Thursday, October 25, 2007

Economic Reckoning Looms

In Argentina's Election 'El Loco' Price Controls Help First Lady Lead, But Inflation Still Rises

October 25, 2007 - WSJ

BUENOS AIRES -- Argentina has had plenty of anti-inflation plans over the years. The current one may be the first that rests heavily on a public servant whom some executives and politicians have nicknamed "El Loco," or the Crazy Man.

The official, Guillermo Moreno, is Argentina's Secretary of Internal Commerce, the government's price policeman. His mission is limiting price markups in the red-hot economy -- at least until the leftist Cristina Kirchner, the wife of the current president, Néstor Kirchner, can win her own bid for president. Elections are scheduled for this Sunday, and she's heavily favored to win.

With the Kirchners' blessing, Mr. Moreno has hammered out price-control agreements with industry, doled out subsidies and imposed export restrictions to keep the domestic market awash in goods. He has also threatened uncooperative businesses with prosecution under a recently resurrected 33-year law against hoarding goods. When none of that worked to restrain prices, a prosecutor has alleged, Mr. Moreno ousted the government statisticians who prepared the consumer price index and installed his own people to massage the numbers. Mr. Moreno denies that; a judge is reviewing the case.

Argentina has often been a standard-bearer for economic trends in Latin America. In the 1990s, it was a leader in the wave of free-market capitalism that swept the region. That ended in a harrowing collapse in 2001. This decade, the Kirchner government has moved toward greater state control over the economy alongside several Latin American countries, including Venezuela, Bolivia and Ecuador. With Latin America divided between those populist governments and countries pursuing free-market economics, the fate of Ms. Kirchner and Argentina could affect policy choices around the region.

As Argentina's governing faction tries to prolong the country's roaring economic recovery -- and maintain its grip on power -- it is waging an increasingly desperate battle to contain inflation. The government's tainted figures put the annual figure at 8%, while most independent economists peg it around twice that high. Rather than cooling off the economy and fixing bottlenecks to future prosperity, Mr. Kirchner's government has been intervening in markets and prices with a heavy hand.

The moves are often proving ineffective and sometimes sow distortions in the economy that could make lasting solutions even more difficult. When Mr. Moreno tried to set potato prices following a bad crop, with a hotline for reporting profiteers, consumers rejected the officially priced spuds as low-quality. ("They were not fit to feed pigs," said a consumer advocate.) Most ominously, artificially low power prices -- one-third the region's average for residential electricity -- have spurred demand while discouraging new investment in electricity and natural gas. That led to power rationing during the last Southern Hemisphere winter in June and July and raised fears about the coming summer months.

Ms. Kirchner, a senator and top adviser to her husband, has been running as the guarantor of his legacy -- a 50% expansion in Argentina's annual economic output in the past five years. Polls show her winning election without the need for a runoff, largely because the boom is the most vigorous in Argentina in the past century. Since Mr. Kirchner took office amid a withering crisis, Argentina has reduced unemployment to about 8% from 18% and taken a big bite out of the poverty rate. His backers note that mainstream economists have frequently scoffed at his policies despite the country's recovery. Mercedes Marcó del Pont, an economist and congresswoman of the Kirchners' party, contends some government intervention in prices is justified to confront inflationary pressures coming from abroad.

The opposition seems too divided to overcome Ms. Kirchner, especially since her husband's government has used the power of incumbency to direct benefits such as pension and wage increases toward key voter blocs. One leading opposition candidate is Roberto Lavagna, Mr. Kirchner's former economy minister who broke with him in 2005 amid disagreements over inflation policy, and wants to restrain government spending to control inflation -- not a popular position. Mr. Lavagna, who also wants to aggressively court investment, derides the Kirchners' policy as "the ostrich plan: You put your head in a hole."

Few expect radical changes in direction under the current first lady, who has been vague about her plans to tackle inflation -- saying only that she wants to broker a pact between business and labor to control prices. At a recent campaign event, Ms. Kirchner boasted her husband's government has produced "an upward social mobility that hasn't occurred in a long time." The Kirchners decided she would be the candidate as Mr. Kirchner's still-high popularity was beginning to ebb, analysts say.

Ms. Kirchner represents "a change in the packaging, but basically the same ideas as her husband," says Herman Weiss, president of the Argentine operations of Chubb Corp., the Warren, N.J., based insurer. It's unclear whether Mr. Moreno, who got his "El Loco" nickname for his hard-nosed style in dealings with business executives over prices, will stay on after the election, but it seems inevitable that the government will maintain an interventionist posture. Mr. Moreno, also derided as "El Sheriff" and "El Taliban," has described himself as simply "a soldier" of the government.

The surest way most economists see to curb demand and upgrade the overburdened infrastructure is through price increases that could spark a nasty backlash on the street. The International Monetary Fund has specifically suggested Argentina get a tighter grip on spending and allow the peso to appreciate, to pursue a "soft landing" with low inflation. The Kirchner government counters that the IMF gives bad advice and the cheap peso is needed to keep its exports up. It also helps boost government tax receipts on agricultural exports, which are denominated in dollars.

The Kirchners' effort to suppress inflation is the latest chapter in a country whose economic history is replete with booms, busts and risky financial experiments that still affect its current dynamics. In reaction to runaway inflation, Argentina pegged its peso to the dollar and adopted an array of free-market policies in 1991. The currency gimmick cured inflation and, combined with measures like privatization of state businesses and trade liberalization, ignited a brief period of growth. But the monetary straitjacket, at a time when global commodity prices and the strong dollar made Argentine exports expensive, limited policymakers from stimulating the deflating economy. It finally led to an economic collapse amid street riots in 2001.

While Argentina was still trying to find its way out of a mammoth recession in 2003, Mr. Kirchner, a little-known Patagonian governor, emerged as the standard-bearer for the party of legendary strongman Juan Domingo Perón, and was elected president. At that point, with the poverty rate just above 50%, many better-known political figures simply didn't want the job. But Argentina's luck was beginning to turn.

From his predecessor, Mr. Kirchner inherited as economy minister Mr. Lavagna, who planned to restore economic confidence by building up the "the twin surpluses." He used a tax on soybean exports to produce a budget surplus in a chronically deficit-ridden government. Applying capital controls and heavy intervention on currency markets, Mr. Lavagna kept the peso undervalued, stimulating exports and helping build a huge trade surplus. It happened that Argentina got a providential tail wind from China's economic boom, which has led to higher prices for Argentina's agricultural commodities.

Argentina habitually tweaked the international financial establishment. Mr. Kirchner infuriated international financiers by paying bondholders only about 30 cents on the dollar after a massive default. He paid off Argentina's entire $9.8 billion debt to the International Monetary Fund, just to have it out of his hair, and began accepting assistance from the Venezuelan leftist Hugo Chávez.

The combination of high commodity prices, extra resources from stiffing creditors, and Mr. Lavagna's "twin surpluses" put Argentina on a roll again. Shoppers and tourists filled Buenos Aires boulevards that not long before had been occupied by pot-banging protestors. Banks, previously boarded up to keep out demonstrators, began competing to hand out credit cards and consumer loans.

Then in 2005 Mr. Kirchner dumped Mr. Lavagna and started taking a more hands-on role in running the economy. Mr. Kirchner has ramped up spending, helping to fuel inflation. The government's fiscal surplus is rapidly shrinking due to subsidies for energy, as well as goodies for pensioners, some public-sector workers and other key constituencies. There are also inflationary pressures from the higher international prices for Argentine agricultural commodities, which are blowing back to cash registers at home.

With Mr. Lavagna gone, Mr. Kirchner bet heavily on Mr. Moreno and a new Internal Commerce secretariat to keep a lid on inflation. Mr. Moreno has used his sweeping powers to thrash out ostensibly voluntary price-control agreements with a range of businesses from supermarkets to soft drink bottlers. Businesses that resist the agreements can find that they really aren't so voluntary after all. Mr. Kirchner often excoriates business people who get too greedy as "rogues who want to earn a little more and do damage to the country."

Mr. Kirchner has carried on a running feud with the Argentine unit of Royal Dutch Shell PLC, which has a refining operation and hundreds of service stations here. Shell's problems started in 2005 when it raised pump prices in line with rising international oil prices. Mr. Kirchner immediately used his bully pulpit to call for a boycott of Shell, urging Argentines to refrain from buying "even a can of oil." The company quickly rescinded a gasoline price increase after pro-government protestors marched on its service stations.

Things got hotter for Shell last December when the government accused it of failing to stock sufficient supplies of diesel fuel. Using the 1974 antihoarding law promulgated under Mr. Perón, Mr. Moreno has levied fines of almost $20 million against the company and sought jail time for the company's local president, an Argentine citizen. Shell, which says it did nothing wrong and is contesting the charges in an Argentine court, maintains it is being singled out for harsh treatment. Shell says it has been the target of close to two-thirds of the about 800 Internal Commerce inspections in the fuel business, though it accounts for only 13% of the diesel market.

Government controls have also caused havoc in the beef industry. Argentines are the world's biggest beef eaters -- annually consuming around 140 pounds per person -- and the government made a priority of trying to keep low-coast beef in supermarkets and butcher shops.

The government last year banned beef exports for a time. Continued restrictions will limit beef sold abroad this year to around 60% of 2005's volume, the industry says. Mr. Moreno also took control of Argentina's main cattle market for several months and tried fixing a maximum price. He only succeeded in stimulating a black market for cattle. When beef producers balked at price constraints early this year, the government temporarily shut down three slaughterhouses over a variety of alleged administrative or bookkeeping violations.

The interference has been the last straw prompting some cattlemen to scale down their herds and turn their lands over to the more lucrative cultivation of soybeans and wheat. "It is impossible to design a business plan with policies that are so changeable," says cattleman Alberto Lasmartres Moyano, who has reduced his herd to 2,000 head from 8,000. Meanwhile, Argentine supermarkets and butcher shops still have periodic problems with the supply and quality of meat, with more expected.

Mr. Moreno increasingly seems like the boy with his thumb in the dike. Consumer groups say that some businesses have been outfoxing price controllers by putting products in smaller volume packages. Mr. Moreno has touted an agreement with bakeries to produce "economical bread" at about 35 cents a pound. But the taste was so bad few bakeries could sell it.

Working Argentines are beginning to find inflation offsetting some of the past years' prosperity. With a recent weather-related spike in some food prices, the poorest fifth of Argentine families would have to spend all their income just to maintain normal consumption of tomatoes, squash and potatoes, according to consumer activist Pedro Bussetti. Marina Pardo, a housewife and mother of four, says she's substituting rice for fresh produce. "There are some foods we can no longer afford," she says.

Unable to halt the march of inflation, the Kirchner government moved early this year to cover it up, according to a prosecutor conducting an administrative misconduct inquiry. The prosecutor's report says Mr. Moreno's new statisticians began "accommodating the numbers to political necessity," in a way that was "deceiving." Mr. Moreno wouldn't comment for this article, but recently told Argentine reporters that the index "reflects reality" and has denied any manipulation.

Increasingly, consultants and consumer groups are preparing their own inflation indexes, which tell a different story. Amanda Ruybal, a price surveyor for the independent Center for Education of the Consumer, might have been in an alternative universe for all her recent supermarket survey had in common with the government's. The official price index showed a dozen eggs cost 3.13 pesos; Ms. Ruybal found them for 4.45. Officially, a package of ravioli cost 4.45 pesos but she found it at 6.49. "You have to trust your own eyes these days, not the index," Ms. Ruybal said.

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