Buenos Aires Times

opinion and analysis ECONOMIC QUESTIONS

Vulnerability begins at home

The real cause for alarm is not so much borrowing abroad as hot money of all kinds and here the problem is as much domestic as international. The root cause is the Central Bank’s anti-inflationary strategy of high interest rates which were upped a couple more points this week.

Saturday 18 November, 2017
Mauricio Macri.
Mauricio Macri. Foto:Pablo Temes - CEDOC.

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In his latest consultation from the ivory towers of New England, Dr Hale writes: “My foremost concern remains the depth and content of the structural reforms being broached by the Mauricio Macri presidency with its newfound electoral momentum, but since these are the object of negotiations at various levels, I can already anticipate you taking a rain cheque (as you spell it on the other side of the Atlantic). So I have another question in reserve – it’s not often that you see Argentina joining any Islamic league (except perhaps when signing memoranda of understanding with Iran) but I notice that you’re grouped alongside Egypt, Pakistan, Qatar and Turkey (the latter always there for one reason or other) among Standard & Poor’s ‘Fragile Five’ most vulnerable to rising interest rates and the end of quantitative easing. So what gives there, I’m curious?”

My reply: “You’re bang on target as to my reluctance to comment on the reforms because that’s still writing in sand in many ways. Thus on Monday the government sent a 219-page tax reform bill to Congress, but I won’t bother you with any details at this stage since there have been and will be changes given a minority administration exposed to pressures – thus since we last communicated wine is now fine according to the exciseman, just to give one example. “Yet at least one development since our last exchange seems irreversible – soon after his return from Manhattan President Mauricio Macri and the provincial governors agreed to consign the absurd Greater Buenos Aires Reparation Fund to the ashcan of history. A quarter-century of inflation had eroded the fixed sum allocated to the corresponding province to little over one percent of the total. There is rather less clarity as to what takes its place – the main idea is roughly that a more generalised federal revenue-sharing will compensate the governors but the latter feel that they stand to lose unless their revenue-sharing cut (which plunged from 56/43 under Raúl Alfonsín to 30/70 under the Kirchners despite the decentralisation of education and health under Carlos Menem) is improved, especially with the idea of transferring all proceeds from the cheque tax (supposedly in line for elimination as a “bad tax”) to the ANSES social security administration to shore up the pension system.

“Meanwhile Buenos Aires province will desist from its Supreme Court lawsuit over receiving almost nothing of its own reparation fund, but only if the price is right. Governor María Eugenia Vidal is evidently high maintenance because that price is 100 times the Reparation Fund fixed sum of 650 million pesos at 65 billion pesos. But not only for that reason – the 2018 provincial budget boosts spending on health, education, welfare and crime prevention by 24 to 35 percent, well above current inflation levels. Vidal has whipped that budget through an overawed legislative chamber with the approval of most of a demoralised Peronist opposition and this factor is worth bearing in mind for the final face of the reforms – whereas these will need weeks and months to gain the necessary consensus, the provincial budgets will be emerging in a much nearer future with spending commitments which might not be easily reversed. 

“Any more details must await further fine-tuning so I will now proceed to your other question. Kirchnerite critics have attributed this vulnerability to high interest rates to extreme indebtedness but it is almost the other way around – Argentine debt at around 35 to 40 percent of Gross Domestic Product is among the lowest in the world and that creates scope for more borrowing which could turn dangerous. 
“Yet the real cause for alarm is not so much borrowing abroad as hot money of all kinds, and here the problem is as much domestic as international. The root cause is the Central Bank’s anti-inflationary strategy of high interest rates, which were upped a couple more points this week to inch ever closer to the 30-percent mark. This strategy has yet to claim success – it could be argued that this year’s inflation has been halved from 2016 but then for electoral reasons there have been far less utility bill and transport hikes from subsidy withdrawals. Various delayed hikes are expected in the rest of the year so that their effect remains to be seen – in the meantime October’s core inflation of 1.3 percent was almost as high as the overall figure of 1.5 percent. Inflation targeting has generally served developed countries well but here it could be running before you can walk – more specifically it can be questioned whether it should be attempted ahead of relative price correction. 

“Perhaps this strategy may never succeed against inflation because it is basically counterproductive, pumping money into the system as fast as it sucks it out via Lebacs etc. The latter have to redeemed (sooner rather than later these days) and paying out interest rates of 30 percent effectively means expanding money supply by 30 percent.

Meanwhile that money supply is being outstripped by the quasi-fiscal deficit – the government likes to boast of foreign currency reserves topping US$54 billion, breaking all records of the Kirchner boom years, but Central Bank debt now reaches US$66 biilion. And some people call this “tight money” (while others call it “gradualism”), contrasting it with lax fiscal policy, but in point of fact the Central Bank keeps the Treasury pretty good company in deficit terms. No wonder Argentina has joined S&P’s ‘Fragile Five.’

“Moreover, quite apart from a debatable monetary strategy, the Macri government faces what former British prime minister Edward Heath called “the problems of success” over four decades ago. Not only is the economy growing in real terms, which is always inflationary or at the very least reflationary, expanding demand and thus facilitating price increases – there is far more money in circulation, quite apart from the number of banknotes printed or Lebacs due to the credit boom, the volume of public works, the nascent mortgage market, etc. Yet while credit markets are on the rise, they remain puny as a percentage of GDP by any international standards – this factor limits any strategy based on interest rates. Anyway these “problems of success” are ineluctable – growth is something the Macri government quite rightly seeks to encourage not curb.

“One last suggestion to explain the regional odd man out in S&P’s ‘Fragile Five’ – sour grapes because Argentina just scraped into the World Cup and the United States did not.”

(*) Michael Soltys, who first entered the Buenos Aires Herald in 1983, held various editorial posts at the newspaper from 1990 and was the lead writer of the publication’s editorials from 1987 until 2017. 


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