Out of Gas - the Argentinan automobile sector

Argentina's automotive sector has stalled. Can President Fernando de la Rua get it going again?

AS ONE OF ARGENTINA'S MOST VETERAN autoworkers, 63-year-old Gustavo Paz has lived through a lot of crises. But never, he claims, did he feel as desperate as he does now. "At least when things went bad, you had well-equipped hospitals, good schools for your kids and your salary was worth more," remembers Paz, who earns US$900 a month as a machinist at Ford Argentina's plant on the outskirts of Buenos Aires. "Today, everyone is scared about the future and there's nothing we can do about it."

Paz isn't the only one feeling such helplessness. For the 11 foreign automobile and truck manufacturers with operations here, Argentina has become synonymous with one huge transmission failure. And despite their confidence in Argentina's new can-do president, most are convinced that their problems are beyond the reach of any single man.

The beginning of the end, automakers say, was Brazil's January 1999 decision to let its currency float, an event that almost overnight made Argentine products twice as expensive. A symptom of a long-brewing fiscal crisis, the devaluation sparked a still unfinished trade row between the two most important partners of Mercosur--the South American common market that includes Paraguay and Uruguay, with Argentine manufacturers protesting that they can no longer compete with cheaper, Brazilian-made cars.

Almost immediately following the devaluation, Argentina's assembly lines came to a screeching halt. "For almost half of the first quarter last year, the plant was vacant and we were all wondering how we were going to survive," Ford Argentina President Francisco Codina recalls. "We were very tense because Ford President Jacques Nasser came down to see how we planned to get through this ordeal, and nobody was sure if what we were telling him would really work."

For Ford, the country's top vehicle exporter, as well as its competitors, the most suitable remedy to the crisis involves a mixture of work stoppages, production slowdowns and early retirements.

Even the country's top seller last year, Italian automaker Fiat, feels like it's running on empty, "We've banged our heads against the wall a lot of times wondering why we invested here in the first place," Fiat Auto Argentina President Cristiano Rattazzi says.

2000, a dead year. In 1995, the height of Argentina's foreign-investment boom, Fiat laid out $642 million to build--in a record 18 months--one of its most modern plants in the world. That plant now barely turns out 210 vehicles per day, well below its 600-unit capacity. "For us, 2000 is already a dead year," Rattazzi says. "And unless something is done soon to boost the auto industry's competitiveness, 90% of the industry will disappear."

While such alarmist predictions may just be a clever lobbying technique, the truth is that Argentina's 87-year-old automobile industry, the oldest in South America has lost much of its former luster. The industry was a pillar of economic expansion during the 1990s. But production fell by a third last year and exports, most of which go to neighboring Brazil, plunged almost 60%, according to the Asociacion de Fabricas de Automotores.

The loss of sales may only be the beginning. The imminent removal of trade barriers with Brazil--and an open-ended currency imbalance with the regional heavyweight--means that the industry's fate is unlikely to improve this year. Already more than 20 key autoparts suppliers, including familiar names like Goodyear and General Motors subsidiary Delphi-Packard, have closed shop and moved to Brazil, taking with them more than 3,000 jobs, according to the Asociacion de Fabricas Argentinas de Componentes.

Now the exodus threatens to envelop carmakers as well. In recent months, Argentina has lost a handful of production lines--such as Fiat's Siena Mile-- and fallen behind Brazil in the race for new investments. Lured by cheaper labor costs, a market of 160 million people (compared to Argentina's 35 million) and $100 million in tax breaks, Ford announced last year that it would build a new plant in the northern Brazilian state of Bahia.

Though Brazil's economy has stabilized since the devaluation, Argentina's automakers, like the rest of the country's manufacturers, have seen their situation worsen. That's because at the current exchange rate, Argentine cars remain 30% to 40% more expensive to produce, effectively pricing them out of the large Brazilian market that was its bread and butter for so many years.

Free-trade brakes. "The auto industry's problem is that it's too Brazil-dependent:' says Marco Lavagna, an economist who studies the sector for Buenos Aires-based consultant Ecolatina. "About 70% of all industrial exports in Argentina are destined for Brazil. But in the case of the auto industry, it's almost 95%, or just over 50% of total production. That means automakers stand to lose even more ground than other manufacturers by Brazil's instability."

Exacerbating difficulties further, however, is the looming prospect of unrestricted trade between the two countries. An agreement that exempted local automakers from the rigors of free trade under Mercosur expired Dec. 31, 1999. A gradual transition to full-fledged free trade by 2004 was supposed to follow, but a diplomatic assault by Argentina has assured that some restrictions will remain in place even longer.

According to an agreement reached in late March, the transition period will stretch until 2006 and contain guarantees against huge trade imbalances in Brazil's favor. The accord also stipulates that only cars with 30% of their parts made in Argentina (and 30% from Brazil) will be entitled to free-trade privileges within Mercosur. To encourage investment in the two countries, a 35% common external tariff will be added to all cars and light trucks imported from outside of Mercousur. A tariff of 14% to 18% will be charged on imported parts that are already produced locally.

So far, reaction to the agreement by Argentine automakers has been positive, if not overly enthusiastic. "The accord allows us to retain at least some presence in Brazil at a time when a huge currency imbalance would normally exclude us altogether," explains Ford's Codina.

Though the accord does give the local automakers some breathing room, few see it as a cure-all for the Argentine industry's recent woes. "Brazil has the market. Brazil has cheaper costs. And they even have subsidies for industrialists. Those are things that the accord is not going to change," complains Fiat's Rattazzi.

Automakers also allege that by offering protection to more expensive local autoparts manufacturers, production costs could rise by as much as 7% this year. At a time when Argentina's economy is still struggling to regain its footing from one of its worst recessions in a decade, transferring those costs to consumers won't be an easy task, says Codina.

Complaints aside, the deal with Brazil, which ends more than 16 months of deadlocked negotiations, is being hailed by Argentina's freshman president, Fernando de la Rua, as a major step forward in regional integration. Since taking office Dec. 10, De la Rua has tried to portray himself as a less quarrelsome neighbor than his predecessor, Carlos Menem. High-profile snubs, such as applying for NATO membership and promising to protect Argentina's industrialists, earned Brazil's reproach during Menem's final year in power. Relations turned so sour that Brazil and Argentina allegedly even considered ditching the trade bloc altogether.

Jump starting jobs. Empowered by the deal that his predecessor failed to achieve, De la Rua now hopes to resolve a number of other trade disputes that have arisen in the aftermath of Brazil's devaluation. Although Brazil, at least publicly, has been more lenient with De la Rua, it's unlikely to be too generous in future negotiations. As politicians on both sides of the border know--and Brazil's still substantial trade deficit with Argentina illustrates--Argentine industry has reaped the lion's share of benefits from Mercosur in recent years. For Brazil, with an economy more than twice the size of Argentina's and facing major obstacles of its own, complaints filed by Argentine industrialists, including automakers, carry little weight.

For De la Rua, however, jump starting an industry that indirectly employs 220,000 workers and accounts for 3% of the country's total gross domestic is no minor concern. He is counting on the auto industry to help deliver on his promise of lowering a record 13.8% unemployment rate. But as both autoworkers and their managers have pointed out, the margin he has to work with isn't much wider than their own. "Given the pressure he's facing on all sides, I wouldn't want his job, either;' Rattazzi says, laughing.

By placing a premium on reining in the government's massive fiscal deficit, a move that automakers and economists applaud, De la Rua has forsaken an active industrial policy of tax incentives like that practiced by Brazil's state governments. The main alternative, devaluation, is even less likely. "Devaluation would do absolutely nothing to solve our problem of overcapacity and would be terrible for industry," Ford's Codina argues. "It would spark a terrible recession, and since commodities and wages are already paid in dollars, it would only usher in an era of hyperinflation like we saw in the 1980s."

Veteran autoworker Paz agrees, adding that because his mortgage is in dollars, devaluation would force him to surrender his home, the only crutch he has left after a decade-long deterioration of public services.

For angry workers like Paz, the answer to the cross-border auto woes is not complicated: the Argentine and Brazilian governments should turn the screws on the automakers. "They're the same companies profiting on both sides of the border," he says. "For me, the answer is simple. Start demanding that they give back."

Instead of radical solutions, economist Lavagna believes that De la Rua will have to focus on more modest, cost-saving proposals to restore some of the industry's lost competitiveness. These include adopting long-standing industry demands, such as reducing the 40% tax burden on Argentine-made vehicles, reforming the country's archaic labor laws, financing automakers' tax payments and reducing import tariffs on capital goods not found locally. "But until the two countries get serious about synchronizing their macroeconomic policies and creating a true common market, the asymmetries will only grow," he says.

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