Sub-prime Crisis: Argentina’s Consumption-Credit Variety

This post appeared on RGE-Monitor (Latin America) on May 28th, 2008.

Global growth during the last five years provided a huge tailwind for agricultural producing countries boosting Argentina’s emergence of one of its biggest crises ever. The government response to this (temporary) windfall in its terms of trade and globalization not seen since the late 1800’s has been to stimulate consumption, instead of investment to capitalize the positive shock for its long-term growth. This can be observed, among many other things, by the huge consumption-credit boom of 2003-2008 (housing credit is relatively small in Argentina), especially to middle- and lower-income families. The domestically generated inflation has exacerbated the extensive use of this form of credit in a potentially unsustainable way.

Inflation, if temporary, can be expected to increase the use of this type of credit. Precisely this is the rational use of credit markets: to finance temporary shocks in order to smooth consumption. However, this is not the appropriate channel for permanent shocks as the current inflation rate, which is not expected to go away any time soon. When inflation starts to accelerate and being incorporated to inflation expectations and the government lacks a serious anti-inflationary program, and real wages start to decline, consumption is likely to lose pace. In this context, it should be expected that lower-income families in countries in which the share of food and basic stuff is non-trivial to being unable to meet all the required payments—the more so the higher the inflation rate—and for such repayments to be put on hold.

Paralleling the home-oriented sub-prime crisis in the U.S. where many credits where extended without the appropriate credit revision, many consumption-loans have been extended in Argentina. Although the amounts involved are lower, the collateral is worse: there is no home to be absorbed by the financial institution in case of default. And many credits were issued not only to buy cars or refrigerators, but also to buy clothes. Recent data from the central bank shows a substantial increase in delinquency rates in these types of credit, which doubled. Recent studies expect the delinquency rate to increase due to higher inflation.

A big share of these lending has been directly extended by stores selling these goods and financial institutions. These credits are then pooled and these financial instruments are then sold in financial markets—the so called financial fiduciary funds—which are supposed to hedge upon risk. As of now, middle and low income families are, on average, indebted on 80% of the monthly household income—for higher incomes this reaches five times the monthly income!).

Although the scale is much smaller, any resemblance to the U.S.? The rest is let for the smart reader to figure out.

Argentina: Some facts and some thoughts

The following post appeared in RGE-Monitor (Latin America) on May 9th, 2008.

Some (common knowledge) facts
- The inflation rate keeps on accelerating—there are suggestions that unions are seeking to renegotiate in H2 the ex-ante annual wage increases arranged around March (of this year!).

- Government bonds are being consistently rejected, their price decreasing; they would have fallen more if it weren’t for public institutions (e.g. public banks) aggressively purchasing them.

- Country-risk has increased.

- S&P put Argentina’s debt in “negative”.

- Government mismanagement, as expected, pushed the farm sector back into strike mode. This time, and to try to avoid food scarcity in cities, the farm sector will stop export products.

- The effect of the latter: reduced tax (export) revenues; if it also implies a reduction if expenditures (likely), it will imply a multiplier-type of effect in economic activity and thus overall tax collection.

- Argentina’s expected growth rate has already been reduced—and this does not take into account the renewal of the farm sector strike (see JP Morgan Research, by Florencia Vasquez—May 01, 2008: “2009 GDP forecast cut to 3% on mounting constraints”).

- In the mist of these inconsistencies, although within a small range, the domestic currency depreciated—despite central bank’s actions—i.e. there was small run against the peso, and is likely to continue, potentially accelerating. CD’s in pesos aren’t being rolled over and they are used buy dollars.

- Government expenditures are very high and are not decreasing. The amount of discretional redistribution from the poor to the rich has increased substantially, and it is expected to accelerate as the inflation rate keeps on increasing.

- Tax revenues increased; but this mainly explained by the inflation tax!

- Debt amortizations are very high and increasing for this year and the next ones—with very limited ability of the Argentine government to access international financial markets and at non-trivial high interest rate.

- Argentina’s national debt has not only increased in absolute volume (some estimates putting it close to US$ 200 billion) but it has increased as a percentage of GDP! Furthermore, this is a lower bound. If correctly computed, it is already in “Danger Zone” (see IDB’s report). No wonder that some other reports has estimated Argentina’s default probability to be the highest among emerging markets!!!

- Income distribution is deteriorating at an increasing rate (wasn’t this a “national and popular” administration?). For analysis I did early in 2007 see HERE (in Spanish).http://uoregon.edu/~magud/Redistribucion.pdf

- Price controls are still in effect. But they are totally ineffective.

- The latter, jointly with a (convenient) change in the measurement of the Consumer Price Index is the only inflation-reduction strategy of the administration!

- The number of bankruptcies is increasing.

- The housing market (one of the main engines in this “model’) is decelerating.

- Terms of trade bonanza is not such a thing, Jose Antonio Ocampo and Maria Angela Parra have shown. And the world economy is now slowing down.

- The Fed is already suggesting interest rate hikes could come sooner than expected to control U.S. inflation.

- The Euro area is slowing down.

- China and India are staring to be affected by higher inflation rates, which suggest that some decelerating of these overheating economies could be expected—and good for them. This, in turn, might impact on other parts of Asia.

- The commodities’ boom has slowed down in line with some small appreciation of the U.S. dollar. If the dollar continues to appreciate, this effect is likely to strengthen. The more so if the Fed increases interest rates and the economy, though slowly (as expected) progressively recovers some of its strength.

- Political acceptance of the five-month-old government is already very low (it looks more like a government about to finish its term in office, not an administration that has been in office for less than a year).

- The strategy of the current administration seems not to attack the source of the problems—the mismanagement of the macroeconomy—but to try to generate social tensions (e.g. t stimulate “class” divisions) to avoid the solution. Furthermore, I wouldn’t be surprised if the administration will eventually let things collapse and then blame “the market” for the problems (it is always “another one’s fault”).

Some Thoughts

The above were just a(n) (incomplete) list of facts. Interestingly, I would have written them in the early-mid seventies, most of them of have been true as well! (and a “funny” way to write a sad piece). So, we saw this picture, and how its ends. Would you put your money in Argentina? I won’t.

For a future posting: I am totally not surprised by the recovery of Argentina: the economy started from a huge collapse in 2001-2002 while its was favored by the so-called savings glut along with China and India (and the world economy as a whole) growing at high rates for a long time period—and the effects that these caused on commodities, the main source of exports in Argentina.

But now, in light of one of the worst macroeconomic admistration in Argentina’s history I am starting to think that the global context, instead of a blessing, it has been a curse. If so, the long-term costs of this will not be small.

Is the Party Over in Argentina? The Market Internalizes the Political Effects of Inconsistent Macro Policies (or vice-versa?)

This posting appeared in RGE-Monitor (Latin America) on April 23rd, 2008

The last couple of days financial markets in Argentina have shown capital flowing away from government bonds and into buying dollars (hoarding them, “jus in case”). This might seem at first glance controversial with the apparently sound macroeconomic figures: fiscal surplus, current account surplus, high growth rate, low official inflation rates, etc. I will argue that it shouldn’t.

Many commentators are suggesting that this is just a political problem—the government vs. farm producers conflict. In my opinion, if anything, the political frictions are just the trigger that shows how the market is internalizing the 5-year long macroeconomic mismanagement—with no long-term view. It clearly reflects the fact that, as I mentioned many times in my postings, even though the flow figures show an apparently solid economy the stock (i.e. intertemporal sustainability) show exactly the opposite.

The fiscal fragility is evident once one considers the heavy debt repayments due this and the coming years, the fragility on relying of very volatile (and temporary) sources of tax revenues to finance permanent expenditures. The former not only includes the export taxes, but also the inflation tax (this last one eventually decreasing as inflation gets out of controls—as it is currently happening—and the Olivera-Tanzi effect jointly with higher tax evasion and lower GDP growth).

Of course, decreasing government expenditures is political impossible for now, as it is appreciating the currency. On the latter, everyone would have expected the domestic currency to appreciate if let to float instead of depreciating[1]; unless this is the starting point of a standard textbook balance of payment crises… We can not rule out this happening (although with a low probability for now it is likely to increase over time). Why? The huge amount of debt needed to roll over in times of dry international financial markets (not to forget that Argentina has not even had a great amount of access to it in the so-called savings glut times) plus an election coming next year. Because let’s face it, the Kirchners receive political support due to the asymmetries in the tax revenue collection (mostly Federal) as opposed to the local (Provincial) expenditures that they manage to control the provincial and local governments.

By the way, the figures in the real side of the economy don’t look that promising either. GDP growth is decelerating as well as house sales, credit is still very limited, inflation is accelerating, provincial fiscal deficits are arising and increasing, lack of investment, energy shortages, wages indexations (although they are already running from behind to the inflation rate), ineffective price controls, increasing crossed subsidies to ineffectively trying to reduce price increases to middle-class, increasing income inequality (the more so the greater the inflation rate), lack of a nominal anchor, no long-term growth plans, lack of productivity-based wage increases, a reasonable exchange rate policy, serious anti-inflationary strategy, respect for the rule of law, etc. (the list can be extended as long as necessary, unfortunately).

It is true that there exist an international inflation problem. But Argentina’s inflation rate has dramatically separated from world inflation. Most of the other Latin American countries raised interest rates to try to reign in their inflation rates. Will Argentina be forced to do it in trying to stop a currency crisis? Hopefully the wrong macro-polices of the past will be recognized in a timely manner and the changes will be made. Even those that originally promoted the so-called “productive model” are now being cautious on reporting the need to correct the deviations. Aren’t they the smart ones that should have anticipated these effects?

The problem is that the longer it takes for corrective measures to be applied the greater the real effects and the more drastic adjustment would need to be. This resembles more and more over time the famous “war of attrition” of Alesina and Drazen (AER 1991): reforms are delayed until they are inevitable; but the costs of such lengthy wait are non-trivial. It also rings a bell in the credibility of inflation stabilization literature (Calvo and his co-authors have been teaching us this since the 1980s!)

Conclusion: I hear a tic-tac. Argentina is running out of time at an accelerating rate (as the inflation rate is clearly indicating). Things are still correctable. But the longer it takes, the greater the pain (i.e. real effects). Commentators presume it is just a political problem. If true, it is because the market is internalizing the huge macroeconomic mismanagement (that I have elaborated on in my previous posts). The market, being forward-looking, is signaling it. The political conflict is just the trigger of economic problems that the society in internalizing. Let’s hope that this time the government is able to interpret the signals and avoid repeating the same mistakes of the past.

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[1] And the central bank could be so creative as to claim responsibility for increasing exchange rate volatility on purpose to stop speculative capital flows.