Unlimited monetary expansion with capital controls, and uncertain fiscal accounts

ARGENTINA - Report 13 Jan 2020 by Domingo Cavallo

Since taking office four weeks ago, the Alberto Fernández government has announced many dispersed economic measures to redistribute income. But there is not yet a consistent or complete plan for stabilizing the economy, and promoting growth -- much less a plan for how to free the economy from the stagflationary web in which it has been trapped since 2012.

In sharp contrast to the monetary policy agreed upon with the IMF in the program negotiated by the Mauricio Macri administration in September 2018, there will be no constraint on monetary emission. Monetary expansion will provide the financing to pay for the fiscal deficit and the net peso-denominated debt due, and to absorb the surplus FX in the controlled market.

The exchange controls that prevent new major devaluations of the official exchange rate, the freezing of energy prices and other public utilities rates, some wage and price negotiations that will try to avoid disruptive relative price changes, and eventual moderation in the demand for nominal wage increases by unions, may produce some inflation slowdown in coming months.

If the monetary expansion significantly exceeds the increase in the demand for money, as is very likely, the monetary disequilibrium will manifest itself first in the widening of the spread between the official price of the dollar and its value in the various versions of the free markets for dollars (the “blue” and the quote from peso-dollar bond swaps) and, eventually, in a larger devaluation in the official market. In such a case, all disinflation achieved through controls and market interventions will give way to inflationary acceleration, and a revival of stagflation.

To increase tax revenue, the government has increased taxes on exports and net wealth, and has created a new 30% tax on tourism and purchases of dollars for hoarding, while the provinces are increasing taxes on property and gross income. On the expenditure side, the government has announced special bonuses for low pensions and public salaries, and new programs to provide additional subsidies to low income families in the informal sector. The fiscal result of the tax increases and announcements on social expenditures, combined with the increase in financial subsidies to the public utilities subjected to price freezes necessary to maintain the energy supply, is still uncertain.

The measures announced so far are unlikely to reactivate production in the short term – and certainly won’t promote investment and growth in the long term. Analysts who want to avoid being too pessimistic think that the announcement of a complete and consistent stabilization and growth plan will be forthcoming after the government succeeds in restructuring its dollar debt. But that’s wishful thinking for now.

Now read on...

Register to sample a report

Register