Argentina can avoid a devaluation, says Domingo Cavallo

As the peso plunges against the dollar in the black market, speculation is mounting in Argentine financial circles that the government will devalue the official exchange rate as soon as early next year. But one prominent economist at least, former economy minister Domingo Cavallo, says it’s still possible to avoid a one-off devaluation.

While dollar futures trading and a widening gap between the official rate and the black market indicate expectations for a weaker peso, Cavallo, who oversaw the country’s one-to-one peg with the dollar in the 1990’s, says many transactions can be pushed through a parallel rate known as the blue-chip swap to relieve pent up demand and pressure in the market.

Despite tight capital controls and a crawling peg on the currency, the official exchange rate has weakened 24 percent this year. The restrictions to access dollars through official channels push both investors and retail savers into unofficial markets where the value of the peso has sunk this year on insatiable demand for greenbacks to protect from inflation and the potential devaluation.

“To face this situation, a big devaluation is not necessary,” the 74-year-old former policy maker said in a video interview from Washington. “It would only worsen the situation.”

A unification of the rates wouldn’t work either, he said, and instead would raise the possibility of political instability amid tensions driven by the coronavirus pandemic. Rather, the government should reserve the official market for essential commercial activity and push other transactions through a free-floating market akin to what the blue-chip swap is today.

“In this way, there would be more confidence and the exchange gap would be reduced,” he said. “The government has been focusing on restricting the blue-chip, when it should do the opposite.”

The government has called brokerages to apply pressure on trades in the market and frequently adjusts rules on how long certain assets must be held before being sold.

The blue-chip swap market consists of the buying and selling of bonds or shares that are priced in both pesos and dollars. The transaction creates an implicit exchange rate which currently stands at 158.8 pesos compared with 78.3 for the official one.

President Alberto Fernández has publicly said his government won’t devalue the peso, and described the use of the blue-chip swap as speculative. Still, analysts and investors point to the gap between official and parallel rates, at the highest since 1989, to point to a looming devaluation.

Of course, Cavallo’s professional trajectory shows that he’s never seen devaluation as a solution to the nation’s problems.

Cavallo, who currently works as a consultant at Global Source Partners, rose to fame in the early 1990’s as president Carlos Menem’s economy minister. To tackle hyperinflation, he implemented a currency regime known as “convertibility” whereby one peso was worth one US dollar.

The former official's flagship policy earned praise from Washington and led to low inflation and strong economic growth by the mid-1990s. While he stepped down from his post in 1996, convertibility outlasted him and eventually became unsustainable by the end of the decade.

At the height of Argentina’s 2001 crisis, Cavallo returned as economy minister in an attempt to restore confidence and credibility but it was too late. In December 2001, he resigned, and Argentina defaulted on US$95 billion of debt and the peso was devalued overnight. Violent protests in Buenos Aires ensued including – among other things the freezing of bank accounts – capping off the nation’s worst economic crisis to date.

The government must also do more work on the fiscal side, especially if it expects to reach a deal with the International Monetary Fund, he said.

Increased money printing due to a lack of financing options during the coronavirus pandemic are amplifying existing economic problems such as a three-year recession and one of the world’s fastest inflation rates, all while reviving memories of past crises.

“The best thing would be for the government to adjust the prices of public services that are not updated, because in this way it would reduce the subsidies to the producers of those services and that would allow a fiscal adjustment that is essential to get out of this situation,” Cavallo said.

Here are other comments from the interview:

Fernández was never a leader
“It is not clear whether the decisions are made by Alberto Fernández or by his Vice-President Cristina Fernández [de Kirchner],” Cavallo says. “There is clear evidence that she has imposed decisions on him that are not the ones he would have made. I doubt that Fernández makes his own decisions. He was never the leader of anything. He always followed as an operator,” not as a decision-maker.

Coalition problems
“There are great divergences in the different groups of the coalition in power. There are those who consider the Maduro regime to be a dictatorship that violates human rights, and others who do not think so. They are very different positions and this which creates great confusion. Argentine citizens are not clear about the direction that the Fernández government wants to give the country.”

Guzmán has no plan
“The Minister of Economy of Argentina, Martin Guzmán, thought that once the debt restructuring was resolved, expectations would be reversed, but none of that happened. He has not yet defined a rational approach to how he’s going to get out of this situation. So far, he did not give clear ideas on any of the aspects of the economy. He does not have a plan for the day after restructuring.”

Fragile social situation
“A devaluation would generate many social problems. There are many people who want the government to give them subsidies and benefits. And there are a large number of unemployed workers. The social situation can become very tense.”

Bi-monetary Argentina
“Argentina has a bi-monetary economy due to its inflationary history. You have to know how to handle it. There are many bi-monetary economies that perform well, such as Peru and Uruguay.”

The relationship with the IMF
“The IMF always asked for fiscal adjustment. The IMF should make demands but be realistic about the situation in Argentina. The IMF should warn the government that the prices of public services are lagging rather than say that they should devalue or immediately unify the exchange system. Unifying the market would unleash another inflationary maelstrom.”

The role of the opposition
“The opposition must help Fernandez get ahead and not bet that he will fail or leave.”