The story of a rapid deterioration
Argentina’s current account deficit rapidly deteriorated in 2017. It reached a historical high of -4.8% of GDP (see figure 1) at the end of 2017, or USD30.7bn (over 4 quarters), from -2.7% of GDP in 2016.
What caused this deterioration? First, a steep import bill: in 2017, the recovery saw imports rising by +14.7% while exports lagged behind at just +0.4%. Hence net exports subtracted -3.8pp from GDP growth over the year. This widening of the trade deficit resulted from a significant rebound of domestic demand. Second, an investment-savings mismatch: by its national accounting definition, the current account balance amounts to the difference between national savings and total domestic investment. A widening current-account deficit signals the need for a country to finance its investment abroad. Argentina’s saving rate stood at 0.42% in 2017, up from 0.17% in 2016 but much lower than 6.89% in Brazil and 2.64% in Mexico (2016 data).
At the same time, investment is rushing back
In 2017, Argentina emerged from a year of recession growing at a strong +2.9% after -2.2% in 2016. While private consumption contributed the most to this performance (+2.6pp), the most impressive recovery is that of investment, which grew +11% in 2017 after contracting -4.9% in 2016. Investment should continue to grow in 2018. Indeed, estimates of total investment as a share of GDP for 2017 (IMF, IDB) show that Argentina has the fifth lowest share in Latin America, c. 17%, behind Brazil (c. 18%), Mexico (c. 22%) and Colombia (c. 25%). Under the impulse of President Macri’s economic policy, Argentina is currently catching up after many years of under-investment in infrastructures. This momentum is therefore likely to persist in 2018, on the back of a supportive global economic context and ongoing infrastructure policy.
Reasons to worry
First, this deficit is now financed up to 113% by portfolio flows, which soared since Macri’s election. But those are short-term investment flows, subject to capital swings triggered by potential confidence shocks. Besides, Argentina came back to bond markets, yet bonds are also sensitive to confidence shocks through interest rate movements. Finally, longer-term flows, i.e. foreign direct investments, only cover 35% of the current account deficit.
Second, national data point to a strong acceleration in domestic credit growth, in parallel to investment’s ongoing recovery. Although credit to corporates only account for 14% of GDP (7% for households and 56% for government), excessive credit growth threatens the current recovery’s sustainability, as real y/y credit growth rate has reached 22% in 2017’s last quarter, a level unseen since 2012.
What could be next?
The Argentinian Peso has depreciated by –14.7% year to date. We expect a dual effect in the medium run of (i) moderating imports, along with the fiscal tightening and still high inflation, which would curtail private consumption; (ii) slightly boosting exports through enhanced competitiveness, helped by the acceleration of Argentina’s two main trade partners in 2018 (Brazil and the US, which jointly receive almost a fourth of Argentina’s total exports). However, as Argentina is gradually converging toward a more open economic model, progress in reducing the trade account deficit could be relatively slow. For instance, by the end of 2017, Argentina has signed new trade agreements with Mexico and Chile, while agreeing to ratify the WTO Trade Facilitation Agreement in the wake of 2018. Moreover, the EU-Mercosur Trade Agreement, in negotiations since 2000, could be successfully signed this year. In the absence of rapid progress in terms of competitiveness, this strategy of trade opening could easily lead to a widening of the trade balance.
The USD26bn infrastructure plan, based on Public-Private-Partnerships, will help attract foreign direct investment and hence ensure a more sustainable financing of the current account deficit, despite endangering the government’s capacity to meet its fiscal deficit target of 3.2% of GDP in 2018. Winning the battle of inflation (still at +25%) would also encourage investors to commit over the longer term. Finally, more clarity in the monetary policy is needed; after the government eased inflation target, the bank cut rates early 2017. Rate increases along with a renewed government commitment to curbing the deficit and fighting inflation would partially restore confidence.