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When Good Countries Go Bad

By Benjamin Shepherd on October 25, 2012

After a huge restructuring of its debt earlier this decade, Argentina seemed to be getting back on track. Under former president Nestor Kirchner, the county paid off its debts with the International Monetary Fund, invested heavily in developing its infrastructure and the government took a largely hands-off approach to the country’s market economy. That attracted huge inflows of foreign direct investment as global companies vied with each other for lucrative development deals.

But under President Cristina Fernandez de Kirchner, the wife of Nestor Kirchner who is serving her second term, the economic boom fomented by her husband is coming to an end as the Argentine economy cools and foreigners are less eager to do business in the country.

Earlier this year Kirchner nationalized YPF SA (NYSE: YPF), Argentina’s largest oil and gas company. Just over a decade ago, Argentina was a net exporter of oil and natural gas. But as the country’s domestic economy took off in the wake of its debt restructuring, energy demand grew even as investment in the country’s energy infrastructure lagged.

As a result, about nine years ago Argentina became a net importer of energy commodities. That was a huge expense and a drag on economic growth. But rather than developing the country’s energy patch and overhauling its energy policy to attract foreign investment, Kirchner in April opted to seize the 51 percent stake in YPF owned by the Spanish company Repsol SA (OTC: REPYY).

Alleging that Repsol was under investing in the company and siphoning off assets, Kirchner’s move gave her government access to billions of dollars of YPF’s cash and about 23 billion barrels of energy equivalent (the country has the third-largest shale reserves in the world after the US and China), enough to meet the country’s energy demand for at least a decade. The nationalization of the company could also helped close what was a growing gap in the government’s balance sheet, assuming much of that energy is ultimately exported.

Energy prices in Argentina have been steadily rising for several years, due to the high price of imports, fueling already high inflation in the country. In response, the government has been spending almost USD6 billion annually in energy subsidies in an attempt to keep a lid on consumer prices. Thanks to the seizure of YPF, the government is now better positioned to sell domestically produced energy into the market essentially at-cost, keeping prices down and saving itself billions of dollars annually.

The seizure was also extremely popular with local voters, likely another critical consideration for Kirchner. The leading member of the country’s Peronist Party, Kirchner is currently serving her second and final term as president. But in a country where sitting presidents typically anoint their successors, Kirchner doesn’t have an heir-apparent in the government.

Highly placed Peronists have hinted that Kirchner is planning to propose a constitutional amendment that would do away with presidential term limits, potentially allowing her to serve as president until a suitable replacement can be found.

The popularity boost she got for nationalizing YPF, coupled with her recent move to enfranchise every Argentinean that’s at least 16 years old, might allow her to do that, by improving her party’s showing in upcoming mid-term elections. If the Peronists can secure two-thirds majorities in both the Senate and the House, Kirchner’s constitutional amendment would be assured of pasage.

While the move might be popular locally, it made foreign investors extremely nervous. Those raw nerves were tweaked again this month when Argentina’s Chaco province made a US dollar-denominated bond payment in pesos.

The provincial government said that the Argentine central bank wouldn’t allow it to buy US dollars in the forex market to make its bond payment, leading to fears that the government was moving to pay its foreign currency denominated debt in cheaper local pesos and prompting Moody’s Investors Services to issue a credit warning for Argentina. And just a few days ago the country’s government announced that it was implementing a policy requiring the country’s insurers to investment about ARS7 billion in medium- and long-term infrastructure projects.

Thanks to the government’s interventionism, shares of almost every Argentine company have been plunging for the past six months. While it’s understandable that financials and energy-related companies would be hit, even consumer companies and industrials have come into question as investors wonder what industry will be nationalized next.

For instance, shares of IRSA Inversiones Representaciones (NYSE: IRS), a major real estate operation and a leading developer of shopping centers in the country, have plunged by nearly a third despite being a great inflation hedge and paying an attractive dividend. The company has experienced solid earnings growth over the past few years as rising Argentine incomes have produced a growing consumer class in the country.

Even Telecom Argentina SA (NYSE: TEO), the country’s leading telecom, has seen share prices nearly halved over the past year.

It’s unfortunate that President Kirchner has decided to play politics with the country’s markets, especially since it was finally on track to become a leading global investment destination. In fact, the country’s equity market was one of the top-performers in the wake of the global financial crisis; Argentina was largely insulated from its effects thanks to its bond default last decade.

For now, though, investors in Latin America should steer clear of Argentina.

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