based on 76 percent participation in January 2005 debt offer.

Includes errors and omissions.

A01ufig03

Fund exposure to Argentina was reduced considerably over the past 12 months.

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

Impact of the Crisis on Social Indicators1

Argentina’s social indicators were already deteriorating for some time prior to the financial crisis. Unemployment rose from 6.3 percent in 1992 to 18.3 percent in 2001, partly as a result of a structural increase in female labor market participation. At the same time, the percentage of the population below the official poverty line almost doubled (from 19.9 to 38.8 percent) and income inequality increased.

The 2001-02 crisis exacerbated the social situation. Poverty peaked at 58 percent of the population and the incidence of extreme poverty doubled, mainly due to a further spike in unemployment and a 31 percent contraction of real household incomes.

A01bx2ufig01

Share of population

(left axis, in percent):

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

The recent economic recovery has brought some alleviation, but it will take considerable time before the social dislocations can be fully reversed. While unemployment has fallen by 6.2 points from its peak—and is now at 1998 levels—poverty still remains well above pre-crisis levels.

The government has responded to the crisis by expanding its social safety net, including through the introduction of the Unemployed Heads of Household program (PJD). The PJD provides a monthly transfer of Arg$150 to unemployed heads of household with children under 18 years, in exchange for their participation in training or community development activities. The program has had a cost of ¾ to 1 percent of GDP per year over the last 3 years and serves some 1.6 million beneficiaries (around 20 percent below the peak in May 2003).

The latest World Bank assessment is broadly supportive of the PJD but suggests a progressive transformation of the program. Monitoring and internal controls have been strengthened and the program seems to be reasonably well targeted—75 percent of beneficiaries are below the 40th income percentile—although there is room for improvement (8 percent of program recipients are in the richest 40 percent of the population). The government is now working with the World Bank and IDB on a gradual exit strategy from the PJD which would transfer some beneficiaries to other social programs and would also expand training and job search support to allow the remaining program participants to transition to the labor market.

1 This box draws on Leonardo Gasparini, “Monitoring the Socio-Economic Conditions in Argentina,” January 2005 (which is, in turn, based on the Permanent Household Survey).

III. Recent Political and Economic Developments

A. Political Developments

7. Two years after his election, President Kirchner’s popularity ratings remain high. The ratings have benefited from a generally tough line taken with foreign investors and multilateral institutions on a number of policy issues including the debt exchange, the renegotiation of utility concessions, and bank compensation. After initial attempts to build his own political base by reaching out to the left-of-center wing of Congress, President Kirchner has more recently focused on broadening his power base within the traditional Peronist party through alliances with provincial governors. The coming period is likely to be devoted to galvanizing support for candidates in the congressional elections to be held in October 2005. A clear victory for his own candidates would help secure President Kirchner the Peronist party’s presidential nomination for 2007.

A01ufig04

President Kirchner’s popular support remains high

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

B. Macroeconomic Developments

8. Economic conditions have remained generally favorable during the first part of 2005. Growth has continued to be strong in the first quarter (estimated at about 9 percent year-on-year) and consumer and business confidence indicators remain at very high levels. Inflation, however, has accelerated amid rising demand, tighter capacity constraints, growing wage pressures and monetary accommodation; consumer prices rose by 4.5 percent during the first four months of 2005, bringing the annual inflation rate to 8.8 percent in April.

9. A strong trade balance and a significant reduction in private capital outflows have facilitated a sharp rise in international reserves (Table 3 and Box 3). The trade surplus has been declining, but is still substantial (an estimated US$2.3 billion in Q1, 2005). Export volume growth has finally begun to pick up and commodity prices generally remain favorable. There has been a decline in private sector capital outflows and some incipient signs of recovery in net foreign direct investment. Despite large net debt service payments to the IFIs, gross reserves have increased to nearly US$22 billion and net reserves are about US$4.8 billion under the program definition (Tables 4 and 5).

Table 3.

Argentina: Summary Balance of Payments, 2001-2007

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Sources: Ministry of Economy and Fund staff estimates.

Based on 76 percent participation rate in debt exchange. Participation by non-residents estimated at 68 percent.

Includes errors and omissions.

Excludes liabilities to non-residents. Fund repurchases are on an obligations basis but include repurchase expectations made Feb-Apr 2005. Projected SDR figures are converted to US dollars using WEO forecast.

Includes public sector arrears to official creditors and private creditors that did not participate in debt exchange, and arrears of the corporate sector.

Table 4.

Argentina: Net Debt Service to the IFIs, 2001-2006

(in millions of US dollars)

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Source: IMF, World Bank and IDB staff.

Assumes payments on an obligation basis and US$/SDR rate in line with WEO projections.

Table 5.

Argentina: Projected Payments to the IMF 1/

(in millions of SDRs)

article image
Sources: IMF staff.

Assumes no Fund disbursements. Repurchase expectations from May 2005 to April 2006 are extended to an obligation basis. Repurchase expectations are assumed from May 2006 on.

Interest savings if payments made on an expectation basis.

A01ufig05

Gross international reserves have risen over US$2.2 billion so far in 2005 despite large payments to IFIs.

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

Export Performance and Competitiveness

The correction that occurred after the floating of the currency in early 2002 has placed the Argentine peso in a range that is broadly consistent with other currencies in the region (Figure 1). Over the last few decades, Argentina’s real effective exchange rate has been extremely volatile, which makes precise estimation of the equilibrium real exchange rate difficult. However, the correction in the Argentine Peso–which is currently at 50 percent of its peak prior to the devaluation of the Brazilian Real - has been larger than that of both the Real and Uruguayan Peso, which are at 60 and 70 percent of their pre-crisis peaks respectively. Moreover, since early 2004 the BCRA has actively intervened to maintain a stable nominal exchange rate, while both the Uruguayan Peso and Real have appreciated against the dollar. All this would suggest the current value of the Argentine Peso is competitive, and may even be somewhat undervalued.

Figure 1.
Figure 1.

Argentina, Brazil and Uruguay: Real Effective Exchange Rate

(Index 1990=100)

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

The response of total exports to the large currency depreciation has nonetheless been moderate, but this is due to a number of factors which have constrained the supply side. Poor harvests contributed to negative volume growth on average for 2002–04 for primary products (Table 1). Export taxes discouraged investment and increases in production. The banking sector crisis may have also constrained financing for investment, particularly for smaller producers dependent on domestic finance. Finally, government actions to secure domestic energy supplies have contributed to negative volume growth for energy exports, despite increases in international prices over this period.

Table 1:

Export volume growth rates

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Source: Argentine authorities

Volume growth in manufactured exports has been more robust. Volumes of agro-industrial products grew 11 percent each year on average over 2002–04, and immediately rebounded following the devaluation with growth of almost 15 percent in 2002 alone. The volume growth of industrial exports has averaged 14.5 percent each quarter from 2003-Q2 to end-2004, and preliminary data for 2005 show this trend is continuing. Available data on market shares of Argentine exports show a more mixed picture, although these data do not yet include information for 2004 (Figure 2). The large increases of market shares in Asia and Chile were largely due to a new pipelines for hydrocarbon products (Chile) and increased agricultural exports (Asia), and do not necessarily reflect improved competitiveness.

Figure 2.
Figure 2.

Argentina: Export Market Shares

Citation: IMF Staff Country Reports 2005, 236; 10.5089/9781451801392.002.A001

In conclusion, while the current exchange rate level appears competitive, long-term export growth will require steps to remove supply side constraints. Because total exports are still relatively small (23 percent of GDP), a sustained and stable contribution of net exports to real GDP growth will depend on continued high volume growth rates. These, in turn, will require further measures, including the phasing out of export taxes, to entrench a supportive climate for exports and investment in the export sector.

C. Fiscal Policy Developments

10. Fiscal policy is targeted to become more expansionary in 2005 (Tables 6–9). The good performance in 2004 (when a record 5.1 percent of GDP consolidated primary surplus was achieved) mainly reflected buoyant revenues—that rose to 29 percent of GDP, from 26 percent in 2003. Tax administration has been strengthened, and VAT and income taxes have performed well. However, there continues to be a high reliance on distortive taxes (export and financial transactions taxes) which account for some 4 percent of GDP of revenues. The primary surplus would have been higher in 2004 but for an acceleration in social and capital spending toward the end of the year that resulted in end-year expenditures exceeding original budget targets by considerable margins. The approved budget for 2005 aims for a consolidated primary surplus of 3.8 percent of GDP on a cash basis. As in the previous year, however, the outcome may be significantly higher; during the first quarter of 2005, the federal primary surplus was 0.8 percent of annual GDP and in line with the 2004 outcome, representing an overperformance of 0.2 percent of GDP compared with the authorities’ own program.

Table 6.

Argentina: Consolidated Public Sector Operations, 2001-2007 1/

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Source: Ministry of Economy and Fund staff estimates.

Revenues and primary spending before 2003 include payments with bonds.

Includes interest (arrears) on non-performing debt.

Includes the settlement of obligations in bonds, often as a result of judicial rulings, and compensation to banks for asymmetric pesoization and asymmetric indexation of balance sheets.

Data for interest capitalization, arrears, debt recognition and bank compensation are estimates.

Table 7.

Argentina: Federal Government Operations, 2001-2007 1/

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Source: Ministry of Economy and Fund staff estimates.

Revenues and primary spending before 2003 include payments with bonds.

Includes interest (arrears) on non-performing debt.

Reflects the settlement of obligations in bonds, often as a result of judicial rulings, and compensation to banks for asymmetric pesoization and asymmetric indexation of balance sheets.

Data for interest capitalization, arrears, debt recognition and bank compensation are estimates.