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Argentina’s Bumpy Ride

SANTIAGO – “Fasten your seat belts, because it should be a bumpy ride,” the captain warned from the cockpit. We were about to enter Argentine airspace.

Investors looking to do business in Argentina have long been issued similar warnings. This is the country that scholars study when they want to understand financial crises. The country’s largest such crisis, in 2001, brought down the local banking system and caused the Argentine government to default on its debts. The economy contracted by a whopping 18%, and the unemployment rate peaked above 22%.

After a period of calm that has now lasted a decade, dire economic warnings are back.  Forecasts for the world economy are turning pessimistic, and economists in export-dependent Argentina are finding much to worry about. Itau, Latin America’s largest bank, is predicting GDP growth in Argentina of only 3.2% next year, down sharply from 6% in 2011.

Inflation is another concern. With official figures widely discredited, private analysts estimate that consumer prices are rising at an annual rate of 25% or more.

Those are careful estimates by serious economists. But, then again, one should take all economic forecasts about Argentina with a grain of salt. In the decade since the last crisis, Argentine policymakers have broken almost every rule in the economic-policy playbook. Again and again, local and international economists have issued dire warnings about what would happen if it persisted in its heterodoxy. And yet Argentina has managed to grow fast, doubling per capita income since 2002.

Energy policy is a perfect example of a wrongheaded strategy. The Argentine government fixed gas prices, despite ongoing inflation. Gas became artificially cheap, consumers seldom bothered to turn the thermostat down, and producers stopped investing. As a result Argentina, once a thriving gas exporter, had to seek imports to overcome domestic shortages.

What saved Argentina over the last decade were highly favorable external conditions: sky-high global commodity prices and technological innovations that greatly increased farm yields. Neighboring Brazil helped by undergoing a boom of its own, which pumped up demand for a wide range of Argentine products.

With rising tax revenues and the burden of debt gone after the default a decade ago, the government went on a spending spree: real public expenditure grew at double-digit rates most years since 2002. At the same time, the central bank kept interest rates low, so that the inflation-adjusted cost of loans is zero or negative.

In this environment, Argentine consumers naturally also went on a spending spree, and corporate profits rose accordingly. Not long ago, I met with a group of foreign investors in Argentina. They owned everything from paper mills to department stores and supermarket chains. After they finished trading stories of endless red tape and arbitrary government decisions, I asked why they kept investing in Argentina. “Because we make a lot of money,” was the unanimous answer.

The question making the rounds in Argentina nowadays is whether this period of plenty is coming to an end. You would not feel any such anxiety in Buenos Aires shopping malls, which are as crowded as ever. Nor could you infer it from the behavior of voters, who seem poised to re-elect President Cristina Kirchner in October. But the signs of economic deterioration are surely there.

With imports still growing strongly and commodity prices beginning to fall as a result of the world slowdown, Argentina’s large trade surplus is disappearing quickly. Fearing a weaker peso, spooked investors demand dollars. Capital is flowing out of the country, and official reserves are slowly being depleted.

To stem the outflow of dollars, the central bank may well be forced to raise interest rates. That, plus the gloomy international outlook and a fiscal policy that will have to become less expansionary after the election, will slow the economy down.

A bumpy ride is acceptable as long as the landing is smooth. Ensuring that outcome will be the number one job for a newly re-elected President Cristina Kirchner. It will prove a difficult period at the controls.