Argentina - Economic Briefing September 2003

 IMF Agreement Crucial for Sustainable Recovery

If the government does not reach an agreement with the International Monetary Fund (IMF) by mid-September, it risks default and a significant blow to investor confidence. The current negotiations are well under way and the government has made significant progress on economic policy. However, the negotiating parties still differ on fiscal policy and public service tariff hikes, as the IMF demands severe adjustments, whereas the Kirchner administration favours a socially more acceptable path, which will not suffocate the budding recovery.

Economy remains on recovery path
In June, the monthly indicator for economic activity (IMAE, Estimador Mensual de Actividad Económica) increased 8.2% over the same month last year – the highest increase observed in five years and well ahead of the 7.1% growth rate observed in the previous month. The June figure confirmed that economic activity continues to accelerate, since it represented the sixth consecutive monthly advance. However, in seasonally adjusted terms, economic activity was unchanged compared to a 0.6% increase in May.

The current improvement in the economy continues to be reflected in Consensus Forecast participants’ assessment of growth prospects for this year. As a result of the June GDP reading, second quarter growth is likely to have reached 7.4% over the same quarter last year, which is up from the 5.4% growth rate observed in the first quarter. Growth is expected to moderate in the second half of the year with a 5.7% and 5.3% expansion seen in the third and fourth quarter respectively. The Consensus figure for GDP growth for the full year has been lifted again – 0.1 percentage point over last month – to 5.7%. This month’s upward adjustment represents the twelfth 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 3.9%, down a 0.1 percentage point from last month’s forecast. 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 robust recovery from the four-year recession.

Currency weakens amid Central Bank measures
In August, the peso depreciated 4.3% in nominal terms, which was up from the 1.9% weakening in July and represented the strongest depreciation observed sine June 2002. The August depreciation resulted in part from higher demand for US$ from businesses that needed to meet debt service payments or are restructuring debt. Demand has also risen as a result of the Central Bank’s decision on 18 August to raise the ceiling on the amount of foreign currency that companies can withdraw on a monthly basis from US$ 500,000 to US$ 40 million. The easing of foreign currency controls, however, remains subject to strict guidelines that specify that foreign currency funds obtained for debt service payments or restructuring must be used for that purpose within 180 days from the date of purchase and cannot exceed 15% of the amount due. The new Central Bank policy follows upon earlier steps to ease capital controls in February, when, among other measures, banks have been permitted to hold foreign exchange up to 10% of capital. Despite the pronounced depreciation in August, however, at 2.97 pesos to the US$, the currency still remained 12.9% stronger than at the end of last year. The government remains eager to maintain a competitive exchange rate and is a strong supporter of the current Central Bank actions. However, participants do not anticipate the currency to weaken much further, as this month’s Consensus sees the peso closing unchanged from current levels at 2.97 pesos to the US$ by year-end. Furthermore, the currency is expected to remain stable next year, depreciating just 2.2% to close 2004 at 3.03 pesos to the US$.