Argentina’s troubles

Monica de Bolle says that the action taken by the government of President Mauricio Macri is hard to square with the fact that the country was the darling of the financial markets a little over a year ago, having pulled off the sale of a 100-year bond.

Part of the explanation of the abrupt turn certainly lies with the excessive optimism over the country’s ability to dig itself out of the very deep hole caused by a decade-and-a-half of economic mismanagement. The tide turned some three weeks ago when skittish investors – fearful of the global repercussions of a potential US-China trade war, combined with a likely rise in US inflation and interest rates due to expansionary US fiscal policy – started to pull their money out of emerging markets. De Bolle thinks that Macri’s request is intended to help the country toe the fine line between financing and adjustment without compromising the reform effort, and it is a bold one. The return of the IMF to a region plagued by a history of failed programmes is less than auspicious. For those who believed the region had graduated from the Fund once and for all, Argentina is again a wake-up call.

John Cochrane hosts a long and detailed post by Alejandro Rodriguez, director of the Department of Economics at CEMA in Buenos Aires, who provides a very detailed timeline of the market movements and the institutional response.

Cochrane argues that Argentina in the 1990s is a test case, as even 100% backing of the currency is not enough to peg an exchange rate, because the government does not back the debt. So even a currency board is not immune from the inflationary effects of fiscal problems. In the early 90s, after two hyperinflations, Argentina adopted the Convertibility – i.e. a fixed exchange rate. The experiment lasted 10 years until a global strengthening of the dollar coupled with other shocks spooked away the capital inflows that were needed to finance Argentina’s fiscal deficit and ballooning debt. In December 2001 President de la Rua resigned, debt was defaulted and the economy collapsed even further. The Convertibility ended and the peso started to float (with interventions) after an abrupt devaluation. The depreciated real exchange and booming commodity prices acted like an adrenaline boost on the real economy, which started to grow. Then populism happened.

Martin Guzman argues that with growth fuelled by an increase in debt, Argentina is facing an uncertain economic future. The government of Mauricio Macri has options to address the country’s macroeconomic risks, but none of them will be free of tough choices.

To stabilise its external debt, Argentina will need to achieve trade surpluses. The optimal way to do this is by increasing the production of exportable goods, rather than through a recession that depresses imports. But, while the goal may be clear, the capacity of current policies to achieve it is not.

Two basic strategies govern the government’s approach to stabilising the economy: interest-rate-based inflation targeting, and gradual reduction of the primary budget deficit (which excludes interest payments). But this policy mix raises several concerns. Guzman thinks that there is little evidence to support the central bank’s assumption that a floating exchange rate will ensure macroeconomic consistency, and that to boost exports Argentina will likely need to begin by changing its monetary-policy strategy.

El Cronista has a collection of economists’ reactions to the news. Martin Redrado argues that the decision is a step back, and shows the government is trying to recover lost credibility but has missed the chance to work in a preventative manner with other multilateral institutions, such as the World Bank. Guillermo Nielsen welcomes the announcement but says it has a sour aftertaste, because it shows the the country is unable to self-control, and has  insufficient political leadership to explain and lead an essential adjustment. Jose Luis Espert is critical, and calls the decision “the failure of gradualism”. Miguel Kiguel also welcomes the decision and says an IMF’s credit line would be the best option for Argentina’s growth and would help in lowering country risk. He says it was known that the Achilles’ heel of gradualism was the dependency on external financing. The question was what would be the plan B, and now we know the answer.

Arturo C. Porzecanski sees the announcement as an admission that time may be up for Macri’s policy of gradualism in dealing with the legacy of populism. The announcement did not have the favourable intended effect on confidence and market behaviour. Despite renewed central-bank intervention to boost the currency, it lost of about  a third of its purchasing power against the dollar.

One reason – according to Porzecanski – is that Macri’s blaming adverse developments abroad for his currency’s woes rings hollow with investors, given how very slowly his administration has moved to reduce a fiscal deficit running above 6% of GDP since 2015; how much debt (around $100 billion) he has taken on in just a couple of years; and how timid his central bank has been in its attempt to bring down inflation running at about 2% per month.

The other reason is that it quickly became apparent that any loan from the IMF will come with strict conditionality attached. The Fund spelt out its economic policy advice for Argentina in its December 2017 “Staff Report for the 2017 Article IV Consultation”. It calls for a more assertive reduction in the fiscal deficit – especially by cutting government spending – and for supply-side reforms it called “indispensable” in order to support economic growth, raise labour productivity, attract private investment, and enhance the country’s competitiveness.

These are all recommendations that fly in the face of President Macri’s gradualist approach to defusing the economic minefield left behind by his populist predecessor, and will therefore paint his government into a politically fragile corner.

The Economist thinks Macri has done a pretty good job. The economy has grown at an annual rate of around 3% for the past 18 months, even while the government has ended most of Fernández’s distortions. It has gradually trimmed the fiscal deficit, partly by raising energy and transport prices. The central bank now only hands over money worth 1% of GDP. The government has bought itself time by issuing debt. The problem is that stabilising the economy is taking longer than the government had hoped and investors have become more reluctant to lend to Argentina.The government is trying to control inflation while also trimming the fiscal deficit and keeping the economy growing. Doing all three things at once is hard, and the world economy is making Macri’s job harder.

Matias Vernengo thinks that the economy under Macri has not performed very well. Inflation has remained high, since the depreciation of the peso has persisted, and the rate of growth has been lacklustre. Vernago argues that Macri's policies are essentially the same as the neoliberal policies of Menem (and his finance minister Cavallo), minus the fixed exchange rate system. The notion was that a flexible exchange rate with inflation-targeting would basically provide the same price stability as Convertibility in the 1990s, without the balance of payments problems that led to the 2001-02 debacle. The result was a significant increase in imports, not matched by increases in exports, and the resort to foreign borrowing to close the gap.