Argentina's Outlook: Bleak

After overcoming a severe financial crisis right and foreign debt default at the start of the decade, Argentina is again in the midst of a financial crisis.

A week doesn't go by without news like this, from Goldman Sachs Global ECS Emerging Markets Research:

Government to Update Public Transportation Tariffs on Monday

Public transportation tariffs (buses, trains, and subway) will rise by 20%-25% on Monday.

The measure is driven by the government’s desire to lower costly budget subsides as government revenue is staring to erode on the back of lower commodity prices and the overall sharp deceleration of economic activity.

This is the second tariff increase in six years; the measure is expected to save the government ARS800 million.

Over the last few years Argentina's neighbor, Chile, used the windfall in copper revenues towards a $21 billion special fund that can bankroll future budgets for nearly a decade. Instead, Argentina used the money from high commodity and agricultural export prices (including soybeans) to increase government spending. Both Néstor Kirchner (president from 2003 to 2007) and his wife, Cristina Fernández (president since December 2007) have vowed to reverse free-market policies, and the economy reflects their approach.

Argentina's economy last year was best summarized in this paragraph:

Argentina also embarked on market-unfriendly moves, boosting government revenue by taking control of private pension funds and raising taxes on agricultural exports. Protesting farmers blocked highways throughout the year. Argentinians began withdrawing money from private bank accounts, fearing government seizure.

The farmers were protesting a proposed sliding-scale taxation system for agricultural exports which eventually didn't pass. A pension nationalization law did pass and was made into law on December 2008. Ten bank-owned pension funds worth over $26 billion were taken over by the government, in an attempt to bolster its finances and prevent a second default in a decade.

The Fernández administration denies that motive, claming instead that the pension funds were mismanaged, and that the global financial crisis made it necessary for the government to step in to protect investors.

The country's investors responded with

a mini-flight of capital to neighbouring Uruguay on fears that the government, in emulation of predecessors, would nationalise bank deposits.

A US district court froze $200 million in Argentinian pension fund assets in the US last month,

Judge Thomas Griesa said the assets should not be transferred abroad because they are now Argentine state property following the government's takeover of the private pension system.

He said the assets are subject to US creditors seeking to recover billions of dollars because their administrator is a government entity.

Investors have lost faith as the

Credit-default-swap spreads on its government debt have surged to horrifying levels, signalling that investors see a high risk of default.

The specter of a default has not vanished, in spite of the pension takeover, since its $21bn in debt-servicing obligations is due this year. Jittery investors are also worried that Ecuador's voluntary default on its debt last month might embolden Fernández to follow Ecuador's precedent.

This Stratfor report spells out the fears:

Setting aside the emotional and financial impact to Argentine workers as they contemplate their futures, the government has ensnared itself in an accounting dilemma. If spending continues in the face of falling revenue and limited credit, Buenos Aires eventually will hit a wall. And so far, its only recourse has been to liquidate what few financial assets remain in-country. Although there could yet be a grand scheme that will compensate for this problem, the government has shown no evidence thus far that one exists. The odds of an outright debt default and a return to the economic crisis of 2002 are growing.

The country's economic disarray has even brought about a small-change shortage.

It comes as no surprise, then that even when bond yields might look attractive, "institutional investors remain reticent about having too many holdings in local bonds."

Fausta Wertz also blogs at faustasblog.com.