Macroeconomic inconsistencies of the agreement between the Macri’s administration and the IMF

By Rubén Lo Vuolo, special for*

Buenos Aires, October 24th. Argentina’s economy is encapsulated. The country used to have many problems before reaching an agreement with the IMF, but now it has even more. The invention of a band based floating exchange rate system – currently ranging from 34 to 44 pesos per dollar – and the idea of setting a 3% monthly average rate of nominal depreciation for the band’s boundaries, pave the way to greater inflation and nominal interest rates that hurt the economy. The Central Bank may only make a limited intervention in the event of an extreme overshooting of the dollar and it is only allowed to sell up to 150 million dollars per day.

Additionally, it has been announced the so-called “double zero policy”, which is aimed at reducing the primary deficit and the monetary base growth to zero, at least until June 2019. In countries like Argentina, whose currencies are not used in international transactions but which are open to capital inflows, the ambition to control both the exchange rate and the monetary expansion at the same time is inconsistent. To start with, it is inconsistent to set a 3% monthly average depreciation rate of the peso against the dollar without monetary expansion. But for this to occur, the country would also need to pay very high-interest rates and, of course, go deeper into recession.

This is all even more inconsistent considering the debt. The only thing we know for sure about the IMF agreement would be that Argentina would not default on its debt by 2019. However, future debt maturities are still a mystery. Future governments will have to turn to financial markets for dollars or use other funding sources, especially in times when the private sector runs a deficit in dollars even after a heavy depreciation of the peso.

However, debts issued by the Treasury and the Central Bank show that the problem does not lie in the primary deficit, but in the financial fiscal deficit and the Central Bank quasi-fiscal deficit, which jointly may reach around 8% of GDP next year. The monetary base expansion would not be a problem either: it has been increased very little over the past months compared to inflation and devaluation. So the two factors used by the government to control the financial crisis – primary deficit and monetary expansion – are not the main problems here. The real issues are the financial deficit and other liabilities of the Central Bank.

The Central Bank keeps issuing high-yield debt instruments. Against the background of decreasing free reserves – adjusted for dollar-denominated private deposits known as “argendólares”, the currency swap deal with China, etc. – it will be needed to issue more debt instruments. These debt instruments offer generous returns in pesos compared to inflation, but also in dollars, with an annual return of nearly 43% considering the exchange rate policy. So this system created by the Government and the IMF only leads to higher debt levels and higher financial returns.

If the government fails to change this system soon, it may eventually collapse. It could only be stabilized by reducing interest rates, reducing the exchange rate and balancing the country’s external accounts. Not only is this goal hard to reach, but it would also lead to a difficult situation: an overvalued exchange rate in the light of raising inflation.

Let us suppose that the exchange rate reaches its floor band price. Considering the 4 pesos per dollar export tax and the elimination of export tax refunds, the exports average exchange rate will be of approximately 25 pesos per dollar. This could hardly lead to a high trade balance surplus, while there could be an increasing demand for dollars triggered by the peso depreciation implied within the band based floating exchange rate system itself.

Not only the economic policy is inconsistent, but also there are inconsistent incentives for economic agents.

If the Central Bank buys dollars to prevent it from falling, then the monetary base will increase. Thus, if the dollar begins trading outside its price floor, the Central Bank will expand the monetary base and then it will contract it by issuing bonds or LEBACs (Central Bank bills), which will expand the quasi-fiscal deficit. The Central Bank can certainly let interest rates go down due to the increasing monetary base. But this will lead to an upward pressure on the dollar and the above-mentioned issues connected with an increase in the exchange rate.

Failure to correct the imbalance in external accounts soon will only raise questions about the dollar supply resource to address debt maturities by 2020, especially if the Federal Reserve continues to raise interest rates – and contracting the monetary base. All in all, Argentina’s financial needs become more pressing in times of low international liquidity and financial operators demanding high returns.

In short, there is no reason to celebrate. In the short term, this system created by the Government and the IMF proved to be useful for showing that the economic authorities have some control over the markets. However, this way to restrict the economy cannot be considered a long-lasting plan.

*Economist, director and researcher at Centro Interdisciplinario para el Estudio de Políticas Públicas (CIEPP)

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