After four years of recession, growth has been robust since 2003, fuelled by import substitutions with the peso's collapse in 2002, high raw material prices and a domestic demand recovery. Inflationary pressures have eased substantially due to the persistence of unused production capacity and a partial price freeze (notably affecting privatised public services).

Judging by the latest indicators, this dynamism could, however, be hampered today and especially in 2005, by electricity shortages, bottlenecks affecting infrastructure and some sectors, and particularly the virtual absence of credit. Restructuring the debt and consolidating the banking sector along with the need to raise prices for privatised public services and improve the legal environment have all remained reforms necessary to ensure durable growth. However, their adoption could ultimately stir popular discontent capable of undermining support for President Kirchner who must contend with strong rivalries within his own party.

>> A SHARP RECOVERY SINCE THE COLLAPSE IN 2002

After four recession years (including a 10.9% decline in 2002), growth was very robust in 2003 (up 8.4%) fuelled mainly by import substitutions permitted not only by the peso's collapse in 2002 but also by high raw material prices and a domestic demand recovery underpinned by expansionary monetary policy and a reduction of political uncertainties.

External demand has been dynamic, driven by high raw material prices, notably for soybeans. After declining 14.4% in 2002, consumer spending rose 7.2%, buoyed by the more favourable environment. Although investment gained 32%, it still only represents 14% of GDP, very insufficient to sustain growth.
Manufacturing, construction, and agriculture have been the most dynamic sectors.
Inflationary pressures have eased substantially (3.1% end April 2004 against 41% end 2002) due to the persistence of unused production capacity, a partial price freeze (notably affecting privatised public services) and the peso's appreciation.
In the first quarter this year, the economy grew 11.7%, albeit from a particularly low base in 2003. Industrial production and construction nonetheless declined in April, that decline being attributable, according to the minister of finance, to the energy shortages' initial effects.
The current energy crisis is the result of the one-to-one pesification and the freezing of gas and electricity prices, which have effectively choked off investment. Although it is difficult to assess, energy crisis effects is estimated at 1% of GDP. Although a sharp drop in growth is thus not likely, the energy crisis is particularly a harbinger of the bottlenecks that should affect Argentina's economy in the absence of reforms.

>> NEVERTHELESS THE GROWTH RATE SHOULD SLOW DOWN SIGNIFICANTLY

In the very short term (2004), the growth rate should remain high (up 6.2%) if only because of the ratchet effect of first quarter performance with the production capacity utilisation rate still only at 66%. The international environment, notably for raw materials, has been very favourable.
Whatever the impact of the energy difficulties, growth should begin to slow markedly next year (up°2.9% according to IFI) due to bottlenecks in the economy linked to the virtual absence of reform and investment. In some sectors, like steel, paper, or refining, production capacity utilisation rates have already reached 90%. However, with virtually no domestic or international bank credit available, companies should find it very difficult to obtain the financing needed to increase capacity. Moreover, privatised public services have not been investing enough due to the price freeze decided two years ago, recent easing measures notwithstanding. The overall investment rate has been too low to sustain growth. To achieve durable growth and reduce the traditional dependence on raw material prices, restoring financial flows toward industrial companies and privatised public services will thus be essential. That will primarily require renegotiating foreign debt to permit resumption of external financing and implementing some difficult reforms like consolidating the banking sector, accepting necessary price adjustments for privatised public services, and improving the legal framework for business.

>> BUDGET SURPLUS INSUFFICIENT AND EXTERNAL DEBT UNSUSTAINABLE

In 2003, the economic recovery and strong soybean demand caused a sharp increase in revenues that permitted the primary fiscal surplus to exceed the objective agreed with the IMF. However, that surplus has remained insufficient to permit a satisfactory partial reimbursement of creditors. Government authorities have nonetheless been seeking a 75% debt cancellation to generate a primary surplus limited to 3%.

Foreign debt, already unsustainable before the crisis, has become even less so since the peso's collapse. Although the debt would be manageable based on the government's propositions of 75% debt cancellation and a 3% primary surplus, it would remain vulnerable to unfavourable trends for macroeconomic variables like the exchange rate or growth. Bond creditors have nonetheless been hoping for debt cancellation less prejudicial to their interests, insisting on a larger primary surplus.

>> IN THIS CONTEXTE, THE RISK OF FOREIGN CURRENCY SHORTAGE REMAINS HIGH

A foreign currency liquidity crisis has remained a critical risk despite the sharp decline in financing needs with that decline attributable to the exceptional collapse of imports and more so to the default on most foreign debt. Finally, the suspension of the IMF program makes Argentina's external position more precarious.

>> A COMPLETE REFORM OF THE BANKING SECTOR REQUIRED FOR SUSTAINABLE GROWTH…

Government authorities have made little progress in consolidating the banking sector, which has remained both insolvent and unprofitable. The improved liquidity was achieved at the cost of a sharp contraction of credit in the private sector. Without reform, notably concerning bankruptcy law, the lack of financing for companies needing to invest could choke off the recovery.

>> …AND A POLITICAL SITUATION REMAINING PRECARIOUS

The economic recovery has consolidated President Nestor Kirchner's authority. To make growth sustainable, however, the president will have to make painful choices currently postponed. By having unpopular but necessary financial reforms adopted, notably concerning banks and public service companies, he could stir popular discontent in a country where rioting has driven two presidents from office in recent years. Argentina's democracy has remained very shaky, especially since rivalries within the Peronist Party, notably with former President Duhalde, could severely undermine the incumbent should his popularity decline. Duhalde's backing for the most radical Piqueteros has stirred tensions between the two men. Moreover, the President has still not succeeded in imposing on provincial governors the reform of tax sharing between the central government and the provinces demanded by the IMF.

In conclusion, the economy has recovered a degree of normality after collapsing in the 2002 first half. Nonetheless, restructuring the debt, consolidating the banking sector, the need to raise prices for privatised public services and improve the legal framework have all remained necessary reforms to permit sustainable growth.

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