ARGENTINA: A RECIPE FOR DISASTER

In this short script, the author aims to highlight three episodes that have characterized Argentina’s economic performance over the last 60 years: in doing so, the author wants to emphasize common features across the three crises presented. However, the central argument the author points out is that without any adjustments in terms of macroeconomic fundamentals Argentina is doomed to another populist experience.

It’s not an easy job for Macri to get rid of Argentina’s image of a serial defaulter on its debt- seven times on its external and five times on its internal debt over 200 years is a record. Despite IMF came to rescue Buenos Aires with a record $56bn loan package-this is a record as well, Argentina is on a cliff edge.

However, Argentina is accustomed to crises.

Since the 50s up until mid 70s, Argentina decided to embrace the so-called Import Substitution industry (ISI): as many emerging markets and developing countries, Buenos Aires committed to replacing major consumer imports by promoting the emergence and expansion of a domestic manufacturing industries through the use of tariffs and non-tariff barriers, to the detriment of export growth (namely, agricultural sector, since Argentina was rich of land). The main rationale was that the key to economic development of their own countries rested on the creation of a strong manufacturing sector. However, import-substituting industrialization ended up benefitting powerful and established political cleavages and coalitions that were interested in it- industrials and trade unions above all- while the agricultural sector suffered the most.

Simultaneously, as Sturzenegger points out, while governments enacted a mix of expansionary fiscal policies and protectionist measures- such as high government expenditures to stimulate domestic demand, nominal wages increase and price controls by decree, a string of nationalizations- Central bank of Argentina was completely overrun by governmental policies. Namely, it lost its independence and its role to become a simple printing-machine to finance government expenditures and large redistributive programs, while intervention in the foreign exchange market was aimed at sustaining a band in the fixed exchange rate in order to cut inflation.

Figure 1. Argentina GDP per capita (in 1990 international Geary–Khamis dollars) as a percentage of the US's, 1900-2008.

As a consequence, government started running large budget deficits and fiscal and foreign exchange constraints came to present the bill.

Inflation skyrocketed, wages fell below the initial level, balance of payments worsened harshly due to the inability to service its debt, budget deficit hit the ceiling as well, while low level of foreign reserves to sustain the fixed (and really high) exchange rate and high level of capital outflows put heavy pressure on currency. Government was thus forced to adjust its programs to reality: a loose monetary policy was replaced by a tighter one, foreign reserves were rebuilt, whilst macroeconomic adjustments such as devaluation of the currency, subsidies reduction and increase in taxes and utilities took place.

2001-02 crisis lies on the same basis. With the difference that while during Peron era Argentina was partly cut off from the international market, during 80s and 90s was not.

Argentina at that time pegged its currency, peso, to US$ to curb inflation and achieve stability-that was the so-called Ley de Convertibilidad (1991). If initially this measure was successful, as Feldstein notes, in the long-run an overvalued peso deteriorated terms of trade, limiting exports and increasing imports, resulting in a trade imbalance in terms of current account and budget deficit that ultimately forced Argentina to borrow even more to repay interests on its debt.

Argentina ended up piling up more and more debt and eating heavily into foreign reserves to maintain its fixed exchange rate, while capital flights grew abruptly. To make things worse, tax evasion steadily increased and wages kept increasing while productivity did not follow suit.

As soon as it came clear that Argentina would not be able to roll over its debt and pay interests on it, Baires defaulted and peso was devalued. Restrictions on bank deposit withdrawal were put into place, and the “pesification” of the entire economy- left in tatters many entrepreneurs and businesses indebted in US$ currency, who found themselves unable to cope with their debts.

A typical case-study of first-generation model of financial crisis occurred.

2001 crisis wreaked havoc on an entire economy and consequences drag along still today, especially in terms of access to international capital markets and consequently on both domestic and external equilibrium.  

Figure 2. Comparison btw rigged CPI by INDEC (Red), Mit Billion Prices Project (Blue) and correlation with Money Base (Yellow)

“Kirchnerismo” has added layers of instability and, as most Argentinian administrations, failed to realize that Keynesian stimulus falters on foreign-exchange and fiscal constraints. The rule of thumb was pretty much the same as previous populist governments in Argentina: central bank as a money-printing machine- M2 ballooned over the last twenty years, large government budget deficit and consequent huge current account deficit, a whole string of nationalizations, rising inflation, products’ subsidies, price controls etc etc.

Figure 3. In mid 2000s soybeans, soybean oil and meat prices’ boom accounted for 20% of exports (source: https://www.webcitation.org/64LnsrQz0?url=http://npr.berkeley.edu/Richardson_eop.pdf)

To make things worse, C. Kirchner laid off CBOA Martin Redrado, over his alleged rebuttal to use central bank’s foreign exchange reserves to finance growing public spending in the aftermath of 2008 financial crisis. Plus, the national institute of Statistics, INDEC, has been steadily subject to political pressure to rig CPI-consumer price index- to provide a low and thus sound inflation rate, as it came out later on. These actions undermined the credibility of Argentina on the international stage.

If initially “Kirchnerismo” was successful, due to booming price of commodities such as wheat and soybeans, however, according to many international organization and reports, real 2002-2007 GDP growth was weaker than in the 1990-98 period and claims that grew up was mainly due to the commodities boom. To make matter worse, real GDP adjusted for inflation has been stagnating and remains on the same level of 1998, as many findings by the enquiry committee set up by Macri have outlined. Debt to GDP ratio initially shrinked but then reached kept increasing, averaging 65% over the last ten years.

Figure 4. Negative Correlation btw Peso (white) and Money supply (yellow)

Nowadays, Macri’s gradualismo falls short of expectations. Major element of country risk- namely, the capacity of Argentina to generate enough foreign exchange to maintain required level of imports and service its foreign debt- remain very high. Despite Macri was able to understand that important measures had to be implemented to fix macroeconomic fundamentals, he enjoyed low consensus amongst major socioeconomic groups over the policies to carry out in case of financial shock. Capital account was liberalized, currency controls were mainly removed, with the peso devalued and let free to float: however, money supply continued to grow and macro-prudential measures, like counter-cyclical fiscal policies (tax or expenditures-based) were hardly implemented.

Figure 6. Argentina downward sloping Yield Curve

In doing so, pro-cyclicality in terms of government spending reinforced output volatility and domestic equilibrium worsened. Therefore, external equilibrium was worsened as well. Indeed, high sensitivity to FED monetary policy, which raised funds rate from 0.25 basis points to 2%, caused a spike in capital flight from emerging markets toward the higher-return haven of U.S. markets: as a consequence, to put it simply, peso hit rock bottom, balance of payments went from bad to worse,  each bond yields priced-in inflationary expectations and government was forced to ask IMF to come in to rescue.

Figure 6. Balance of payments analysis, in $

Argentina keeps having a sizeable current account deficit and a rapidly increasing stock of external debt: as this research outlines, drawing on IFF data, situation might get worse since a fairly relative small banking system and a little export-import ratio to GDP provide Argentina with a low degree of capital buffer to cover its funding.

Figure 7. Argentina's peso, century bond and stock index through 2017-2018

The three crises presented share three main features: a fiscal profligacy, an irresponsible monetary policy and a weak institutional setting. Many structural adjustments are needed to improve domestic equilibrium in terms of standard of living and external equilibrium as well.