Hold The Sighs Of Relief

As Argentine President Carlos Menem counts down to Election Day on May 14, the winds seem to be blowing in his favor. Opinion polls give him a wide lead to win another four years in office. The Buenos Aires stock index has recovered by 60% from its Mar. 9 low, as investors who fled from emerging economies after the collapse of Mexico's peso signal their renewed faith in Argentina. And a bank-deposit guarantee plan announced on Apr. 14 by Economy Minister Domingo Cavallo has slowed a run on beleaguered Argentine banks.

Yet even if Menem is reelected, he and his team are not out of the woods. While Argentines have so far accepted the belt-tightening imposed to shore up the peso, they still face years of austerity. They must start living within their means because they can no longer depend on hot-money inflows to finance the trade deficit, which ballooned to $5.8 billion last year. The painful adjustment is expected to brake the growth of gross domestic product to a scant 1% this year from an average 7.5% annually in the past four years (chart). To meet payments on the country's $80 billion debt, the government and Congress will have to impose further spending cuts and tax hikes. Unemployment is expected to jump to 14% this year, up from 11.5% in 1994, as hard-pressed companies shed workers or go out of business. "If [policy is] not austere enough, we'll have another crisis, and it could be worse," warns Abel Viglione, an economist at Buenos Aires' Foundation of Latin American Economic Research.

BANK BUYOUTS. For now, the government seems to have averted such a situation. Tax increases and spending cuts in recent months, backed by $6 billion in credits from the International Monetary Fund and other lenders, have braked a flight of capital. The exodus dropped Argentine currency reserves from $16 billion at year-end to as low as $10 billion on Mar. 30, threatening to force devaluation of the peso after four years of 1-to-1 dollar convertibility.

If Menem defeats opposing candidates of the center-left Radical Civic Union and Frepaso, a third-party coalition, skittish depositors who have pulled $8 billion out of Argentine banks are likely to return some of their funds, thus easing a severe shortage of bank credit. In addition, a bank-deposit guarantee plan announced by Cavallo on Apr. 14 has slowed, though not halted, the decline of deposits to $38 billion in late April, down from $46 billion on Dec. 19, before the Mexican crisis. Now, bank accounts will be guaranteed up to $20,000 per depositor, backed by a $2 billion fund to be raised from levies on all deposits.

Two fiduciary funds totaling $3 billion will further shore up the banking system. They are being set up with money from the World Bank and Inter-American Development Bank and from a $2 billion, three-year issue of government bonds that holders will be able to swap for credits against Argentine corporate taxes. Citibank and Deutsche Bank, acting as sales agents, have peddled half of the issue to international banks, while local and foreign companies doing business in Argentina have bought the other half. Mainly, the funds will help bigger banks buy out smaller, troubled ones--particularly provincial government-owned banks, which are among those in the worst shape.

But the scarcity and high cost of bank credit remains a severe threat to Argentine businesses. Although interest rates on 30-day peso loans have dropped below 20%, down from 70% in early March, there's still a danger of cascading defaults. On Avenida Santa Fe, Buenos Aires' main shopping street, many of the biggest-name stores have shut down, and the national merchant association estimates that tens of thousands of businesses have already closed.

Manufacturers, particularly small and medium-size companies, faced added pressure from foreign competitors with access to cheaper credit as well as lower costs and better technology. EICA, a 70-employee company that makes valves and auto parts in Buenos Aires province, once thrived as a supplier to YPF, formerly the national oil company. But recently, foreign makers undercut EICA's prices by one-third on bids to supply valves for plants of the now-privatized YPF. "The whole game has changed," says EICA Director Armando Schatz, who is looking abroad for a joint venture or license in order to obtain credit and better technology.

To offset plummeting domestic sales, Argentine producers will also have to step up exports, particularly to Brazil, which expects 5% GDP growth this year. "We are now Brazil-dependent," says economist Miguel Angel Broda. Exports are expected to rise 30% this year, eliminating the trade deficit that has been a root cause of Argentina's financial troubles (chart).

NEW STRENGTH? At the same time, the country must wean itself from dependence on rich but fickle foreign investors. The flood of speculative capital that formerly poured in has shrunk drastically since the Mexico crisis. It financed 50% of economic growth in recent years, economist Carlos Rivas estimates. Now, even though foreign investors in stocks and bonds appear to be returning cautiously to Argentina, such "hot money" flows aren't likely to regain past levels. "That's the difference between 5% and 9% growth" of GDP, Rivas says.

Still, despite the skittishness of portfolio money, Argentina keeps attracting long-term corporate investors--such as General Motors Corp., which plans to spend $1.1 billion on an assembly plant, parts manufacturing, and other investments over the next four years. "If anything, Argentina will come out stronger" from the crisis, says David C. Mulford, vice-chairman of investment bank CS First Boston. But on the way to economic strength, Argentines have plenty of pain to endure. For Menem, winning the election may be only half the battle.

    Before it's here, it's on the Bloomberg Terminal.