The Effects of Argentina’s Currency Devaluation in Latin America

For the past four years, the Argentine economy has been shaken by a string of decisions from a government that once enjoyed full approval and an economic might that seemed unparalleled and that today is being mocked for its unpreparedness and poor timing, to say the least. Yet, to understand the Argentinean problem, we have to look deeper into the roots of it and understand that it is more about a fractured political model than just a bad set of reversible policies. And that it has consequences for the entire Latin American continent.

A little bit of the Economic and Political history of Argentina

Image courtesy of http://www.kirkgallery.com/
Image courtesy of http://www.kirkgallery.com/

That Argentina has been battling against poor management is an understatement. Having undergone one of the deepest processes of privatization of public companies and known for its high levels of corruption, bank runs and the largest government default in history, the country seemed to have found its way back to growth when in 2003, then-President Nestor Kirchner arrived to power. After years of unprecedented success, born from a strong relationship with rising-giant China, a never-ending increase of prices of agricultural and energy products, and an iron fist on taxation, it was as if the model of President Kirchner and President Cristina Fernandez was opening the way to a new era for the South American power.

Once known as the barn of the world, Argentina was right where it belonged. It started befriending the likes of Venezuela, Bolivia, Angola and Iran because it was possible to and speaking about its model to everyone who wanted to hear it. But then, a set of policies to increase incomes (including but not limited to the seizure of public pension funds and a whopping 35% tax hike on soy exports) made some investors check again whether or not to put money in this corner of the world. Social plans, strong subsidies for utilities and shopping sprees for military products, begun hurting the country’s bottom line, depleting little by little the foreign exchange reserves it had so well increased. Then, the loss of confidence in the political class set off something very common for this country: deposits first started flying out of the country and then, it was pure bleeding.

On the way to devaluation

The government responded with resolution, with an overall program to heal the wound that included charges on purchases made abroad (both online and during trips), forbidding the purchase of US dollars without consent of the government and taxation over basically every import made and every profit received. The black market for dollars exploded and today’s gap between the official exchange rate and the unofficial stands at a staggering 50%, and it has known even higher levels. Projects to invest in the country stalled, inflation soared to the second highest level in Latin America, income from tourism plummeted and savings, both from households and the government disappeared.

And then last week unraveled, with a wide array of prohibitions, permissions and public relations disasters from a cabinet that now looks more improvised than ever, trying to find answers to problems it once said did not exist[1]. The biggest decision of course, was to let the official exchange rate go with the market and then the possibility to again buy dollars, at least for imports, exports and personal savings.

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Importance for Latin American businesses

The first and most important shock so far has been on Spanish investments: Telefonica, BBVA and Santander[2] all saw drops in the prices of their shares because of the exposure they have to Argentine assets.  And in the list, we are not counting oil giant YPF, who is negotiating its payment for the expropriation of its operations. If the bonds of Argentina lose value (and they will if inflation keeps on the rise and the currency further weakens), all these companies should brace for large losses. And consequentially, countries with strong presence of Spanish companies such as Brazil, Uruguay, Chile, Colombia, Venezuela and Panama[3] should start considering some project being cut-back or discarded, as less money is available for them.

Image courtesy of http://cdn.lightgalleries.net/
Image courtesy of http://cdn.lightgalleries.net/

In addition to just the traditional economic fears, the current devaluation could substantially affect the political history of the country. With examples such as Brazil, Venezuela, Ecuador, Nicaragua, and other countries in the region, one of the unintended consequences of the current economic crisis could be a return to power of the previous populist and communist party leaders. Such a measure could help destabilize even more the precarious balance that the region has experienced during the last 10 years, and reduce even more the ability of the regional countries to continue developing their economies, and to integrate to the overall worldwide economy.

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Apart from companies backing down from new projects, the way in which these events affect the rest of the Latin American economy remains unclear. Still, some assumptions can be made on how this will end up shaping the months to come:

Argentina’s biggest trading partners are also among its most fierce competitors. The global economy is changing, going back to a stronger dollar (and a stronger overall American economy) and as a response, influxes of money will be returning to the US for better, safer returns. Some of those emerging markets are in Latin America and include almost all countries of the continent. A strong relationship with both Asia and the US will shield Chile, Peru and Colombia and the size of its economies will also protect Uruguay and Paraguay to some extent.

Brazil’s case however, is the grimmest and President Dilma has tried to assure investors in Davos, Switzerland (as part of the World Economic Forum)[4]that her government will not follow the same path of Argentina. Nevertheless, Brazil is the largest of Latin America’s emerging economies and will suffer greatly from the tapering measures of the Federal Reserve Bank of the US. As a competitor for investment projects, oil and gas sales and agricultural products (soy for example is the best-selling crop of both countries) the fact that Argentina’s products become cheaper – as every dollar is worth more Argentinean Pesos – will affect the performance of the Real, which will likely need a readjustment in the near future. The effects of a Brazilian devaluation will be far-reaching and in that case, only countries with strong diversification such as Chile and Peru will result more or less unharmed.

Summary

013114 Argentina Currency Devaluation
Image courtesy of http://www.divergingmarkets.com/

In any case, the effects of Argentina are not only important for what they could mean to investors from outside when trying to choose Latin America but also because of the way prices will increase, if a devaluation race starts. Chile, Colombia and Peru have all started letting their currencies float a bit more[5], bracing for the changes to come. That will impact certainly impact prices and in turn, will make it more costly to invest in the Latin American markets. Needless to say, the political and social implications of high inflation would interfere with strategies to bring investments and the way in which governments act in front of these situations will shape the years to come[6]. Investments that haven’t been done in education, transportation and technology are far less probable to happen in the years to follow, because of its costs and not doing them would mean losing even more competitiveness to other markets in the world.

The Argentinean example, as distant as it can seem from others in the continent offers a glimpse of what happens when trying to curtail free market in an inter-connected global world. And it also strengthens a lesson that Latin America is painfully learning in some of its richest regions: growth, if not coupled with wise decisions and long-term goals, will not be enough to sustain models that rely on giving the people what it wants today instead of tools to keep it tomorrow.

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Jorge Mastrapa

Managing Director at Inloso LLC
Dr. Jorge Mastrapa is an international author, speaker, executive coach, and entrepreneur. His areas of expertise include cultural diversity, global leadership, organizational culture, and human capital management.

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CC BY-NC 4.0 The Effects of Argentina’s Currency Devaluation in Latin America by Inloso is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.

About Jorge Mastrapa

Dr. Jorge Mastrapa is an international author, speaker, executive coach, and entrepreneur. His areas of expertise include cultural diversity, global leadership, organizational culture, and human capital management.

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