Argentina feels the heat

What should the international community ask in return for the early release of program funds?

• Drought has added to an already unsustainable policy mix—contributing to weaker official and black-market exchange rate, accelerating inflation, falling gross reserves, and a run on deposits amidst rumours of devaluation;

• The IMF is recalibrating the program—which was already certain to fail before the drought hit; the US Treasury has signalled a willingness to support bringing forward program funds planned for the rest of this year;

• But what measures should be asked of Argentina for the early release of program funds?

THE ECONOMIC NEWS from Argentina keeps getting worse—and the sense is growing that a step devaluation is necessary to restore sustainability. But while necessary, this would still be insufficient.

Of course, bad luck has contributed to this outcome—as she always does when “the time comes.” The “worst drought in over 60 years” is set to reduce vital export foreign exchange earnings.

But other problems are the predictable result of policy failings.

The growth of central bank liabilities is out of control while international reserves wilt. Resolving these flow imbalances will be key to restoring sustainability, in conjunction with fiscal adjustment, and ought to be the focus of new program negotiations.

We outline the size of the challenge below.

For now, a painful summary: inflation exceeds 100% with predictions that it will approach 150% in coming months. The central bank’s main policy rate has been increased to 91%. The black market exchange rate now exceeds 400 pesos per dollar while the official rate exceeds 200. Gross international reserves are at the lowest level in nearly 8 years. Argentines withdrew USD1 billion from their dollar accounts over the past month while devaluation rumours abound—rumours quashed alongside ever-more-onerous restrictions on capital flows. Brazil is considering propping up their exports through trade credits.

For their part, the IMF is recalibrating the program, as they should, hosting officials to negotiate in DC.

And it is said that the United States Treasury Department is considering agreeing to the acceleration of program funds in recognition of Argentina’s precarious situation—providing a deal with the Fund can be struck.

But a crucial question needs to be asked by the IMF and US Treasury: What minimum prior actions are needed of the Argentine government as a downpayment on sustainability in order to trigger the release of such funds?

Prices versus quantities

It has come to be realised that monetary aggregates can contain different, and sometimes more useful, information to interest rates. This has been the case in Argentina for many years, where interest rate increases are only a harbinger of greater money creation ahead—and therefore pressure on the currency and inflation.

The apparently unfathomable consequence is that tighter monetary conditions—through higher interest rates—results in greater money expansion and therefore inflation.

The reason for this perverse outcome is simple.

Argentina’s central bank (BCRA) has very few interest earning assets (mainly interest on foreign exchange reserves converted into local currency) and so can only pay interest on liabilities by printing money.

Such money printing is on top of transfers to the government to make up for a shortfall in taxes that below current spending—given government recalcitrance when it comes to taking on debt. Temporary advances of ARS100 billion over the past month and ARS230 billion so far this year (0.3% of 2022 GDP) confirm that monetary financing of the deficit continues—and nothing in Argentina is as permanent as a temporary advance from the central bank.

This debt only ends up hidden as BCRA monetary or near-monetary liabilities, of course—eventually expressed through the exchange rate and an inflation tax.

We next review the latest data from the weekly balance sheet through end-April and ask where we are headed into year-end.

BCRA liabilities consist mainly base money (currency in circulation plus current accounts held by banks) and securities (mainly LELIQs these days.) These liabilities are now approaching ARS20 trillion, a thirteen-fold increase since the ARS1.5 trillion at end-2016. BCRA securities are growing at a pace of about 150% year-over-year, base money at about 50%.

Total growth of these liabilities now exceeds 110%, the highest during the period under consideration.