The latest measures adopted by the Central Bank and the government of Argentina have stopped the collapse of the peso. However, without structural reforms on the spending side, we may find ourselves with a period of calm before a new storm.
Argentina’s revised agreement with the International Monetary Fund (SBA) includes a commitment to reach a primary budget balance in 2019, one year earlier than previously agreed, and a strict reduction of monetary financing of the budget to control inflation. To that end, the money lent by the International Monetary Fund is the highest figure expected by consensus and exceeds by more than three times the amount that would correspond to Argentina.
The most recent data show a significant reduction in the primary deficit, which has been reduced by almost 30% between January and August, but in turn, the interest expense figure has increased.
If the Macri government does not carry out important reductions in public spending, the primary balance will not be reached and, what is worse, if it is achieved, it will come at the expense of future growth because it is achieved via huge tax increases.
Without a structural reform of unnecessary spending, Argentina will find itself in a few months with the reality of having consumed the loan of the International Monetary Fund and realize again that the huge imbalances accumulated in the last ten years explode from two sides: a huge increase in debt or a collapse of the peso and higher inflation.
There is no other option, without structural reforms, Argentina is doomed to massively increase its debt or increase an already high inflation and, in both cases, worsen the situation for Argentine citizens. Therefore, no excuses can be given to the re-evaluation and reduction of the huge imbalances in the public sector of the last decade. Because the government will not be able to cover the budget with large increases in tax revenues when the global and local growth estimates are being revised downwards.
The consensus of economists that Focus Economics publishes expects that Argentina will return to a growth of 2.3% in 2020 with a drop in GDP in 2018 and 2019. Therefore, even in these optimistic estimates, we cannot expect a strong rise in fiscal income. Those same estimates expect a drop in gross capital formation of 2.4% in 2019 but a very optimistic estimate for 2020 of a 5.6% rise. All this with an overly optimistic estimate of inflation reduction to 18% in 2020.
Consensus estimates, therefore, show an excessively optimistic scenario with Argentina and the government must be cautious. A path of growth that estimates an increase of reserves and exports of 9% and 8% annually is not a pessimistic or conservative scenario. Analysts expect inflation of 44% in 2018 and 27% in 2019, falling to 18% in 2020. This is impossible to achieve if the economy is not reactivated and public spending is really reduced. This uncertainty is reflected in the enormous dispersion in the LELIQ rate estimates, which range from 35% to 57%.
It is not surprising that, despite the fact that the Central Bank no longer finances the Treasury, a funnel effect is being created via short-term debt instruments which delay the problem. With estimates of a reduction in public consumption of 2.5% per year, it is difficult to think that the primary deficit is contained, and even more complicated to think that the increase in the cost of debt does not continue to increase the external debt.
Remember that primary public spending as a percentage of GDP shot up from 23.6% in 2004 to 40.4% in 2017. The reduction cannot be gradual because the disproportionate increase was not either.
Argentina must take this period of calm for what it is, the last opportunity to abandon gradualism and solve the real challenges of the economy. Reducing public spending is the fundamental pillar to control inflation, stop raising debt and, with it, attract investment and wealth. If public spending remains at current levels, it will be difficult to meet the objectives of the IMF agreement and the placebo effect of the loan will cease to have an effect.
Beware of waiting for miracles through tax revenues when the country has one of the highest tax wedges in the continent. Time passes, and reforms are urgent.
A version of this article first appeared here.
Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of Economics, Funds Society Forum in Miami, World Economic Forum, Forecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; “The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBC, World Economic Forum, Epoch Times, Mises Institute, Hedgeye, Zero Hedge, Focus Economics, Seeking Alpha, El Español, The Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).