As Argentina prepares for presidential elections, FDI is trickling back into highly selective business sectors such as agriculture and wine-making. But political consensus will be the key to more confidence in the economy, says Jonathan Gregson

In downtown Buenos Aires, one year after Argentina stumbled into the largest sovereign default in history, the boarded-up banks and long lines of their customers patiently queuing out in the street tell their own story. The steel shutters defending Lloyds and HSBC still carry the scars of being assaulted with blunt instruments. Heavily-armed security personnel control the narrow entrance, allowing customers in one at a time, each one hoping to access some of their long-frozen deposit accounts which, since Argentina’s dramatic devaluation early last year, have lost two thirds of their real value.

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All the warning signs are there. Massive public indebtedness, a dysfunctional banking system and levels of poverty rising above 20% of the population. There are also serious questions about political and social stability, particularly whether the necessary consensus will ever emerge for an orderly debt restructuring to allow the recovery of what was seen during the 1990s as Latin America’s most successful economy from what President Eduardo Duhalde describes as a state of “intensive care”.

Record debt ratios

The scale of Argentina’s debts to the multilaterals and international banks are of unprecedented proportions. Having defaulted on payments due to The World Bank and the Inter-American Development Bank, this year Argentina owes nearly $16bn to the multilaterals alone. The successful negotiations with the IMF for a rollover facility of $6.8bn provides a breathing space through to mid-summer – well after the presidential elections scheduled for April 27. Nonetheless, Argentina’s debt:GDP ratio of about 170% is well above the previous worst-case peaks reached in Russia and Ecuador prior to their debt restructuring.

These are hardly the conditions that would encourage a potential foreign investor to move into Argentina. The big international banks – and especially those such as Citibank, CFSB, BBVA, BSCH, Lloyds and HSBC, which have extensive retail networks – have borne extensive write-downs on their commercial loan portfolios and are maintaining a damage limitation stance.

“We are not investing in Argentina,” is Banco Santander’s curt message. This is scarcely surprising because the mere mention of Argentina has generally had a disproportionate downward impact on the share price.

Much the same could be said of the major utility companies, Vivendi, Endesa and Lyonnaise des Eaux, which invested heavily during the privatisation of Argentina’s public services during the 1990s. They now face the combination of frozen tariffs and heavily devalued assets, with nothing to offset against obligations mostly in hard currencies.

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A spokesman for Vivendi specifies that Argentina represents “less than 1% of our total turnover” and that the company has “no ongoing investments”. This was part of a broader move away from developing countries towards further investment in water and waste management in the US and Asia. “It is not just Argentina but part of our strategy to develop a stronger profile in developed countries”, he says.

Argentina investors

So who is investing in Argentina, and in what sectors of the economy? During the first half of 2002, when the peso was in freefall and there were widespread expectations of hyperinflation, the answer would have been virtually nobody. A handful of legacy deals – such as US investment bank Donaldson, Lufkin & Jeanrette’s taking on the outstanding free equity in Peńaflor, the country’s largest wine and juice concentrate group – were finalised. Otherwise, there was no new FDI whatsoever.

Even government statistics, which show that the downturn in FDI began in 1999 (well into Argentina’s four-year recession but equally long before the peso’s devaluation), show zero FDI during the first quarter of 2002. Given that during the 1990s Argentina attracted some of the highest per capita investment in the world, this was indeed a rapid fall from grace.

Yet, even during the dark days when nobody seemed willing to invest in Argentina, the scouts were out looking for solid assets at knock-down prices. Private helicopters ferried sharp-suited entrepreneurs around the vast agricultural heartland. For it was that traditional mainstay of the Argentine economy, large scale agro-business, that first tempted potential investors back after pesification. The near fourfold devaluation against the dollar easily translated – even after inflation – into at least a 50% reduction of the price for prime farmland or vineyards. And, apart from matters of price, these were asset-backed investments whose products were either mainly destined for export markets (as with fine wines) or, as in the case of cereals, soya bean and other agro-commodities, were priced in close relation to the dollar.

At this stage in the cycle, it is mainly private equity groups that are investing in Argentina. These include the purchase last September of 75,000 hectares by a private fund in which financier George Soros is the main investor, although it is managed by Indiana-based Halderman Farm, a large US farm management and consultancy group.

Mr Soros has been building up his investments in Argentine agro-business for almost a decade but the timing of this purchase is typical of his counter-cyclical investment record. So, too, is the source: the agricultural assets of the troubled energy company Pecom. Richard Halderman, who is a minority investor and the fund’s US agricultural consultant, says: “The opportunity to buy assets of their production base looked very good. The agricultural systems in place within Argentina are excellent, this being one of the strengths of the country. The assets were very good and the price we paid very fair. It represented an opportunity and, while others were interested in different parts of the portfolio, we were the only group looking at buying the whole package.”

As for the timing of the deal, he says: “Mr Soros’s experience is inherently very good.”

Mr Halderman points out that the fund “bought the investment knowing fully the background: the government’s imposition of export taxes and other duties, the ongoing financial concerns. Now these have become less of a factor”.

As for further investments in Argentine farmland, he says: “We are still interested and have looked at several opportunities, although we have not yet made a decision to go forward.”

Since making that investment, many of the external concerns have been greatly reduced, he says. For the present – and despite its mountain of debt – Argentina’s economy appears to have bottomed out, with modest increases in GDP during the last two quarters of 2002 and industrial production showing growth for two consecutive months. The gradual loosening of the corralito – the unfreezing of first deposit and then savings accounts, allowing Argentineans to hold a certain percentage of their total assets in dollars – has been accomplished without triggering another bout of capital flight or further depreciation of the peso.

High base rates

One of the main reasons behind the relatively orderly transition is the maintenance of very high real rates of interest, which have discouraged further transfers into the dollar. This, however, represents one of the main constraints on economic growth and attracting new inward investment, according to Nicolas Catena, a former economics professor at Berkeley and adviser to previous governments. “We are not seeing capital flight because the annual real rate of interest is above 40%. This will be a problem for emerging from the recession and for growth,” he says.

Dr Catena’s businesses include export-oriented fine wines – his top wine retails in the UK at Ł61 ($100) a bottle – through to the mainly domestic-oriented Dos Anclas salt brand and the leading bathroom appliances manufacturer, Ferrum. From this perspective, he sees export businesses, which have been the main beneficiaries of the peso’s sharp devaluation, as most likely to be the main focus of future foreign investment.

Several European investors have been buying up land in the wine-growing region of Mendoza “with the idea of planting vineyards, mainly for the export market”, he says.

One such is the Clos de Sept, a French consortium that includes the D’Assault family and legendary winemaker Michel Rolland. It has bought around 1000 hectares and is building three wineries. Another is a joint venture between Dr Catena’s own Catena Group and Chateau Lafite-Rothschild to produce mainly for export. As for his bathroom appliance business, he notes that devaluation has allowed production to start growing at the expense mainly of imports from Brazil.

Other industries competing with exports, or which can substitute for them, are now doing well, even though the economy as a whole remains in recession.

Opportunism knocks

Private equity investors may be the first to focus on opportunities in Argentina but they have recently been joined by a handful of quoted companies that are investing for opportunistic and long-term strategic reasons. Brazil’s partly state-owned oil company, Petrobras, has made a $1.1bn offer for energy company Perez Companc which, provided it surmounts the politically sensitive anti-trust hurdles, is likely to go through.

Toyota has announced a $200m investment in Argentina as part of its global strategy of “optimising its worldwide development, procurement and production activities through orderly tie-ups between production bases outside of Japan”. This investment will make Argentina Toyota’s main base for commercial and multi-purpose vehicles throughout Latin America. Significantly, it is envisaged that three quarters of the 60,000 units a year will be exported to Central and South America.

Other large multinationals with a long-established presence in Argentina take a more cautious approach towards new investment while continuing to support their existing operations. The supermarkets group Carrefour opened one new hypermarket and took over the Metro chain of 12 smaller stores in the Mendoza region as part of its strategy to infill where it previously had less than adequate coverage. As Carrefour is renting rather than purchasing the stores outright, the deal does not involve large sums and is described as “a bargain”.

The abrupt devaluation has also persuaded some manufacturers to switch production back to Argentina. Nestlé, which moved some of its production lines out of the country during the hard currency recession of 1998-99, has reopened chocolate production, especially of its Bananita brand which is primarily for the domestic market. According to Nestlé spokesperson Hans Renk, the company is currently investing in expanding its production of pet foods and milk powder for export markets, primarily to Latin America, and across the board its investment programme in Argentina remains stable.

The energy sector offers two scenarios – depending on whether the investments are mainly in dollar-priced oil or the strictly regulated prices for gas and electricity. BP’s mainly upstream operation, managed through the Pan American Energy group in which it has a 60% share, continues to expand and remains profitable on the back of high crude prices and lower domestic production costs. However, some of these cost savings are offset by the 20% export taxes that the government has imposed. Downstream, there has been investment in local production of lubricants to replace those previously imported. BP is also seeking opportunities to expand in the internationally-priced aviation fuels sector, though as yet no deal has been signed.

For the electricity transmission and distribution company National Grid Transco, which through its subsidiary Transfer has been operating Argentina’s national grid, the past 14 months have been a disaster. Tariffs remain frozen at pre-devaluation levels, while the company’s borrowings are in dollars, so that by April 2002 it was unable to service its $500m of debts.

Mike Tarney, the parent company’s international operations financial controller, is hopeful that an agreement to unfreeze tariffs that had previously been blocked by court actions or public consultations will finally become law. But whether that will come through before the presidential elections is uncertain.

Picky investment

While some FDI is beginning to pick up in Argentina it is either highly selective, focusing on agricultural real estate and other asset-backed investments whose products are geared towards export markets, or it is from those who take a long-term view.

While the larger multinationals, such as Toyota, see it is part of the streamlining of their global production base, private equity investors are using the combination of a devalued peso, high domestic interest rates and the virtual collapse of financial intermediation through Argentine-based banks to snap up “bargains” that can be financed by offshore borrowings.

That means taking on exchange rate risk and, while the peso has stabilised and the IMF has allowed a breathing space, much will depend on the outcome of the forthcoming elections. This is because the country’s fragile recovery, underpinned by a relatively stable currency, relies very much on there being a political consensus that permits an orderly restructuring of Argentina’s debt mountain.

Until that process seems more certain, FDI in Argentina is likely to be restricted to the speculative or those with deep pockets who are in for the long term.

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