Argentina Business Forecast Report Q4 2008

Policy Outlook Offers Little Hope

Political uncertainty and the threat of a hard economic landing remain the key issues in Argentina. The hammer blow delivered by Vice-President Julio Cobos in the senate against the presidents rural tax reforms in July, together with low public support, suggests that the future of the Fernndez government is growing increasingly uncertain. Meanwhile, the persistent inflation problem and the ongoing deflation in commodities prices suggest that the economic downturn may be harsh. We were hoping forCristina Fernndez to adopt a more conciliatory tone following her defeat over the agriculture bill, which would suggest that more moderate economic policy decisions would be implemented. However, despite an attempt to calm the markets by agreeing to pay off Argentinas outstanding Paris Club debt, we have seen little to change our view that distortionary economic policies will remain in place, posing a risk of a sharp economic slowdown. We note the continual under-reporting of inflation as evidence to support this view.

Following his controversial decision to cast the deciding vote in the senate against the presidents rural tax reforms in July, Vice-President Julio Cobos has seen his popularity soar and looks set to further distance himself from the ruling coalition. On August 31 Cobos held talks with Ral Alfonsn, former president and a leader of the opposition Union Cvica Radical (UCR), in an attempt to mend relations with the UCR after he and a number of allies (so-called K-Radicals) detached to forge a political alliance with Kirchnerismo for the 2007 elections. There is a growing likelihood that the K-Radicals will split from the government and set up an alliance that will challenge the Partido Justicialista (led by Nestor Kirchner) at next years mid-term legislative elections. On August 30, rural leaders Eduardo Buzzi and Alfredo De Angeli announced that they will lead a march on congress to press the government to alter its agricultural policies. Given the political damage that the previous farming conflict had on the government, another round of farmers strikes could see Fernndez popularity come under increasing pressure.

The latest data coming out of Argentina suggests that the economy is in the midst of a slowdown. We are keeping our 2008 and 2009 real GDP forecasts at 6.0% and 3.6%, respectively, but caution that given the pro-cyclical nature of economic policy, the risks lie to the downside. Argentina holds the potential for high levels of long-term economic growth. The country has a wealth of natural resources, a well-developed education system and boasts a highly skilled labour force by regional and global standards. However, these factors are unlikely to be sufficient drivers of long-term economic prosperity, in our view. Indeed, with the energy sector likely to continue to suffer from underinvestment, capital markets remaining underdeveloped, and economic freedoms coming under increasing attack from government interference, we question whether the countrys potential will be reached.

We see President Fernndez decision to cancel Argentinas US$6.7bn of defaulted Paris Club debt as a marginally positive development for the business environment as it suggests to us that the authorities are at least beginning to take seriously the negative implications of such high credit spreads, and are willing to act to counteract them. However, we believe that the business environment will continue to suffer at the hands of politically motivated economic policy decisions.