Since taking office on December 10, Argentine President Javier Milei pushed the government to achieve in January its first monthly budget surplus since 2012.
It achieved that result thanks to a currency devaluation and reduction in public expenditure, with the phasing out of some subsidies and the freezing of discretionary transfers to the country’s provinces.
“They’ve changed the exchange rate policy and are trying to shift as much of the debt from the central bank to the government, so that the central bank can focus on monetary policy. These are very complicated, difficult issues, but he’s made progress on that,” says Joydeep Mukherji, managing director at S&P Global Ratings.
While the surplus in January is good news, it remains hard to see if this trend of fiscal adjustment will continue in future months as so much of it had to do with a dramatic increase in inflation, explains Todd Martinez, senior director in Fitch Ratings’ sovereigns group.
The fact that the central bank has built up gross foreign currency reserves since Milei took office is one of the most important parameters at which Fitch is looking. “That’s the best piece of news Argentina could deliver. But if it is still happening later this year, with the economy coming out of recession and import demand recovering, then it will be really good news,” explains Martinez.
Sustainability concerns
The big question is if Milei’s reform plans are going to be politically and socially sustainable.
Milei is pursuing the drastic fiscal adjustment that he promised. “He said it is going to be painful and it is painful,” says Mukherji. The reduction of subsidies for public transportation and energy bills has pushed up prices, for example. “People may be willing to bear with it for a while because they understand that there’s no alternative, but nevertheless, it’s going to hurt,” he adds.
The government had to halt investment in public works, inflation outpaced pensions and discretionary financial transfers to provinces were all but frozen. This has pitched governors against the central government, says Hector Torres, senior fellow at the Centre for International Governance Innovation and a former executive director at the IMF.
“Over time, the cost of economic adjustment is a dramatic erosion of their savings and their income; it could become much harder for Milei to keep delivering this fiscal adjustment,” adds Martinez.
Milei is facing opposition in the Congress too, where he lacks a majority, which resulted in the non-approval of a key presidential decree. Instead, he is leveraging what he can do without congressional approval to change fiscal policy.
“Certainly on the monetary policy side, he has the ability to go ahead; he doesn’t need congressional legislation to do something with the exchange rate,” says Mukherji.
Torres highlights how Milei is being far from pragmatic. “He has an abrasive personality, and he seems to enjoy confrontation. Indeed, he has managed to pick up fights even with legislators and governors that are close to his political camp,” he says.
Playing the dollarisation long game
Dollarisation of the economy was the flagship of Milei’s electoral campaign but it is unclear whether and when the president will follow through with his initial plans for full dollarisation.
During the electoral campaign, it seemed Milei wanted to pursue dollarisation as an immediate stabilisation program. “That would have been a risk because it could be very dangerous to dollarise an economy without enough dollars [in the economy],” says Martinez.
At the moment, the government seems to have adopted a more pragmatic approach, aiming at getting the “guts of the economy” back on track, and then maybe pursuing dollarisation as a long-term plan rather than a shortcut to stability. “Whether dollarisation happens or not, that’s very much a political question,” says Mukherji.
“I’m not sure we will see full dollarisation as happened with Ecuador or rather legalisation of a second currency, as is the case of Peru and Uruguay,” says María Castiglioni, director at financial advisory firm C&T Asesores Económicos.
Dollarisation in Argentina regularly becomes a hot topic each time inflation gets out of control. But while Milei seems to have brought the topic back in vogue, the use of the US currency for setting prices has been increasing in recent years, note experts.
Banks still on the fence
Despite all the macroeconomic dysfunctions going on, the country’s banks have managed to stay profitable because they are getting compensated for all the money they parked in the central bank, explains Martinez.
This has come at a cost. By lending so much to the central bank, the credit market has collapsed. “Credit to [gross domestic product] is among the lowest in the world,” says Martinez.
Since June last year, banks started to reduce their exposure to corporates while increasing their exposure to the government through the purchase of bonds that protect against dollarisation, explains Sergio Garibian, managing director at S&P Global Ratings.
S&P Global Ratings classifies Argentina’s banking sector into group 9 of 10, with 1 being the lowest risk, under its banking industry country risk assessment system.
At the moment, the banking system is in “wait and see mode”, preferring to maintain an extremely high degree of liquidity rather than taking risks.
“We need to wait for a couple of months to see how Milei’s plans evolve, how eventually dollarisation will be implemented and the impact on banks’ balance sheets,” says Garibian.
Castiglioni hopes that in the future the banking system will be back to its core function: extending credit. “If Milei manages to change the structure of the economy, banks might be able to increase their role in the economy,” she predicts.
Additional reporting by John Everington
