Key takeaways:
- Argentina elected Javier Milei to address its latest economic crisis. He promises to radically reform current institutions.
- Investors will want to see an improvement in government credibility and commitment to fiscal and monetary adjustments.
- This crisis is not unique and solutions exist. We’re hopeful that Argentina will reach a turning point.
New President Javier Milei has vowed to tackle Argentina’s economic crisis
Argentina is in crisis. An unsustainable fiscal position triggered an inflation crisis, fed further by a lack of credible monetary policy. An unsustainable external balance triggered negative net reserves. As a result, Argentina’s poverty rate is 40%, which is four times that of its neighbor Uruguay. Argentina just elected Javier Milei on an ambitious reform platform. Milei’s election starts a new economic experiment: he’s stated he wants to dramatically cut government spending and dollarize the economy.
As a result of previously failed policies, investors have lost faith in Argentina as a borrower. The government’s dollar denominated debt trades around 30 cents on the dollar, implying an imminent restructuring. There are a few key policy corrections we want to see to regain confidence in the Argentina story. Credible fiscal policy is the first. Argentina cannot afford the current level of spending and needs a policy adjustment to run smaller, sustainable fiscal deficits. The International Monetary Fund (IMF) estimates an average deficit of -5% of GDP over the past five years, largely financed by external borrowing and the central bank (October 2023 World Economic Outlook, IMF). The government need to commit to fiscal austerity. To slow inflation, Argentina needs a credible monetary policy framework. Part of this will need to be better foreign exchange management. Milei’s proposal is to dollarize the economy, one of the few things Argentina hasn’t tried yet on this front. This discussion is quite radical with only a few countries having done it, such as El Salvador, Ecuador, and Panama. Argentina is up against a multi-dimensional problem and all these issues will need to be attacked simultaneously.
Milei is proposing a radical reworking of the system. This requires buy-in from Congress, where Milei does not have a majority coalition. The Argentine population also needs to be willing to undergo the adjustment. The IMF is another important player as Argentina’s single largest creditor. Part of the fiscal solution will eventually require a restructuring of their sovereign obligations, and all creditors will need to make concessions – the IMF, China, and the private sector. Success begets success, and an improvement in government credibility will lead to more support from the IMF.
In the short-term, Argentine citizens will bear the costs of these reforms. A fiscal adjustment will likely result in a recession, a weaker social safety net, and higher poverty. Argentina’s crisis is not unique: many emerging market countries have successfully navigated similar crises. Latin American crises in the 1980s and Russia in the 1990s offer a few examples. The policy toolkit is well known at this point, which is why elections present an opportunity for a turning point. Dollarization is a high-risk experiment, with uncertain outcomes for private creditors. I expect Argentina eurobond prices to rise at the early stages of this experiment as initial policy announcements and adjustments are made. After two lost decades, we’re hopeful that Argentina won’t see a third.
