Martin Castellano, senior Latin America economist at the IIF in Washington, warns that the government’s short-term policies will lead to further devaluation and potentially social unrest.
“Without a shift in policies, a sharp depreciation of the official exchange rate is unavoidable,” he says. “However, we should not expect what we have seen in January this year. The ability and willingness to engineer a traditional adjustment is much more limited now. The main risk is a disorderly market-driven adjustment, particularly if intervention on banks escalates.”
Rapid deterioration of macroeconomic and social conditions will erode the president’s political support, which could lead the government to backtrack politically next year, says Castellano.
Argentina is facing the twin challenges of reigniting growth and protecting its dwindling international reserves. Fiscal policy is increasingly expansionary as the government seeks to prop up growth. As public spending continues to grow above 40%, the fiscal deficit could reach over 5% of GDP by the end of the year. The IIF says that, with global capital markets off limits, public sector financing is being constrained by narrow domestic sources, including a squeezed central bank.
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| Without a shift in policies, a sharp depreciation of the official exchange rate is unavoidable Martin Castellano, IIF |
“Recent government policies have increased uncertainty and damaged an economy already in stagflation,” says Castellano. “The gap between the official and the parallel exchange rate widened to 80% in October from 30% in March.” Castellano adds that the pressure on foreign reserves, which stand at $27 billion, has resumed. Inflation expectations surpassed 40%, deepening the deterioration in macro conditions in a context of a weakening trade surplus amid lower soybean prices and sluggish demand from Brazil. However, at the recent IMF/World Bank meetings, Argentina’s economy minister Axel Kicillof claimed that the country could access international markets. Speaking to Euromoney’s sister publication, Emerging Markets, he said: “There have been offers all the time. But we will not accept any of them. There is no need to access international capital markets now.”
Many people at the meetings disputed these claims, asking why, if access is available to Argentina, it chooses to pay a domestic rate of about 25%.
According to Castellano, the treasury’s reliance on central bank financing has become deeply ingrained. The stock of claims on the public sector, including non-transferable bonds, temporary loans and other sovereign bond holdings, reached 70% of total central bank assets. Rising fiscal dominance has severely constrained monetary policy and the weakening of the central bank’s balance sheet has eroded confidence in the peso.
“The government attempts to minimize international reserve losses while boosting growth. However, the policy instruments chosen to protect reserves harm growth while the measures aimed to boost activity add downward pressure on reserves,” says Castellano. “The effectiveness of controls and one-off measures aimed to boost reserves is bound to decline.”
In the short-term, many observers expect a new round of controls, moves to ease credit conditions and efforts to boost the dollar supply from the agricultural sector. However, the IIF warns that a policy response to worsening conditions that includes tighter currency controls, further fiscal deficit monetization and increased state intervention in the economy fuels inflation, deepens the recession and adds to peso depreciation pressures. Inflation will be in the 40% to 45% range in December and real GDP is set to decline by 2.5% this year.
As the stagflation scenario worsens, 2015 is likely to be a rough transition year. Three factors cloud the outlook: lower agricultural export prices; tighter external financing (FDI, intercompany loans and trade credit); and potential for more frequent episodes of social unrest amid the emerging costs of several years of idiosyncratic economic policies.
Critical levels
The IIF forecasts that GDP will contract by 2% and inflation will remain above 40% next year. Foreign reserves could drop to critical levels of about $15 billion to $20 billion given that dollar requirements will be higher. With prices of Argentina’s main source of dollars – soy – uncertain, the country will be increasingly reliant on an economic rebound in Brazil to sustain its reserves through 2015.
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Beyond the presidential elections, scheduled for October 2015, the outlook appears better. The IIF says that all candidates are advocating pro-business policies and the economy has underlying strengths, such as a low ratio of debt to GDP and high potential in the energy, agribusiness and mining sectors.
Many candidates are comparing Argentina and Mercosur unfavourably with the growth being achieved in the Pacific Alliance countries of Colombia, Mexico, Chile and Peru. A realignment of Argentina’s economy along more orthodox lines could have large and swift results. “While challenges will be sizeable in 2016, this should help to boost investment and jump-start growth in a context of improved policies,” says Castellano. “With the right measures in place, Argentina could easily grow 4% to 5% by 2017.”
