Argentina is perhaps the only example of a country that, while it was among the 10 richest at the beginning of the 20th century, was driven into poverty by the populist state diet economic model of the Peronists. A country rich in natural resources followed a failed development model based on industrialization behind a wall of protection against competition. The economy was built on industries and companies that enjoyed privileged access to finance, foreign exchange, tax breaks and government contracts.
The country has defaulted nine times, three of them in the 21st century. Bonds issued after the last public debt restructuring in 2020 are trading at a third of their face value. Inflation is running at 150%, the currency has lost 90% of its value on the black market, 40% of the population lives below the poverty level, and factories are closing for lack of foreign exchange for imports.
The country relied on a loan from Qatar and swaps with China to repay the tranche owed to the IMF on a record $57 billion loan agreed to by President Macri in 2018, making Argentina the largest borrower in IMF history. The program was revised by the left-wing president Fernandez who then ruled, but soon derailed and disbursements stopped. The current crisis is the worst the country has faced since the bankruptcy of 2011 that caused mass protests with 30 deaths.
The new president Javier Millay is called to reverse the wrong policies of a century. The obstacles are huge. He will have to face the Peronists in the congress and maintain the support of the citizens despite the austerity measures. In any stabilization program things get worse before they get better. By devaluing the currency and removing price and exchange controls, inflation will initially rise and real incomes will fall.
The absurd system of multiple rates depending on the source and use of the currency creates huge distortions and should be abolished. So are the extended subsidies on energy consumption. How much patience will an already troubled electorate show? The new President Millay warned of a painful economic shock in order to correct the economy. “There is no money,” he said at his inauguration.
The timing of reforms matters. If the currency is freed before the budget is balanced there will be massive capital flight. If interest rates are raised to retain capital, the recession will deepen. First priority is to prove that he means what he says in terms of balancing the budget so that inflationary money is issued. He certainly learned something from the soft adjustment that former President Macri chose, leading the country to bankruptcy in 2018.
Countries that have lost access to capital markets do not have the luxury of soft adjustment. Lack of fiscal discipline doomed to failure the previous attempt to liberalize the economy by President Menem and Finance Minister Cavalo in the 1990s, with the peso-to-dollar convertibility program at a one-to-one rate, while today the black market rate is 1000 to one.
Having lost control of monetary policy due to a fixed exchange rate and free movement of capital, fiscal policy was the only means of compensating for the recession caused by the Asian crisis of 1997-98. The failure to run surpluses in the golden era of rapid growth that preceded it left no room for expansionary policy without raising concerns about debt sustainability.
Before his inauguration the new President Millay visited the US government and the International Monetary Fund to which Argentina still owes 41 billion dollars. Argentina’s relationship with the IMF has been stormy due to successive unsuccessful stabilization programs. On December 7, an IMF representative said that Argentina needs a strong and credible stabilization program with political support to address economic imbalances and structural problems and to protect the most vulnerable in society.
The IMF is unlikely to offer Argentina new financing beyond what is needed to repay what it already owes. Although Millay champions free-market capitalism, investors worry about the country’s governability, as the new president will inevitably clash with labor unions and powerful left-wing forces in Congress.
Millay claims that Peronist policies threaten to turn Argentines into “cavemen” and that only shock therapy can save the situation. In reality, he will have to ally himself with center-right policies that will moderate his more radical proposals. Good luck Argentina, the whole liberal world is with you.
