With new virus cases still high, capital controls more pervasive, and fiscal policy unlikely to stay loose, we are nudging down our Argentina GDP forecasts. We now expect an 11% drop this year and just a 4% rebound in 2021 (previous forecasts -10% and +5%). Our GDP projections imply a much weaker recovery than the consensus currently expects.
- With new virus cases still high, capital controls more pervasive, and fiscal policy unlikely to stay loose, we are nudging down our Argentina GDP forecasts. We now expect an 11% drop this year and just a 4% rebound in 2021 (previous forecasts -10% and +5%). Our GDP projections imply a much weaker recovery than the consensus currently expects.
- National accounts data released yesterday show that, after a 4.2% drop in Q1, Argentina’s real GDP slumped by a hefty 16.2% q/q in Q2. This means output fell by a cumulative 19.7% in the first half of 2020, which is more than we had initially expected. And it is a bigger fall than most EMs suffered. (See Chart 1.)
- This is mainly due to the relatively strict lockdown measures imposed in March and April, which brought activity to a near standstill. While restrictions were eased slightly in May, they remain much more stringent than in other countries. (See Chart 2.) Accordingly, while activity is gradually recovering, high-frequency mobility data suggests it has stayed sluggish throughout Q3. (See Chart 3.)
- Unfortunately, these stringent containment measures have yet to succeed in getting the virus outbreak under control. New daily cases remain high. (See Chart 4.) It’s likely that restrictions will remain in place for a prolonged period to prevent a further escalation in cases. This will keep activity depressed in Argentina.
- There are three other major headwinds to Argentina’s economic recovery. The first is from pervasive capital controls. They were tightened last week to prevent the central bank from burning through its FX reserves as it tries to manage the peso. Strict capital controls can disrupt activity though numerous channels. They make it harder for firms to import the intermediate goods used in domestic production. That may force companies to restrict output or use more costly unofficial markets to access dollars.
- Additionally, Argentina’s experience using tight capital controls in 2011 to 2015 shows that they can damage the export sector. Against a backdrop of high inflation, the currency became overvalued which eroded the price competitiveness of exports. The same pressures seem to be building, judging by the high spread between the official and unofficial exchange rates. (See Chart 5.)
- The second headwind is unfavourable external conditions. An upturn in the global economy and high commodity prices were key to dragging Argentina out of its 2001/02 slump. But this time, the recovery in the global economy, and in Brazil in particular, is set to slow. And we think that the prices of agricultural goods such as corn and soybeans will decline, which will dent Argentina’s terms of trade.
- The third is the government’s fiscal stance. The sizeable fiscal stimulus, which has totalled around 6% of GDP during the crisis, is partly responsible for the massive hole in the public finances. Now the government will have to walk a tightrope to keep the economy afloat while improving its own balance sheet.
- The 2021 budget suggests that policymakers are trying to have their cake and eat it. The plan includes keeping real expenditures high relative to pre-crisis levels, while also narrowing the primary deficit to 4.5% of GDP next year, from a projected 7% this year. This is predicated on an unlikely rebound in revenues and real GDP growth of 5.5% in 2021. As a result, we think that some fiscal slippage is likely next year.
- However, policymakers would not want to risk retribution from investors or the IMF by moving slowly on fiscal consolidation. One lesson from the recent debt restructuring talks is that the government is keen to keep investors on board – otherwise it would not have agreed to a lenient deal. In the same vein, it would presumably want to maintain investors’ confidence by materially reducing the budget deficit over the coming years. That would entail a shift to fiscal tightening at some point. The same will be required to keep the IMF on side too. The government is seeking a new arrangement with the Fund and, while a deal is still in the works, fiscal consolidation will almost certainly be a prerequisite to an agreement.
- As a result, while the current government is unlikely to impose harsh austerity, we suspect that fiscal policy will become less accommodative after 2021. This will come at the cost of weaker demand. While it’s possible that the government dogmatically sticks to its anti-austerity stance, the economic impact of loose fiscal policy would be dampened by greater concerns about the public debt. There would probably be a loss of investor confidence, a sell-off in financial markets, and tighter financial conditions. This is similar to the current policy dilemma in Brazil. Tighter fiscal policy may therefore be the lesser of two evils.
- Taking this all into account, we now think that Argentina’s economy will contract by 11% this year and rebound by just 4% in 2021 (previous forecasts -10% and +5%). We continue to expect just 1% growth in 2022. Our forecasts imply a much weaker recovery than the consensus expects. (See Chart 6.)
- Finally, the persistent weakness of the economy will put pressure on the public debt position. All else equal, it means that the public debt-to-GDP will remain uncomfortably high. And the government may struggle to generate sufficient revenues to service its new external debt repayments, which surge after 2024. This adds to our scepticism about the medium-term sustainability of the newly restructured public debt.
Chart 1: Change in Real GDP (%, SA, H1 2020)
Chart 2: Oxford University Government Response Tracker (100 = Maximum Stringency)
Chart 3: CE Mobility Trackers (% change from Jan. – Feb. Median)
Chart 4: Argentina New Daily COVID-19 Cases (‘000s)
Chart 5: Difference between Official & Unofficial Peso vs US$ (%, 3-day Moving Ave.)
Chart 6: Argentina Real GDP (% y/y)
Sources: Refinitiv, Oxford University, Google, CEIC, FocusEconomics, CE
Nikhil Sanghani, Latin America Economist, email@example.com