The problem with the Argentine economy
With sustained economic growth, Argentina would be able to avoid another debt crisis. While there are no quick fixes to put the economy on a more stable course, changing current macroeconomic policies would at least give the country a chance.
In 2018, Argentina experienced a currency crisis and stagflation. Annual inflation reached 47.6%, GDP fell 2.5%, and unemployment and poverty increased.
These indicators reflect chronic problems. Argentina’s economy has contracted in four of the past seven years. And, for more than a decade, structural deficiencies placed strong constraints on real demand growth and prevented the economy from growing sustainably.
When the current government, led by President Mauricio Macri, took office in December 2015, it said its economic policies would attract foreign direct investment and lead to sustained increases in productivity. The monetary crisis that erupted in April 2018 underscored the failure of its political approach.
In response, the government turned to the International Monetary Fund, secured a $ 57 billion support loan, the largest in IMF history, and agreed on a new approach to address macroeconomic imbalances. from the country. But the terms of the loan deal kept changing as investors remained nervous.
When the IMF approved the new deal with Argentina last June, the government said that instead of spending the funds, it would use them to increase its liquidity and restore market confidence. But when the peso fell further, the government and the IMF agreed Argentina could use the loan to meet debt repayment and avoid default in 2019, a presidential election year. And yet the doubts persisted. Last month, amid fears of another peso rush, the Fund authorized the central bank to sell up to US $ 9.6 billion of its foreign exchange reserves to help support the exchange rate.
The situation remains delicate, in particular because a large part of Argentina’s public debt is denominated in foreign currencies. The IMF says the country’s debt “remains sustainable, but not with a high probability,” although the real test of Argentina’s debt sustainability will begin in 2020.
Six months before the election, there are other more immediate concerns. On the one hand, the IMF-backed macroeconomic plan of restrictive fiscal and monetary policies will help prolong the current recession. Moreover, the approach to monetary policy appears to repeat some of the fundamental mistakes made before the monetary crisis.
While the Macri administration planned to gradually reduce the budget deficit, the central bank took a much more aggressive approach to curbing inflation. In doing so, it relied on two main assumptions: that government policies would put the economy on a sustainable growth path and that higher interest rates would be effective in stabilizing the price level.
Both assumptions have turned out to be disastrously wrong. Much of the investment in the real economy has not materialized. In addition, high interest rates have attracted short-term speculative portfolio capital, making Argentina – and the peso – increasingly vulnerable to a sudden change in market sentiment.
The authorities should have learned at least two lessons. First, tackling chronic inflation requires sustained and coordinated political efforts rather than simply tightening monetary policy.
And, second, inflation in Argentina will continue in the short term, no matter how tight monetary policy. Yet the authorities persist with the same policies.
The devaluation of the peso and the resulting rise in inflation intensified the distributive dispute in Argentina, with workers demanding wage increases that offset the loss in purchasing power over the previous year. In this context, the monetary policy announcements will not reduce inflation expectations, especially since the Macri administration has missed its inflation targets over the past three years by 15, 7.8 and 32.6 percentage points. percentage respectively. Not surprisingly, inflation has risen again in recent months, despite aggressive monetary tightening.
In addition, financial markets will not allow the real exchange rate of the peso to appreciate significantly anytime soon. This means that the nominal exchange rate will come under downward pressure, in turn fueling further inflation. Breaking this vicious circle will not be easy, as it forces policy makers to resolve the distributive conflict in a sluggish economy.
Meanwhile, the central bank continues to rely on high interest rates to support the peso. Although the bank had to act aggressively to contain the currency crisis, it has persisted for too long with an expensive policy of high interest rates which now not only prolongs and deepens the recession, but also – attracting what the called hot money – increases the volatility of exchange rates. And while exchange rate interventions may be warranted in extreme circumstances, the sale of foreign exchange reserves borrowed to support the peso will make the economy even more fragile.
In 2020, the debt situation will come to the fore. The next government will try to regain access to international credit markets when the country is already heavily in debt. If the economy shows no signs of taking off quickly by then, there will be over-indebtedness. In this scenario, higher debt renewal costs would be fatal to the economy, as the authorities would have to allocate a larger share of the country’s stagnant foreign exchange earnings to debt repayment.
The new government would then be faced with two unpleasant options: a straitjacket with higher debt payments, more austerity and more recession, or a painful debt restructuring with an uncertain outcome.
One thing is clear: to be able to avoid another debt crisis, Argentina will need sustained economic growth. While there are no quick fixes to put the economy on a more stable course, changing current macroeconomic policies would at least give the country a chance.
By Martin Guzman
Martin is Associate Researcher at Columbia University Business School and Associate Professor at the University of Buenos Aires, Co-Chair of the Columbia Initiative for Policy Dialogue Working Group on Debt Restructuring and Sovereign Bankruptcy, and Principal Investigator at the Center for International Governance Innovation (CIGI).