As the IMF negotiating team arrived in Buenos Aires on February 12, comments from the Argentine government and the central bank led to sharp price movements of the sovereign’s debt – both in hard and local currency. However, while the market’s focus is on the issues surrounding a debt relief agreement that is “sustainable”, there is a surprising lack of debate about the fact that the economy – on its current trajectory – is itself completely unsustainable and headed for a sharp crisis.
The country is already in recession and is facing a set of challenges that even orthodox economic policies would be hard pressed to meet. Meanwhile the country’s president, vice-president, economy minister and the governor of its central bank remain committed to a mix of price and capital controls to create a semblance of stability in inflation and the exchange rate.In January, Argentine inflation surprised to the downside, coming in at a monthly rate of 2.3% and an annual rate of 52.9%. The Central Bank of Argentina (BCRA) reduced its policy rate by 400 basis points to 44%. Experts expect such containment to be short-lived and costly in the mid-term.
Talking about monetary policy in the context of Argentina suggests a country with a currency that has a store of value – and that isn’t a feature of the Argentine economy- Gabriel Gersztein, BNP Paribas
“We may even see an increase in economic activity in the short term as Argentines can’t access dollars and the real rates on local peso deposits are negative, so the only rational response from the population is to buy durable goods – and that will lead to an increase in consumption,” says Gabriel Gersztein, global head of emerging markets strategy at BNP Paribas.
Gersztein says he doesn’t even like to use the term 'monetary policy' when it comes to discussing Argentina: “Talking about monetary policy in the context of Argentina suggests a country with a currency that has a store of value – and that isn’t a feature of the Argentine economy.”
He says that the price and capital controls will lead to higher inflation and further depreciation in the future.
Tiago Severo, Argentina economist at Goldman Sachs, agrees: “Price controls will likely lead to growing distortions in relative prices over time, eventually forcing the authorities to allow for corrective measures, which could boost future inflation.”
In addition, Severo says that the increase in domestic liquidity and the resulting decline in bank deposit rates – ex-ante real rates are currently tracking in negative territory – may boost the demand for both goods and dollars, fuelling the spread between the official and unofficial exchange rates and raising depreciation expectations. “These undercurrents would likely contribute to inflation expectations remaining unanchored, and could eventually result in renewed bouts of price pressures,” he notes.
Some bankers also believe that trying to work out the current fair value of outstanding bonds has been hugely – and incorrectly – optimistic in recent weeks. While the fluctuations have provided speculators with volatility, ultimately there is a growing belief that no agreement will be reached and default is on the way.
“This Argentine government knows that it has no chance of re-accessing the international capital markets and is very unlikely to get any more IMF financing and so there is absolutely no incentive to accept anything other than absolutely huge write-downs,” says one banker who declined to be named given the sensitivity of the relationships with the government.
However, this shouldn’t be controversial or surprising as large and rapid debt relief was the conclusion of Argentina’s economy minister Martin Guzman’s published academic studies into sovereign debt relief.
The banker adds that, with interest and principal repayments at $38 billion in 2020 alone, he believes default is now unavoidable.
The absence of international and IMF financing makes the government’s decision not to pay a peso-denominated (though dollar-linked) bond payment a policy mistake, according to BNP. “The government said it didn’t just print money to pay because that would pressure the FX but it’s an error because the only source of credit is local – and that decision antagonised those investors.”
Since the decision, the government has already had to suspend a local debt auction and there are now large questions about the government’s ability to rollover local debt.
Capital controls will likely buy the government some time, but not much. According to a report from the IIF: “For as long as growth remains depressed, there will likely be a trade surplus that the central bank can capture through intervention. In this environment, liquidity will be available to service FX debt for a period, [but] as the experience of 2011 to 2015 shows, in the next few years capital controls alone are unlikely to deliver a sustainable funding model. Domestic and foreign capital will only return under a full set of coherent policies.”
In the absence of funding, there are few other options for the economy to keep going. Gersztein states raising taxes isn’t an option: he says the government is already seeing the impacts of the Laffer curve, with real tax receipts falling in January despite tax hikes.
Fiscal cuts would appear to be a logical policy response, with public spending now at 40% of GDP – nearly twice that of 2001 when Argentina last defaulted, which led to a financial and economic crisis. However, the government is committed to its belief in the need to provide further fiscal stimulus.
One economist discounts the possibility of private-sector investment, either domestic or international, coming to the rescue: “Apart from a very few select industries, doing business in Argentina is a nightmare – over-regulated and expensive. I don’t expect any material investment.”
Gersztein says: “We expect a structurally higher inflationary environment in the near term.”
He adds that such a consequence might even be seen as a favourable outcome by some in the government as it will erode the peso debt burden.
However, further devaluation would increase the relative size of the dollar debt. Which is why, according to more than one banker, even if an amicable agreement is reached around extending maturities, coupons and haircuts, any agreement is likely to be unsustainable given the coming financial crisis.
“The real question isn’t debt sustainability,” says one, “because looking at the debt in isolation misses the point that nothing is sustainable in Argentina right now.”