In Argentina, an energy and infrastructure deficit is a major constraint on what the economy needs for growth: investment.
Roads get clogged in the farm belt during harvests, cargo train services are limited and summer power outages are frequent. This year, natural gas imports reached the maximum capacity that can be handled by the country’s pipelines and two floating regasification units, as growth in demand outpaced domestic production for the twelfth year in a row.
With gas shortages taking a toll on industrial production, President Mauricio Macri has come out as a crusader for conservation. “If you’re wearing a T-shirt and walking around barefoot at home in the winter, then you’re consuming too much energy,” Macri said in July as a cold snap ramped up household heating demand and left factories short of gas. “A country without energy cannot grow,” he said.
Energy supplies and infrastructure investments suffered under the populist administrations of Cristina Fernández de Kirchner and her late husband, Néstor Kirchner. They kept energy and public service prices among the lowest in the world for most of their time in office from 2003 to 2015.
The price caps along with capital controls, high taxes, limited access to credit, high borrowing costs and state intervention deterred investment in everything from highways to power lines and sewage systems. The World Economic Forum ranks Argentina 87th out of 144 countries for the quality of its infrastructure, little improvement over the past decade.
With the country’s budget in deficit and borrowing costs still running high, the new government cannot spend only its own money to fix the situation. So Macri, a 57-year-old former businessman and soccer club president, needs private companies and multilateral lenders to pitch in on financing infrastructure projects.
He also wants Argentines to bet on the country with their own money. He hopes to bring in billions of undeclared dollars this year through a tax amnesty. Investment fund managers hope to capture some of this inflow, including funds for infrastructure projects. So do municipalities, several of which are planning to enter the bond market, some for the first time, to fund public works.
Since coming to power in December last year, Macri has done away with the capital and currency controls and slashed the export taxes that drove away investment under the Kirchners. He has led the country out of a 15-year debt default and taken steps to improve power and natural gas pricing.
But to pull the economy out of a recession, he needs foreign investment to offset dwindling consumer spending as inflation soars.
Macri has announced plans to invest more than $26 billion in infrastructure over the next four years, the bulk of it coming from the private sector. Projects include upgrading airports, freight rail lines and roads in the north, a new nuclear power plant, a gas line in the northeast, and several tunnels under the Andes for transport links with Chile.
Investment is needed across sectors, from hospitals to railways. Existing capacity has deteriorated because of the serious underinvestment and increasing usage under the Kirchners. The economy grew rapidly between 2003 and 2011, and more people got connected to the grids for gas, internet, water and other services, while sales of cars, dishwashers and televisions surged, says Fernando Lago, director of the department of strategic thinking at the Argentina Chamber of Construction.
“There is a big need for investment in water and sanitation, and there is a need for investment in logistics, roads and trains, and in the connection of trains with ports so that production can reach the centers of demand or the ports for export, so it can run more efficiently and economically,” Lago says.
The big question is will the investment come? Under the Kirchners, foreign direct investment lagged behind that of Brazil, Mexico, Chile and Colombia and at times Peru, even though Argentina is the region’s third-largest economy, according to data from the United Nations Economic Commission for Latin America and the Caribbean, or ECLAC.
To lure investors, the government has drafted a bill for public-private partnerships (PPP), a system hardly used in Argentina. The goal is to attract more than $5 billion a year in investments through these partnerships, which spread the risk of a project between the state and the private sector.
Presenting the legislation in June, Macri’s interior minister, Rogelio Frigerio, said PPPs were part of a wider plan to rebuild investor confidence in Argentina. The government’s plans also include creating a national registry of construction companies and respecting the real cost of the projects to protect profits, he said.
Frigerio calculates that for the economy to grow 4% or 5% a year, infrastructure investment must reach at least 5% of GDP. The increase would stand above the investment of 3% to 4% of GDP in public works in recent years but less than the Argentina Chamber of Construction’s estimate that spending must be ramped up to 8% of GDP for the economy to grow at 5% a year.
“This is an enormous amount of investment, and it can only be met by using all possible financing sources,” Lago says.
Governments will still use public funds for projects, particularly those that are not suitable for PPPs, but funds for long-term projects like transmission lines will largely come from multilateral lenders like the World Bank, he says.
Cities may also consider selling bonds to finance public works. Many provinces have sold bonds since Argentina emerged from a debt default earlier this year, and the next wave could be municipalities, says Eduardo De Bonis, a partner at FIRST Corporate Finance Advisors, a Latin American financial services advisory firm in Buenos Aires. He is working on structuring such bonds with three cities, driven by demand from institutional investors.
Municipalities likely will pay yields of 100 to 150 basis points more than provincial issuers, given their smaller size, De Bonis says.
With provincial bonds yielding 7% to 9% a year, bond issues are more expensive than financing from tax collections. The flip side, however, is that the cities will get all the money upfront for a project or a public works program, making it more efficient in finding a contractor and ordering supplies and materials at the start, helping to lock in prices against inflation.
Cities are likely to finance water and road works projects using bonds, he says. “The driver for investors is that there is a lot to do in Argentina,” De Bonis says.
A concern, however, is the economy. It is poised to shrink by more than was expected when Macri took office. The IMF expects Argentina’s GDP to fall 1.5% this year, before growing 2.8% in 2017. Other estimates are more downbeat. Inflation has risen above 40%, up from 26% in 2015.
Construction activity dropped 12% year-on-year in the first half of 2016, shaving the roster of registered builders by more than 13%, according to government data. Orders for asphalt plummeted 38%, iron rods for concrete fell by 17% and cement by 14% over the same period.
The one bright spot is building permits for private projects, which were up 3.4% in the first half of the year, recovering from a 7.8% decline in 2015.
A promising industry for investment is renewable power generation. The country has set a target to get 8% of its power from renewable sources by the end of 2017 and 20% by the end of 2025, up from 2% this year.
The first tender will be held this year for 1,000 MW of mostly wind and solar power capacity, helping to diversify a natural gas-heavy power matrix and meet pent-up demand that has saddled the country with blackouts and brownouts.
“Argentina is under the gun now on getting more generation installed,” says Carlos St. James, managing director of Santiago & Sinclair, a Texas-based energy consultancy and renewable energy project developer. “They are trying to get everybody who wins these bids to get the capacity up and running by end of 2017. So the winners are going to have a little over a year to get their wind farms up and running.”
In terms of financing, it means the winners likely will be large international players like France’s Engie, Italy’s Enel and Spain’s Acciona, St. James says. They have access to international lines of credit and can buy solar panels and wind turbines for less than smaller companies.
That shifts the attention for gauging investor optimism to the subsequent renewable energy tenders.
Banks are still wary of lending to projects in Argentina, especially long-term investments like power plants. They will probably wait a couple of years to see if the economy revives before they begin to make loans, which will make it harder for smaller companies to build wind farms in the contracted timeframe, according to St. James.
As a result, it is unlikely that investment will revive until the Macri government can chalk up a few successes, like getting wind parks into operation from the first tender and pulling the economy out of recession. “As things improve, people will become less scared of Argentina and they will start investing over the long term,” St. James says.
While investments trickle in, Macri is using increasing amounts of public funds for infrastructure projects to try to revive the economy from the worse-than-expected recession, says Federico MacDougall, an economist at the University of Belgrano in Buenos Aires.
However, the increase in public spending threatens to widen the budget deficit, stoking inflation and keeping interest rates high – the benchmark rate is 30%. Without a decline in borrowing rates, it is harder for companies to finance investments, MacDougall says. If inflation is to come down, Macri will have to slow the economy further. This will put at risk his chances in a mid-term election next year and the longevity of his conservative brand of politics – the basis of the renewed investor confidence in Argentina.
“To solve one problem, you have to jeopardize the other,” says MacDougall. “You have a problem with inflation, so you have to slow the economy and keep interest rates high. At the same time, you have a problem with high public spending and low investment. You have to sustain the economy, but investment isn’t coming because of the high interest rates, and reviving the economy with public spending generates inflation. It’s a vicious circle.”
Even so, a first wave of investment is poised to come through thanks to a tax amnesty this year. The government is offering the amnesty for residents who collectively hold an estimated $400 billion to $500 billion in undeclared funds.
Under the amnesty, some of the funds are expected to go into long-term investments in infrastructure projects, which offer participants less of a penalty than paying 10% of the value of the assets if they keep them outside the country. The government is expected to bring in an estimated $10 billion to $20 billion from the amnesty. “It’s not going to be much,” MacDougall says. “But in a country with practically zero investment, $10 billion or whatever it will be is a lot.”
The second wave of investment may come after the October 2017 legislative elections if Macri’s coalition has a successful showing.
“The real investment will come after the elections if people see the economy is recovering thanks to the new reforms,” MacDougall says.
While Macri was a leading opposition figure as the mayor of Buenos Aires from 2007 to 2015, he is part of a new political coalition, Cambiemos (Let’s Change), that has not had time to prove its mettle. And it will not be easy to gain the nod from investors, given that the economy is flagging, inflation is surging and consumer discontent is simmering.
“To sustain support and do well in the legislative elections, Macri must show by the first quarter of 2017 that the economy is improving,” says Juan Cruz Díaz, managing director of Cefeidas Group, an international advisory firm in Buenos Aires.
And that could also attract the attention of more foreign investors.
Add into the mix the troubles in Brazil, and investors likely are going to become even more buoyant about Argentina.
“Investors are saying that they are going to take a break from Brazil,” says St. James. “Where else can they go? Well, there’s Argentina, which is suddenly promising the world to everybody. It’s a great opportunity for Argentina to capture the companies that have already invested in Latin America and who know what it’s like to invest in Brazil, and who are now saying they are going to put money into the new and improved Argentina.”
First, though, it will be the bolder investors who take the leap.
“They’ll take that risk because they know they are going to get a better return,” St. James says. “For someone who jumps in later, the risks will be lower and the returns will be lower. Most investors are saying, ‘You know, we’ll wait. We may actually not end up making so much money, but we want to see that the country is not going to go crazy on us.’” LF