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July 14, 2020

Argentina: The Week at a Glance

BY Miguel A. Kiguel, Andrés Borenstein, Lorena Giorgio, Mariela Díaz Romero, Rafael Aguilar, Isaías Marini

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( 14 mins)

Editorial: The Financial Health of the Provinces

Argentina’s provinces finished 2019 with a primary fiscal surplus for the second year in a row. But, despite this improvement in fiscal behavior, three provinces have already defaulted this year and the fate of the rest seems to be contingent on the success of the national debt restructuring.

Even though the consolidated primary surplus of the provinces reached scarcely 0.17% of GDP and 1.02% of revenues, it was achieved in a year of recession, in which governor elections took place, which is traditionally a year of profligacy. Something clearly improved in the provincial administration. However, when we look at the disaggregated numbers, we see that Buenos Aires and the City of Buenos Aires accounted for a large part of the aggregate result, with contributions of 0.9 and 0.4 percentage points over the ratio on revenues. In total, 14 districts had surpluses and 10 had deficits.

Part of the recent improvement occurred in a context in which the percentage of automatic transfers to provinces has been rising after the Court’s ruling in 2015 and the negotiation between the Macri administration and the districts to return the 15 points that previously went to the social security in 3-point installments, ending in 2020. However, this year the outlook changed radically, and not only because of the pandemic:

The fall in economic activity of almost 13% not only undermines automatic collection, but also lowers compliance with some taxes such as property tax, since it cannot be withheld from transactions as would be the case with turnover tax.

At the beginning of the year, the national Government increased taxation that is not shared with the provinces such as export taxes and the tax on FX purchases. The rise in export taxes reduces the income tax base, which is fully shared with the provinces.

The greatest real fall in national revenues are being recorded by the taxes that contribute most to the automatic transfer pool, VAT and Income Tax. In fact, we expect automatic transfer taxes to be reduced by half a point of GDP this year.

As for the revenues of the oil-producing provinces, the drop in crude oil price was a hard blow. Another problem for the provinces is that the Federal Government finances part of its expenses with seigniorage, something it does not share with the provinces. The card that the provinces hold to get some of that “manna from heaven” is to threaten with the issuance of quasi-currencies, the funny monies that most districts issued in the 2001/2 crisis. So far, this has not happened, but Córdoba and Neuquén have already issued bonds for suppliers which are not quasi-currencies, as they have minimum denominations that are high enough to keep them from reaching the retail level. The government’s response has been to increase discretionary transfers, which have quadrupled so far this year (nominally), and also, to avoid swelling the deficit, to lend in pesos to the provinces at soft rates (ARS 60 billion have already been approved) so that they can eventually be diluted by inflation.

In this context, the total debt of the provinces was 7.4% of GDP at the end of 2019. Out of that total, a little over 3% of GDP was represented by the province of Buenos Aires. Other districts with relevant debt stocks are the City of Buenos Aires and Córdoba. 70% of the aggregated provincial debt is held by the market, a number that rises to 88% in the Province of Buenos Aires. It is no longer as it was when the federal government was the biggest creditor when we got out of the 2001 crisis and that gave room for maneuver. Now the State, including trust funds, only has 15% of the debt.

While the debt as a whole is not large, dollar capital maturities are putting several provinces on the spot, even more so with cash boxes that shrank with the pandemic. So far, three provinces have defaulted: Buenos Aires Province, Mendoza and Rio Negro, where the debt seemed sustainable, especially in the last two, but they were unable to restructure “amicably” as was the case with YPF, largely because the national Government also defaulted. Now, they just have to wait for the Nation’s agreement to seize that momentum.

What’s coming up this week…

  • The report of installed capacity utilization in the industry corresponding to May will be released today Tuesday 14 th , in which we should see a rebound in line with May´s 9% monthly increase.
  • On Wednesday, June 15 th , INDEC will release June’ inflation. We expect a rise in the CPI of around 1.9%. This is a small increase compared to April and May, but still low compared to the average we expect for the second half of the year.
  • Wholesale prices and construction costs will be released on Thursday 16 th . After the deflation in April and low inflation in May, we expect a normalization of wholesale prices in June, as the price of oil will not have an influence as in previous months.

Argentina: The Week at a Glance 13

The Exchange Rate Anchor Prevails Over the Accumulation of Reserves

  • The Central Bank went back to selling reserves in the first days of July, while the exchange rate kept its 0.09% daily depreciation rate
  • On July 8 th , the cepo was granted some extra flexibility for the payment of commercial debts of up to US$ 1 million and for letters of credit issued by international banks
  • Analyzing FX controls since December 10 th , international reserves remained stable although with scarce build-up, and the drain on dollar deposits lasted until June, slowing down in the last week.
  • The data show that the Central Bank is willing to prioritize exchange rate stability over the strategy of accumulating reserves

Argentina: The Week at a Glance 14

During the first days of July the Central Bank sold reserves again. According to the latest data published, on average the monetary entity sold around US$ 75 million a day until July 3rd, after having been able to add US$ 672 million to the reserves during June by tightening exchange controls for importers via Communication “A” 7030. The official exchange rate kept moving at a constant daily rate of 0.09%, accruing 0.3% on Mondays due to weekends (today it was 0.42% for the long weekend). So far this year, it has moved 19%. Thus, yesterday it closed at ARS 71.23 per dollar, with spreads with BCS/MEP around 55% and 71% with the parallel dollar ─slight drops regarding June’s record.

Argentina: The Week at a Glance 15

On July 8th, the cepo was granted some extra flexibility. Through Communication “A” 7068, the CB relaxed the FX controls once again, this time for the payment of foreign trade debts within the limit of US$ 1 million with direct access to the FX market, which was already in force for the advance payment of imports. In addition, importers will be able to pay at maturity letters of credit issued by international banks. These small changes do little to ease the strict exchange controls in place since Communication “A” 7030 was introduced in early June.

Argentina: The Week at a Glance 16

As for the effectiveness of the FX controls, since December 10th, when the new administration took office at the CB, reserves managed to remain relatively stable at around US$ 43 billion and have only fallen US$ 500 million since then. The reason for this performance was tightening exchange controls over and over again, in addition to interrupting debt payments in dollars since last April. Nevertheless, the Government was able to pay debt for around US$ 4 billion. On the other hand, the accumulation of reserves due to intervention in the FX market was scarce considering the tight FX controls and the time of year. Particularly, the bulk of grain and oilseed proceeds is concentrated between April and June. Since December 10th, only US$ 983 million could be purchased, as opposed to US$ 11 billion in agricultural foreign currency settlement for the same period one year ago (CIARA-CEC). The advance payment of imports is behind this performance. On the other hand, the drainage of dollar deposits totaled US$ 1 billion, intensifying before June although it slowed down when exchange controls agricultural foreign currency settlement for the same period one year ago (CIARA-CEC). The advance payment of imports is behind this performance. On the other hand, the drainage of dollar deposits totaled US$ 1 billion, intensifying before June although it slowed down when exchange controls were tightened that month, improving marginally. In fact, during the first days of July, dollar deposits increased, probably favored by the purchase of the US$ 200 per month allowed for individuals due to mid-year bonuses.

In brief, data show that the CB is willing to prioritize exchange rate stability over a strategy of accumulating reserves

Argentina: The Week at a Glance 17

The Industry, Still Far from Its Pre-Quarantine Levels

  • Even though the IPIM-INDEC increased 9% compared to April, when it had recorded its lowest level in the historical series, the industry is still 8% below its level in March.
  • At the same time, the official indicator was 26.4% below its level from May 2019, reflecting the poor performance of the sector
  • Among the main sectors, the strongest falls were recorded by the automotive sector (-73.7% y/y), the textile sector (-57.2% y/y) and the nonmetallic minerals and basic metals industry (-52.5% y/y)
  • Thus, industrial production accumulated a 16.3% drop during the first five months of the year compared to the same period in 2019

Argentina: The Week at a Glance 18

After reaching its floor in April, industrial production slowly began to pick up again during May. Even though most industries were unable to operate normally due to social, preventive, and obligatory isolation, others were able to reopen in accordance with established protocols. In fact, according to the INDEC, among the productive establishments surveyed, 38.7% were able to operate normally, while in April only a third had been able to operate without restrictions.

Argentina: The Week at a Glance 19

In this context, according to the manufacturing IPI ─seasonally adjusted series─ estimated by INDEC, industrial production increased 9% in May after falling 20.2% in March and 15.5% in April (reviewed by INDEC from 17.3% and 18.3%, respectively). However, the May increase was insufficient to compensate for the post-quarantine falls, and activity in the sector is still 8% below its March record and 26.5% below February. In y/y terms, industrial activity fell 26.4%, reflecting the poor performance of the sector.

Argentina: The Week at a Glance 20

Among the main sectors, as in April, the sharpest drop was recorded by the automotive sector (-73.7% y/y). Despite the fact that in May it was authorized to operate, the sector started to do so progressively as it adapted to the sanitary protocols, within the framework of a compressed internal demand and a strong drop in external demand, mainly from Brazil. Despite the growing FX spread that is an incentive for sales in the sector, production began to react gradually and demand was covered by selling off stocks.The textile sector followed, with a 57.2% y/y fall, affected by the null or partial activity in some industries due to the lockdown, and by a demand conditioned by the closing of stores. On the other hand, the production of on-metallic minerals and basic metals plummeted 52.5% y/y, due to the halt in construction activity and the scarce automotive production, the main demanders for this sector.

The other main sectors also recorded significant falls in y/y terms. The production of equipment, devices and instruments recorded a slump of 51.6%, while the sector of metal products, machinery and equipment reduced its activity by 34.3%. In turn, the furniture sector and other manufacturing industries contracted 22.5%, and petrochemical activity fell 17.1%.

The only sectors that recorded single-digit falls were wood, paper, publishing and printing (-9.7%) and food, beverages and tobacco (-5.6%), although the latter shrank more sharply than in April (-2%), due to a decline in demand for vegetables and beverages.

Argentina: The Week at a Glance 21

This way, during the first five months of the year industrial activity scored a 16.3% contraction compared to the same period in 2019, with all the major items recording falls – although of different magnitudes.

In June, the quarantine restrictions continued to loosen and we expect manufacturing production to have increased accordingly. Even if we look at the electricity consumption of industries, which is strongly correlated with production, we can infer that in the last month there should have been a further cut in the y/y fall in industrial activity. However, it will remain at very low levels, and the recovery is far from being immediate.

In May, Construction Rebounded to March Levels

  • In the second month of quarantine, activity in the sector recovered 99.9% compared to the scarce movement recorded during April, although it remained 48.6% below its levels from May last year
  • The demand for main construction materials exhibited a similar behavior, with a significant monthly recovery in the use of cement (56.8%), hollow bricks (501.1%) and asphalt (86.8%) but still far from the summer’s figures
  • The favorable trend carried on in June as restrictions continued to relax: cement shipments grew 22.2% that month, according to AFCP

Argentina: The Week at a Glance 22

As preliminary data had anticipated, construction activity hit its floor in April, and the easing of quarantine along with the boost to public works allowed for some recovery. This way, the ISAC index published by INDEC recorded a monthly rebound of 99.9% in May, after the sharp falls in previous months. This rebound was enough for the index to exceed its March levels, although activity remains 30% below the summer’s records. Additionally, construction slumped 48.6% compared to May 2019, cutting its y/y decline after an historical 76.2% drop in April.

Argentina: The Week at a Glance 23

In line with the general index, the demand for main inputs experienced a marked increase, but it is still far from the January and February volumes. Specifically, cement use increased 56.8% during the month, 32.8% below its level of a year ago. Starting at very low levels, hollow bricks consumption grew six-fold between April and May (501.1%), but still fell 39.0% compared to the same month in 2019.

Argentina: The Week at a Glance 24

On the other hand, the use of asphalt increased 86,8% in May, although in y/y terms it declined 61.1%. The demand for this input, linked to state initiative, is at historically low levels since December, with public works mostly stopped awaiting the national budget’s definition and used as an adjustment variable in face of accelerating primary deficit.official announcements have yet been made apart from some specific initiatives.

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