Argentina—Latin America's third-largest economy and second-largest country geographically—may soon default as it struggles to repay heavy government borrowing.
The country's central bank has boosted interest rates to historically high levels and the national currency (the peso) is down 45% against the U.S. dollar over the past year.
After the peso collapse, the MSCI Argentina index has slid almost 60% since the beginning of 2018—with more downside performance expected as President Mauricio Macri and his pro-business government face an uphill climb in stabilizing the country's currency and solving its mounting economic problems.
Trouble Behind—Trouble Ahead
For U.S. companies and other foreign investors engaged in Argentinian commerce, the traffic lights are flashing bright red.
That scenario heightens the business risk for companies operating in and around Argentina in myriad ways, with emerging currency and payment issues, business fees and taxes skyrocketing, an unstable business climate, and higher operating costs when doing business in Argentina all very much in play.
To provide some clarity, let's take a deeper dive into Argentina's currency crisis and its impact on business operating in the Latin American country. The following issues are at the top of the list:
Currency issues are only going to get worse.
President Macri took what he thought were corrective steps to stem Argentina's currency woes by tasking the International Monetary Fund to prioritize a $50 billion aid package to defuse the currency skid.
Argentinian interest rates have skyrocketed from 45% to 60% which makes it exponentially more expensive to do business there.
That move backfired immediately as the peso dropped further at the end of August, causing the Argentinian government to already skyrocketing interest rates from 45% to 60%. That makes it exponentially more expensive to do business in Argentina, hikes borrowing costs, and moves investment cash away from the region, which only feeds the country's downward economic cycle.
The U.S. dollar is dominating the peso – and the gap is widening.
Foreign currency issues were bad enough in 2017 when a single U.S. dollar was worth 17.40 Argentinian pesos. While economists predicted a continuing decline against the dollar in 2018—a 30% drop was a consensus number at the start of 2018—the damage is far worse. As September opens up, the dollar is trading at 38 pesos, representing a 54% decline against the Argentinian currency.
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Inflation is cutting into Argentine economic growth—and making it less attractive as an export destination.
While economists predicted a 30% decline against the dollar in 2018, the actual damage is far worse.
The exchange rate in free fall has accelerated inflation in Argentina - which means trouble. The Macri governing coalition has struggled to reduce rising Argentinian debt. The International Monetary Fund pegs Argentina country debt at 65% of GDP before falling to 56% by 2021.Years of government spending on popular government programs, like curbs on utility bills, has led to huge deficits in Argentina and driven inflation northward to 31.20% at the end of July 2018.
A burgeoning inflation rate not only reduces the purchasing power of local consumers, it also negatively impacts foreign direct investment, as it increases the cost of borrowing money in Argentina, and drives up the price of commodities, infrastructure development, and in-country goods and services.
Foreign currency reserves are a rising issue.
Foreign currency risks in Argentina have become a hot-button issue as the Macri government has sold billions of foreign currency reserves to bolster the nation's currency. That has drained all-important Argentinian currency reserves, causing further downward pressure on the peso, and is triggering a vote of “no confidence" among foreign companies who might otherwise be pouring capital into a country that badly needs it.
A “Perfect Storm"
Call it an economic perfect storm that shows few signs of abating. Certainly, Argentina and President Macri have experienced some bad luck - like massive droughts which devastated the country's soy crop, a major commodity in Argentina. But there have been a number of unforced errors as well, especially in not seeing the peso free-fall coming and by sending mixed signals to out-of-country investors.
The result? Foreign investors are side-stepping Argentina in growing numbers, causing a massive reduction in capital inflows to Argentina.
That hammers the peso even further downward, reduces household income in the country, snaps consumer and business wallets shut, and hamstrings foreign companies doing business in Argentina—all as uncertainty looms over the country's economic landscape.
The takeaway? Expect things to get worse in Argentina before they get better, and expect foreign companies doing business in the Latin American region to gauge their risk exposure—and act accordingly.