Writing’s on the Wall for Argentina

Cristina de Kirchner has brought her country to the brink of the abyss.

Step into a discount department store in New York or Miami these days, and you're likely to hear Spanish in the aisles. Not just any Spanish, though -- Argentine Spanish. The distinctive accent, where "y" becomes "zh" and the final "s" sometimes disappears entirely, has lately become the sound of a massive transfer of wealth. Ringing through American checkout lines, it is also the sound of another economic crisis on the way.

Argentina has become much more important to the global economy in the decade following its last crisis, which began in 2001. Back then, its exports were only worth about $31 billion, or 11 percent of its gross domestic product. Today, Argentina's exports have almost doubled, even after accounting for inflation, and it is a central player in commodity markets ranging from lithium to soy. Yet its trading regime is notoriously fickle, and another crisis -- economic, political, or more likely both -- could cause severe disruption.

Argentines have been talking about the imminence of their next crisis for about two years now, and their economy is showing plenty of worrying signs. Private economists estimate that inflation is running between 20 and 30 percent, while the government has doctored economic statistics to such an extent that the International Monetary Fund may censure it. The peso trades at more than six to the dollar in the street, though the official exchange rate is 4.7. The central bank maintains the artificially high value of the currency by buying pesos with its reserves, while the government limits the purchase of dollars by ordinary Argentines.

The combination of high inflation in wages -- as well as prices -- and an artificially strong peso has been a boon to Argentine consumers, especially the upper-middle class. Foreign goods are cheaper than ever, as is tourism. Visitors to Argentina, on the other hand, will find prices for clothing, electronics, and other manufactures in Buenos Aires on a par with New York, London, or Tokyo. The question for many well-to-do Argentines is not whether they will go abroad to shop, but how they will sneak their purchases through customs on the way back.

Almost inevitably, the cost of this government-backed spending spree will be another sharp economic adjustment. When the central bank can no longer prop up the peso, a selling frenzy will push the peso down to, and probably below, its black-market rate. This is essentially what happened in 2002, when the Argentine government had to abandon the peso's peg to the dollar and default on its debts. Within a few months, the peso-dollar exchange rate went from 1-to-1 to about 4-to-1, and Argentines lost a huge chunk of their savings as bank deposits were forcibly converted from dollars to pesos.

Now as then, a sudden devaluation will make it tougher for Argentine companies to pay debts in foreign currencies. But the bigger losers will be average Argentines who didn't convert their savings from pesos into other currencies or assets, either because they lacked access to securities trading, didn't have bank accounts abroad, or couldn't afford to buy dollars on the black market. They will lose perhaps a third of their wealth overnight. And all Argentines will suddenly face much higher prices for products with imported components, as well as for fuel and energy. These last items have been subsidized in the past, but subsidies may be too costly for Argentina's cash-poor government once the crisis hits. Naturally, the higher prices will hit the poorest Argentines hardest.

In other words, wealthier Argentines are benefiting today at the cost of poorer Argentines tomorrow. And when the crisis finally arrives, the rich will benefit again. After the Argentine markets crash, they'll be able to snap up property at bargain prices -- often from less-well-off people who need cash -- just as they did a decade ago. The profits they later earn will exacerbate inequality in a country whose middle class was finally regaining the strength it had in the mid-1990s.

For the moment, however, Argentina is still a country with sky-high prices and per capita income at $11,000.  Its success in exporting crops and raw materials, along with a more limited ability to attract foreign investment, has allowed this bizarre reality to last until now. With enough cash flowing into the country, the central bank has been able to replenish its reserves and keep buying pesos... just as the government has kept printing them.

But the central bank's capacity to support the peso may finally be running out. For the first time since 2009, its reserves have fallen below $45 billion, or about 9 percent of Argentina's gross domestic product. (Back in 2009, $45 billion would have been about 15 percent of the economy.) Moreover, the government continues to use the reserves to pay its debts and fund its treasury. And though the IMF estimates that Argentina's current account balance -- the net income from trade and other incoming payments from the rest of the world -- might well stay in surplus this year, it forecasts deficits for the next five years. There simply won't be any more hard currency coming in to buy pesos.

At the same time, the government continues to run structural deficits, meaning it isn't balancing its books over the economic cycle. The revelation that thousands of public employees are paid under the table has not helped to foster confidence in its ability to collect taxes, either. Together with its reliance on the central bank for financing, these factors strongly suggest that the Argentine government's debt would not be sustainable in the event of a currency crisis.

The writing is on the wall. Already, the province of Chaco has had to make payments in pesos on a dollar-denominated bond. If that occurred at the national level, it would signal default and devaluation. Global investors can see the writing, too, and some are recommending a complete exit from Argentine assets.

All of this is happening in a country that has yet to close the book on its last crisis. This month, owners of debt left over from the default in 2002 seized an Argentine frigate in port in Ghana, in an effort to force repayment. It would be comical, if it weren't so tragic.


Daniel Altman

Reaching Tomorrow's Consumers

Why the BRICs aren't where it's at anymore, if they ever were.

Hey, buddy, looking to sell some products abroad? Need to find the best new market for your pillow shams, or maybe your shampoo? A new book, The $10 Trillion Prize: Captivating the Newly Affluent in China and India, purports to have the answer. Yet the hype about China, India, and other big emerging economies glosses over the difficulties of doing business within their borders. Sure, size matters, but plenty of other factors should make companies look elsewhere, as well as make governments take a hard look at their policies.

Enormous populations make China and India obvious targets for business, but selling to their people is only half the battle. Once a multinational company has collected its revenue and paid its costs, it has to bring its profits home to shareholders. That's not always easy in developing countries, where corruption, arcane tax and legal systems, changeable customs regimes, unscrupulous self-dealing, and self-serving joint venture partners can eat away at the final take.

Just imagine you've arrived in a big emerging economy, and you're hoping to sell to tens of millions of new consumers. If you work in, say, consumer products -- toilet paper, soap, and so on -- your business might normally earn margins of 10 to 15 percent. But what if each of the problems above eats away a bit of your revenue, even just 1 or 2 percent? Pretty soon, your margins are down to zero -- and that's without considering other issues like exchange-rate fluctuations and capital controls.

All the BRIC countries -- Brazil, Russia, India, and China -- suffer from a selection of these problems, and often to a much greater degree than some of their smaller neighbors. As a result, the consumers who are truly profitable for companies might be located in places with better economic institutions and friendlier business climates, such as Malaysia, Peru, South Africa, and Turkey. These midsize countries are by no means perfect places to do business, but by several metrics they're a lot better than the BRICs.

Of course, executives of multinationals are still under tremendous pressure from analysts and investors to come up with a "China strategy" and an "India strategy." These markets' size makes them hard to ignore, and they offer the potential to realize huge economies of scale. After all, you only have to pay the setup costs of entering the market once, and then you have access to almost unlimited consumers.

But companies have to balance the apparent savings -- which may not be so large once you account for differences in regulations across 35 Indian states and territories and 32 Chinese provinces, municipalities, and autonomous regions -- with the costs of doing business in a difficult environment. For all but the biggest multinationals, serving several countries of 30, 50, or 70 million people where doing business is relatively easy might be more profitable than fighting for a share of China's market. Not every company should be in China, India, and the other BRICs, just as not every company should be in the United States, or any other country for that matter.

The flip side of this conclusion is that China and India, even as their economies cool a bit, still offer fantastic opportunities to grow. The gradual opening of their economies over the past three decades has already lifted hundreds of millions of people out of poverty. It's hard to imagine that China and India could repeat this feat, yet they just might by removing some of the obstacles outlined above. By fighting corruption, making legal systems more transparent, and instituting better protections for investors, these countries could see a second, perhaps even bigger boom.

The possibility of these reforms has long seemed remote, like the advent of democracy in China or the resolution to India's feud with Pakistan. Now, however, the economic picture has changed in a way that makes change more urgent.

The BRICs are still feeling the effects of the global downturn; the International Monetary Fund has predicted growth rates for this year that are just a shadow of what they were in 2007. Moreover, the BRICs can now begin to see the limits of their growth in the absence of reform. Wages are finally rising in China, along with the currency, making exports more expensive. Brazil is reaching peak urbanization. Russia's energy-based influence will dwindle as substitutes and other sources come online, and India has been reluctant to lay out the welcome mat for foreign companies in many industries.

Soon enough, all the BRICs will need to find new ways to attract investment, create jobs, and raise living standards. Making their consumers a more attractive proposition to foreign companies would go a long way to achieving all three by laying the groundwork for new production facilities staffed by local workers making goods and services for local households.

India, the poorest of the BRICs, has finally started down this road. In the past few months, it has made industries ranging from insurance to supermarkets more open to foreign companies. Joint ventures with local players will still be required in many cases, but greater foreign ownership will be permitted. It's not quite a multitrillion-dollar free-for-all just yet, but it's a start.

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