Argentina 2008 Investment Report Executive Summary

2008 Investment ReportArgentina’s National Investment Development Agency

�ARGENTINA’S NAT IONAL INVE S TMENT DEVELOPMENT AGENCY - �008 INVE S TMENT REPORT

OVERVIEW

The purpose of this report is to take an in-depth look at

Argentina’s investment profile and performance during

the period of 2003-2008 with a focus on the last year. A

comprehensive understanding of investment behavior is a

key element for the management and strategic planning

carried out by ProsperAr, Argentina’s National Investment

Development Agency. This analysis provides an understanding

of the investment process, its strengths, and the challenges

Argentina faces in the current context of international

crisis. The 2008 Investment Report is a critical tool to draft

hypotheses about the future performance of the economy

and the actions required to face the international crisis.

Executive Summary


Chapter 1: Introduction

>> THE ROLE OF INVESTMENT

While investment growth leads to the expansion of an economy’s production capacity,

it goes even farther. Investment performance is closely tied to technological change,

innovative activities and the development of new and increasingly dynamic businesses.

The accumulation of capital and know-how play a complementary role in the long

term as critical factors to ensure economic growth sustainability. Investment volume,

as much as its breakdown, are key factors to the development process. In this context,

productive investment stands out as a greater contributor to the process.

Chapter 2: Investment Performance 2003-2008

>> HIGH AND SUSTAINED ECONOMIC GROWTH

After the 2001-2002 crisis, Argentina experienced an outstanding economic recovery. The

accumulated annual growth rate for the 2003 -2007 period was 8.8%, and 7.8% in the first half

of 2008. As a result of this remarkable growth, Gross Domestic Product (GDP) in the second

quarter of 2008 was 49.6% higher than in 2001 and 31.1% higher than the historic record of the

90s reached in 1998.

>> INVESTMENT DRIVE

After reaching its lowest point in the first quarter of 2002, Gross Domestic Capital Formation

(GDCF) began to recover, and then grow. The recovery phase started in the second quarter of

2002 and continued through 2003 and 2004 at an extraordinarily high growth rate (over 35%

per year at constant prices). An investment growth phase immediately followed to reach an

accumulated annual rate of 18.1% between 2005 and 2007. This dynamic investment process

continued through the first half of 2008, when GDCF grew 16% relative to the first half of 2007,

reaching AR$226.44 billion (at current prices). Investment has grown steadily for five consecutive

years and given data available for the first semester of 2008, it will most likely be six years

running. This behavior is unheard-of in three decades. In spite of this, a shift in the international

context and its impact on the Argentine economy could result in the deceleration in investment

growth in the second half of 2008 and in 2009.

�008 Investment Report - Executive Summary


>> INCREASE IN INVESTMENT SHARE IN GDP

Investment’s strong performance has lead to sustained growth of its share in GDP, which climbed

from of its lowest point at 11.3% in 2002 to 22.6% in 2007, both measured at constant prices.

The uptrend held in the first half of 2008, when investment expansion again outpaced GDP’s

growth rate. The growth dynamic was reflected in a 22.8% investment rate (GDCF / GDP), 1.6

percentage points (p.p.) above its share in the first half of 2007. The results are similar when the

investment rate at current prices is taken into consideration. In this case, its recovery and growth

over the last five-year period started from a 12% low in 2002 to reach 24.2% in 2007 and 22.8%

in the first half of 2008. Based on these rates, Argentina’s investment to GDP ratio in current

terms is among the highest of Latin American economies.

>> 30-YEAR BENCHMARK

The investment rate in 2007 was higher than in 1998, the highest level achieved during the 90s.

Furthermore, taking into account consistent long-term series registered since 1950, the current

investment rate is higher than benchmarks hit in other periods (1951, 1958, 1961, 1971, 1974,

1987) with the exception of historic highs in 1977 and 1980 (by just 1 p.p. of GDP). In conclusion,

the current investment rate is the highest in the last 30 years.

>> INVESTMENT: ONE OF THE DRIVERS FOR GDP AND JOB CREATION GROWTH

The rapid growth of GDCF between 2003 and 2008 was one of the main drivers behind

Argentina’s economic growth. Investment has been the most dynamic component of aggregate

demand, contributing 44.1% of GDP’s growth between 2003 and 2007, and 34.9% of the

expansion of aggregate demand in the same period. On the other hand, and unlike in the recent

past, GDP and investment have grown parallel to employment since 2003. GDP growth, driven

by job-promoting investment, was associated to improvements in equity, a critical element for

achieving sustainable development. In fact, the GINI coefficient, which measures the degree of

inequality in per-capita family income distribution, dropped from 0.537 in the third quarter of

2003 to 0.490 in the first quarter of 2007 (latest data available).



>> POSITIVE SAVINGS - INVESTMENT GAP

The sustained increase in domestic savings has been a key factor in funding this dynamic

investment process. Gross Domestic Savings in terms of GDP increased significantly from

a low of 14.2% in 2001 to 26.6% in 2007, a savings rate ranked among the highest in

historic terms. This positive savings - investment gap was the result of twin fiscal and

current account surpluses, a contrast with the model of high consumption and dependence

on external funding (reflected in twin deficits) which prevailed in the previous decade.

>> IMPROVEMENTS IN INVESTMENT BREAKDOWN

Investment can be classified into two major components: durable production equipment—

inclusive of machinery and equipment, and transport equipment—and construction.

By 2002, investment was fairly biased toward construction. However, during the 2003-

2008 economic expansion, equipment demand climbed higher than construction

investment, with accumulated annual growth rates of 32.2% and 21.2%, respectively. This

translated into an increased share of durable production equipment in total investment

to reach 42.4% in the second quarter of 2008. This figure is slightly higher than that

for 1998 (42.0%), which represented the maximum level achieved in the 90s.

>> PRODUCTIVE INVESTMENT LEADERSHIP

Even when investing in durable production equipment is typically associated to greater

increases in the global productivity of an economy, non-residential construction—public and

private infrastructure—also brings about improvements in production capacity. For this reason,

productive investment is defined as the sum of investment in durable equipment and non

residential construction. Between 2003-2007, GDCF was mainly driven by productive investment,

which grew at an accumulated annual rate of 26.8%, higher than the 22.4% accumulated annual

increase in residential construction over the same period. In 2007, productive investment’s share

of GDP reached 15.1%, higher than in any other year for which data is available (1993 - 2007).



>> COMPLEMENTARY PUBLIC AND PRIVATE INVESTMENT

A distinctive feature of the current investment process is that both private and public

investment have grown simultaneously, complementing each other. Public investment,

which had fallen in terms of GDP in the 90s, grew at such a pace between 2003 and

2006 (the latest data available) that it doubled its share compared with the average

for the 90s, reaching 3.1% of GDP. This expansion was mostly due to the renewed drive

of public investment in construction—which grew at an accumulated annual rate of

51.3% between 2002 and 2006—driven by new infrastructure works. In terms of private

investment, durable equipment investment has been the most dynamic component

and grew at an accumulated annual rate of 34.5% between 2002 and 2006.

>> GROWTH IN LOCAL PRODUCTION AND DURABLE EQUIPMENT IMPORTS

Domestic capital goods production was quite dynamic in 2003-2008. This sector expanded at an

accumulated annual rate of 17.4% between 2002 and 2007. The domestic equipment investment

rate downtrend suffered since 1977 underwent a reversal, although it is still far from levels reached

in the 60s and 70s. On the other hand, capital goods imports experienced an even more remarkable

recovery despite their initial relative appreciation after the 2002 currency devaluation. The

accumulated annual growth rate between 2002 and 2007 was 53.9%. This strong growth places

capital goods imports at a historic high in terms of their GDP share.

>> CHANGES IN THE ORIGIN OF CAPITAL GOODS IMPORTS

The breakdown of imported capital goods per country of origin has undergone changes over the

growth phase that began in 2003. In particular, imports from Mercosur have gained relevance;

Brazil stands out, representing 17.7% of capital goods imports in 1998 and 28.5% in 2007. In

contrast, NAFTA and European Union countries now have a smaller relative share. The United

States was the source of 29.1% of capital goods imports in 1998 and 16.7% in 2007. Countries

such as Germany and Italy also reduced their share. China, on the other hand, which had a

marginal role as capital goods supplier for Argentina (2.8% of the total amount in 1998) has

taken a more relevant role (15.8% in 2007).



Chapter 3: Foreign Direct Investment in Argentina


>> STRONG FDI GROWTH

The evolution of Foreign Direct Investment (FDI) following the convertibility crisis can be divided

into two stages. The first stage was between 2002 and 2003 and corresponded to a period of

recovery after the crisis, with reduced FDI flows. The second stage between 2004 and today

registered a vigorous growth in FDI inflows. In 2007 FDI reached US$6.46 billion, in excess of the

average annual inflow in the 90s net of privatizations (US$5.3 billion). The balance of payments

data for the first half of 2008 show a 64.3% increase compared with the same period for 2007.

Also, the exchange balance data published by the Central Bank of Argentina for the third quarter

of 2008 (which only consider the category “contributions”) show a 40% increase when compared

with the same quarter of 2007, thus confirming the positive FDI uptrend until that period. This

high growth rate, however, may not hold in the fourth quarter of 2008, not in 2009, given the

changes in international markets and their impact on FDI flows globally.

>> IMPROVEMENTS IN FDI’S BREAKDOWN

An improvement in FDI can be seen since 2004, mainly explained by foreign companies

increasing their local production capacity, new international companies entering the market and

new plants with greenfield investment. Equity contributions and reinvested earnings represented

51.5% and 29.9%, respectively, during the 2004-2007 period, up from 25.2% and 7.2% between

1992 and 2000. In contrast, mergers and acquisitions (investment changing hands) represented

only 6.3% in the last four years, down from its 56.9% share of total flows received in the 90s.

>> INTERNATIONAL POSITIONING

When looking at FDI inflows over the last few years, Argentina ranks among a group of such

varied and different countries as Portugal, Hungary and Finland, and above developed countries

or recently developed countries like South Korea, Norway, New Zealand and Greece. Aside from

the BRICs (Brazil, Russia, India and China) markets, which are both FDI destinations and FDI

issuers at a global scale, Argentina is in the ninth position among the high growth emerging

markets which prove most appealing in terms of FDI. Despite the strong FDI drive in recent years,

Argentina lost part of its share of the Latin American FDI inflows (primarily due to the increase of

FDI flowing into Brazil).

8ARGENTINA’S NAT IONAL INVE S TMENT DEVELOPMENT AGENCY - �008 INVE S TMENT REPORT

>> HIGH PROFITABILITY OF FOREIGN INVESTMENT

The high levels of profitability of foreign investment have been an outstanding feature of the

current situation. Earnings as a percentage of FDI stock reached 8.9% on average between 2004

and 2007, as compared to 6.1% on average between 1992 and 2000. Also, profitability was a key

factor that determined investment funding, supporting higher disbursements through reinvested

earnings. The share of reinvested earnings by foreign companies with offices in Argentina

recovered after the 2001-2002 crisis, registering an average 33.8% between 2005 and 2007.


Chapter 4: Investment from a Microeconomic Perspective

>> INCREASED MAJOR BUSINESS INVESTMENT

ProsperAr’s investment database tracks investment at a microeconomic level based on

accounting information from 369 major companies. In 2007, the Investment Database found

investment increases in most economic sectors; the extractive industry, the services sector and

the manufacturing industry registered the most dynamic investment behavior. A more detailed

breakdown reveals that electric appliances and office machines, then metal and steel works—all

of them part of the manufacturing industry—lead the ranking; followed by the media and

entertainment industry in the services sector, and activities in the extractive industry.

>> HIGH PROFIT REINVESTMENT

The information produced by ProsperAr’s Investment Database also reveals the investment

financing method used by businesses. The high corporate profitability found in 2003-2008 was

a key factor to support the investment process, allowing higher disbursements through self-

funding. The Investment Database shows that in 2007, 64.3% of the earnings of major companies

operating in the country were retained by the companies themselves.



Chapter 5: Perspectives and Challenges

>> THE ARGENTINE ECONOMY IN THE LIGHT OF THE GLOBAL CRISIS

The country is currently facing an international scenario marked by an onslaught of negative

shocks, which imply a drastic shift away from the favorable international conditions Argentina

met in recent periods. However, the Argentine economy is entering the current global financial

turmoil from a position of less relative vulnerability, compared with prior periods of international

volatility, counting with a more solid fiscal and external position; less public debt; a more flexible

framework of monetary and exchange policies; a substantial stock of international reserves; and

a strengthened productive network. These factors make for a more robust country in the face

of external upset. Less vulnerability, however, does not necessarily imply that Argentina can

isolate itself from international turmoil. Different mechanisms through which international crisis

is transmitted create—smaller or greater—risk and uncertainty in the domestic economy. Apart

from a general decline in world trade, which would have an impact on Argentine exports, another

contraction could come from the strong reduction in credit worldwide, resulting in scarce

and more costly funding for both governments and businesses. Greater difficulties to access

voluntary credit markets could deepen the impact of the international crisis on investment

performance in the country’s private sector.

>> THE LOCAL INVESTMENT PROCESS IN A GLOBAL CONTEXT OF FINANCIAL RESTRICTIONS.

The Argentine investment process over the last five years was less dependent on external

funding, a favorable condition for an economy facing volatility in world financial markets.

However, the uncertain time span of the international lending retraction makes the efforts to

maintain high investment levels more relevant than ever..

>> CHALLENGES TO ENSURE A STEADY INVESTMENT PROCESS

In this context, while domestic efforts must be increased to consolidate the investment

process and continue on the growth path (even when rates may not be as high as in the

recent past), actions must be taken to build microeconomic capabilities and improve

infrastructure, technology and labor training levels to support long term competitiveness

of Argentina’s economy. These efforts also need to aim at the country continuing up the

ladder of development, ensuring Argentina is a step ahead for when the international cycle

reverts. Medium and long term collective strategic efforts to identify and leverage investment

opportunities and challenges for Argentina in the new world scenario will need to be in the

pipeline.<

2008 was the sixth consecutive year of robust economic growth and investment expansion

in Argentina. During this year, GDFI at constant prices grew by 9%, a significant growth rate,

although somewhat below levels reached in 2006 (13.6%). The drive to invest in the Argentine

economy continued the upward curve begun in 2003. The increase in GDFI during 2008 was

the result of growth registered by both of its indicators: investment in durable production

equipment increased by 16.3% while investment in construction did so at a rate of 4%.

In 2008, GDFI continued to grow faster than the GDP growth rate of 7%, which corroborated

new increases in the rate of product-related investment, reaching a level of 23%. This figure

not only exceeded 2007 figures (22.6%) but also set a new historical high in terms of the

values recorded in the last thirty years. In current terms, however, the level of investment in

2008 was 23.2%, down from 24.2% in 2007. The difference between these rates—constant

and current—is due to the disparate behavior of the costs of investment versus those of the

average economy as a whole. In other words, this is due to the lower relative increase in the

prices of investment assets compared with the GDP implicit price.

Graph 1: Evolution of Rate of Investment, 1993-2008

As a percentage of GDP

Investment Report – AddendumFull data for 2008*

Gross Domestic Fixed Investment (GDFI) performance

Investment rates

Source: compiled by ProsperAr on the basis of data from the National Accounts Directorate, INDEC

18,3

20,6 21,1

17,9

15,8

24,223,4

21,5

19,2

15,1

12,0

14,2

16,218,0

19,919,4

18,117,9

19,919,1

23,222,6

21,619,8

17,7

14,3

11,3

19,118,9

20,519,1

23,0

0

5

10

15

20

25

30

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

GDFI / GDP at current prices GDFI / GDP at constant prices

Given that this Investment Report was drawn up on the basis of information available until the second quarter of 2008, this note synthesizes the final results of the years, thus complementing the analysis presented in the Report. *

2.087 1.8583.499 4.496

6.3698.268

6.8595.372

2.141 2.149 1.6524.125 5.265 5.537 6.473

7.9798.899

0

5.000

10.000

15.000

20.000

25.000

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008*

FDI net of privatizations Total FDI

The pattern of GDIF for the second half of 2008 was not uniform. While GDIF grew by 8.5% in the

third quarter (compared with the same period in 2007), the consequences of the global economic

and financial crisis made themselves felt towards the end of 2008. In the last quarter of the year,

GDIF fell by 2.8% compared with the same period during the preceding year, which was the first

time that inter-annual investment figures had dropped since the last quarter of 2002. This change

was due to a tail-off of 2.4% in investment in construction and a drop in 3.4% in durable production

equipment compared with the fourth quarter in 2007.

Chart 1: Evolution of the Investment Rate in terms of GDP


During 2008, FDI continued the upward curve of growth and expansion begun in 2004. Thus, in

2008, FDI totaled USD 7,979 million, an increase of 23.3% compared to the amounts recorded

the previous year. According to UNCTAD estimates, this growth rate was among the highest

recorded at world level, above the average registered by the group of emerging economies

(3.6%) and the regional average for Latin America (12.7%). FDI performance in Argentina during

2008 is all the more impressive if compared with FDI in developed countries, which fell by 32.7%

over the last year. This expansion in 2008 was fundamentally due to new capital contributions

which represented 43.5% of total FDI, while changes in ownership came to 8.9% of the total. This

meant that the trend followed by foreign investment aimed at expanding productive capacity and

acquiring new plants or Greenfield investments continued, in contrast to the trend for mergers and

acquisitions which prevailed in the previous decade. Argentina reached third position in the 2008

Latin American Greenfield projects ranking according to the trade publication FDI Intelligence

published by the Financial Times.

Graph II: Total Foreign Direct Investment and net of privatizations 1993-2008

In USD millions

Period GDIF/GDP (in % at constant prices)

GDIF/GDP (in % at current prices)

% variation (compared with the

same period in 2007)

1st quarter 2008 22.7 24.1 20.3

2nd quarter 2008 23.0 21.7 13.8

3rd quarter 2008 24.1 24.2 8.5

4th quarter 2008 22.4 23.0 -2.8

Average 2008 23.0 23.2 9.0

Performance of Foreign Direct investment (FDI)

Evolution of Investment during the Second Quarter of 2008: the first signs of the impact of the global crisis registered towards year-end

* 2008 data are preliminary as they do not include FDI arising from debts with head offices and affiliates.


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Argentina 2008 Investment Report Executive Summary

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