Argentina - Economic Briefing June 2003

Kirchner Assumes Presidency with Weak Mandate (continued)

Consumer prices drop amid stronger exchange rate and continued weak domestic demand
Consumer prices declined 0.39% in May – the second monthly drop observed since the devaluation in January last year. The May figure was down from the 0.06% drop experienced in April and lowered the annual inflation rate further to 14.3% from 19.4% in April. Similarly, wholesale prices experienced their third consecutive monthly decline in May, dropping 0.69% over the previous month. The May wholesale price decline almost halved the annual inflation rate to 17.4% from 32.8% in April. The rapid convergence of wholesale and consumer prices promises to ease inflationary expectations further in the coming months. Nevertheless, recently monetary authorities intervened in the exchange rate market to weaken the increasingly stronger peso. If successful, these interventions will exert some pressure on consumer prices, as the currency weakening passes through to domestic prices. Following five consecutive months of robust currency appreciations, the peso depreciated a nominal 2.1% in May to reach 2.88 pesos to the US$. Furthermore, the new government sooner or later will have to liberalize public utility prices, which have remained contained by government decree since early 2002. This liberalization could exert upward pressure on consumer prices. However, Consensus Forecast panellists do anticipate any further increases in consumer prices, as annual inflation is expected to drop to 12.4% by the end of the year – down 2.7 percentage points from last month’s forecast.

The Central Bank has announced that it plans to adopt an inflation targeting regime next year. The monetary authority has stated that the inflation target for 2004 is likely to be situated in between 10% to 15%. This month’s Consensus figure of 10.5% indicates that the Central Bank will take a more aggressive stance at lowering inflation next year.

Economy showing signs of recovery
In March, the monthly indicator for economic activity (IMAE, Estimador Mensual de Actividad Económica) rose 6.4% over the same month last year – the highest monthly increase observed in five years and well ahead of the 4.9% growth rate observed in the previous month. The March figure confirmed that economic activity continues to accelerate, since it represented the fourth consecutive monthly advance. However, in seasonally adjusted terms, economic activity was unchanged compared to a 0.9% increase in February, which indicates that the recovery is still erratic.

Even though the easing of inflationary pressure is likely to gradually bring down interest rates, at current levels, a significant recovery in domestic demand is likely to remain absent. Furthermore, credit conditions remain very tight. According to Central Bank data, non-financial private sector loans were down 28.0% in April compared to the same month last year, which was down modestly from a 30.7% drop in March. Along with high unemployment, the current adverse credit conditions continue to keep any meaningful recovery at bay. In March, real supermarket sales were down 26.5% over the same month last year, which was only a moderate improvement from the April decline of 28.9%.

The current improvement in the economy is being reflected in participant’s assessment of growth prospects for this year. The Consensus figure for GDP growth has been lifted again – 0.6 percentage points over last month – to 4.9%. This month’s upward adjustment represents the sixth consecutive improvement in the growth outlook for this year. However, the pace of economic activity is likely to moderate next year with GDP seen to expand at a lesser 4.1%, down a 0.1 percentage point from last month’s publication. The less propitious outlook may indicate an underlying sentiment that the Kirchner administration will face challenges in its attempt to progress on needed economic reforms, which will forestall a more sustainable recovery from the four year recession.