Political climate deteriorates and recession worsens despite the agreement with foreign bondholders

ARGENTINA - Forecast 10 Aug 2020 by Domingo Cavallo

The successful restructuring of the government debt has reduced the risk of a disorderly default during Alberto Fernández’s presidency. But in all other respects, the political climate and economic prospects have deteriorated since our May 18th forecast.

By mid-May it seemed that the government was winning the health battle against coronavirus. However, by the beginning of August, the number of infections and deaths was increasing rapidly, and worries about a collapse of the health care system are preventing the government from relaxing the lockdown and allowing the people to return to work.
Furious political confrontations have re-emerged since mid-May, after two months of political calm in which the approval ratings for Fernández and all the governors, including those of the opposition, increased, amid the perception of success in fighting the coronavirus. This time around the political battles include nasty reciprocal accusations of past and present corruption, and unscrupulous institutional manipulation.

The initial popular approval for the strict regulations imposed to ensure social distancing, even when they meant limitations to individual freedom, reinforced the belief by the political leaders of the coalition in power, and many of their economic advisors, that the state has to regulate and intervene in almost every aspect of economic life. This even applies to the property and management of companies that grew and expanded by private initiative, and produced goods and services for domestic and foreign markets.

As a consequence, the expectations of business people have worsened to such an extent that several companies are announcing that, after the pandemic is over, they won’t resume their activities, or at least won’t expand their domestic productive capacity. A significant number of them, especially young entrepreneurs, are looking to move their activities to other countries, particularly in areas of production based on knowledge and new technologies for the global market. Uruguay is looking forward to welcoming those entrepreneurs.
In terms of our forecast for the rest of 2020, the incoming information since mid-May has accentuated our pessimism about economic activity. We expect a 14% drop in GDP, down from the previous 12% forecast. The fiscal deficit is now estimated at 9% of GDP, one percentage point above our previous estimate.

Our new forecast for 2020 and its comparison with our previous one is summarized in Table 0. The colored column sets forth our May 18th forecast.

The extension of lockdowns will allow the government to maintain the exchange and price controls for a longer period of time. The Central Bank has begun to encourage banks to pay higher interest rates on time deposits. Together with prices and exchange controls, this will dampen the inflationary effect of the monetary expansion required to finance the increasing fiscal deficit. Therefore, we reduced the expectation of adjustment of the exchange rate in the official market, and the inflation forecast. We predict the exchange rate to be 91 pesos per dollar instead of 100 pesos in the previous forecast. And the annual rate of inflation during 2020 is expected to be 44%, down from 60% we had estimated in the May forecast.

Even though for the coming months the risk of an inflationary burst is now lower than we foresaw in May, it continues to be a high risk for 2021, particularly, after the mid-term election of that year. The government will probably insist in repressing inflation to improve their electoral chances. The gap between the parallel and official exchange rates will be the best indicator of the size of the repressed inflation and the possible magnitude of the post-election surge in inflation.

We consider that there is still no reliable basis to make a forecast for 2021. However, for those who want to have an idea of the average opinion emerging from the Market Expectation Survey published by the Central Bank on July 31st , 2020 we report this in Table 0.1.

We will publish our detailed forecast for 2021 in our October forecast report, once the government has submitted the budget for 2021.

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