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WorldOctober 1 2014

Martin Redrado: Argentina must look beyond 2015

The debt crisis is not Argentina’s only problem. The authorities also need to put the county back on a sustainable growth path. 
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Martin Redrado: Argentina must look beyond 2015

A long-lasting resolution of the conflict between the Argentine government and a group of holdout creditors would have been consistent with the normalisation steps towards the international community adopted earlier this year by the government. See, for example, Argentina’s settlement with Repsol, its engagement with the International Centre for Settlement of Investment Disputes, and the country's agreement with the Paris Club group of international creditor governments to repay arrears. Instead, only six months later, authorities decided to administer the scarcity of dollars available by a continuous use of the central bank’s chequebook and muddle through the imbalances until the election. 

Even though this selective default suits no one and has nothing to do with Argentina’s real macroeconomic situation, outlook or sustainability, a collaborative solution was not set in place between the holdouts, the holdins, US district judge Thomas Griesa, who is presiding over the country’s debt restructuring, and the Argentine government. That would have allowed this administration, including YPF (the national oil company) and the provinces, access to capital markets to finance public spending ahead of the October 2015 presidential elections.

Manners matter

There is a need to resolve this situation as soon as possible as Argentina needs dollar inflows to calm the tensions on the foreign exchange market. It is true that when dealing with a negotiation from a position of weakness, manners matter almost as well as content. Credibility and a professional approach are mandatory to achieve a win-win solution. 

Argentina’s default on restructured debt, combined with tighter foreign exchange controls and increased intervention in private-sector activities, is damaging an economy that is already in stagflation. And this reality is here to stay. The default means higher inflation, and a recession that is deeper and longer. Inflation could reach 40% by the end of 2014 and real gross domestic product (GDP) is set to decline 2.5% this year and about 2% in 2015. In this context, economic policy appears to have two main objectives until the end of the current government’s tenure: protecting international reserves while trying to sustain economic activity. These goals, however, are clearly incompatible under current policies.

Higher reliance on the central bank to finance fiscal spending is fuelling inflation and widening the gap between the official and parallel exchange rates. Public spending is growing well above the rate seen more than a year ago. As a result, the fiscal deficit, excluding financing from the central bank and the social security agency (which is considered as income by official statistics), is likely to rise to 5% of GDP by the end of the year.

Most of the central bank assets are public sector assets (for example, temporary advances, non-transferable notes and other sovereign bonds), rather than foreign reserves. With temporary advances reaching their legal limit and foreign reserves declining, transfers of unrealised profits have gained relevance, adding pressure on foreign exchange.

There is nothing new with this, anyway. This has been happening since 2010, when I left my tenure as governor of the Central Bank of Argentina due to the government’s willingness to tackle the monetary authority resources, and I foresaw the fiscal dominance and its impact on inflation. It is worth mentioning that the stance of fiscal policy will remain overly expansionary until the end of 2015 and public spending growth will be limited by the lack of financing sources. Indeed, this rising fiscal dominance is severely constraining the power of monetary policy while threatening the stability of the foreign exchange market.

Brewing imbalances

In the final stage of this administration, I anticipate periods of nominal exchange rate instability combined with attempts to reduce interest rates and ease bank lending conditions. These will likely be followed by phases of faster official peso depreciation and interest rate hikes to minimise reserve losses, particularly when energy import payments go up.

In spite of trying to minimise foreign exchange pressures, the government will likely tighten further controls on imports, tourism outflows, repatriation of profits and dollar purchases by residents. On the dollar supply side, measures such as selling dollar holdings by the banks using the central bank currency swap signed with China, or increasing reliance on bonds in the hands of the social security agency, could only provide very temporary relief to the foreign exchange market.

This strategy is clearly bound to fail and there is no certainty that the government would be able to avoid a more critical situation before the election. The risk of a full loss of confidence in the Argentine peso is on the rise as a result of increased central bank inflationary financing and a shortage of dollars. Foreign reserves could be at dangerously low levels next year to face higher public-sector dollar requirements.

Renewing credibility

Whereas the quality of economic policy to contain brewing imbalances will shape the scenario for the next administration, the outlook in the short term remains positive and the medium-term perspectives for Argentina, intact. While the government has started paying the price of years of poor-quality economic policy, its approach of muddling through the imbalances means that the next administration will have to adopt the needed corrections.

With renewed credibility, reasonable economic policies to restore macro stability and provide predictability to the private sector would include: measures to reduce inflation with multi-year targets to limit public spending and monetary aggregates growth; measures to minimise price distortions, including the unwinding of foreign exchange controls, an increase in expenditure efficiency and improvements in tax and regulatory policies; and measures to rebuild economic institutions, which have been severely weakened in recent years, to regain macroeconomic stability and boost productivity.

A new administration in office undoubtedly generates optimism. Presidential runners from the entire political field have more centred views about the market so they ought to be more pragmatic in economic issues. Moreover, the public agenda to achieve macroeconomic consistency will not differ as much in any case, and consensus among the main presidential candidates on more prudent policies is quite broad.

While more reliance on Congress to reach consensus on policies and increased checks and balances is expected, a weak economy will require skilful political leadership and strong commitment for the incoming government, as they will receive a deteriorated economy. Finally, as most of the existing imbalances have been driven by ill-conceived policies, a clear shift towards sustainable policies will renew expectations and increase confidence, translating into sustained capital inflows and higher investment with a positive impact on growth.

Getting it right

The right set of policies could help lift trend growth and improve social conditions relatively quickly. First, the domestic banking system remains sound: liquidity is high, solvency is adequate, exposure to a sharp depreciation of the peso is limited; and holdings of public-sector assets by banks are small. Second, overall external indebtedness is low: total public debt is 45% of GDP with most of it in the hands of government agencies or official creditors. Third, there is high investment potential in several sectors of the economy, including energy and agribusiness. In energy, for instance, the current imbalances could be quickly reversed under the right policies and a new hydrocarbons law. In the agricultural sector, extraordinary productivity gains in recent years have made companies along the whole production chain highly competitive.

In my view, professional policymakers are essential to provide guidance and conditions through pro-business and predictable policies to support private sector efforts. This, however, is a two-fold challenge that we face as policymakers: growing and building institutions simultaneously. Policies need to be consistent and socially sustainable. We need to address urgent social tensions and, equally as important, build lasting and useful institutions for society as a whole, at the same time. It is a task long overdue for Argentina.

Martin Redrado is the former governor of the Central Bank of Argentina and
 is now dispute settlement board member at the World Trade Organisation. 

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