Just 13 years after Argentina’s economy ground to a halt, its peso reduced to rubble by the corralito, South America’s second-largest country has yet again confirmed its ‘basket case’ status, writes Eleanor Wragg.


Argentina, long synonymous with financial mismanagement, was declared to be in default by ratings firm Standard & Poor’s in July this year after it failed to make a US$539mn interest payment on bonds owed to creditors since the last time around.

While global markets are to a great extent unsurprised by the latest episode – the country first reneged on a government bond in the 1820s, defaulting a further seven times since, and holds the unenviable title of most-sued nation in the World Bank’s arbitration court – Argentina’s partners in trade bloc Mercosur are feeling the heat. Brazil for example, limping through a close-run presidential election and tackling some serious structural problems of its own, could do without its exporters losing one of their most important markets. Uruguay, which saw itself engulfed by Argentina’s last default, is also understandably concerned. But with much of Argentina’s economic woes already baked into the markets after many years of financial isolation, does its most recent foray into crisis present a real threat to its neighbours?

In a note to clients shortly after the default, UBS economist Rafael de la Fuente was quick to point out that both the character and magnitude of this default differs from 2001. At that time, total public debt leapt from 63% of GDP in 2001 to 150% of GDP in 2002, and overnight, almost US$100bn was owed to foreign creditors and bondholders. The 2014 issue is very different: a US court ruling has driven the nation to default on bonds that had already been restructured after the previous default, because its only alternative would have been to pay out on both restructured and un-restructured bonds, hugely increasing the country’s liabilities. “It’s not that they don’t have the money to pay,” explains Carlos Caicedo, senior principal analyst for Latin America at research firm IHS. “They offered to pay the bondholders but the judge in New York took a different view.”

But whether a bankruptcy or an insolvency on a technicality, the fact remains that Argentina is doing badly: the government has cut its 2014 GDP growth forecast to 0.5%, although there are doubts about both the reliability and the veracity of official economic statistics, and JP Morgan says it expects a contraction of 1.6%.

Brazil counts Argentina among its top export markets, behind the United States and China. Exports to Argentina account for 8% of the total, and were worth US$19.6bn in 2013 – almost 1% of Brazil’s GDP. Worryingly for Brazil, total exports to Argentina have already fallen 20% in the first six months of this year, with demand looking likely to cool further as import controls and currency restrictions take hold. According to Brazilian bank Itau, for every 10% drop in exports to Argentina, Brazil’s GDP growth could fall by 0.2%. Given the makeup of the Brazil-Argentina export basket, Brazil’s manufacturers will be the hardest hit, and given their extended supply chains, the shocks will be felt right across the country.

“The technical default in Argentina has started to and will continue to, in the short term, affect Brazilian exports because it appears that presently Brazil benefits very much from Argentina as a buyer,” says Corina Muller Monaghan, head of North America crisis management at political and credit risk insurer JLT Re.

“Some of the exporters in Brazil are now doing so poorly as a result of their reliance on Argentina that their competitors and new investors from other countries are coming in and establishing themselves alongside them and finding other buyers, domestically and in other markets in the region.”

Indeed, of most concern is the performance of Brazil’s carmakers. Argentina accounts for around 80% of Brazil’s car exports, but according to Brazilian carmaker association Anfavea, sales to Argentina already slumped 32% in the first three months of 2014, compared to the same period a year earlier. Volkswagen, General Motors, Fiat and Ford all build cars there, and all are suffering: Fiat was forced to put 1,700 of its Brazilian employees on mandatory leave in April, while Volkswagen has announced 900 temporary layoffs. A bilateral car trade pact was signed between the two countries in June, allowing Brazil to export US$150-worth of cars for each US$100 it imports from Argentina without paying tariffs, but since the default, Argentina is hard pressed to find dollars to pay.

“The situation is so serious that the Brazilian government is even considering offering a credit line to Argentina to pay the Brazilian exporters. The Brazilian government is having to look at a kind of bailout to Argentina; not because they want to help Argentina but because they don’t want their producers and exporters and businesspeople to suffer because of this crisis,” says Caicedo.

It’s not just the manufacturing sector that has been afflicted: Argentina’s woes have even hit Brazil’s postmen, as Bloomberg reports a US$168mn fund used by their pension plan has written down its value by about 51% after losses on securities linked to Argentinean government debt.

If Argentina can affect an economic behemoth like Brazil, what lies ahead for tiny Uruguay? “Brazil and Uruguay are a bit different,” says Monaghan. “Uruguay is, I think, more resilient than people give it credit for. While Uruguay’s economy still relies on Argentina, the country appears to be proactively trying to change this. What’s more, depending on how the elections go, there is an indication that they are going to be really focussed on business, so while the contagion risk is there, I am bullish on Uruguay. I would recommend, however, that traders and investors work with an insurance intermediary to determine potential political and economic risks.”

Just over a decade ago, Uruguay followed Argentina into default. This time, it’s different, or so says its finance minister, who points to the Uruguayan economy’s diversification since 2003. Exports to Argentina, which used to make up around a quarter of Uruguay’s total external sales, now represent just 4%, while Argentina’s banks no longer feature in the country’s financial landscape – a far cry from 2001, when Argentina held a fifth of its banking assets. In fact, by all accounts, Uruguay is having a pretty good year, with its economy up by 3.7% in the second quarter of 2014, versus the same period in 2013. That said, its tourism industry is heavily reliant on its neighbour: Argentineans account for 60% of all tourists, and tourism accounts for 6% of GDP, which could lead to a slowdown in growth. As a result, Itau pegs the country’s GDP growth at 3% in 2014 and 2015, down from 4.4% in 2013.

Uruguay has also seen Argentinean investors pull out of the country, most notably renewable energy firm Impsa, which had won three tenders to carry out works on four wind parks in Maldonado and Lavalleja, but declared itself in default after being unable to pay interest on two domestic bonds, the first such event by a private Argentinean company since the default in July.

“Argentinean companies have had their external credit lines cut,” said Guillermo Rimoldi, president of the Argentine Institute of Finance Executives (IAEF), speaking to the Argentinean press. “It’s not an issue of company risk, but rather country risk.”
As Mercosur looks ever weaker due not just to Argentina, but Venezuela too, could now be the right time for the rest of the trade bloc to shift their sights elsewhere? “There is a silver lining here for Mercosur,” says Caicedo. “Argentina’s difficulties in terms of trade flows, capital controls and import controls are forcing Brazil, Uruguay and Paraguay to consider a more liberal trade policy and forget about Mercosur.” Indeed, Brazilian presidential candidate Aecio Neves has already spoken publically about the need to rethink the trade pact.

It’s also not entirely doom and gloom in Buenos Aires. In a recent white paper, Scott Mathis, chairman of Algodon Wines and Luxury Development Group which has been investing in the country since 2006, expressed optimism around the outcome of the upcoming presidential elections. “There is now certainty of political change in 2015. Once this happens, we believe that Argentina’s economy can soar. We expect the next administration to establish normal, business friendly relations with the international financial community which could in turn restore investor confidence and boost the economy by attracting billions of dollars more in new financing.”

“In October 2015, Argentina is going to have a new government that is going to tryto address the imbalances,” adds Caicedo. “People have suspended decisions to invest in Argentina, people are waiting on the wings, and everything depends on trying to hold it for another year because it’s obvious that Argentina is going to have a new government. They will be able to muddle through until then.”

Until then, its Mercosur partners can only sit back and watch as uncertainty around Argentina hurts their exporters and nudges growth ever lower.