Argentina Downgraded to Kazakhstan on Foreign Fund Restrictions

By Bill Faries

March 23 (Bloomberg) -- In February, landslides tore through the northern Argentine town of Tartagal, leaving 10,000 people homeless.

Since President Cristina Fernandez de Kirchner was on a trip to Spain, her vice president, Julio Cobos, headed to the airport to board a presidential plane to visit the stricken region.

Cobos, 54, says he waited an hour and a half, but the plane never arrived to pick him up. From Madrid, Fernandez, who hasn’t spoken to her second in command since July 2008, had instead dispatched her interior minister to oversee the government’s aid efforts.

“It’s not the type of relationship I want, but you get used to it,” says Cobos, an engineer and former governor of Mendoza province. Fernandez has snubbed him since he cast the deciding vote in Congress against her plan to raise farm taxes last July.

Unexpected moves have been a hallmark of Fernandez’s administration since December 2007, when she succeeded her husband, Nestor Kirchner, 59, as president.

Fernandez, 56, began her term amid scandal after customs police stopped a man at a Buenos Aires airport carrying $800,000 in cash he said was a campaign contribution from Venezuelan President Hugo Chavez.

Nationalization Plans

On Oct. 21, Fernandez suddenly announced plans to nationalize 10 pension fund companies holding $24 billion of assets. The benchmark Merval Index dropped 11 percent that day -- its biggest decline in a decade. Then on March 13, she called on Congress to move up the country’s legislative elections four months to June 28. A week earlier, her husband had criticized a regional governor who called for such a change.

Fernandez’s shifts of direction have left investors leery. “I don’t think anyone has successfully predicted the moves of this government, to put it mildly,” says Dario Pedrajo, who manages about $100 million in emerging-market bonds at Kapax Investment Advisers in Coral Gables, Florida. Pedrajo doesn’t own Argentine debt.

Roberto Sanchez-Dahl, who manages $300 million in emerging-market debt including some of Argentina’s at Federated Investment Management Co. in Pittsburgh, agrees. “It’s very hard for companies to make any investment plans when the government’s policies change every few weeks,” he says.

‘Frontier’ Economy

MSCI Barra, whose stock indexes are tracked by investors with $3 trillion in funds, downgraded the country to a “frontier” economy from an “emerging market” in February, citing its restrictions on foreign capital. That puts South America’s second-biggest economy, after Brazil, in a category with Sri Lanka and Kazakhstan.

On March 20, the Merval stood at 672.31, down more than 50 percent from a year earlier. By comparison, Brazil’s Bovespa and Mexico’s Bolsa declined about 40 percent during the same period. Argentina’s economy is foundering. After more than five years of annual economic growth faster than 8 percent under Kirchner, it will shrink 1.1 percent this year, putting it on track for the first recession since 2002, according to a Bloomberg survey of eight economists.

Access to fresh international loans is blocked by lawsuits from holders of $20 billion of bonds the country defaulted on in late 2001; an additional $140 billion of outstanding debt trades at default levels.

‘Prospects Aren’t Good’

Government estimates of indicators such as inflation, meanwhile, diverge sharply from those of independent economists. “Argentina’s short-term prospects aren’t good,” former Economy Minister Domingo Cavallo says in his office in Buenos Aires’s wealthy Palermo neighborhood. “The only thing this government can do is muddle through the next three years.”

Fernandez has repeatedly clashed with the country’s powerful soybean farmers, whose crops are the country’s biggest source of export revenue. In February, she dispatched two ministers to begin talks about agricultural policies amid a global decline in commodities prices.

Farmers were complaining that the worst drought in 50 years and taxes on their crops were pushing them toward bankruptcy. Three days after the talks started, Fernandez’s government announced that it might try to nationalize the purchase and sale of grains.

Fernandez’s popularity plummeted to 20 percent during a face- off with farmers in 2008. It stood at 29 percent in February, according to Poliarquia Consultores, a polling organization in Buenos Aires.

Cash in Mattresses

The current slump is the latest in a series of economic crises Argentina has faced since the Great Depression. Today, middle-class and wealthy families keep thousands of U.S. dollars in cash stuffed under mattresses or in home safes for just such emergencies.

“I think the government confused the fact that it was coming out of a recession, and that the world was doing well, with its own policies,” says Claudio Loser, an Argentine who is a former International Monetary Fund official. “Now they’re finding out that it’s not that way.”

Unless Fernandez can stabilize the economy in the coming months, she risks losing her governing coalition’s majority in the congressional elections.

Fernandez, who gives hour-long speeches without notes, relies in part on a shrinking list of defectors from opposition parties to form a majority. Even her fellow Peronists have been deserting her, leaving her with a slim one-vote margin in the upper house of Congress.

‘Instability’

“The way in which these decisions are being made is disastrous,” says Felipe Sola, a member of the Peronist party who broke with the president last year. “Instability is being generated at the highest levels of the executive branch.”

Amid the controversy, Fernandez has been making herself scarce in the capital. Rather than coming to the presidential palace, she prefers to do her day-to-day work at home with Kirchner, who handpicked her to be his successor and who is now head of the Peronist party.

She also makes frequent visits to a vacation home in her husband’s native Patagonia. The newsweekly Noticias branded Fernandez the “Part-Time President” for her travel and work schedule in a February 2008 cover story. Fernandez declined to be interviewed for this article.

Fernandez, the daughter of a bus driver, met her future husband while studying law in La Plata, the capital of Buenos Aires province, where she was raised.

Protest Against Dictatorships

The couple, who spent a month in jail for their protests against Argentina’s dictatorships in the 1970s, later moved to Kirchner’s home province of Santa Cruz, a desolate, wind-swept region bordering Chile and Tierra del Fuego that’s known for its sheep and oil. They married in 1975 and have two children, a grown son and a teenage daughter.

Fernandez became a deputy in the Santa Cruz legislature in 1989 and then was elected to the national senate in 1995. Kirchner, who became the governor of Santa Cruz in 1991, didn’t leap to national prominence until 2003, when the country was trying to recover from yet another crisis.

A three-year recession, fueled in part by the peso’s peg to the dollar and ballooning debt payments, led the government to partially freeze bank accounts, default on $95 billion in bonds and let the currency devalue nearly 70 percent in 2002.

Protests against the government and banks left more than two dozen people dead in December 2001. Within a few weeks, Argentina had five different presidents, and the following year the poverty rate rose to 50 percent while the economy shrank 10.9 percent.

Kirchner won the presidency in May 2003 with 22 percent of the vote after his opponent, former President Carlos Menem, declined to compete in a runoff.

Bailed Out by Commodities

The global commodities boom bailed Argentina out. Surging prices for soybean and wheat exports helped Kirchner boost government spending as much as 50 percent a year. His administration maintained a freeze on utility prices instituted during the crisis by former President Eduardo Duhalde.

Kirchner also ensured that unions got the wage increases of more than 20 percent per year that they sought. The economy responded, growing more than 8 percent per year during his term while unemployment declined to 7.5 percent in 2007 from nearly 20 percent when he took office.

Kirchner’s policies were controversial. Ignoring advice from independent economists and the International Monetary Fund, he fought inflation by prodding supermarkets to cut prices. He told domestic business leaders to “share” more of their wealth.

30 Cents on the Dollar

He offered foreign investors who held Argentina’s defaulted bonds 30 cents on the dollar -- the worst terms since at least World War II -- and refused to negotiate.

Fernandez, who became a senator from Buenos Aires after the couple moved to the capital, shepherded his legislative efforts through the Senate. She also backed laws overturning amnesty for military officers accused of human rights abuses during Argentina’s 1976-1983 “Dirty War” and helped extend emergency economic powers for the president that allowed Kirchner to redirect government spending without consulting Congress.

“The country needed to rebuild the authority of the president,” says Cobos, sitting at a conference table outside his office next to a sculpture of a hunched man and horse titled The Long Day that may sum up the vice president’s remaining time in office. “It was a different time.”

One way in which Kirchner used his authority was to designate his successor.

On July 2, 2007, Kirchner announced that his wife would be the Peronist party’s candidate to succeed him in October elections. “We all believe in Cristina’s profound abilities to transform Argentina,” he said in his speech.

Eva Peron

The Peronist party, a populist movement which traces it roots to the 1940s and ’50s, when President Juan Domingo Peron and his charismatic wife, Eva, ruled Argentina, didn’t have a primary. Nor did any other major party.

“In 2001, the country’s political and economic systems collapsed,” says Felipe Noguera, an analyst and pollster who served as the first president of the Latin American Association of Political Consultants. “In 2002, the economy started to get back on track, but the country’s political institutions never did. There still haven’t been any real primaries or party platforms.”

Fernandez spent much of the campaign abroad, meeting foreign leaders such as Chancellor Angela Merkel of Germany and Prime Minister Jose Luis Rodriguez Zapatero of Spain. She held no press conferences in Argentina as a candidate -- and has held only one since being elected. Kirchner never held a press conference in Argentina during his entire 4 1/2 year term.

The popularity of her husband’s policies carried the day, and Fernandez won 45 percent of the vote -- double the amount received by her closest rival, former lawmaker Elisa Carrio.

Snubbing Leaders

Fernandez’s travels abroad raised hopes that she would be more diplomatic than Kirchner, who was famous for snubbing visiting dignitaries including former Vietnamese President Tran Duc Luong and former Hewlett-Packard Co. Chief Executive Officer Carly Fiorina when they visited Argentina.

Then, during her inaugural speech in December 2007, she began to discuss a dispute about the construction of a paper­processing factory on a river bordering Uruguay, while that country’s president, Tabare Vazquez, sat stone-faced in the audience.

“We are facing off at the International Court in The Hague because the Uruguay River treaty was violated by the installation of these paper mills,” she said.

Two days later, Argentina’s relations with the U.S. soured after prosecutors in Miami said they’d arrested four people for being illegal agents of Venezuela’s Chavez. Their alleged mission was to cover up the $800,000 donation to Fernandez’s presidential campaign.

‘Garbage’

Fernandez denied the money was for her, calling the charges “garbage.” She ordered the U.S. ambassador not to meet with any official outside the foreign ministry. Former U.S. Assistant Secretary of State Roger Noriega said the move was “the kind of treatment usually meted out by governments that consider the U.S. a hostile country.”

The economy Fernandez inherited was dependent on high commodity prices, rising tax revenue and government spending increases. “It was an economy on steroids,” Goldman Sachs & Co. economist Alberto Ramos says.

Just how healthy Argentina’s economy actually was has been hard to discern at times. In January 2007, Kirchner began changing personnel at the National Statistics Institute to “improve operations,” he said.

Kirchner’s former economy minister, Roberto Lavagna, and research institutes including the Buenos Aires-based Latin American Economic Investigations Foundation, or FIEL, say the government numbers underestimate inflation by at least half.

Numbers Disputed

For example, in March 2008, the National Statistics Institute said consumer prices were rising 8.8 percent per year compared with an 8.4 percent annual rate the previous month. That figure was more like 22 percent, according to Claudio Mauro, an economist at M&S Consultores, an economic research company in Buenos Aires. Martin Lousteau, Fernandez’s former economy minister, says the dispute over the inflation figures is damaging the country’s credibility.

With inflation quickening and the government still blocked from international credit markets, in March 2008 Fernandez turned her eyes toward agriculture to raise funds.

Argentina is the world’s third-biggest soybean exporter and prices for the crop were booming. A bushel of soy that cost $11.25 on the day Fernandez took office surpassed $15 per bushel barely two months later -- a windfall for the government, given a tax rate of 35 percent on exports.

Fernandez wanted even more.

Taxing Farmers

Without having met with farm leaders since taking office, Fernandez tapped Lousteau, 38, on March 11, 2008, to unveil new variable taxes on soybean exports that would bypass Congress to raise tariffs as high as 44 percent.

“Cristina promised to be different, to promote more dialogue, strengthen the government’s institutions and improve relations with the rest of the world,” Noguera says. “People thought they were going to get the successes of Nestor while making progress on other problems. That hasn’t happened.”

Farmers called a strike the next day that lasted, with some interruptions, for four months. One of the world’s biggest food- producing countries began suffering from grocery shortages, and hundreds of thousands of people turned out at rallies to back farm leaders.

Lousteau resigned six weeks after introducing the taxes. Fernandez said that $1.5 billion in new revenue from the taxes would fund hospitals, roads and schools. Attempts to negotiate a compromise failed.

‘Oligarchs’

Kirchner attacked the farmers, calling them “oligarchs” who drove expensive sport utility vehicles and supported the country’s military dictatorships in the 1970s.

“One of the main mistakes we made was getting into a game of ‘chicken’ with the farmers, where instead of getting everyone to sit down and talk about the best way to structure the system, each side set out to defeat the other,” Lousteau says.

On the rural highways of Argentina, farmers manned roadblocks, letting passenger cars go by while trucks were left idling. They held roadside prayer services and cooked midnight barbecues to get through the winter nights.

“Cristina won a lot of votes around here,” says Raul Victores, a provincial farm leader, while driving through the dusty riverside town of San Pedro, two hours northwest of Buenos Aires, in his white Toyota Hilux. “But now relations are terrible. This government is destroying the farming sector.”

A self-described “revolutionary,” Victores, 55, wears a crisp Polo dress shirt, jeans and a faja, a wide, multicolored belt with dangling beads traditionally worn by Argentine gauchos, or cowboys. The president of the local chapter of the Rural Society, Argentina’s biggest agricultural group, Victores has spent a lifetime protesting on behalf of farmers.

Argentina’s ‘Backbone’

“The farming sector is the backbone of Argentina,” Victores says. “But this government views us as the enemy. There’s not going to be a peaceful resolution of these problems if the political class here doesn’t see the risks their policies are creating.”

Facing a stalemate, Fernandez sent her tax proposal to Congress, counting on her ruling coalition’s support to step up pressure on the farmers.

Senate debate began on July 16, 2008, and continued past midnight. Vice President Cobos, a member of the Radical party who serves as president of the Senate, oversaw the deliberations.

In the early morning hours, sensing that momentum was shifting against the government, Cobos sat in his offices trying to convince Fernandez’s cabinet chief that a final vote should be delayed, he says. The idea was rejected.

Call for Voting

In the ornate Senate chamber, Fernandez’s coalition was crumbling. Cobos rejoined the debate and, after all the senators had spoken, called for the voting to begin.

Ten seconds later, an electronic scoreboard read 36-36. Cobos called for a second vote.

Again, it was a tie.

Then, a little after 4 a.m., Cobos took the microphone, his voice quavering.

“I don’t believe in backing a law that won’t help resolve this situation,” Cobos told the hushed chamber. “I can’t go along with this. ... My vote isn’t for, it’s against.”

At a public park in Buenos Aires, where they had gathered to watch the proceedings on a giant outdoor screen, farm leaders and their supporters burst into celebration, dancing en masse and praising Cobos.

Two weeks after the vote, Cobos says Fernandez told him that their relationship would be purely “institutional.” He says it was the last time they spoke.

Grab for Pensions

With the tax increase on soybeans scuttled, Fernandez needed other sources of cash. The government’s borrowing needs will total about $20 billion this year, up from $7 billion in 2008.

So Fernandez turned to the country’s private pension system, managed by companies such as Bilbao, Spain-based Banco Bilbao Vizcaya Argentaria SA and London-based HSBC Holdings Plc. About 3.6 million Argentines keep their retirement savings in the private system and 450,000 receive monthly payments. In addition to $24 billion in assets, the pension funds also will take in $4.5 billion in contributions this year, says Javier Kulesz, an economist at UBS Pactual in Buenos Aires.

In October, Fernandez stepped to a podium in a tent outside the social security agency’s headquarters to call for the nationalization of the private pension plans. Cheered by a crowd of more than 500 agency employees, legislators and union workers that spilled out into a blocked-off street, Fernandez cited the global financial crisis as justification for the move.

Trumpets and Drums

“While the world’s biggest economies are undertaking policies to protect banks, we’re doing this for our retirees and our workers!” Fernandez said. The crowd blew trumpets and banged on drums.

Investors were less sanguine, with Citigroup Inc. strategist Geoffrey Dennis calling the decision the death knell for Argentina’s equity markets. That day, Argentine bond yields soared above 24 percent from 8.3 percent on the day Fernandez took office.

The nationalization, along with two subsequent debt swaps that lengthened the maturities of about 18 billion pesos ($5 billion) of debt, bought Fernandez some time.

“They’ve raided the deep pockets in the country and can now weather the storm,” Pedrajo, the foreign investor, says. “This isn’t a model for growth. It’s not a model for sustained health. And it’s a very bad model for attracting new private capital, but it is a functioning country.”

Still, to keep Argentina functioning until the 2011 presidential elections, Fernandez needs global growth -- and commodity prices -- to pick up. “The Kirchners are always finding ad hoc solutions to the country’s problems,” Cavallo says. “But we can’t fix our problems one by one; we need access to financing.”

There again, Fernandez is changing her tune. She now says she’s willing to consider a deal with holders of about $20 billion in defaulted debt. Barclays Plc, Deutsche Bank AG and Citigroup have submitted a plan to Fernandez that aims to resolve the outstanding claims.

Spokesmen from all three banks declined to give details of their proposals or to comment on the status of the talks. With Fernandez in charge, the only thing worth betting on is that the outcome will not be what anyone expects.

Published in the May issue of Bloomberg Markets magazine.

-- With reporting by Eliana Raszewski in Buenos Aires. Editors: Colby, Dieterich

To contact the reporter on this story: Bill Faries in Buenos Aires wfaries@bloomberg.net.

Last Updated: March 22, 2009 23:00 EDT