This post appeared in RGE-Monitor (Latin America) on December 9, 2008.
Fiscal Accounts Shortage (flows). In response to the crises, the government has announced a battery of government expenditures’ increases and (subsidized?) credit supply with the pension funds recently nationalized—very likely reducing the rate of return to future retirees instead of increasing them, the main official argument for nationalizing these funds in the first place. I argued in a previous post about the contractionary effects of these measures. This seems to be exacerbated by the fact that tax revenues are markedly slowing down—as predicted (not by the government, though). Unfortunately, this seems to be just the starting point, as tax revenues are likely to contract in real terms in the short-run, while spending seems to be on the rise.
Financial Account Shortage. The central bank is trying to help by gradually letting the domestic currency depreciate. This should come at no surprise. Capital flows have been leaving Argentina, exports are now decreasing in quantities (prices have already started their downward movement before), and neighbor countries let their currencies depreciate in response to the external change in relative prices. That helps to explain the need for the government to let capital that out-flowed to return in too benign conditions—although, rationally, I would expect this not to work, as a strong driving force for capital flows is confidence in the country and respect for property rights; neither high in Argentina nowadays. Add to that that, in parallel, the administration is trying to enforce restrictions for capital outflows. But if the domestic currency is expected to continue depreciating and capital finds it difficult to exit the country, why will it enter in the first place? Additionally, in collaboration with Carmen Reinhart (University of Maryland and NBER) and Ken Rogoff (Harvard University and NBER) I have shown that capital controls do not work!
I can only hope for the government to be smarter (am I being too optimistic?) and just making announcements knowing that they will not be enacted—trying to look “as if” they are doing something (and in control) regardless of the truth. Because if not, Argentina is poised to fail sooner rather than later. Alternatively, I guess political economist will have (even more) material to work on.
Fiscal Accounts Shortage (stocks). Let me now factor in the fact that debt to GDP ratio is in levels similar to the 2001-2002 crises.
This is so even if not including the quasi-defaulted CPI-indexed debt (roughly 40% of total recognized public debt) and borrowing from the central bank. Regarding the latter, it includes not only the so-called “transitory advances”, but also the new debt contracted by the treasury in order to pay to the IMF (wrongly dubbed as “de-indebtedness”). The latter is not part of the country’s public external debt, but it is debt denominated in foreign currency—thus, it increases in real terms as the domestic currency depreciates. Granted, the percentage of (the recognized) public debt denominated in foreign currency decreased from close to 97% to 53%, which is likely to be reduced in real terms as the peso continues to depreciate. However, it basically means that Argentina is in route to renege on part of its financial obligations either through inflation, depreciations, or both (conditional on the degree of pass-through).
This is compounded by the fact that the fiscal surplus is mainly used to make interest payments, rolling over most of the debt. Worse, the government’s lack of financing availability implies canceling outstanding debt by borrowing from different government agencies (intra-government debt). Within those, of course, is the nationalized pension fund. Not surprisingly, the latter tends to lend to the government at negative real interest rates. (I hope you are not among those to retire in the near future.) Thus, nothing precludes the level prior to the debt swap (2004) to be reached quite soon—especially if you add the debt issued to the central bank, the hold-outs, and the present discounted value of the lawsuits that the government will face as a result of the AFJPs nationalization, among others. The more so if we consider that the fiscal budget law enables the government to increase its ability to borrow from the central bank and from Banco Nacion (the main public bank).
Bottom line: Argentina apparently intends to increase its outlays while the expected revenue seems to be trending down. The indebtedness ratio has already reached levels similar to those of the latest default and the risks are in the upside. On top of these, the world that helped (a lot!) in the 2002-2007 period is looking quite gloomy. The U.S. seems prone to be in recession throughout 2009, and the recovery looks sluggish—below potential GDP during the H2 of 2010. Europe and Japan do not look much better. Asia depends mainly on exporting to developed countries. In particular, China growing at 7.5% is not promising enough, as Nouriel Roubini pointed out in his blog. This certainly affects Brazil and Russia as a consequence. Overall, it ends up impacting Argentina quite seriously. But had Argentina “made its homework” during goods time, things would have looked extremely differently now. Now the due date for the assignment has passed.
P.S.: It is also worth mentioning the regressive income redistribution embedded in these policies. Out of tax revenues and retirement funds (which all workers, rich and poor as far as they are registered workers, pay at the same rate), the government plans to subsidize credits for new cars and other durable goods. But who is more likely to receive these credit lines—provided that they are credit worthy and willing to borrow? (The willingness might result from expected negative real interest rates, though; provided you are quite optimistic about your expected future income.) On average, not lower income people. Actually, if any, those that are paid in dollars could be the more likely ones to take advantage of this consumption subsidized credits—usually not poor people.
Thus, not only these counter-cyclical fiscal policies might be contractionary, and potentially de-stabilizing for financial markets and triggering high risk of default. On top of all these things they worsen income distribution markedly. This sounds contradicting for a so-called “progressive” government—but not for a populist one.
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