2024-07-11 14:11:01
Unlock Editor’s Digest for free
Financial Times editor Roula Khalaf picks out her favourite stories in a weekly newsletter.
The writer is director of Georgetown’s Institute for the Americas. Nonresident Senior Fellow, Peterson Institute for International Economics
On June 28, following weeks of stress in currency and bond markets, Argentine Finance Minister Luis Caputo uttered the words heard repeatedly by many of his predecessors in Latin America: I will not devalue. In 1981, then-Mexican President José López Portillo famously said he would defend the Mexican peso like a dog. Then, Latin America’s debt crisis and lost decade began.
Unlike previous governments in Argentina and the region, President Javier Milley’s government has done many things right. Now, Argentina and the IMF must redefine success in order to succeed, shifting the focus away from the sustainability of the currency’s quasi-peg to the dollar and the rapid deflationary process. Macroeconomic policies should focus on economic recovery and slower but sustainable deflation.
Since taking office in December, Millais has eliminated the public sector deficit, a huge adjustment of more than 4.5 percentage points of GDP. He has corrected the real value of many regulated prices, which had been artificially set by the previous government to mask some of the effects of its terrible policies. He has adjusted the real exchange rate to more realistic levels and has launched an impressive deregulation and modernization agenda.
As expected, his first few months in office have been difficult. Monthly inflation has exceeded 25%, economic activity has collapsed, and poverty has risen. On the positive side, inflation has fallen much more than expected, and the government’s commitment to correcting the deficit has not changed. Millai’s approval ratings have remained intact, and some important legislative initiatives have been approved, paving the way for a successful first year of the economic program.
Its Achilles’ heel is the anchoring of the exchange rate policy at a slow rate of 2% per month, well below average inflation. Negative real interest rates are now also a burden. This combination was sensible and useful in the initial stages, as it allowed for a quick elimination of inflation, a rapid accumulation of international reserves, and a reduction in the real value of the central bank’s liabilities. But now, as the real exchange rate has reached its pre-devaluation level, it does not provide exporters and other economic agents with a financial incentive to convert dollars into pesos.
This, in turn, has put enormous pressure on Argentina’s financial markets. Faced with this, the Millais government is determined to defend its 2% inflation rate and continues to equate success with a significant drop in monthly inflation. Previous Latin American governments have been forced to exaggerate their commitment to fixed exchange rates because their willingness to adjust economic fundamentals was weak or non-existent. In this case, however, Argentina has built the fundamentals but mistakenly put its achievements at risk through a disorderly monetary adjustment.
To regain market confidence and recalibrate stabilization measures, the government needs to move to the second phase of the plan. In this phase, deflation will occur at a slower pace and the government will focus on economic recovery. In this way, Argentina will be able to embark on a more sustainable path of stabilization, as its Latin American peers experienced in the 1990s.
The Mille government needs to make a clear commitment not to dollarize the economy and support its currency competitiveness strategy by strengthening institutions and policies that will allow the peso to surpass the dollar as the currency of choice for Argentines. To this end, the government should submit an amendment to the fiscal responsibility law to Congress as soon as possible. This update should establish zero deficits as a fiscal goal for the next few years and should establish the independence of the central bank.
The government also needs to announce the adjustment path for controlled prices. The central bank should allow the official currency to adjust to a more realistic level and move to a more flexible official exchange rate mechanism. Together with a modern monetary policy framework, this would result in a strongly positive real interest rate policy.
On the back of these strengthened policies, the IMF should support Argentina with a new, larger financial support program. With these elements, Argentina will be ready to remove capital account controls and float its currency freely. Together with renewed IMF financial support, these would provide Argentina with the best conditions in generations to escape decades of instability and economic decline.
1721198927
#Millais #IMF #address #Argentinas #Achilles #heel
