Argentina: Provincial Update

A collective sigh of relief blew through the corridors in La Plata, after the provincial government retapped the international capital markets for an additional $250 million. This brought the government’s total bond placement to $800 million, and it allowed it to end the year without any worries or concerns. The smiling faces of provincial officials were a sharp contrast to somber demeanour of only six months ago. Fortunately, some of the provinces are doing very well, thanks to the surge in commodity prices and Brazil’s ravenous appetite for Argentine exports. The Provinces of Chubut, Mendoza, Neuquén and Salta are booming thanks to rising energy prices. The Provinces of Buenos Aires, Cordoba and Santa Fe, the major manufacturing centers in Argentina, are benefiting from the record level of automobile exports to Brazil and the rise in soybean prices. Exports from the Province of Buenos Aires rose more than 16% since 2005, and 38% of its embarkations are destined for Brazil. Like the rest of the country, the Province of Buenos Aires enjoyed an enormous boost in competitiveness due to the massive appreciation of the Brazilian currency. We estimate that the Argentine peso is almost 40% undervalued to the Brazilian real. This is why we believe that the biggest threat to Argentina is an unexpected and abrupt slowdown in Brazil.

The improvement in economic activity helped boost prosperity in the provinces. The unemployment rate in the Province of Buenos Aires, for example, dropped to 9% in June 2010, from a level of 12.7% in 2005, and the poverty rate plunged by almost two-thirds, collapsing to 13.8% from a level of 35.3% in 2005. It is also why Governor Daniel Scioli is such a popular figure, with a 52.3% approval rating. His ability to grow his tax base and access the international capital markets is the reason why he has been able to break free from the apron strings of the federal government. The Province of Buenos Aires generates almost 60% of its own tax revenues, while other provinces are almost completely dependent on federal transfers. Fortunately, tax collection receipts have been growing at an accumulated pace of 29% since 2007 in the Province of Buenos Aires, due to a high level of economic activity and several tax reforms. During the first half of this year, tax receipts increased 17% y/y. However, rising wages and inflationary pressures also pushed up expenditures. As a result, the province is expected to post a primary fiscal deficit of $1 billion and an operational shortfall of $1.3 billion. Nevertheless, the recent bond issuance, along with an active local treasury bill program, will allow it to comfortably close its books in 2010. Prudent liability management and a booming economy also allowed it to reduce its debt load to 11.4% of GDP in 2009, from a level of 15.4%. This gives the Province of Buenos Aires a very good bill of health.

However, one of the major problems facing the provinces is the lingering legacies of the public sector tariff subsides. In the aftermath of the maxi-devaluation of 2002, the federal government was forced to break the privatization contracts. Almost all of the concession contracts allowed the utility companies to set their rates in dollars. However, the government was forced to redenominate the tariffs in pesos, as well freeze them in nominal terms. As a result, utility rates plunged in real terms, as the currency went from 1:1 to 4:1 and inflation soared. Faced with a possible collapse of the public utility system, the federal government was forced to keep it alive through major subsidies. Slowly, the government phased out some of the tariff controls, but it was unable to make significant headway in electricity, gas and transportation. Today, those subsidies account for 2% of GDP. It is, by far, the biggest distortion for the government and the economy. With the demise of President Kirchner, the government now needs to bring them to an end. In the meantime, the federal government will have to hold back co-participation receipts from the provinces in order to keep the fiscal accounts in the black. While the economic impact on provinces with strong energy-related royalties, such as Chubut, Salta, Neuquén and Mendoza, will be limited, the effect on many of the other regional governments will be hard. Likewise, provinces with strong industrial bases, such as the Province of Buenos Aires, the City of Buenos Aires, Santa Fe and Cordoba, will be able to survive by generating their own tax revenues. Still, it leaves more than a dozen other provincial governments in dire straits. Therefore, the provincial picture in Argentina is mixed. About a third of the local governments are in good shape, but the rest are being squeezed by the federal government, mainly due to the high costs of subsidies.