After taking office last December, President Macri quickly pushed for a series of major fiscal, political and regulatory measures that marked a significant shift from the policies of his predecessor, Cristina Fernandez de Kirchner. A decade of excessive public spending, distorted populist controls, and protectionist measures left Argentina’s fiscal accounts with a deficit of over 5% of GDP and out of the international bond market and trade community.

The new administration’s focus on trade and monetary liberalization went into immediate effect with the implementation of four key corrective macroeconomic policies:

1. Elimination of trade restrictions. Taxes on most agricultural and industrial goods were eliminated and the new Integral System of Import Monitoring (SIMI) has simplified customs’ bureaucracy. By ensuring timeliness and clarity of procedures, a 6% increase of consumer goods imports was registered during Q1 2016.

2. Capital controls were lifted. Business confidence boosted as companies are now able to operate more easily while repatriating profits, while local currency has experienced a sharp depreciation of 30%, from US$ 9.80 to US$ 13.33 –increasing exports’ competitiveness. During this year’s first five months, total exported goods increased by 12.9% when compared to the same period the previous year.

3. Government spending cuts, especially on consumer subsidies. Fiscal deficit pushed for reduced subsidies on public utilities, which were equivalent to almost 4% of GDP during 2015. Cutting electricity subsidies alone could save the government US$ 4 billion in 2016.

4. Deal with holdouts. Ending the legal battle against holdouts funds was a boost for the government’s confidence, especially after sealing a US$ 16.5 billion global debt offering, the largest ever bond issue from an emerging market economy. A big part of the proceeds from the bond sale will go towards repaying hedge funds and other investors, while remaining capital will be destined for infrastructure projects.

While the combined effect of these corrective policies is expected to improve Argentina’s business environment in the medium-term, with expected investment inflows of up to US$ 20 billion during 2016, these reforms have already caused unavoidable short-term hardship for both consumers and businesses as consumption and production seem to have slowed down during the past couple of months.

Inflationary pressures unlikely to subside until 2017

The end of government subsidies translated into electricity, water and gas bill increases of up to 700%, 375% and 300%, respectively. The rising cost of household expenditures has exacerbated inequality: while the highest tenth percentile of the population lost approximately 11% of its purchasing power, the poorest tenth percentile suffered a loss of 25%.

In an effort to counter Argentinians’ decreasing disposable income, the government has decided to continue to expand the previous administration’s Price Protection Program which, since 2014, has limited the ability of some companies to be competitive and profitable in the Argentine market. While most price-controlled products include consumer goods such as vegetables, cereals, meat, beverages and cleaning supplies, the government is now negotiating with main pharmaceutical laboratories to include a number of drugs in the program.

Despite government efforts, according to Universidad Torcuato Di Tella, consumer confidence has been decreasing for most part of the first half of 2016, especially after the increase in public utilities was announced. In April, numbers hit an all-time low, reaching -10.3%. But recently released numbers for June showed a mild increase of 0.2%, suggesting that Argentine households may have begun to perceive an improvement in the local economy.

However, businesses should be fully aware that substantial improvements in consumer confidence and consumption levels won’t be fast, as inflation is expected to curb slowly throughout the second half of 2016 (reaching an annual average of 30%) and Argentine households will only begin to truly assimilate the economic improvements towards the end of the year.

Argentina’s operating environment will remain challenging in the near future

While retail sales have dropped by 5.7% during the first half of 2016, industrial production has also contracted by 5.4% during the January-April period; mainly as higher energy and labor costs are significantly increasing operating costs and slowing down production.

Underinvestment and cuts in energy subsidies have translated into higher energy costs

Energy costs for factories and businesses have increased by 200% to 300%, due to lack of sufficient energy supply to cover current demand – a consequence of years of insufficient investment and a decade of highly subsidized electric prices. An Energy Crisis decree, expected to last until the end of 2017, was passed on December 15, 2015 and the newly-created Emergency Committee has requested the industrial sector to keep gas consumption levels low, in order to prioritize supply of households, schools and hospitals. Additionally, scheduled blackouts that have been announced for 2016 could be extended throughout 2017.

Investments in the oil sector, renewables and shale gas have already been announced, but palpable results will not be seen in the short-run. Meanwhile, state regulation in energy usage and the announcement of new electricity tariffs will be somewhat of a constrain, as it is expected to limit the ability of businesses to determine production schedules while struggling to cover higher operating costs in a context of slower demand.

Higher labor costs are putting pressure on businesses’ competitiveness in a context of slower sales

Spiked inflation has turned the annually-held wage negotiations (“paritarias”) into semi-annual adjustments. The Commerce labor union, one of the biggest in the country, recently reached an agreement of a 20% increase for the April-September period – setting the pace for all other negotiations. But ongoing lack of agreement between the truck drivers’ union, which holds nationwide political and social leverage and is asking for a 42% raise, and the business sector (counter offering 29.5%), has led to a number of strikes that are affecting the distribution of products throughout Argentina while generating significant economic losses.

The threat of continued strikes has recently forced the government to step in as a mediator, trying to persuade union leader Hugo Moyano not to demand excessive wage raises, which would drive inflation even higher. But truck drivers seem unwilling to make sacrifices.

While this is a complex scenario, it is a good moment for companies to re-think operating strategies, looking for more productive and efficient processes: developing new products that meet the clients’ specific needs, ensuring good distribution integration, and improving plant operations through employee training.

What to expect

This year will be a complex, transitional year for the Argentina, as the key challenge for Macri’s economic team will be to effectively curb inflation during Q3 2016. While the government forecasts full-year 2016 inflation at 25%, FSG expects inflation to curb at a slower pace, reaching an annual average of 30%.

Price increases in public utilities and recent semi-annual wage negotiations held with main labor unions have pushed inflation up during the past months, hampering the possibility of reaching the targeted 25%. However, several government mechanisms suggest that Argentina is on the right path and that inflation should reach the single digits in the next three years:

• Argentina’s regained access to international capital markets has helped increase foreign reserves by US$ 3 billion, precluding the central bank from having to print money in order to finance fiscal deficits, a main driver of inflation.
• Higher interest rates and lower bond prices are reducing money supply, with Central Bank interest rates having reached 38% shortly after Macri took office – compared to an average 26% during the second semester of 2015 under CFK’s government.
• Austerity and rationality are guiding government spending, with cuts on consumer and energy subsidies equivalent to almost 4% of GDP. In addition to these policies, the government is also keeping previous price controls that are more transparent and coherent than what they were last year. Although current controlled prices are 4.8% higher than during CFK’s government, they are still significantly lower than what they would be without the program.

As orthodox policies are expected to remain in place, FSG anticipates average inflation to continue to go down to 19% and 12% for 2017 and 2018, respectively, and investment to experience positive growth over the short- to medium-term. In fact, foreign investment has already been flowing into Argentina at a fast pace: in the first six months of government, Argentina attracted US$ 15 billion or 75% of what President Macri expected to attract throughout the whole year. This number shows the level of confidence that investors are having in Argentina despite current difficulties in production and consumption levels, which will most likely improve in the medium-term.

Potential failure to control inflation means that the new administration would have to re-think its political and economic strategy under the threat of nationwide labor strikes, social unrest and decreasing approval ratings. As such, companies should continue to be cautious and include contingency scenarios in their strategic planning processes, as Argentina’s transitional period and economic recovery might not be overcome as quickly as expected.

This blog post was written by FSG Latin America Research Intern Martina Farías Bouvier.

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