New President Javier Milei has vowed to tackle Argentina’s economic crisis. We assess the potential impacts of his radical policy proposals.
18.12.2023 | 06:10 Uhr
Argentina is in crisis. An unsustainable fiscal position
triggered an inflation crisis, fed further by a lack of credible
monetary policy. An unsustainable external balance triggered negative
net reserves. As a result, Argentina’s poverty rate is 40%, which is
four times that of its neighbor Uruguay. Argentina just elected Javier
Milei on an ambitious reform platform. Milei’s election starts a new
economic experiment: he’s stated he wants to dramatically cut government
spending and dollarize the economy. As a result of previously failed policies, investors have lost
faith in Argentina as a borrower. The government’s dollar denominated
debt trades around 30 cents on the dollar, implying an imminent
restructuring. There are a few key policy corrections we want to see to
regain confidence in the Argentina story. Credible fiscal policy is the
first. Argentina cannot afford the current level of spending and needs a
policy adjustment to run smaller, sustainable fiscal deficits. The
International Monetary Fund (IMF) estimates an average deficit of -5% of
GDP over the past five years, largely financed by external borrowing
and the central bank (October 2023 World Economic Outlook, IMF). The
government need to commit to fiscal austerity. To slow inflation,
Argentina needs a credible monetary policy framework. Part of this will
need to be better foreign exchange management. Milei’s proposal is to
dollarize the economy, one of the few things Argentina hasn’t tried yet
on this front. This discussion is quite radical with only a few
countries having done it, such as El Salvador, Ecuador, and Panama.
Argentina is up against a multi-dimensional problem and all these issues
will need to be attacked simultaneously. Milei is proposing a radical reworking of the system. This
requires buy-in from Congress, where Milei does not have a majority
coalition. The Argentine population also needs to be willing to undergo
the adjustment. The IMF is another important player as Argentina’s
single largest creditor. Part of the fiscal solution will eventually
require a restructuring of their sovereign obligations, and all
creditors will need to make concessions – the IMF, China, and the
private sector. Success begets success, and an improvement in government
credibility will lead to more support from the IMF. In the short-term, Argentine citizens will bear the costs of
these reforms. A fiscal adjustment will likely result in a recession, a
weaker social safety net, and higher poverty. Argentina’s crisis is not
unique: many emerging market countries have successfully navigated
similar crises. Latin American crises in the 1980s and Russia in the
1990s offer a few examples. The policy toolkit is well known at this
point, which is why elections present an opportunity for a turning
point. Dollarization is a high-risk experiment, with uncertain outcomes
for private creditors. I expect Argentina eurobond prices to rise at the
early stages of this experiment as initial policy announcements and
adjustments are made. After two lost decades, we’re hopeful that
Argentina won’t see a third.Key takeaways:
New President Javier Milei has vowed to tackle Argentina’s economic crisis
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