Argentina’s Macri looks to build on initial gains

by Joseph S. Tulchin

Argentine President Mauricio Macri enters the second half of his first year in office having made a solid start in the transition from the populist government of Cristina Fernandez de Kirchner. However, the economy remains sluggish. The challenge for the Macri administration now is to consolidate its gains by continuing to reduce inflation and articulating a coherent program.

Local and congressional elections in 2017 will form a crucial test, potentially allowing the government to increase its support in Congress and avoid the high-risk bargains that it has so far been making with the majority Peronists.

The government benefits from a fragmented opposition. This has made haggling for votes in Congress a bit easier, but the cost of such dealmaking will increase with each bill under consideration. The corruption scandals involving former President Kirchner and her closest aides continue to give Mr. Macri a boost in public opinion.

However, the appearance of his name in the Panama Papers, which showed that a portion of his family’s wealth was hidden offshore, did not enhance his image as someone with a new, clean approach to government.

Economic first steps

The Macri administration’s initial challenge was to end the regime of subsidies and export taxes, calledretenciones, as well as the drastic price controls on public utilities. These distorted the market and reduced domestic investment, while creating inflation that reached nearly 30 percent per year when Mr. Macri took office in December 2015.

The government’s first response was to take steps to restore market confidence. It eliminated exchange rate controls, reduced subsidies for utilities and reduced the retenciones. It also resolved the long-standing dispute with holdouts on Argentina’s old defaulted national bonds. This immediately allowed the government to reenter the international capital market, which it did with great fanfare.

These measures produced a relatively stable exchange rate of about 15 Argentine pesos to the United States dollar (up from the previous official, controlled rate of 9 pesos to the dollar) and spurred agricultural exports. They also began to reduce inflation, which now stands at about 25 percent per year and is expected to reach 20 percent or even slightly lower by the end of 2016.

To prevent a political crisis with the provincial governors, most of whom belong to the opposition, the government has renegotiated the fiscal pact under which the federal government distributes funds to the provinces. The deal is a stopgap measure and does not include any reforms of provincial finances. In some cases, local budget policies have been wildly irresponsible, producing massive deficits that the federal government must cover. In other instances, they tolerate widespread corruption and spending that cannot be accounted for in a transparent manner.

In another temporary fix, the government has negotiated wage agreements with the powerful labor unions. These will preserve social peace in the short run but will also make slowing inflation more difficult. Labor will become a more prominent political issue if real wages continue to fall – they are down more than 10 percent since the government took office – and employment remains flat.

Education and environment

The government has taken significant steps in other policy areas as well. Over the past decade the education system’s decreasing quality and falling student retention rates had become serious problems. To address them, a group of experts led by Education Minister Esteban Bullrich formulated a strategy to adjust education to the country’s needs.

The strategy has four priorities: early childhood development, improving assessment and evaluation, reducing the skills gap and teacher training. The Education Ministry has made technical-professional education a priority, launching initiatives that connect technical education with the labor market. It began by surveying companies about which hard and soft skills would be required in the labor market by 2020; 19 provincial Councils of Education, Work and Production were then created to put the strategy into operation. To complement these efforts, the ministry signed 40 agreements with private companies to provide internships for students in technical high schools. Fortunately for the government, none of these initiatives required legislative action. However, none of them will produce quick results, either.

President Macri also created the Ministry of Environment and Sustainable Development, and appointed activist Rabbi Sergio Bergman at its head. To emphasize his differences with the previous government (whose official policy was skepticism toward climate change), a Climate Change Cabinet was introduced to encourage ministries to cooperate on mitigating and adapting to environmental change.

Minister Bergman has made it clear that the new government is determined to join the growing international effort to reduce climate change and has declared that Argentina will adhere to the Paris agreements. On the domestic front, the ministry has submitted a bill to Congress to protect wetlands and created a Federal Council of the Environment to bring the provinces’ environmental ministers together to discuss matters of common interest.

While these initiatives serve as good indicators of how Mr. Macri wishes to govern, education and the environment remain much less significant in the public debate than the economy and corruption.

Challenges ahead

One bad sign for the administration is President Macri’s decision (after a meeting with President Barack Obama) to commit his government to the U.S. war on drugs. Unfortunately for Argentina, this appears to mean involving the armed forces in counter-narcotics operations. This is never a good idea in Latin America and especially in Argentina, where the history of armed forces intervention in domestic politics is filled with nasty episodes.

It is especially unfortunate since Interior Minister Patricia Bullrich (the education minister’s second cousin), has put together a team to reform the police and make it an effective partner of the judiciary in combating crime, including organized crime. There will be more on this in the second half of the year.

The administration must solve two major problems if it is to govern successfully. The first is the economy and, more specifically, the lack of domestic investment. The second is its minority status in the legislature.

Corruption battle

When it comes to the economy, Mr. Macri’s economic team must calibrate the reduction in subsidies with the inevitable pressure that this will put on prices. If it does, investment appears likely to pick up, although slowly. But the deep-seated tradition of crony capitalism is still the economy’s biggest structural problem. Private companies, large and small, prefer to seek rents from deals with the state rather than compete in the marketplace.

The Kirchner governments turned this tradition into an accepted practice that distorted investment and stymied innovation. For example, when Mr. Macri indicated, following his conversation with President Obama, that he would invite U.S. construction firms to bid on upcoming infrastructure projects, the strongest complaint came from one of the country’s most powerful businessmen, Eduardo Eurnekian, the owner of Corporacion America. Mr. Eurnekian made a fortune working closely with Argentine governments, including President Carlos Menem (1989-1999) and both Kirchners (Cristina, 2007-2015, and Nestor, 2003-2007).

For the moment, the economy is stalled. It is headed for a contraction of about 1 percent in 2016 and a possible expansion in 2017 of about 2.8 percent – far below the government’s expectations. Consumer confidence is weak. Confusion in applying new rules for reducing utilities subsidies and repatriating private capital are only making matters worse for the government. The effort to reduce the subsidies has been paralyzed by a local court’s decision that the proposed changes infringed on consumers’ rights. The flimsy regulatory framework that governs utility prices offers little guidance in the matter and it may require a decision by federal courts to resolve the issue. That could take months.

Crony capitalism also creates an environment in which corruption of all kinds flourishes throughout the economy. Gross examples of such abuses are driving the scandals involving former President Cristina Fernandez de Kirchner, members of her immediate family and several of her closest associates. The Kirchners became fabulously wealthy through “friendly” contracts awarded to family businesses in their home province of Santa Cruz, and, according to court documents revealed during the current investigations, through direct kickbacks worth tens of millions of dollars.

The Macri administration has declared its intention to clean up government and eliminate corruption. In part, its will to fight against corruption is strengthened by the need to widen its political support, from the left and the right. That leads to the second major problem.

Building a majority

The governing coalition consists of three parties. The biggest is the president’s party, Republican Proposal (PRO), a center-right group that represents about one-third of the popular vote and a similar share of the congress. PRO controls both the city and province of Buenos Aires. It is joined by the Radical Party, which has another small chunk of seats in the congress and, most significantly, controls five of the most important provinces in the country. The third party, Civic Coalition, is a left-leaning offshoot of the Radical Party.

President Macri is looking for support from other groups on the left, especially the Party for a National Encounter (GEN), led by Margarita Stolbizer, a powerful voice for women’s rights, social justice and eliminating corruption. Mr. Macri’s own progressive views on social issues will make it easier to win over Ms. Stolbizer and a few others on the left. But they will not give him the numbers he needs for a congressional majority. For that, he must win over some of the Peronists.

As revelations of corruption around former President Kirchner increase, some factions of her party have begun to distance themselves from her and deal with Mr. Macri. The agreement with the Peronist governors was a move in this direction. For now, the largest group of dissident Peronists, known as the Renovation Front, has refused to back the government, except on an ad hoc basis. On various pieces of legislation, different elements of the Peronists, who hold a majority in both houses of Congress, have voted with the administration. This is a very precarious way to govern. Over the next few months, President Macri must get some of these opposition groups to commit to his agenda. That, in turn, makes it more important for him to formulate and articulate a program.

Scenarios

Under the most likely scenario, the inflation rate will continue to fall, the money supply will come into balance and the government will make more progress on eliminating the market distorting policies that scare off investments. Nevertheless, economic recovery is likely to remain sluggish through the end of 2016.

However, the government is likely to benefit from growing public support in the next three months due to its education and environment initiatives, which demonstrate its capacity to govern responsibly. At the same time, the judicial cases against the former president and her circle will boost the government’s support and make it easier for Mr. Macri to build a coalition of groups that favor ending the culture of corruption that poisons Argentine politics and holds back the economy.

Less likely is a scenario in which inflation stubbornly refuses to abate and the various short-term measures, such as cutting subsidies and retenciones, cause a recession. In this scenario, domestic investment would remain sluggish and employment stagnant. Because these negative developments reduce support for the government, Peronist elements would be reluctant to throw in their lot with President Macri, making it very difficult for him to translate his agenda into legislation.

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Source: Geopolitical Intelligence Service