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Argentina risk: Financial risk
(RiskWire)COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentC54C54Financial riskC50C50Note: E=most risky; 100=most risky.SUMMARY
The fall-out from the financial collapse of 2001-02 will be reflected in a lingering credit squeeze in the outlook period. Banks' balance sheets remain weak and their solvency is linked to that of the public sector as government bonds account for around one third of the system's total assets. Rehabilitation of the financial system will be a protracted process and the availability of loans for productive activities, scarce even in the 1990s, will be restricted in the main to short-term working capital. The government may try to revive the role of state-owned banks in providing credit to productive sectors although fiscal constraints will restrict the amount of resources available. As for the banks themselves there is still some uncertainty over whether they will receive compensation for having followed court judgements and reimbursed some investors who had savings in dollars before the crisis.
SCENARIOS
Companies are forced to operate without a properly functioning financial system (High Risk)
Following the collapse of 2001-02, much of the financial system is still recovering. Most firms will remain reliant on self-finance in the outlook period although the capital market revived in 2004 and could become a growing source of funds for SMEs over the medium term. Bank lending grew by around 20% in 2004, although the stock of credit to the private sector is far below its pre-crisis level. Foreign companies will find it difficult to borrow and will be reliant on overseas sources of credit to finance operations. Firms should also explore the range of alternatives which have grown up in the domestic market to replace scarce bank financing.
A freer float of the peso increases exchange rate volatility (Low Risk)
The real exchange rate will not remain indefinitely at its current historically weak level. However, a real appreciation, whether via domestic price increases or a nominal appreciation will occur only slowly. The authorities' heavy intervention in the currency market has demonstrated their commitment to a competitive exchange rate. The IMF believes that Argentina should allow a freer float of the exchange rate, which has been kept remarkably stable for the 12 months. Should the authorities move to a freer float, then the peso would strengthen, but in the medium term exchange rate risk would rise, as the currency became more prone to react to developments affecting commodity prices or the fiscal deficit. Although there are no plans to let the currency float freely, investors should bear in mind that recent stability in the exchange rate is unlikely to last indefinitely.
BACKGROUND
(Background material is updated twice yearly. Last update: May 5th, 2005)
Financial Services
In the 1990s the new macroeconomic and regulatory environment brought sweeping changes to Argentinas banking industry. The 1995 foreign-exchange and banking crisis triggered a process of consolidation in banking, which was reinforced by more stringent regulations aimed at making the industry more resilient to external shocks. Foreign investment increased the share of foreign banks in Argentinas total loans and deposits, and privatisation of provincial banks reduced the share of public-sector institutions in the banking system. Retail banking grew, although the level of bank penetration remained low by international standards.
During 2001 confidence in the sustainability of the currency board weakened and there was a run on the banks. Initially there was a shift to dollar-denominated assets, but by the second half of the year banks were suffering large withdrawals from dollar as well as peso accounts. Before the collapse of the currency board in January 2002, nearly 68% of the banking systems deposits and 70% of its loans were denominated in dollars. In September 1997 (just before the Asian crisis) dollar-denominated deposits had accounted for 51% of the total. In December 2001, faced with an accelerating rate of deposit withdrawal, the government announced a partial deposit freeze.
These measures did not succeed in halting the run on the banks. In January 2002 the currency board collapsed and the government decreed an asymmetric pesification of bank assets and liabilities, severely weakening commercial banks balance sheets. Financial institutions suffered a renewed setback with the sovereign debt default, owing to their large holdings of government debt. To avert a systemic collapse the authorities made the deposit freeze more stringent and announced a mandatory rescheduling of term deposits. The decision provoked a wave of legal challenges, many of which were upheld by the Supreme Court. The continuing drain of deposits further weakened the banks.
The Banco Central de la Republica Argentina (the Central Bank) resumed its powers as lender of last resort following the devaluation. This enabled it to grant large rediscounts to the commercial banks to prevent bankruptcy. The recovery of deposits since mid-2002 (helped by more stable conditions in the financial and foreign-exchange markets and high deposit rates) increased banks liquidity and enabled them to start to pay back the rediscounts received from the Central Bank. Total deposits grew by around one-third in 2003.
In contrast to deposits, credit contracted uninterruptedly until the first half of 2004, reflecting the repayment of existing loans and a lack of demand for and supply of new credit. In the second quarter of 2004, a recovery in credit began. Nevertheless, the stock of credit as a proportion of GDP, at 7.8%, is well down on the pre-crisis level of 23.3% recorded in 1998. The divergent trends in deposits and loans have boosted the liquidity of the banking system. However, the banks still suffer from poor solvency indicators and they have a high exposure to the public sector. A high share of banking revenue is generated by commissions and the sale of secondary services, such as credit cards and household insurance fees. The banking system as a whole recorded a profit for the first time in 2004 in May and the during the first half of the year the rate of non-performing loans improved by 7 percentage points, although it remained high at 26%.
The government has made progress towards compensating banks via bonds for the effect of asymmetric pesification. The banks have already recorded this as an asset in their balance sheets and the resolution of this issue alone will not lead to an upsurge in financial intermediation. The government requested that the deadline for the compensation be postponed to the end of June 2004, although it did not meet this schedule.
A history of high inflation and macroeconomic instability has hindered the development of domestic capital markets. The stockmarket grew rapidly from the early 1990s, but between 1998 and 2002 this trend reversed owing to the delisting of several large companies (such as YPF, which was acquired by Repsol of Spain) and falling valuations. The number of quoted firms fell from 156 in 1994 to 107 by the end of 2003. The relatively high costs involved in listing on the stockmarket have deterred many medium-sized firms from engaging in public offerings. At the same time, the arrival of foreign firms and the internationalisation of domestic conglomerates during the 1990s led to higher borrowing abroad, where costs were lower.
The 2001 financial crisis hit the stockmarket severely and the Merval stockmarket index plumbed record lows in mid-2002. Thereafter it started a sustained recovery, aided by the recovery of the economy and lack of investment options. The Merval index, having lost 47% in dollar terms in 2002 (although in local currency it rose by 62%), surged by 136% in 2003, partly because of currency appreciation. In July 2004 the index was 324, compared with its lifetime high of 850 reached in July 1997. Ten companies account for 95% of total market capitalisation, which makes for high volatility.
The private domestic bond market expanded rapidly in the 1990s. However, access was largely restricted to banks and other large firms operating in the construction and energy sectors and in service industries such as telecoms. Since the devaluation of the peso the level of activity has fallen.
Deposits and lending by banks (Ps m)Dec 2001May 2004% changeAll banksDeposits65,60196,04846.4US dollar-denominated46,7343,054-93.5Peso-denominated18,86786,995361.1Loans72,38556
,389-22.1US dollar-denominated57,3331,325-97.7Peso-denominated15,05152,721250.3Source: Banco Central delaRepublica Argentina.Private pension funds (Administradoras de Fondos de Jubilaciones y Pensiones, or AFJPs) were created in 1994 as part of the reform of the retirement system and rapidly became an important source of domestic financebut mainly for the public sector. Pension funds were among the worst casualties of the financial crisis as the government restructured the assets they held at the end of 2001 and later pesified dollar-denominated assets. The forthcoming debt restructuring will inflict further pain on pension funds. In July 2004 the funds administered by the pension funds totalled Ps48.4bn (US$16m). They still held 59% of assets in government bonds and only 10% in equities. Pension funds have recently increased their investments in bonds issued abroad. They have also channelled new funds to exporters through special trust funds, but the amounts involved are modest.
Investment funds also recorded rapid growth in the mid-1990s and by the end of the decade were the second-largest class of institutional investor after the pension funds. Growth was fuelled by small and medium-sized investors who diversified their portfolios away from bank deposits towards more profitable financial assets. Market growth slowed after the Asian crisis, and during 2001 the value of funds under management (mostly fixed-income) contracted by nearly 40% from the US$9.5bn peak recorded in February 2001. The sovereign debt default and the deposit freeze practically wiped out investment funds. More recently, the renewed economic stability has revived them. The strong growth of the stockmarket also encouraged new investment funds.
In the 1990s the insurance industry was transformed by the liquidation of the state-owned reinsurer, the deregulation of rates and policies, the elimination of restrictions on the activities of foreign-owned insurance firms, and tighter solvency requirements. These changes produced a shake-out in the industry, which underwent a far-reaching process of concentration and internationalisation. At the end of 2002 the annual turnover of the industry reached Ps7.3bn (at nominal values). Nearly two-thirds of this value was accounted for by property insurance, whereas life and retirement insurance accounted for 20% and 12%, respectively. These two types of insurance suffered the most from the crisis, since households used them as savings instruments. The assets of insurance firms also suffered as a result of pesification.
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