Dancing with the Devil

Argentina and the IMF have just signed a new deal. Will it work out?

Protesters burn the IMF’s Spanish initials in US-themed effigy.

Last week, Argentina and the International Monetary Fund opened a new chapter in their long, tortuous relationship: after hours of deliberation, the lower half of Congress approved a new program with the organization. The move was controversial even within the government itself, since a third of the governing party’s members voted against the motion (including the sitting Vice President’s son, Máximo Kirchner, who resigned from being caucus leader over the very idea of an agreement) and another number abstaining. In fact, more members of the largest opposition party supported the law (111 - all but one) than of the governing party (76).

The bill was also controversial with the public, as many left-wing groups traditionally friendly to the government staged massive protests - occasionally resulting in violence, including the setting of a police officer on fire and rocks being thrown at the Vice President’s office. Two questions remain: what the hell have Argentina and the IMF agreed on? And will it work towards ending the country’s issues?

Fine print, signed in blood

While technically what the Fund calls an “Extended Facilities Program”, Argentina’s deal drastically differs from past experiences - instead of asking for strict, market-directed reforms to core items in the economy, the program is far less ambitious in scope, limiting itself to fiscal and monetary targets.

The two core figures, which constitute the bulk of what was agreed upon, were the primary fiscal deficit and the change in international reserves: the authorities agreed to reducing the deficit by 0.5% of GDP in 2022 and 2023, with 1 point of adjustment in 2024 and 2025 - from a 3.0% deficit in 2021 to fiscal balance four years later. In addition, the annual change in international reserves would go from -1.5 billion in 2021 to ~6bn in 2022, 4bn in 2023, and 5bn in 2024. In addition, there would be a reduction of inflation from 50.9% YoY in 2021 to 38 - 48% in 2022, and then roughly five points per year for the next few years. This program would also boost growth and maintain a current account surplus. Of course, the devil is in the details - and in such a complicated deal, there’s lots of them.

Let’s start with fiscal policy: what gets cut, what gets increased, and how do you pay for the gap between the two? Two ways of reducing the deficit are mentioned: reforming taxes, and reforming spending (no clear “raising” or “cutting”). On the tax front, the authorities super extra promise not to raise taxes (especially export taxes, the most distortionary of them all) and instead propose increasing revenue through better tax administration (1% of GDP in the medium term) and a change in the fiscal valuation of certain assets (0.2% of GDP). Spending-wise, they have not mentioned any cuts to pensions, welfare, or any other big-ticket items, and have promised increases in investment, education, science, and healthcare. This does not pass a basic smell test, but there is one exception: a reform to energy subsidies (discussed previously on here).

There are two main ways this that energy subsidies will be slashed: through the direct removal of subsidies in the top 10% of households by income, and through real increases in regulated prices. The former, while maybe a political winner, is small potatoes: the government’s own estimates show savings worth a whopping 0.06% of GDP. The latter is a big deal, considering spending on subsidies has soared since 2020 while real utility prices plummeted 15% a year both years since. To be fair, a somewhat detailed formula has been unveiled, with an instant 20% increase for the top 10% of incomes, increases of 80% of monthly registered wages for the bulk of the population, and increases of 40% of this amount for the poorest users.

Ivan Baumann Fonay @ivanfbf

Las metas de financiamiento monetario del déficit fiscal "entendidas" con el FMI, en perspectiva. De cumplirse, serían una noticia excelente para anclar expectativas y bajar la inflación

How do you pay for the deficit? Currently, the government has two main sources of spending: debt and monetary assistance (i.e. “printing money”, Weimar-style). Currently, a larger part of the primary deficit is funded through monetary emission than through the debt market; instead of, as traditionally demanded by the Fund, immediataly eliminating this source of revenue, the agreement progressively phases it out, with about 1% of GDP worth of emission in 2022, and then progressively less and less until it would hit 0% by 2024.

With regards to monetary and FX market policy, there hasn’t been as much clarity on the measures to be taken; the authorities have promised to devalue the real exchange rate (which has risen 20% since 2020, roughly speaking) and to increase interest rates to positive real levels. While the former of these promises might be achievable, it should be noted that the promise of real positive interest rates has been occasionally floated since December 2019, and rates have still not been above the annual CPI for a single day ever since. There is not a lot of hope that the government will drop its stupidest anti-inflationary policies, since it mentions inflation is “multicausal” (the two causes: monetary emission and expectations) and shouts out price controls and other various incomes policies. This, as I’ve said before, is all dumb nonsense that any half-serious agreement would have dispensed with instantly, but whatever.

The devil’s own job

So, will this agreement work? Depends on what “work” means. Since it contains no meaningful reforms to anything whatsoever, it won’t reverse the decade-long stagnation Argentina has been mired in (if not for longer, considering GDP per capita peaked at levels not much higher than those in the mid-90s and also the early 70s). I’m not an expert in every single field of economics, sadly for the reader, but it’s fairly clear that taxing exports, bank transfers, and businesses at over 100% of earnings does not seem like a good way to incentivize exports, grow the financial system, or create new companies and new jobs.

The parts that are not about macroeconomic managements, such as “growth programs” or whatnot, are exceedingly thin on details and mostly revert to the usual faux-economist, flowery language of “evaluating projects to revert long-standing bottlenecks” and “promoting development of vital sectors”; without any clear resource commitments, and without any major reforms, this is just a pile of meaningless platitudes (and with either it still is) at best, and more corrupt handouts to well-connected businessmen at worst.

So what goals does this program actually have? Well, breaking with the IMF’s tradition up to 2001, it aims for something more modest: reduce the deficit, reduce inflation, reduce the imbalances in the external front. The growth goals are just a fantastic pipe dream, as GDP was not stagnant between 2011 and 2020 for no reason, so the only way to increase incomes is by increasing at least some real wages over a short period.

This self-imposed mandate to improve wellbeing is tricky, since any growth that isn’t a recovery from the previous recessions is unlikely, and since there will be no productivity growth, it will all come from repressed inflation. So the political imperative to increase real wages is inherently incompatible with the basic arithmetic of stabilization: the main cost of doing business cannot increase permanently without anything to back it up. Plus, the registered private sector accounts for a dwindling share of employment, and like activity writ large has not increased in real terms since 2009 while all gains have come from self-employment (frequently just a way to avoid the gigantic legal burden of formal employment), the public sector (which is like trying to power up an extension cord by plugging it to itself), and the informal sector. So the wage increases are not going to be especially successful in the medium run, and are definitely not consistent with macroeconomic stabilization after the economy returns to its, quite predictable, steady state. What about the fiscal and external targets?

They’re not doable either. The fiscal side of things is actually quite simple: regulated prices are a quarter of the CPI. Increasing them in real terms raises inflation in the short run at the cost of a lower steady-state inflation rate (since there is a lower deficit and ergo lower money creation). Even if the steady-state disinflation is real, the short term also includes more inflation. This is actually bad news: pension spending, accounting for a tenth of GDP and about a quarter of all government expenditures, is backwards-adjusted to inflation, meaning that a present acceleration of headline inflation would result in temporarily lower pension spending that becomes higher and higher while the disinflation continues. Similarly, a large percentage of all debt is inflation-adjusted too, meaning that the fiscal burden would temporarily increase. Inflation won’t make the deficit smaller, but disinflation could very well make it bigger.

Lastly, onto the external front: the exchange rate has to be devalued in real terms for the Central Bank’s goals to be possible. In 2021, the real exchange rate rose about 15% (which means Argentina’s exports got 15% more expensive for other countries, and imports got 15% cheaper - adjusting for inflation), and in consequence the Central Bank squandered a 15bn trade deficit in defending the value of the currency (which rose 1.3% a month, in nominal terms, versus 3.3% monthly core inflation) and ended up losing 1.5 billion in reserves during a year with sky-high commodity prices. The big risk is that, if the Central Bank runs out of reserves (its actually available ones, called net liquid reserves, are running low - at about 1 billion in total according to the most optimistic projections), it will have to abruptly devalue the currency, as happened in Russia recently. But, because real devaluations are inflationary, since the exchange rate both represents a share of the cost of products and also acts as an anchor for inflation expectations, then improving competitiveness adds fuel to the fire.

Something I would like to note is that the two government-controlled goals, fiscal and currency, are at odds with each other in two fronts. A higher real exchange rate means more exports, increasing export tax revenue, but also increases the cost of imported natural gas, making the required increases to regulated prices even steeper. At the same time, higher interest rates imply higher financing costs for the government, and ergo higher nominal spending on pensions. And the second-order effects of both adjustments, to utilities and the dollar, imply that both will require a certain level of overshooting to achieve their real aims, since short-term nominality will certainly increase.

Conclusion

The program the IMF and Argentina signed does not aim to accomplish much at all, and fails at doing even that. The lack of any meaningful reform effort, and the fact that all of the targets are toothless and kick the unpleasant parts of fiscal correction down the road to after the 2023 presidential elections, means the government will not gain any credibility or respect in the market whatsoever. A plan that wins the authorities no credibility, then, has to be achievable and viable - and this one might be the former but it definitely is not the latter. Any program that has such glaring contradictions can only be papered over through real unpleasantness masked by money illusion - in layman’s terms, more inflation. The fact that all quarterly fiscal goals are nominal is not lost on anyone either.

The truth is that, if you promise that all the prices you control will go up, but that inflation will go down, then you’re either lying or stupid - as Dornbusch (1985) calls it, “the land of poets and magicians”. The government has the wrong ideas about the very functioning of the economy itself, and even if it wasn’t entirely wrong, over the past two decades it has implemented all of its wholly irredeemable ideas to such an incompetent degree the whole ordeal long ago had become indefensible. The country might have signed a deal with the devil, but the economy’s fate is in God’s hands now.