2024-09-01 03:01:00
Javier Mire came into government promising to solve Argentina’s problems. He focused on one problem: high inflation. So far, it’s been an easy ride: Inflation rose to 4.2% in May from 25.5% in December. Few believe this goal can be achieved in one semester. The stabilization program has brought inflation down so quickly that would have been unimaginable just a few months ago and should not be underestimated.
As inflation falls, there is a sense that the worst is over. There will undoubtedly be relief from slower price growth. Incomes (wages and pensions) are slowly recovering, credit is re-emerging after many years, consumption is increasing and more productive sectors are starting to show positive trends.
But uncertainty remains
To simplify the statement, we face a trilemma. Three desirable but mutually exclusive goals: lowering inflation, accumulating reserves, and eliminating the exchange rate. The government has done everything it can to reduce inflation. The most powerful evidence is that it has begun to use its foreign exchange reserves to intervene in the foreign exchange market. The basic idea is that the exchange rate gap narrows, that is, the dollar price converges. When this point is reached, the trap can be removed.
financial pressure. Lower paise tax: What happens to prices and inflation?
This is a risky strategy. Regarding doubts about the success of the official proposal, the most objective evidence is that the national risk has not been reduced. Since the fiscal surplus is insufficient to repay all maturing debt, it will be necessary to renew at least some of the debt. But with country risk so high, exorbitant interest rates must be paid. International advisory firm Moody’s warned in its latest report that Argentina may default on its debt repayment obligations, leading to a restructuring. Underlying this pessimism is the fact that new financing appears unlikely from the International Monetary Fund (IMF), whose officials have been expressing growing dissatisfaction with the exchange rate strategy being followed by the government.
In terms of urgency, the challenge of obtaining financing to repay some debt maturities supersedes the removal of inventory. But maintaining inventories has two very distorting effects. On the one hand, it taxes exports and inhibits production in the export sector; thereby reducing the supply of foreign exchange. On the other hand, it acts as an import subsidy, stimulating demand and increasing the demand for U.S. dollars from the Central Bank of the Republic of Argentina (BCRA). Furthermore, this hinders production in sectors that compete with imports.
Starting on Monday, September 2, the problem became more serious. As expected, the Ministry of Economy decided to reduce the Pais tax by 10 percentage points, from 17.5% to 7.5%. The government hopes the cuts will achieve its main and only goal of lowering inflation. The B-side is that this measure means increasing import subsidies and further encouraging imports by reducing import costs. This will further complicate competition between domestic and imported producers. That said, there’s good news for those who use imported ingredients. But for those companies that compete with imported products, the currency delay will deepen.
There are other options. For example, lowering the paise tax, depreciating the exchange rate in the same proportion, eliminating mix For export. That is, applying compensatory devaluation. This would have a neutral impact on domestic prices but put less pressure on local production competing with imports. Instead, the government’s choice is to go all out to reduce inflation, even if this means increasing pressure from exchange rate appreciation.
Illustration Eric Zampieri.
The official view is that competitiveness is gained not through devaluation but through productivity improvements. This requires more than just the private sector to redouble its efforts. It is crucial for the country to provide macroeconomic stability and a more enabling environment for production, investment and job creation. This means continuing to advance the 10 points of the May Pact. One focus is on eliminating bad taxes.
The risks of betting everything on reducing inflation
We are faced with a very complex paradox. Stabilization programs aim to eliminate inflation quickly. But so far, this has not been considered possible. The clearest evidence that the plan appears inconsistent, or at least considered risky, is that country risk levels make debt maturity extensions unfeasible.
The way to increase credibility is to speed up the reform process. But this requires a level of political expertise and operational capacity that the government has so far not demonstrated it possesses. The problem is not the direction of change but the enormous difficulties involved in implementing it.
The stabilization plan requires a much faster pace of reform than is indicated. As long as these rhythms don’t converge, stress will build. Resolving the tempo differences was decisive. Either find a way to speed up the pace of reforms, or make the stabilization program more flexible and acknowledge that it is impossible to reduce inflation so quickly. Continuing at this different pace will cause tensions to build up and, at some point, become unsustainable.
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