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Recession & Argentina

Prepared By
MOHAMMED AHMERUDDIN KHAN
09BSHYD0458
CHETAN MUKHERJEE
09BSHYD0226
PRATEEK KANODIA
09BSHYD0580
SABYASACHI GHOSH
09BSHYD0710 VIRAJ KATEWA
09BSHYD0981
Contents
INTRODUCTION.......................................................................................................2
BACKGROUND.........................................................................................................2
IMPACT ON VARIOUS ECONOMIC INDICATORS........................................................4
GROSS DOMESTIC PRODUCT...................................................................................4
THE DOMESTIC ECONOMY.......................................................................................5
EXPORT PERFORMANCE..........................................................................................6
FOREIGN INVESTMENT............................................................................................7
INFLATION...............................................................................................................9
EXCHANGE RATES.................................................................................................11
UNEMPLOYMENT....................................................................................................12
INTEREST RATES...................................................................................................15
Why is Argentina facing recessionary trends?.......................................................16
Corrective Measures taken by the Central Government........................................17
Fiscal Measures Undertaken..................................................................................17
Monetary Measures Undertaken............................................................................18
THE ROAD AHEAD.................................................................................................19
THE ROAD AHEAD

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“We shouldn’t be ashamed of supporting domestic demand, of recovering
what was taken from us. Growth in Argentina will continue, the latest data
show we are not in recession, not even a slowdown: we continue to expand,
the economy is back on its tracks in spite of the global situation” -
Cristina Fernandez de Krichner President, Argentina

INTRODUCTION

The emphatic statement above by the argentine president is highly disputed
around the world. The data made public by the “National Statistics Institute
(INDEC)” is looked upon with suspicion with by a plethora of critics who
suggest the data is not entirely accurate.

INDEC has reported that for the fourth quarter of 2008 there has been a 0.3
% drop in the overall economic activity compared to the third quarter. INDEC
announced a 2 % rise over January and February 2009, with a growth of 5.9
% over a period of 12 months. Private analysts though have indicated
otherwise with a drop in overall economic activity of 2 %. Further their
findings indicate a decrease of 3 % in the first quarter rather than an
increase.
By & large the general opinion was that the economy had in fact gone in to
recession. Our subsequent work in this project is an attempt to quantitatively
establish the recessionary trends observed in the argentine economy. The
root causes of the recession & the impact it had on the major
macroeconomic components of the economy.

BACKGROUND

In the 1990s the argentine economy witnessed a swift restructuring exercise.
This was done by liberalization of trade and capital accounts, deregulation of
key economic activities & privatization of a large number state owned
enterprises.
Price stabilization was achieved through a currency board scheme, which
pegged the Argentine peso to the US dollar from 1991 until the end of 2001.

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Though these steps fuelled economic growth up to early 2000, they failed to
make the economy truly competitive. Argentina never fully opened up its
market & when in 1999 Brazil devalued its currency, the argentine economy
was severely affected. By the end of the 1990s the country was constrained
by a total external debt of 50 percent of GDP & 14 % unemployment.

At the end of 2001 Argentina defaulted on its public external debt, causing
the biggest default in history.

Bank Deposits were frozen in late 2001 & the peso was allowed to be
devaluated. The devaluation helped improve the country’s balance of
payment as almost half of its Bop is agricultural exports. The government of
Argentina ended the freeze on bank savings accounts, releasing around US$
5.5 billion to Argentine households – a sign that the four-year recession was
ending.

Post mid-2002, there had been a strong recovery in real GDP with growth in
industrial production and construction. Consumer confidence was on the rise
and unemployment had fallen.

GROSS DOMESTIC PRODUCT (2000-2004)1

IMPACT ON ECONOMIC INDICATORS

GROSS DOMESTIC PRODUCT2

1 Source: World Bank; IMF. *FIEL forecast **: own estimates

2 www.indexmundi.com

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The freezing of bank accounts resulting in a concurrent decrease in the
money supply had its impact felt up to the year 2003 as far as the real
growth rate of the GDP is concerned. The decreased money supply in the
economy meant reduced private investments in the economy. Further
surprisingly government expenditure also seemed to be inadequate.
Consequently public support for President Duhalde evaporated & a political
upheaval followed. Provincial governor Néstor Kirchner, was inaugurated to a
four-year term as president on May 25, 2003.
In 2003, the government introduced import substitution policies. Import
substitution industrialization as an economic policy attempts to reduce
foreign dependency through local production of industrialized products.
Coupled with increasing exports, lower inflation and expansive economic
measures, this induced a surge in the GDP. This was repeated in 2004 and
2005, creating millions of jobs and encouraging internal consumption. Capital
flight decreased, capital inflow began returning. The influx of foreign
currency due to exports created a trade surplus. The Central Bank bought
dollars from the market to prevent the Argentine peso from appreciating
significantly and cutting competitiveness.

The situation by 2006 was further improved. The economy grew 8.8% in
2003, 9.0% in 2004, 9.2% in 2005 and 2006 was on the same track
(predictions are between 8.5% and 9.0%), though inflation, estimated at
around 10 to 12%, has become an issue again, and income distribution is still
considerably unequal.

The bold policies implemented by the Krichner regime ensured that
Argentina sustained its robust recovery from the crisis in 2001/2002 through
2007 & 2008 recording GDP real growth rates of 8.50% & 8.70 %
respectively.However global financial turmoil and rapid declines in world
commodity prices and economic growth during 2008 and 2009 brought
Argentina's rapid rate of economic expansion to an end.In the second
quarter of 2009 the economy shrank for the first time in eight years. In the
third quarter the goods producing sector fell 3.6% while the services sector
rose 1.6% year-on-year.

Demand for labor in the Beunos Aires area fell by 42 % compared to the
same period in January 2008.

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THE DOMESTIC ECONOMY
In the last quarter of 2008 & first quarter of 2009 consumption declined by
6.3% when compared with the corresponding quarters of 2007 & 2008.
Investment had declined by 11.5 % in the last quarter of 2008 and first
quarter 2009 when compared to the same period in the earlier years. It was
estimated that the unemployment rate will increase to 9.9% in 2009 from
7.3% in 2008.

Food prices on the domestic market are capped, which creates a surge in
demand at home & encourages farmers to export their products to get better
prices in more open markets. Farmers also chose to grow export crops such
as soybeans (Argentina produces more than 20 percent of the world’s
soybeans), which are quickly purchased on the world market.

The government tried to increase the export tax already which was already
35 percent for soybeans in May 2008, forcing the farmers to sell their
products on the domestic market. Various farmer strikes throughout 2008
protesting both the increases in export tax and the long-standing domestic
price cap threatened to generate food shortages and did succeed in causing
short-term domestic supply interruptions.

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EXPORT PERFORMANCE3

Argentine exports have been adversely hit by the global recession. They are
down 26.8% in the first 3 quarters of 2009 as compared with the same
period in 2008.

The situation has been worsened further by a drought, the worst in the last
50 years that the country is currently facing. It is expected that overall
agricultural production & livestock industry in Argentina will fall by at least
15 percent this season compared with last year. The drought is expected to
cost the state $5.5 billion in revenues. The drought has been especially
devastating to the wheat and corn crops and to cattle production.As can be
seen from this graph, all major exports fell sharply in the first ten months of
2009. Only meat, wine and gold increased over this period.

FOREIGN INVESTMENT4
The biggest winners after the economic restructuring of the economy in the
1990s were transnational corporate affiliates or TNCS. Since then foreign
investment has steadily gone up between 1992 & 2001 FDI inflows
amounted to more than US$76,000 million & the FDI stock went up from 6.4
to 25.6 % of the GDP.

Argentina remains open to foreign investment & presently hosts over 500
U.S. companies that employ over 155,000 Argentine workers. Five
consecutive years of real GDP growth over 8.5 percent between 2003 and
2007, and preliminary estimates of 7% growth in 2008 had attracted

3 http://www.bcra.gov.ar, http://www.indec.gov.ar

4 Deutsche bank research – country information base

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considerable U.S. and other international investor interest in the Argentine
market.
Argentina has two types of tax-exempt trading areas: Foreign Trade Zones
(FTZs), which are found throughout the country. These are trade regions
were neither the inflows nor the outflows of exported final merchandise are
subject to tariffs, non tariffs or other taxes on goods.
According to the United Nations Conference on Trade and Development
(UNCTAD) World Investment Report 2008, the total stock of FDI in Argentina
at the end of 2007 was estimated at $66 billion. Spain, the United States,
and France remain the top three investors. Other important sources of
investment capital include Brazil, Canada, Mexico, U.K., Italy, Chile, the
Netherlands, and Germany.
Argentina is a member state of MERCOSUR (Common Market of the Southern
Cone) with Brazil, Paraguay and Uruguay; and Bolivia, Chile and Peru are
associateMERCOSUR members. Since the MERCOSUR was established
.Argentina’s trade with other member countries has strongly increased. As
from the end of the 1980s, following a significant reduction in tariff
and non-tariff barriers, foreign trade, including trade with the countries in the
region, has shown significant dynamism.

As is clearly visible from the graph plotted above that post the economic
restructuring of the early 1990’s there was a steady increase in the foreign
investment in Argentina. This boom reached its zenith in the financial year of
1999-00. Clear signs that the economy was opening up becoming more
receptive to foreign investment.

Then followed the year of 2000 were in the argentine economy recorded the
highest public debt in its history. Interestingly the foreign investment trends
show very clear patterns on that. Clearly there was a case of Capital Flight
with foreign investments hitting rock bottom at 0.9 billion dollars in 2003
from a high of 22.6 billion dollars in 1999. In terms of percentages a
staggering decline of 96.03 % within a span of 4 years.

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In 2003 the Kirchner regime came to power & then expansionary policies
seem to have borne fruit with an increase in FDI to 3.4 US billion dollars by
the end of 2004. A robust recovery had followed with a steady increase in
foreign investment to almost 6.5 US billion dollars up to the year 2008.

However the imminent recession in the US (one of the top 3 investors in
Argentina) had a significant impact on the Argentine economy. Huge capital
outflows seem to have occurred in the year 2009 with a 50.57% decrease in
foreign investment.

Signs are fortunately encouraging for the Argentine economy with the
Deutsche Bank forecasts suggesting no further slide in FDI at least in the 1st
quarter of 2010.

INFLATION

According to the Kirchner administration inflation in Argentina last year was
below 8% taking into consideration that the accumulated inflation in the first
eleven months of 2009 was 6.7%.

Argentina is reporting that inflation rose 7.7 % in 2009, though private
economists say the true rate is at least double that figure.5

The national statistics institute also said Friday that consumer prices
increased 0.9 percent in December over the previous month.

The yearly rate is below government forecasts of 8 percent.

However independent economists, business organizations, consultants,
consumer groupings and even trade unions indicate that the real inflation in
2009 ranged between 15% and 18%.

The government is commonly accused of underreporting inflation since 2007
to reduce interest payments on inflation-linked bonds.

Thus according to private consultants in Buenos Aires and some provincial
governments which have their own statistics offices, Argentina ranks third in

5 http://www.businessweek.com/ap/financialnews/D9D8D7AO0.htm

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the IMF inflation list which has Congo with 31.2% at the top followed by
President Hugo Chavez Venezuela with 28%.

Mariano Lamothe, an economist from consultants Abeceb, estimates inflation
in 2009 reached between 14% and 15%. Consultants Joaquín Ledesma &
Associados argue “real” inflation accumulated in the eleven months of 2009
was 14.3% and Ecolatina, founded by former Minister of Economy Roberto
Lavagna considers that the average inflation in Argentina between 2005 and
2009 was 17.8%.6

Economists anticipate that the recovery of economic activity in Argentina
during this year is going to expedite inflation & without an official
preparation it’s going to be very difficult to stabilize the increase in prices.

Also there is the fact that following several years of strong rates the
inflationary dynamics has its own inertia which makes it into a persistent
problem.

For 2010 the Kirchner administration estimates inflation at 6.1%, however
economists anticipates it will be closer to 17%.

INFLATION RATES SINCE 20037

6 http://en.mercopress.com/2010/01/05/argentinas-inflation-third-highest-in-the-world-say-
private-consultants

7 http://www.indexmundi.com/argentina/inflation_rate_(consumer_prices).html

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LATIN AMERICA INFLATION RATES8

EXCHANGE RATES
In 1991, the Government of Argentina created the Argentine Currency Board.
The Argentine Peso was pegged to the United States Dollar. The fixed
exchange rate of one peso to the dollar allowed for a macroeconomic
stabilization. The BCRA (Central Bank of Argentina) was mainly in charge of
keeping foreign currency reserves in synch with the money base.
After the collapse of the Argentine economy at the end of 2001 and the
subsequent devaluation of the peso in 2002, imports fell by half and
Argentina's trade surplus soared to over US$16 billion, providing for the first
current account surplus since 1990. As recovery ensued and the exchange
rate stabilized around 3 pesos/dollar, exports (mainly soy, cereals and other
agricultural products, as well as machinery and fuels) grew steadily.
Since the Convertibility Law was repealed in January 2002, the devaluation
and depreciation of the peso after the economic crisis, the Central Bank’s
role has been the accumulation of reserves in order to gain a measure of
control of the exchange rate.

8 http://www.latin-focus.com/latinfocus/countries/latam/latcpi.htm

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EXCHANGE RATE STATISTICS OF ARGENTINE (2002-2009)9

The Central Bank of Argentina buys dollars from the market to
counterbalance the surplus of the foreign trade balance and keep the
exchange rate at the level desired by the Government, currently around 3.7
pesos per dollar, which are considered competitive for exports and useful to
encourage import substitution.Near the end of 2005, the Government of
Argentina decided to pay back the Argentine public debt with the
International Monetary Fund. The payment was effected on 3 January 2006,
employing about 9,500 million USD from the Central Bank's reserves. This
led to the decrease in the amount of reserves by one third, but did not have
harmful side effects save a slight increase in the dollar-peso exchange rate.
The Central Bank of Argentina intervenes in the exchange market, usually
buying dollars, though occasionally selling small amounts (for example,
reacting to rumours of a possible increase of the U. S. Federal Reserve's
reference rate, which caused a minor spike in the dollar's value). Its reserves
reached more than US$ 28 billion in September 2006, recovering the levels
prior to the IMF payment, and rose to US$ 32 billion at the closing of the
year. The exchange rate experienced a gradual increase prompted by the
Central Bank’s market intervention as a buyer, reaching 3.12 pesos per
dollar, and then decreased slightly again.
Since early 2008, the Central Bank of Argentina has held foreign exchange
reserves of between US$47 and US$50billion. The official exchange rate,
which had oscillated around 3 Argentine pesos per US dollar since early
2003, was adversely impacted by the international, 2008 financial crisis, and
hovered around 3.80 pesos per dollar during most of 2009.

UNEMPLOYMENT

One of the more alarming measures of the economic crisis in the United
States has been the number of states breaking 10 percent unemployment.

9 http://www.latin-focus.com/latinfocus/countries/argentina/argexchg.htm

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But in Argentina, such numbers aren't news: Here, double-digit
joblessness has been part of everyday life for years.

More than a tenth of Argentina's labour force was jobless till 2007, and the
number peaked above 20 percent in 2002 after the national economy
crashed. Since 2007, the rate has never fallen below 7 percent.

Official statistics put the unemployment rate at 7.5 percent at the
end of 2008 — a surprising decrease from previous levels at a time
when many would expect the Argentine economy to share in the job
losses taking place worldwide.

But there are signs that the global crisis has affected Argentina at large.

A government survey found that job offers dropped 30 percent in the last
quarter of 2008.

Often referred to as "black market of jobs", informal workers constitute a
gray area of employment in Argentina as they're unregistered by the tax
bureau and therefore somewhat invisible to the official picture of Argentina's
labor market but are too visible on streets of Argentina.

In a country with a history of massive unemployment, it's not surprising that
jobless residents have, over the years, developed ways to make their
grievances known, waving signs and chanting slogans demanding jobs and
money.
This sort of protest has its roots in the upsurge of joblessness that took place
in the late 1990s, when unemployed workers gave birth to Argentina's
particular form of the "piquete," a phenomenon that took its name from the
American picket line.10
Instead of the usual labour unions that bargain with particular employers,
these are generalized organizations of unemployed persons that block public
roadways and occupy buildings. The piquetes climaxed after Argentina's last
economic crisis, and today the term "piqueteros" is synonymous with these
unions of the unemployed.
The Argentinean government fakes unemployment rate values in the same
way it fakes its other economic indicators.

When the government statistics say that it is 7% of unemployment
it means that the real value of unemployment is about 12%.

10 http://www.globalpost.com/dispatch/argentina/090331/be-job-seeker-buenos-aires

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Since the global economy right now cannot help any first nor third world
country and also Argentinean presidents keep heavy-taxing exports,
companies are really having a hard time employing people and selling
products outside the country which is one of the main reasons that
Argentinean unemployment is always high and growing.

The last but not least reason that unemployment will keep rising in Argentina
is because presidents of Argentina are rising minimal wages to a point that a
company cannot hire more than a half of people that the company really
needs because they don’t have all that money to waste in unskilled labour
force such as the Argentinean one.
So instead of hiring 2000 employees they hire 500 and make them work like
they were 2000 so you have 1500 more unemployed people with no earnings
at all and 500 people that are always super busy and get a first world
country wage.

Sizzling economic growth above 8.5 percent in each of the last five years has
helped Argentina lower its unemployment rate after it reached 21.5 percent
during a 2001-2002 economic crisis.

But as the economy begins to slow, in part because of the global financial
crisis, keeping people employed has become a top economic priority for the
government.

UNEMPLOYMENT RATES SINCE 200211

LATIN AMERICA UNEMPLOYMENT RATES12

11 http://www.latin-focus.com/latinfocus/countries/argentina/argeireal.htm

12 http://www.latin-focus.com/latinfocus/countries/latam/latunemp.htm

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INTEREST RATES

Argentina benchmark interest rate stands at 10.13 percent. In Argentina,
interest rate decisions are taken by the Central Bank of Argentina (Banco
Central de la República Argentina, BCRA).

The international financial crisis hit Argentina after what can be described as
a ‘false spring’ in 2008.At first, the country’s government and most analysts
thought Argentina would be insulated from the crisis, or ‘decoupled’ from it,
and even seemed to be benefiting. This perception arose as funds gushed
into commodities markets early in 2008 because of the banking and sub-
prime mortgage problems that were rocking the financial markets.
Cutting interest rates: Interest rates on loans for small- and medium-size
companies were reduced, initially for a total of US$ 55 million.

ARGENTINA also attempted to ease the strain of its billion dollar debt
problem by paying lower interest on its bonds, a move seen by investors as
an effective default on loans.

ARGENTINA INTEREST RATES13

13 http://www.latin-focus.com/latinfocus/countries/argentina/argeimonetary.htm

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Why is Argentina facing recessionary trends?

• The country’s primary problem still concerns its 2001 default. After
defaulting on $95 billion on debt, holders of approximately $75 billion
settled in 2005 at 35 cents on the dollar.
• The country has primarily relied on local markets & loans from
Venezuela to meet its financing needs. In 2008 it seized about $ 24
billion in pension assets to compensate for falling tax revenues.
• The country’s dollar supply is falling as demand increases while capital
flight seems to continue. This is adding pressure on the government to
tap in to its central bank reserves or devalue its currency severely.
• Argentina is facing the worst drought in its History in the last 50 years.
This has further complicated the situation as Argentina is heavily
dependent on its agricultural sector for exports. In fact reports suggest
that their exports are likely to go down by at least 26.8%.
• Further the economy having opened up to the extent it has to foreign
investment is being affected by the current Capital Flight phenomena
that it is experiencing.
• As a consequence of Capital Flight the demand for industrial labor also
seems to have drastically fallen. In Buenos Aires area alone the
demand for industrial labor fell by almost 42 %.
• In addition a combination of external shocks also slowed down regional
GDP growth in 2009.
• The world wide recession hit provinces within Argentina harder than
the Central Government because:
• The provinces depend upon funds sent by the federal government:
Almost 80% of provincial budgets come directly from taxes or transfer
payments from the federal government and these have been lower
due to smaller tax revenues.

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Corrective Measures taken by the Central
Government
Argentina’s fiscal situation has not worsened as much as it could have
thanks to additional sources of revenue. The treasury’s first quarter financial
position showed the government in deficit by $610 million when social
security surplus is factored in it becomes a positive $257 million.

Fiscal Measures Undertaken

The provinces have increased their income tax rates even after the central government decided to
distribute 30% of export tax revenue to them. In spite of such measures the provincial
governments could end up with a fiscal deficit of nearly $2.8 billion. The Central government
will have to cover for this situation may be by resorting to social security surplus & bonds for
financing it.

An extended tax amnesty & capital repatriation plan were introduced which were effective till 31
April 2009 to obtain additional revenue & lure back revenue from abroad.

Further the government also reduced export duties on wheat, corn, fruit & vegetables.

The government also initiated a process of swapping loans wherein debts issued by the national
government in 2001 were exchanged for new bonds maturing in 2014 to obtain debt service
relief.

The government also launched a public works plan worth US$ 33.2billion of which US$ 21.2
billion will be financed through structured debt while the remainder is being negotiated.

An incentives program which was designed to encourage acquisition of capital goods by cutting
tariffs & granting local manufacturers a 14% refund was extended by 1 year by the federal
government.

Interest rates on loans for small & medium size companies were reduced initially for a total of
US$ 55million.

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The country also drew a loan from the Bank of International Settlements for US$ 4.6 billion for
Central Bank reserves.

Monetary Measures Undertaken

A currency exchange pact was signed with Chinese Central Bank for up to 70 billion yuan.

Further an allocation of 2 billion convertible Special Drawings Rights or SDRs was made to
increase Central Bank reserves.

The central bank of Argentina is now designing a framework by which it can provide liquidity
support to avoid banks from closing. The policy of course will be conditional to share holder’s
participation & to an aggressive interest rate policy of the banks.

Further the Central Bank is also gearing up to utilize part of foreign exchange reserves in the
foreign exchange market to slow the pace of depreciation of the national currency.

To strike a balance between money supply & demand instruments such as the placement of
securities at fixed & floating rates have been implemented.

The liquidity stress caused by international financial volatility in the local markets was dealt
through measures such as buying back part of LeBAC & NoBAC stocks directly or at auctions.

The Central Bank has intervened in the spot market & in the Futures market by resorting to the
stock of external liquidity to curb depreciation of the local currency.

Central Bank regulations, which provide the legal framework for the financial and banking
system operation, were tailored to circumstances in order to minimize the adverse effects of the
shock.
Changes were made with respect to operational aspects (the use of federal bonds as a collateral
for repos) accounting standards (valuation of instruments held by banks in their portfolios to
buffer the impact on their balance sheets)liquidity regulations (extension of the calculation
period for reserve requirements & reduction of daily cash requirements)

From the onset of the turbulence the central bank sold approximately 3 % of international
reserves ensuring that the argentine peso exchange rate fluctuated within a 2.5 % range against
the US dollar.

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THE ROAD AHEAD

In the midst of the economic gloom descending on the country there are
fortunately several streaks of silver lining which are clearly visible.

Argentina has always been & still is a country rich in natural resources. A
major chunk of argentine exports are constituted by food products. The
global population is still growing at an exponential rate, so the demand for
food items is unlikely to recede in the foreseeable future.

The key to a quick recovery is therefore restoring the agricultural sector to
its healthy self. The argentine government must design programs to combat
the effects of the drought that the country is currently facing.

Further it must reach an amicable solution with the farmers over the export
tax rates to ensure that there is enough production to meet local demand as
well as fuel its foreign reserve accounts.

The fiscal & monetary policies implemented by the government seem to be
bearing fruit already.

According to the Central Bank of Argentina the country has amassed almost
USD 45 billion in foreign reserves A record according to the federal body.

There is no doubt that the Country will be facing tough times in the near
future & that president Kirchner will have her hands full but with the right
policies being implemented at the right time chances are Argentina will
come out of the recession relatively unscathed.

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