According to an old saying, “Trust is like money; it is hard to gain and easy to lose.” Something similar is happening in Argentina, which is dealing with a loss of credibility among both local and foreign investors, translating into a decline in capital inflows compared with other nearby countries such as Brazil and Chile. According to ECLAC (the Economic Commission for Latin America and the Caribbean), Foreign Direct Investment (FDI) in Argentina amounted to US$12 billion in 2012, lagging behind FDI of US$65 billion in Brazil, US$30 billion in Chile and US$16 billion in Colombia.
During the first quarter of 2013, Chile received 87% more foreign investment than it did during the same period in the previous year, according to that country’s Central Bank. Over that entire quarter, foreign direct investment in Chile rose to US$9.113 billion, compared with US$4.87 billion during the same three months in 2012.
In Argentina, in contrast, the Brazilian mining firm Vale announced last March that it was leaving the country, despite having announced an initial investment of US$5.9 billion in its Rio Colorado plant in Mendoza. According to Murilo Ferreira, CEO of Vale, “Inflation and foreign exchange rate variations” raised the cost of the plant to almost US$11 billion, or almost twice the amount of the initial estimate.
Private sector economists estimate that inflation in Argentina this year will be less than 25%, while the gap between the official dollar-peso exchange rate and the “blue” (black market) rate exceeds 74% — a formal rate of 5.22 to one versus an informal rate of 9.15 to one. This disparity in the exchange rate accelerated when the government imposed a “clamp” on the purchase of dollars last October. That is to say, it prohibited the purchase of the foreign currency except for use in foreign travel. The measure wound up leading to capital flight from Argentina amounting to US$80 billion. The funds went into foreign accounts, safe deposit boxes and were placed under mattresses because of a lack of confidence in the economy and the Argentine government.
Following in the footsteps of Vale, other Brazilian firms have also withdrawn from Argentina, such as the construction firm Andrade Gutierrez, which was going to undertake a port terminal project in Bahia Blanca for the transportation of potassium, and faucet manufacturer Decca Piazza, which stopped manufacturing in the country after 125 years of activity there.
Other companies that have packed their bags recently include the luxury retailers Calvin Klein Underwear and Fundi, as well as Louis Vuitton, Escada, Ermenegildo Zegna, Yves Saint Laurent and Cartier. In these cases, the principal reason was the restrictions on imports imposed in order to protect local textile producers.
The Perfect Storm?
“There are various reasons why Argentina is less attractive nowadays,” says Edgardo Bindelli, director of the international trade program of UMSA, the University of the Argentine Social Museum. Bindelli notes that rising costs in terms of dollars are a factor that can influence some companies more than others, especially if they are long-term projects that have requirements for major investments, such as in the case of mining. As for other industries such as pharmaceuticals, “they are more troubled by shutdowns in utilities; while for others, such as garments and high priced automobiles, it is their problems with importing,” he adds. Moreover, in the current economic model of the administration of Cristina Fernández de Kirchner, companies cannot return dividends and profits to their countries of origin, and they face numerous challenges for importing because of the government’s goal of protecting domestic industries.
According to Marcelo Celani, director of the corporate economic and business administration program of Torcuato Di Tella University (UTDT), “The macroeconomic situation results in such a great distortion.” For example, the cost of electricity continues to be at the same level as in 2000 because it is subsidized. In addition, there is “a distortion in the exchange rate that prevents investments from being profitable. Vale is a clear example of that.”
This situation has led even many Argentine companies to search for new horizons, notes Diana Mondino, director of institutional relations and professor at the University of CEMA. In her opinion, this is having an even “much more serious impact” on El Tejar, the largest Argentina agribusiness company, “than it is on Vale.” That’s because El Tejar –Argentina’s largest grain company — is active in Uruguay and Brazil but it does not produce in Argentina. As a result, El Tejar “brings people to other locations where there may be less profitability but the rules of the game are clearer,” she notes.
While each industrial sector faces different pitfalls when it is time to manufacture, for those firms that need to think long-term, the instability of the rules of the game is damaging the investment climate. Celani notes, “Historically, Argentina has not been very fond of maintaining [the rules], and so with projects that take a long time to mature, such as Vale, any changes in the rules for capital, such as for the repatriation of dividends as well as any tax increases, wind up making those projects much riskier.”
But the widespread distrust in the government has political roots. Eduardo Fracchia, director of economics at IAE, notes that there are some measures that have had a significant influence on the investment climate. These include the “nationalization of the AFJP, Argentina’s retirement and pension fund, in 2008; the changes in the organizational chart of the Central Bank, which affected confidence in investments (because they placed their independence in doubt); the expropriation of Spanish energy giant Repsol last year, and the way it was taken over, as well as the delay in paying the debt in default, which has led to a higher country risk.
Add to all that the recent reform of the Council of Magistrates, the entity responsible for appointing judges and removing them from office. In that regard, restrictions in the cautionary measures against the state approved by the government of Cristina Kirchner limit the possibility of taking action against the government in power. According to Fracchia, this situation has “not been viewed positively by the United Nations itself.” Fracchia explains that Gabriela Knaul, a Brazilian-born United Nations Special Rapporteur, commented recently that there is “a potential risk of destroying the independence” of the Argentine judiciary.
The government’s meager level of investment in energy and infrastructure is another complication in this situation. Since 2003, when the late President Nestor Kirchner took office, the country’s electricity capacity has not increased despite the fact that the economy has, at times, experienced annual growth of 8%, and there has been strong consumption of such products as air conditioners. Mondino notes, “In order to produce, you need to have knowledge of technology, the right personnel, and enough energy, which has been extremely scarce for at least five years. They have not even been building bridges, roads or ports in order to lower [transportation and logistics] costs.”
Last year, Argentina imported US$4.69 billion worth of gas, the equivalent of 37% of its trade balance, which is the macroeconomic indicator that the government studies in order to figure out how many dollars will be available, and to what point it must persist in exerting its “clamp” restrictions on foreign exchange. According to Ernesto O’Connor, director of the graduate program in applied economics at the UCA (Argentine Catholic University), “For the moment, the scarcity of hydrocarbons is compensated for with imports, but the trend toward decreased inputs of foreign exchange [because of the flight of the dollar] opens up more questions about the future supply of hydrocarbons, given that these inputs are critical for production.”
Effects on Employment
This year, the Argentine economy will grow by 3.5%, according to ECLAC, which is a lower forecast than its earlier projection of 3.9%. This decline in activity will mean, among other things, an adjustment in employment over the longer term. “If the economy does not grow, then sales stagnate and employment either stays the same or it falls. It is a slow process but in a year and a half, you can feel it,” notes O’Connor.
For Celani, the data do not bring good news. But neither is the situation tragic, “because while new jobs are not being created, those that do exist are being maintained.” He adds that “consumption is still at a high level, and there are no significant losses in sources of labor. The unknowns are four or five years ahead, when there is no net growth in employment because, in addition, companies are working at their maximum capacity.”
The fact that companies are fully active and cannot expand their workforces with new investments shows that the policy of protecting domestic industry has not been a success. “It is a myth,” says UCEMA’s Mondino. “It didn’t make domestic industry grow, but it prohibited competition without modernizing or capitalizing any of the industries.”
IAE’s Fracchia notes how in the province of Tierra del Fuego telephones and televisions are assembled locally because industry there is protected by the government. “However, what they get are telephones that are not so modern and are more expensive than those that are sold abroad. The same thing happens in the textile, toy and machinery sectors. Greater protection boosted industrial production, but it has done so with a clear inefficiency,” says Fracchia.
In that respect, Mondino notes that automotive parts are more expensive in Argentina than elsewhere because of the impossibility of setting up a value chain free of unpredictable events. In his view, efficiency has been affected by “the inability to resolve strikes or picketing or the lack of diesel fuel. There are not enough imports, so producers must pay twice the usual freight rates because there aren’t enough containers.”
One of the most notable costs are the salaries, which result from the joint wage talks each year but have not yet been set for this year. The unions are asking for an average wage increase of between 25% and 30%. The problem is that the inflation rate is rising faster than the value of the dollar. “In May 2009, one dollar was worth 3.71 pesos, but today it is 5.22 pesos, which represents an increase of 40%. But salaries continued to grow along with an average inflation of 125% [which amounts to an annual rate of 25% since 2009],” notes Bindelli.
The Opportunities
Another popular phrase is applied to the Argentine case: “Troubled waters offer opportunities for fishermen.” According to Mondino, the current context does not preclude opportunities for some local entrepreneurs in the country who are close to those in power, such as Cristóbal López, who has invested in casinos, ships, communications media, fuels and food. “The concept of a conglomerate formed by 12 or more companies in different sectors no longer applies [elsewhere] in the world, but it is growing in Argentina, and they are the friends of power. These firms are expanding in a horizontal way, in a direct form, and that provides inefficiency because you can’t know everything at once,” he notes.
On the other hand, adds O’Connor, Chinese and Arab companies are also arriving in Argentina, with “plans for expansion, and they are looking for markets that have a supply of companies.” This year, for example, the 103 branches of the old Standard Bank were purchased by the Chinese entity ICBS (Industrial and Commercial Bank of China), which acquired 80% of Standard Bank’s financial operations.
Binelli believes that there is always going to be someone interested in investing; it only depends on the business and the risk that they are going to assume. “They were saying, because of the problem with YPF and Repsol, that it was going to be impossible for an oil company that wanted to invest in Argentina, and we see that this is not the way things are turning out. There are several Argentine and foreign companies that are exploring possibilities for associating with each other,” he notes.
Even so, if the investment climate in Argentina is to improve in the future, says Fracchia, the government will have to send signals “above all, about the transparency of legislative and judicial power; the reliability of its regulatory framework; and the decline in inflation. That’s because all of this commotion in the economic system takes the place of actual investment. It is very important to make stronger efforts in infrastructure and education. More innovation is essential for creating a system that has more productivity and greater efficiency.”
Mondino adds: “The economy is a web, and when you touch one part of it, the whole thing vibrates. You have to start being consistent, as the books say. There should be fewer restrictions,and those [restrictions] that remain must be fixed so that the market can go on and adjust.”
