Recession deepens and inflation is momentarily contained, but monetary expansion raises the risk of inflationary explosion

ARGENTINA - Forecast 18 May 2020 by Domingo Cavallo

Quarantine and social distancing measures were implemented in Argentina mid-March, as soon as the initial COVID-19 infection cases were detected in people who arrived from abroad. So far, the early reaction has contained the number of coronavirus deaths to around eight per million inhabitants, well below the number in the United States (263), in European nations (Belgium, Spain, Italy, UK and France, at above 400, and Germany at 95) and in neighboring countries (Brazil, at 67 per million, and Chile, at 20).

This relatively benign outcome on the health front has had the effect of increasing the approval ratings of President Alberto Fernández, and his government. But against this background, the economic scenario has deteriorated very rapidly. This is probably not different from in the rest of the world, as the quarantine has prevented approximately 70% of the labor force from working normally.

To make an economic forecast amid the current level of uncertainty is very difficult; however, we expect that during 2020, GDP will be at least 12% lower than in 2019.

The government has implemented subsidies to support low-income families, particularly for those lacking formal employment. It has also tried to help firms forced to restrict their activities, with subsidies and low-interest loans, so they can continue paying the salaries of inactive workers. The government has banned layoffs, initially for two months. But the ban will continue for a longer period.

Due to a lack of fiscal space, subsidies to families and firms were lower than in other countries that have good public credit and stable currencies. Therefore, the risk of social upheaval is higher in Argentina than in such countries, particularly if the flattering of the infection curve has the counter-effect of making it harder for the government to soften the quarantine. This could happen for fears of reviving the spread of the pandemic.

The federal government’s fiscal deficit will increase to about 8% of GDP in 2020. As there won’t be credit available to finance it, the Central Bank will be forced to double the monetary base, and to allow an increase in private sector M2 by 65% during the year. For now, inflation is contained, due to the restrictions that the quarantine imposes on the demand and supply of many goods and services, to the freeze of public utility rates imposed by the government, and to the acceptance by unionized workers of reductions in their real wages, to avoid layoffs. But as soon as the restrictions are eliminated, inflation will accelerate. We predict 2020 inflation will reach 60% for the year.

Our forecast for 2020 is independent of the outcome of the ongoing debt restructuring process. Even if the restructuring is successful, Argentina will not be able to issue bonds at reasonable interest rates for a long period of time. Of course, if the attempt to make an orderly restructuring ends in a disorderly default, the chances of a hyperinflation increase substantially.

In addition to the uncertainty over the outcome of the debt negotiations, the government does not seem to know what kind of an economic organization the Argentine economy requires in order to stabilize and ignite growth. Therefore, there are no indications about how the government will manage the very complex fiscal and monetary situation that we foresee for the end of the year. For these reasons, we will postpone our forecast for 2021 and thereafter.

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