In a shocking development, political outsider Javier Milei won Argentina’s November 2023 presidential election, taking 56% of the vote, with leftist opponent Sergio Massa receiving 44%. The television personality and economist, who is a self-described anarcho-capitalist, campaigned on a radical far-right platform which saw him compared to former U.S. President Donald Trump. Key among Milei’s controversial proposals to fix Argentina’s badly distorted economy is dollarization, slashing excess fiscal spending, and abolishing the central bank. This is occurring at a time when Latin America’s third largest economy is suffering its worst crisis since the 2001 economic collapse, severely impacting the lives of everyday Argentineans. While Milei is taking drastic action to revive Argentina’s fortunes, there are doubts as to whether he can turn the economy around even with the country enjoying a major oil boom.
Buenos Aires' heavy spending, particularly on costly energy and transport subsidies, has drained government coffers despite rising income from the Vaca Muerta’s oil boom. Argentina’s fiscal vulnerability is exacerbated by the country’s staggering sovereign debt, which by the end of June 2023 was an eye-popping $404 billion. This makes Argentina, on the basis of sovereign debt as a percentage of gross domestic product (GDP), South America’s second most indebted country. Argentina’s chronic fiscal weakness is underscored by multiple sovereign debt defaults and restructurings. That debt bomb is placing considerable pressure on Buenos Aires, with upcoming payments of $16 billion significantly exceeding Argentina’s financial reserves.
Those unenviable characteristics make Latin America’s third-largest economy extremely susceptible to external shocks, like the current drought, which is pummeling the economically crucial soybean crop. A chronic lack of public savings coupled with over-the-top fiscal spending magnifies that vulnerability while fueling inflation by forcing Buenos Aires to keep printing pesos to meet its financial obligations. It is for those reasons the November 2023 inflation rate soared by 18.2% month over month to a multi-decade high of 160.9%, which saw the 2023 forecast inflation rate revised upward to an eye-watering 185%.
President Milei has promised to bring Argentina’s economic crisis, including out-of-control inflation, to an end, although he has warned doing so will not only take extreme policy decisions but also initially lead to far greater hardship. Among Milei’s opening measures was switching Argentina’s benchmark interest rate to the overnight reverse repo rate, currently standing at 100%, which came into effect on December 19, 2023. This occurred after the central bank’s multiple 2023 rate hikes lifted the official rate to an eye-popping 133% but failed to tamp down inflation. The change forms part of the newly inaugurated president’s strategy to simplify monetary policy and make decisions more transparent. While it should indirectly reduce the government’s fiscal deficit, by pushing savers to treasury bills, there are fears the cost of U.S. dollars could increase, contributing to further price hikes.
Another key part of Milei’s plan is to remove the capital controls that artificially bolster the value of the peso and create an unwieldy array of exchange rates, thereby distorting prices in Argentina. After appointing Luis Caputo, a market-friendly experienced central banker, as Economy Minister, the peso was devalued by a whopping 51%. This was the first measure to tame triple-digit inflation while preparing to eventually remove all capital controls that distort the peso’s value and lead to price inefficiencies that contribute to rampant inflation. Sharp spending cuts, particularly for costly subsidies, are also on the table, with Milei determined to reduce fiscal spending to sustainable levels and rein in Argentina’s budget deficit.
Those actions, especially devaluing the peso, have caused prices to soar at an unprecedented rate. According to a recent New York Times article, beef rose 73%, while the price of diapers doubled, and fuel shot up by 60%. This is causing considerable consternation in a country where the population is accustomed to blistering inflation and a severe cost of living crisis. There is further pain ahead for Argentineans with Milei preparing to unwind fiscally unsustainable energy and transport subsidies, which will allow long-controlled prices to rise. Energy subsidies alone cost Buenos Aires over $12 billion during 2022, while fanning inflation with the central bank printing pesos to meet that cost. Starting in 2024, Milei will cut public transport subsidies, although his administration has yet to provide guidance on how that will occur.
Such measures will sharply impact everyday Argentineans who are already facing a cost-of-living crisis that is pushing people into poverty. By the end of the first half of 2023 the national statistics agency published (Spanish) that 40.1% of Argentineans are living in poverty compared to 39% for the same period a year earlier and 27% during 2018. Indeed, the last time energy subsidies were dialed back, by then President Mauricio Macri, during 2016, prices surged, even rising tenfold or more in some places. This caused the cost of living to spike, resulting in the poverty rate rising to over 30% and triggering a tremendous political backlash that ended in a landslide vote against Macri in the 2019 presidential election and restoring the leftist Peronists to office.
There are questions as to whether Milei can successfully dollarize Argentina’s economy, which, if successfully completed, will stabilize the financial system and significantly reduce inflation. Those countries in Latin America that have made the U.S. dollar their official currency, Panama, Ecuador, and El Salvador, have far smaller economies than Argentina’s, where GDP topped $631 billion in 2022. A looming headache for Milei is the central bank simply lacks sufficient reserves to successfully dollarize such a large economy, with the shortage estimated to be around $50 billion. It will be an extremely difficult and costly exercise for Buenos Aires to fill that gap, especially after a long history of debt defaults.
There are also other policy considerations weighing on Milei’s planned dollarization of Argentina. Not only is it unpopular with many Argentineans who wish to retain their own currency, but it effectively removes monetary policy as a means of managing the economy. By dollarizing, monetary policy is effectively outsourced to the U.S. Federal Reserve. The Fed manages the money supply and sets interest rates according to the needs of the U.S. economy. That can lead to a misalignment of policy priorities with the Fed’s monetary policy acting contrary to Argentina’s economic needs which could harm Latin America’s third largest economy. Indeed, dollarization only prevents a country from excess printing of its own currency it does not instill fiscal discipline, as Ecuador has demonstrated. For those reasons, economists believe if a country can maintain the discipline not to excessively print money to the point of default, then it is better off with its own currency.
Argentina’s disaster-prone economy is locked in a deep crisis and desperately needs reform. Even rising fiscal revenue and a greater contribution to GDP from Argentina’s unconventional oil boom, long seen as a silver bullet for the economy, has failed to soften the sharp economic downturn. While questions loom as to whether Milei can successfully repair Argentina’s heavily distorted and broken economy, he may be the country’s last hope. The new president has appointed a bevy of accomplished, market-friendly ministers who are more than capable of executing his policies. Reducing costly energy and transport subsidies will sharply decrease spending, making a major contribution to reestablishing fiscal discipline. The removal of capital controls will lessen market distortions, further strengthening the economy. Those measures over the long term will reduce inflation and bolster economic growth, although there are fears that for the short-term inflation could surge up to 40% a month and even unleash hyperinflation.
By Matthew Smith for Oilprice.com
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