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Summary of Argentina: Twin Deficits

Core Content

This document provides an analysis of Argentina's twin deficits – the current account deficit and fiscal deficit – in the context of a volatile financial environment. It outlines the trends, underlying causes, and future outlook for these deficits, emphasizing the country's reliance on external financing and the risks associated with its external imbalances.

Main Points

• Current Account Deficit Widening:
  Argentina's current account deficit widened significantly in 2017, reaching 5.2% of GDP from 2.8% in 2016. This was driven primarily by a sharp deterioration in the merchandise trade balance, which turned from a USD2.1bn surplus to a USD8.5bn deficit.

  • Merchandise Trade Deficit: The trade deficit was the largest since the 1990s, reaching USD8.5bn in 2017.
  • Import Growth: Imports surged by 20% year-on-year in 2017, contributing to the widening deficit.
  • Export Decline: Exports have been in decline, with a 30% drop over five years, driven by both volume and price reductions.

• Fiscal Deficit Expansion:
  The fiscal deficit also increased, reaching 6.1% of GDP in 2017. This reflects a long-term trend of rising primary spending without corresponding revenue growth.

  • Primary Spending Increase: Primary spending at the central government level rose by 6% of GDP from 2004 to 2015.
  • Fiscal Consolidation: The government has initiated a fiscal consolidation strategy, which is expected to reduce the nominal fiscal deficit in 2018.

• Twin Deficits and External Vulnerability:
  The coexistence of a large current account deficit and fiscal deficit has created a "twin deficit" scenario, raising concerns about Argentina's vulnerability to external shocks.

  • External Financing Needs: Argentina continues to rely heavily on external financing to cover its deficits.
  • Low External Debt Ratio: Despite the twin deficits, Argentina's external debt remains relatively low at 36% of GDP.
  • Market Volatility: The increased volatility in global financial markets could raise borrowing costs, but the country still has capacity to manage its debt.

• Future Outlook:

  • Near-Term Deficit Trends: The current account deficit is expected to widen modestly in 2018, reaching 5.4% of GDP.
  • Moderation in the Medium Term: With ongoing fiscal consolidation, the current account deficit should begin to moderate in later years.
  • Exchange Rate Impact: A lower fiscal deficit is expected to ease pressure on the currency and support a weaker real exchange rate, which could improve the external sector.
  • Policy Commitment: The authorities have committed to reducing the primary fiscal deficit by 1% of GDP annually starting in 2018.

• Regional and Global Context:

  • Brazil's Role: The recent economic recovery in Brazil has positively impacted Argentina's industrial goods exports.
  • Global Risks: Argentina's position in a context of high market volatility and unimpressive international reserves places it in a vulnerable position.
  • Investment Advice: The report suggests buying protection via Argentina 5y CDS against a basket of Latam 5y CDS (Brazil, Colombia, Mexico) due to heightened risk exposure.

Key Information

• Twin Deficit Emergence: Argentina has entered a situation where both the current account and fiscal deficits are significant, creating a dual financial challenge.
• Export and Import Dynamics: The collapse of exports, especially in agricultural and industrial sectors, has contributed to the trade deficit, while rising imports have further exacerbated the imbalance.
• Fiscal Strategy: The government is pursuing a fiscal consolidation plan, which should lead to a decline in the nominal public sector deficit in 2018.
• Economic Outlook: While the current account deficit is expected to widen slightly in 2018, a more balanced economic environment is anticipated in the medium term.
• Risk Exposure: Argentina's heavy reliance on external financing, combined with a volatile global market, increases its exposure to financial shocks and negative sentiment towards emerging markets.

Conclusion

Argentina faces a challenging external and fiscal environment, with twin deficits creating a significant risk profile. Although the fiscal deficit is expected to stabilize in 2018, the current account deficit will likely remain a concern in the short term. The country's dependence on external financing and its limited international reserves make it vulnerable to shifts in global risk sentiment. The report highlights the need for caution and suggests the use of protection instruments to hedge against potential financial risks.