Argentina and Potential Emerging Markets Contagion

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One of the concerns about the tribulations in Turkey is that underperformance there could trigger or at least contribute to contagion through the emerging markets sphere. Among those is Argentina, which as the second largest economy in South America, and can add to the domino effect should it be adversely affected.

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Since the crash of 2001, which severely impacted Argentina but mostly left neighboring countries unscathed, the level of concern that Argentina could precipitate contagion through emerging markets has diminished. However, given the nation’s precarious economic situation, many analysts view it as something of a canary in the coal mine, as being the first to see the impact from changes in global policy.

How did we get here?

For years, Argentina was ruled by the Kirchner faction, which was mainly seen market-adverse. During that period, economic growth was sluggish, with the Argentine government engaging in a protracted dispute with creditors. High taxes, massive government spending, and capital controls keep foreign investment muted. Argentina was also cut out of international credit markets.

Following an unexpected victory in 2015, a new pro-market President, Mauricio Macri, took the reigns of the government, promising to bring down trade barriers and integrate Argentina into world markets. After securing an agreement with creditors, Argentina was able to return to international bond markets, and quickly took advantage of the lower interest environment, as well as world accommodative monetary policy. Funds borrowed were meant to finance a series of ambitious domestic policy proposals, as well as help tide the budget over following tax reductions and trade restrictions.

However, with the Fed winding down asset purchases, and raising rates, the subsequent loss in market liquidity particularly impacted Argentina. Capital outflows in early 2018 lead to broadening economic concerns, forcing the central bank to raise interest rates to now be the highest in the world in a desperate effort to keep capital in the country. Argentina when accessing credit markets had acquired a significant amount of short-term debt, and having difficulty rolling it over in the tightening liquidity conditions, faced budget issues and a government liquidity issue.

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Macri has recently reversed on market-oriented policies, including raising taxes on exports and rescinding other market liberalization policies. This is in line with previous Argentine crisis scenarios and is followed by capital restrictions and price fixes – leading to widespread concern among investors that Argentina was once again heading for a 2001-style crisis.

To make matters worse, during the summer of 2017-2018, crops were hit with a significant drought, putting pressure on Argentina’s primary export and key economic sector. With Macri raising taxes on exports and failing to keep taxes on agriculture low, the concern turns to economic impact as well as popular unrest, and loss of political support among his key demographic.

Where is this headed?

After well over a decade of price controls and export restrictions, Argentina is no longer significantly connected with the region’s markets – consequently impact from an Argentine crisis should be relatively small on neighboring countries. Countries like Chile and Peru have economies oriented towards basic materials exports, leaving them mostly immune to Argentina. Brazil has its internal economic issues, and Colombia has little trade with the second most southerly economy in the world.

At the beginning of the year, Argentina’s economy was expected to grow by a healthy 3.0%, but given the current situation, projections are now for a contraction of 1.2% – with many analysts saying Argentina is already in a recession at this point.

Argentina is mainly vulnerable economically due to debt issues – which would imply that Argentina by itself wouldn’t be likely to precipitate economic problems in emerging markets. However, there are many emerging economies which have taken advantage of low interest rates over the last year, and investors could be concerned they might follow an Argentina-like pattern.

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