In this holy land we never lack imagination
To fix the kettle and fix the bed precisely.
I tie him with wire, I tie him, I tie him with wire sir.
Ignacio Copani, “I tied him up with wire”
In Argentina there is a phrase that we use a lot and also characterizes us quite well, “tied with wire”, which means to solve something in a creative and quick, but precarious and transitory way.
This phrase fits very well with the current situation of the Argentine economy since, as we will develop below, there are aspects in which it shows an undeniable improvement, but when we delve into the causes behind it, we find that the Most are not sustainable over time.
What are those positive results? Firstly, a significant drop in inflation in recent months. Although it is true that it had increased significantly after the strong devaluation that the government applied as soon as it took office, from that point on it was reduced at a great speed, even faster than that projected by all the market consultants.
The second economic aspect to highlight was the notable increase in international reserves that the Central Bank managed to accumulate, for more than 15.3 billion dollars. During the last year of the previous administration, international reserves had been reduced dramatically, making the position of the monetary authority to maintain exchange stability very weak.
Precisely for this reason, another positive aspect that Javier Milei’s government can show is an extremely stable financial dollar (it increased only 5% since the beginning of his administration). Let us remember that, as a result of the strict regulations on the purchase of dollars that currently exist, in Argentina there is an official exchange rate – cheaper – that is mainly used for the settlement of exports and for the payment of imports and debts. in foreign currency, and a more expensive financial exchange rate for the rest of the transactions. The gap between the two had reached more than 150% during the Frente de Todos government and is now stable at around 20% for several months.
Finally, the most important positive element for the government, to the point of being announced through a national network, was the fiscal surplus that it showed consecutively in the first three months of the year.
Now, as we said, the noise appears when we investigate the reasons behind this improvement. Let’s start with inflation, the most relevant data for citizens. When one looks at the causes that explain the significant slowdown in the rate of inflation, one finds, first of all, the strong recession that the economy is going through. The falls in all sectors of economic activity – in some cases with values similar to those of the pandemic – generated a significant accumulation of unsold stocks (which represent a cost for companies) that put downward pressure on prices. In addition to the above, the other key component was that the Central Bank practically froze the value of the official exchange rate (it set a 2% monthly increase), which worked as an anchor to pull prices downward.
The problem is that neither of these two factors can be maintained over time. Without going any further, although there are still few indicators linked to economic activity and consumption that show a rebound, both the IMF projections and those of the various consulting firms estimate that the recovery will begin in the second semester, which, will put pressure on prices.
On the other hand, the fact that the exchange rate has increased every month less than inflation implies that its value was reduced in real terms, that is, it became systematically cheaper every month, which is also not sustainable over time. If maintained, sooner or later this will boost the demand for foreign currency – both on the import side and on the purchase side of dollars for hoarding -, which could trigger a new devaluation (with the consequent inflationary impact).
A third element that contributed to the lower inflation was the aforementioned stability observed in the financial exchange rate. The price of this dollar is very relevant because it is a good thermometer of the market and its devaluation expectations.
In this case, there are two regulations that are fundamental to understand the stability observed recently. Firstly, the fact that exports are settled 80% in the official dollar and the remaining 20% in the financial dollar. The logical increase in these exports that was observed after the strong 120% increase in the exchange rate not only served to strengthen the Central Bank’s reserves, but also to keep the financial exchange rate stable. But is only 20% of the liquidated amount enough? Yes, because the average volume operated in the financial market is four times smaller than that of the official one, that is, it is only 25%.
Added to the greater supply generated by exports, the demand of this market is restricted by a “cross” regulation that does not allow companies to access the purchase of financial dollars (for example, to dollarize their profits), if in the In the previous 90 days, he bought dollars in the official market (used to pay for imports).
The fact that Milei left these restrictions reflects two opposing readings that are nevertheless compatible with each other. The most critical refers to the frequent contradictions that are observed between his extreme free market discourse and what he actually does; but, on the other hand, this is also a show of pragmatism, something that is obviously necessary to govern.
Reserve accumulation
Aside from these regulations, the stability of the financial dollar is also explained by the notable accumulation of international reserves mentioned previously, a key element to strengthen the Central Bank’s ability to intervene in the exchange market. Here the increase in the supply of foreign currency that caused the exchange rate jump played an important role, but again two other demand regulations appear that helped the monetary authority to increase its reserves.
Firstly, the strict regulation on the purchase of dollars for hoarding (established by the previous government), to which was added another on imports -established by this administration- that imposed on companies “quoted” access to the purchase of dollars to import (they could only acquire 25% of the value in the official market, the remainder was postponed for the coming months, generating a debt between the Central Bank and the importing companies). By the end of March, said debt amounted to 11.1 billion dollars, which means that 72% of the reserves accumulated by the monetary authority are explained by the postponement of these payments.
Finally, we have the most important achievement (from Milei’s point of view): The fiscal surplus that it showed in these first four months of the year. This is key because the government set the goal of sustaining it until the end of the year.
To achieve this surplus, Milei applied what he called the “chainsaw” during the campaign, a drastic adjustment to public spending of more than 30% (compared to the first quarter of the previous year and discounting the inflationary effect).
The main problem that is noticed in this case is that almost 40% of said adjustment is explained by the “liquefaction” of the expense associated with the payment of pensions, since in all these months they increased well below the high inflation, which translated into a drop of more than 15% in its purchasing power so far this year. For this reason, the government decided that from now on salaries will be updated every month based on inflation, which will put a stop to the fall in the purchasing power of pensions, but also public spending. , being an obstacle to the fiscal goal.
In short, although in these five months of management the government of Javier Milei has shown improvement on several fronts (reduction of inflation, accumulation of reserves, exchange stability and fiscal surplus), when examining the causes behind it we find with which they can hardly be sustained over time.
Firstly, the harsh recession combined with the fall in the purchasing power of workers and retirees is finding a floor and it is very likely that a recovery will be seen in the coming months, which is encouraging data for society, but a problem for the government, since it will put pressure on inflation and the fiscal goal.
Likewise, this recovery of economic activity together with the fact that the Central Bank must begin to pay off its debt with companies will significantly boost the demand for dollars for imports in the exchange market, making it more difficult to accumulate reserves. .
So that this does not lead to a new exchange rate jump, the government must encourage the entry of dollars, either through foreign investments or financing in international markets. Either of these two options requires that all the foreign exchange regulations mentioned above be eliminated, which is also going to be quite a challenge. Can he achieve it?
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