Argentina: From Gradualism to Shock Therapy

By Arturo C. Porzecanski*

Argentine President Mauricio Macri

Argentine President Mauricio Macri. / Wikimedia / Creative Commons

The austerity measures that President Mauricio Macri announced yesterday to deal with the sharp depreciation of the Argentine peso and acceleration of inflation in the past couple of months are a belated but entirely appropriate effort to stem the country’s massive capital flight.  His administration intends to lower government spending and reimpose taxes on exports to reduce the fiscal deficit faster than envisioned in May, when a three-year economic program was agreed with the International Monetary Fund (IMF).  This is in addition to a previously announced government hiring freeze and cuts to subsidies for electricity and other services.

  • Specifically, the goal now is to minimize the public sector’s financing requirement for 2019, limiting it to rolling over debt maturities coming due plus borrowing $15 billion mostly from the IMF, World Bank, and Latin America’s development banks (CAF and IADB), to cover the interest payments coming due next year. All told, the fiscal deficit contraction that would be achieved between 2017 and 2019 is equivalent to about four percentage points of GDP, compared to the previously pledged 2¾ percent of GDP in savings embodied in the IMF program.
  • In return, Macri’s government has requested the IMF to speed up disbursements under the $50 billion loan facility, which had envisioned a $15 billion up-front payment in June, made on schedule, plus installments of about $3 billion per quarter through June 2021, depending on performance and need. The Fund’s Managing Director, Christine Lagarde, has instructed IMF staff to work with the Argentines to reach a rapid conclusion of discussions to present to the Executive Board for approval.

Macri’s announcement was an admission that what had been advertised in May as a strictly “precautionary” loan must now be amended to provide emergency financing full-throttle.  While a number of emerging-market currencies have come under downward pressure in recent months, the sell-off in Argentina is only comparable to that in Turkey: both the Argentine peso and the Turkish lira currently buy about half as many U.S. dollars as they did at the start of the year (now 100 pesos = $2.60 vs. $5.40 then).  The currency downdraft has dragged Argentine stocks and bonds down when measured in dollar terms; the probability of a debt default in Argentina, as deduced from bond yields, currently ranks highest of all in the emerging markets but for Venezuela, in default since late 2017.

  • Last December, the central bank of Argentina (BCRA) committed itself to achieving an inflation rate of 15 percent during 2018, but prices rose more than that just in the first six months of the year. Given the cost-push pressures unleashed by the peso’s sharp depreciation since May, Argentina would be lucky to end the year with inflation cumulating less than 40 percent.  The patent failure of monetary policy to stabilize the currency and curb inflation thus far will probably be hotly discussed during the government’s negotiations with the IMF.  Last week the BCRA hiked its target interest rate to 60 percent from 40 percent in early August, which is more than double the level that prevailed through May.  Chances are that the IMF will pressure the central bank to keep interest rates significantly above expected inflation until the fever breaks.

We wrote in mid-May that we were witnessing in Argentina the demise of President Macri’s cherished – and popular – gradualism in tackling the poisoned inheritance left after 12 years of populism under presidents Néstor and Cristina Kirchner.  Now we are beholding the embrace of “shock therapy” in fiscal and monetary policies by the Macri administration.

  • Macri and his economic team keep blaming adverse circumstances, such as the worst drought in 30 years, which has delivered the poorest harvest since 2009; risk aversion among investors because of the tightening of U.S. monetary policy; and uncertainty generated by the “corruption copybooks” scandal involving Kirchner government officials and construction industry businesspersons. Their diagnosis is patently wrong.  Despite the poor harvest, Argentine export earnings through July have increased in the best performance in several years.  The tightening of U.S. monetary policy has been very gradual and well telegraphed in advance; it has not caused problems in prudently managed countries.  And the recent scandal is tarnishing Macri’s opposition in the legislature and has not reached the scope of the “carwash” scandal in Brazil.
  • Macri and his team are reaping what they sowed. In 2016-17 they claimed that they could do little to address the inherited fiscal and monetary problems because otherwise they would lose precious seats in midterm congressional elections and end up as lame ducks.  And then, after Macri’s party Cambiemos did well in the October 2017 contest, they claimed that in 2018-19 they could do little to address the inherited fiscal and monetary problems because otherwise they would lose the presidential elections in October of next year.  Up until February, local and foreign investors were willing to give the Macri administration the benefit of the doubt, but then they got impatient, started to pare their positions especially in short-term government bonds, and subsequently decided to exit on a large scale when the central bank failed to tighten monetary conditions sufficiently to keep the peso from depreciating rapidly.

September 4, 2018

*Dr. Arturo C. Porzecanski is Distinguished Economist in Residence at American University and a member of the faculty of the International Economic Relations Program at its School of International Service.

Brazil’s Protest: If You Get QE3, We Get Tariffs

Photo by “SqueakyMarmot” | Flickr | Creative Commons

For two years Brazilian voices have complained that U.S. policies of near-zero interest rates and “quantitative easing” have been damaging its economy.  Lax monetary policies in the U.S. and Japan are blamed for the high valuation of the Brazilian real, which further suppresses Brazil’s  languishing manufacturing sector.  Tensions escalated following the September 2012 announcement of the U.S. Federal Reserve’s third round of quantitative easing.  Now the debate has spilled over into discussions about Brazilian restrictions on trade.  As Finance Minister Guido Mantega warns of a “currency exchange war,” Brazil is increasing tariffs on U.S. goods and foresees the imposition of taxes on inflows of foreign capital, which further inflate the Real.  Writing in Folha de São Paulo, Luiz Carlos Bresser-Pereira argues that Brazil is acting in self-defense.  The tariffs Brazil is contemplating are by his account not protectionist but simply an effort to compensate for the unfair advantage that the U.S. seeks to achieve through its monetary policy.

The tension is spreading beyond Brazil, as currency appreciation is portrayed as a drag on manufacturing in much of South America.   In an interview with CNN, Chilean President Sebastián Piñera criticized “QE3,” asserting that “printing money” would not solve U.S. economic woes.  So far, Andean countries are responding by purchasing dollars and cautiously reducing interest rates, but the Brazilians, in particular, present protectionist measures as counter-cyclical tools of their own, necessitated by American attempts to “drive down” the dollar.

The Brazilian and South American claims may be overdrawn somewhat; many experts believe that overvaluation is primarily a consequence of Chinese demand for South American commodities and the decision by most Latin American countries to maintain high interest rates in order to forestall inflation.  But U.S. policies meant to boost job growth are indeed having unintended consequences in the hemisphere.  There has been little thought in the United States of the external implications of Fed policy—beyond a belief that a reinvigorated U.S. economy would be good news for everyone.  Brazil has been the first, and most vocal, challenger of a stance that always frowns on tariffs while presenting monetary policy as a purely domestic matter.  It is a bit much for Brazilians to expect that U.S. monetary policy should be crafted with an eye to its impact on the region, particularly when conventional fiscal policy measures are thwarted by Congressional dysfunction, but Washington should not be surprised when efforts to tamp down its currency – not unlike Chinese policies that Washington condemns  – are seen abroad as aggressive threats to competition.