Put simply, Argentina is spending more than it takes in. Its current fiscal deficit is more than 5 percent of its gross domestic product. Since 2011, the deficit has grown at an average of 1.5 percent of GDP per year. In order to cover this deficit, the government has been borrowing from central bank reserves. This is tantamount to drawing water from a reservoir — a reservoir that is now draining faster than it can be replenished. This has caused reserves to drop from more than 12 percent of GDP in 2011 to a current level of 6 percent of GDP — slightly over $28 billion. The deficit, by comparison, is around $25 billion.
Because of its foreign debt stemming from the 2001-2002 national economic crisis, Argentina does not have access to foreign credit and maintaining the central bank reserves hinges entirely on revenue from foreign trade. If it is able to keep its trade surplus over 3 percent of GDP, it can hold out for a little over a year. But Argentina's trade surplus depends, in turn, on price variations for its two largest trade products: soy and petroleum. These products are key for Argentina. Exports of soy products bring currency into Argentina. Oil and natural gas imports, however, take currency out. Soy exports constitute more than 22 percent of the country's export revenues and petroleum products account for 10 percent of imports; together, they represent more than 30 percent of Argentina's overall trade and play a large part in the country's trade surplus of 2 percent of GDP.
Both commodities are vulnerable to drastic fluctuations in value. This means that Argentina's trade balance, too, swings wildly. In recent months, soy prices have risen and energy prices have fallen. This has given the government more financial leeway. Argentina's debt will be its major challenge for 2015, one that it will have to address before reserves run dry in 2016. If favorable commodity prices for soy and energy hold, this could ease some of the government's immediate fiscal constraints and allow it to postpone spending cuts and present a stronger position in debt negotiations.
Major Causes of Argentina's Crisis
A variety of economic factors drove Argentina toward a financial cliff. Prominent among these were changes in Argentina's trade position as regards soy and energy. Historically, Argentina had been a net exporter of both oil and natural gas. In 2010, amid declining production, it became a net importer of natural gas and became effectively neither a net exporter nor an importer for oil. Energy had formerly constituted a net inflow of currency, but now took U.S. dollars out of the country — $10 billion in 2012 and 2013. In a bid to halt declining oil and gas production, the government expropriated Spanish energy company Repsol YPF's energy assets. It then had to allocate $6.5 billion in new bonds to compensate for damages.
Additionally, after December 2013 agricultural revenue began to fall as soy prices dropped from $620 per ton to $300 per ton. This confluence of higher energy spending and lower agricultural revenues eroded central bank finances and reserves dropped from $55 billion in 2011 to $28 billion in 2014.
Government spending also now rose because of increased energy spending and higher inflation. The growth of public expenditures outpaced economic growth. The government deficit, at 5 percent of GDP, now nearly matches Argentina's international reserves, which are at a decade low of 6 percent of GDP.
Before, Argentina's finances had been operating on the "twin surplus model" in which government finances depended on two factors: domestic taxation surpassing expenditures and export revenues offsetting import costs. The rise in government spending meant that tax revenues no longer met needs. Now trade surplus bore the weight. The government realized that its reserves would not last long and that it needed another means of support. For this, it looked toward the possibility of restoring its access to international credit. In 2014, it signed an agreement under which it would make more than $10 billion in payments over three years to the Paris Club and other creditors.
The government now faced the challenge of stemming the outflow of U.S. dollars from Argentina. It implemented several mechanisms to reduce black market outflow. At the same time, the administration put limits on the amount of U.S. dollars that individuals and companies could spend on importing goods into Argentina, hoping to artificially increase the country's trade surplus. The government also adopted a 30 percent inter-annual monetary expansion to make the most of lower revenues amid 35 percent annual inflation. Overprinting currency, however, spurred high inflation, which drove up demand for U.S. dollars as Argentinians sought to escape the decreasing purchasing power of the peso. In turn, the growing black market availability of the U.S. dollar pushed speculation further and forced a devaluation of the peso, which in turn worsened inflation.
With fluctuations of 45 percent to 90 percent between official and black market currency rates, plus a 50 percent drop in soy prices between December 2013 and June 2014, farmers hoarded their harvests for speculation, expecting the government to implement a currency devaluation as it had done in the past. Nearly half of the 55 million-ton harvest was estimated to have been hoarded, causing a sharp drop in the inflow of dollars from soy exports.
Amid all of this, Argentina's efforts to return to the international credit markets failed in July 2014 following a U.S. court ruling that barred the country from repaying its restructured bonds until it settled with the holders of its non-restructured bonds. Unable to simultaneously pay all bondholders at full value, the nation went into selective default again. This left Argentina, once again, with trade as its only source of foreign currency.
The government had already compromised its future finances by issuing new bonds in order to settle outstanding obligations to the Paris Club. This had been done in expectation of renewed access to foreign credit. When this failed, Argentina was left with even more limited financial operations than before. Unable to have any influence on commodity prices or to totally rule over the volume of imports and exports, the government's only options to avoid bankruptcy were now limited to either reducing outflows by making deep cuts to public spending — a difficult move during an electoral year — or regaining access to credit by settling with the debt holdouts.
Commodity Prices Give Some Leeway
Facing potential bankruptcy, the government entered damage control mode and prepared for a stormy 2015, bracing to make painful cuts to the energy and transport subsidies that represent 4 percent of GDP. The recent unexpected drop in crude prices (by about 37 percent) and recovery in soy prices (which are up around 30 percent) between June and November — along with a closing of the currency gap that made it more in farmers' interests to sell — have eased Argentina's currency outflow. This trend could give Argentina a larger trade surplus than was expected when it entered its second default. So far, the state has saved nearly $3 billion in energy imports, and most of the hoarded soy harvest has been sold. This has not only reduced the drain on central bank reserves, it has refilled the reserves more than expected.
With a larger trade surplus, Argentina could postpone its spending cuts until after the presidential election, particularly since energy and transport subsidies would increase the cost of living and spur inflation. This in turn would affect the debt negotiations in New York, where the bondholders' strategy has been to deprive Argentina of much-needed external funding. However, there are limits to this seemingly promising scenario. More than 50 percent of Argentina's energy imports are natural gas. The price of natural gas has not been affected by the drop in oil prices. The margin of savings is limited to refined fuels and the extent to which an expected domestic recession will affect demand. Moreover, another year of flat soy demand from China plus an exceptional U.S. soy harvest could seriously threaten Argentine finances, even if oil prices remain low. Soy exports represent twice the value of energy imports for Argentina, and thus the fluctuation of soy prices make a substantial difference.
Argentina's Way Forward
In a difficult balancing act, the administration will try to stretch the lifespan of its reserves by engaging in more currency swaps with China and enforcing the recent Supply Law to ensure that farmers will not hoard soy and lower Argentina's export revenue. As long as the administration manages to delay cuts, the ruling party candidates will have a slight advantage in the upcoming elections over opposition candidates, whose campaigns rely heavily on expectations of a bad fiscal crisis that would force subsidy cuts and leave many voters feeling alienated.
Argentina has nearly $10.7 billion in debt payments entering maturity in 2015, which implies investing nearly a third of its reserves. However, the recent currency swap with China — $11 billion over three years — plus a momentary easing in the black market on the dollar could allow the government to postpone some payments by restructuring $3 billion of bonds maturing in 2015 and exchange them with bonds maturing in 2024 but with higher yields.
Hedge funds, who are among the debt holdouts, fearing their strategy will fail, will likely ask the court in New York to seize Argentina's central bank reserves, under the justification that Argentina's national treasury is an extension of the Argentinean government. The fight is likely to continue into the coming year.
Meanwhile, the government's negotiations with bondholders could remain frozen until the bondholders' minimum expectations meet Argentina's maximum viable offer. The bondholders are demanding a minimum of 80 cents per dollar, though the government's latest offer was 35 cents per dollar. How long this takes depends greatly on the size of the trade surplus gap created by energy and soy prices. The more favorable the commodity prices are, the better the government's bargaining position will be but the faster it will need to reach a settlement. However, Argentina does not have an economic need to settle with the bondholders quickly. No one, neither the government nor the opposition, wants to see the country collapse before elections.
As the negotiations continue, a third party could see the chance for profit and bail Argentina out of default in exchange for future benefits. Before any debt agreement can be made, the Argentine Congress would have to modify at least three national laws to make any payment feasible. Thus, unexpectedly quick movement in the legislature could be an early sign that perhaps behind the scenes negotiations are underway and gaining momentum.
If Argentina manages to regain access to the credit markets without drastic economic consequences, other nations in fiscal difficulties could be tempted to pursue the strategy. The outcome of Argentina's debt struggle could send a message to other countries that have much of their debt issued outside their legal dominion, inciting them to disregard their international obligations in favor of domestic stability.
