Argentina's Macri seeks mandate for reforms

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Will Mauricio Macri's strategy work? Argentina's midterm elections on Sunday will be a test of the president's plan to turn around the country and move it on from its populist past, says Benedict Mander. Mr. Macri will be seeking a bigger mandate for his reform agenda to satisfy both the people and investors. But, as he says, Argentina needs to become a country of realities, not just potential.

Few have navigated Argentina's erratic economy as shrewdly as Eduardo Eurnekian. Despite a half century of recurring financial crises, the 84-year-old billionaire has come out on top. He now controls one of the world's largest private airport operators, as well as a string of other businesses.

But the protectionism that critics say has long held businessmen like Mr. Eurnekian is set to end as part of President Mauricio Macri's drive to modernise Argentina. Sensing the shift, Mr. Eurnekian is moving into a business that would have been almost unthinkable only a few years ago in a country infamous for cronyism, debt defaults, and high inflation-- mobile banking. Mr. Eurnekian, who is backing Walap, Argentina's first online-only bank, says, there is no way we are going back to the past. Globalisation will either absorb us or it will not. There is no halfway house.

Many want to believe Mr. Eurnekian, not least global investors who have brought over $54 billion of Argentine bonds since the country splashed back into the international capital markets in March 2016 after a decade of abstinence. They, like Mr. Eurnekian and many others, have bought into the Macri plan to turn around the G20 country and move it on from the shadow of its populist past. Their hopes will be tested on Sunday in midterm elections widely seen as a referendum on Mr. Macri, who took power in 2015.

The 58-year-old engineer and former businessman is the first of the new wave of technocratic presidents in a region that, out of character, is mostly rejecting populism. Polls predict Mr. Macri's coalition could win close to 40% of the national vote, an improvement on the 34% it won in the presidential race, and extend its control over Congress. In turn, that would allow Mr. Macri to press ahead with structural reforms and cement the macroeconomic stabilisation he began when he took power in December 2015.

Eduardo Levy Yeyati, an economist and government adviser, says, without political support, these reforms are not going to get anywhere. At stake is what critics have called Mr. Macri's neoliberal agenda, which includes shrinking the size of the state and slashing trade barriers. One of his greatest challenges is to convince investors that Argentina really is leaving its volatile past behind in order to attract enough investment to unlock growth and reverse a century of decline.

Unusually for the region, Mr. Macri's programme has won plaudits from both Donald Trump and his predecessor as US President, Barack Obama. But even if he wins the domestic political support he needs, many problems lie ahead. Some of the biggest risks stem from the gradualist agenda that Mr. Macri has pursued to sweeten the bitter pill of his reforms.

Apart from some sweeping macroeconomic measures, such as lifting currency controls, his decision to maintain or expand social programmes has kept the fiscal deficit uncomfortably wide. To many, this echoes past efforts to plug the chronic fiscal deficit with international borrowing, all of which have ended badly. Critics observe that the government has borrowed more than almost any other emerging market nation since Mr. Macri took office. Mr. Levy Yeyati says, the fear is that one day investors could calculate the debt has grown too much. It is the age-old structural problem that Argentina has always suffered from.

So far, the Macri strategy appears to be working. Solid progress has been made in unpicking the legacy of his populist predecessor, Cristina Fernandez de Kirchner, who bequeath a cat's cradle of economic distortions, including price controls, and a central bank that had almost run out of foreign exchange reserves, leaving the country on the verge of a balance of payments crisis.

Alfonso Prat-Gay, Mr. Macri's first finance minister, says, we had to avoid a financial crisis, referring to an economic rebound that is likely to favour the government in Sunday's vote. He adds, we always knew that our decisions were going to bear fruit very close to the elections. Although he resigned late last year, Mr. Prat-Gay still supports the government, having laid the foundations for gross domestic product to grow around 3% this year, driven by the construction and banking sectors, while inflation has halved from its peak of 44% in July 2016.

After the elections, the government says it plans to double down on its reform agenda, tackling issues that require cross-party support. Officials say fiscal, tax, labour, and capital market reforms will be presented to Congress before the end of the year. Mr. Macri told business leaders last week, this is just the beginning. We still have many battles to fight. We are no longer going to be the country of potential, but the country of realities.

Yet, even if Mr. Macri's Cambiemos, or Let's Change, coalition does well in the vote, the measures will still face resistance. The latest opinion polls suggest it could increase the seats it controls in the lower house of Congress from 89 to around 105. But that would still fall short of the 130 it needs for overall control. Similarly, in the Senate, Cambiemos is likely to grow from 18 seats to around 25, again, leaving it short of the majority.

In addition, powerful trade unions are expected to oppose attempts to make the labour markets more flexible, while regional governors, whose support Mr. Macri needs to build coalitions and pass legislation, are likely to resist attempts to rein in spending. The picture would potentially be far worse for Cambiemos if it were not for the disarray in the main opposition. Nothing illustrates the crisis in Peronism better than the fact that Mrs. Fernandez, tarnished by corruption allegations including bribery and embezzlement-- charges that she denies-- remains its most influential figure.

Complicating matters, she has put together her own coalition, Unidad Ciudadana, Citizen's Unity, for the midterm elections.

Arguably the most powerful politician in the nation for almost a decade, the 64-year-old leftist is struggling in the polls in her contest for a senatorial seat. That is, despite running for the most populous province of Buenos Aires, usually a bedrock of Peronism, and a dominant political movement in Argentine politics for the last 70 years, and against the relative unknown. Gustavo Marangoni, a former adviser to Ms. Fernandez's successor, Daniel Scioli, the loser in the 2015 presidential election, says, for Peronism, Christina is like a Chinese vase-- large, but there is nowhere to put it. It's very easy for Mr. Macri to govern when your opposition is failing.

Mr. Macri has also benefited from flattering contrasts with his predecessor, whose second term was marked by economic stagnation and a bitter battle with bondholders after a 2014 default. Despite scandals over conflicts of interest, he appeared on the list of offshore accounts published in the Panama Papers as the director of a shell company and was accused of favouring a company owned by his father.

Mr. Macri is the most popular president in Latin America. His approval ratings hit 54% in September, up from 45% in July, according to Poliarquia. Luis Toneilli, a political scientist, argues that few Argentines want to return to the past. He says, Cristina gives energy to Macri. She helps to remind everyone that the past is just around the corner.

While the domestic political situation appears to favour Mr. Macri, he has yet to confirm that he will seek re-election in 2019, but many analysts think he would win. The greatest risks lie abroad. The gradual macroeconomic rebalancing that he is pursuing depends on Argentina's continued ability to access international credit to finance its fiscal deficit.

For now, Argentina's debt remains relatively low after a decade of being frozen out of bond markets. Economists at Bank of America Merrill Lynch estimate government debt at 24.3% of GDP, excluding intra-public sector debt. Given the global context of low interest rates and yield-hungry investors, the government's dependence on international credit is unlikely to present a problem before the 2019 elections. By then, the government is aiming for a primary deficit of 2.2% and inflation of 5%.

Yet Argentina's external vulnerability is compounded by deep-seated issues that make it hard to compete in global markets, with the notable exception of its highly advanced agricultural sector. Mr. Macri's efforts to open up Argentina's hyper-protected economy have so far only led to a surge in imports. Walter Stoeppelwerth, head of research at Balanz Capital, an Argentine investment bank, says, the current account deficit is running wild. With foreign direct investment failing to pick up the slack, he expects bulging trade and tourism deficits to generate a current account gap of as much as 5% this year, compared with 2.7% in 2016. He adds, this is Argentina's Achilles heel.

The exchange rate is another problem. Economists estimate that the peso is overvalued by around 15% to 20%, and it will probably stay like that while inflation continues at around 21%. High interest rates are slowly wringing inflation out of the economy, but continue to attract hot money flares from abroad, strengthening the exchange rate father.

Mario Blejer, a former central bank governor, remains optimistic. He argues that the key to improving long-term competitiveness depends on productivity growth, which in turn depends on investment. He says, the key factor regarding whether this will be a solid recovery or just another of the ups and downs of the past 100 years is how much investment we can attract.

The early signs are that productivity is indeed rising, in part by prioritising projects on economic rather than political grounds and increasing transparency. The so-called multiplier effect of public investment has tripled to 7.5% of GDP under Mr. Macri, according to the central bank. Private sector investment is also finally beginning to pick up. The political continuity signalled by the elections is expected to provide a further boost.

Noah Mamet, former US ambassador in Buenos Aires, who has returned to the private sector, says, it took a year and a half for investors and companies to get comfortable with the idea of investing in Argentina, but now I'm being contacted several times a day. There are a few more dangerous phrases in investment than this time is different. There have been too many false dawns in Argentina's past when governments have come to power riding a wave of optimism only to end in crisis.

But Mr. Blejer believes it really is different this time. Why? he asks. Because this government doesn't believe in magic. He argues that his policy choices are realistic and have so far been competently executed. There is nothing inherently wrong with borrowing to spur growth, he says, adding, if we are going to implement policy here only based on history, then we had better close the country.