Argentina’s crisis response: some likely effects

The following appeared on RGE-Monitor, on December 22, 2008.

1. Argentina’s economy is slowing down—a recession can not be disregarded for 2009. Data on this abound from any bank or investment-research firm (domestic or foreign).

2. The world economy is also slowing down with non-trivial chances of many developed and developing economies being in recession during most of 2009. The recovery, in the best case scenario, might not be observed until (probably H2 of) 2010. Regardless of the exact date that the world economy starts to recover it will be a very progressive increase in growth rates—specifically, below potential GDP. More likely the US will be the first economy to start the recovery phase thanks to its more developed financial markets and the willingness of the authorities to (rationally) act–even if with some mistakes on the way. Europe, Japan, and the rest of the developed world will follow suit but with lags. These lags will be more pronounced for developing nations, as their external and internal demands depend very heavily on the developed world’s real and financial sectors. The latter applies, for example, to China, India, Brazil, Russia, and SE Asia.

3. Back to Argentina: expenditures have been on the rise; tax revenues are going down and will probably continue on this trend—due to decreases in external and internal demand alike. The official response to the effects of the external crisis on the already prone-to-crises policy is more expansionary fiscal and credit policies. Note, however, that the (regressive) proposed policy distributes resources from poor to middle income and rich people. In the first place because it is mainly financed or leveraged from the recently nationalized pension funds, which are more relevant for retirement for lower income families. Other examples include tax reductions for middle to high income households, credit for cars and other durable goods (that only already credit-worthy individuals will be able to take advantage of, i.e. poor people less likely), etc.

It is worth mentioning that the higher the household’s income, the higher its marginal propensity to import. Why is this important? An explanation follows.

The deterioration in the external terms of trade (which is here to stay for some time) jointly with the decrease in investment, export infrastructure investment, and the instability of property rights is already worsening the (quantity and quality of) exports—not to mention that rural sectors are again in protest-mode. Imports, despite the economy’s slowdown, might tend to increase. This results from the appreciated real exchange rate and the right-hand-side tail of the income distribution’s higher marginal propensity to import—mainly consumption goods, though. Thus, the administration’s policy looks likely to worsen the (already decreasing) current account balance. The financial account is already looking gloomy, as the official data shows alarming levels of capital outflows—some even suggesting levels higher than in the 2001-2002 crisis (see INDEC’s Q3 figures for these and other related data).

The exchange and price controls/crossed subsidies that distort the entire vector of relative prices could exert domestic pressure on central bank’s reserves. People might start thinking about running against the domestic currency in expectation of a depreciation of the domestic currency—the more so if you factor in the deterioration of the fiscal accounts already mentioned and the industrial sector demands for a “competitive” exchange rate. In turn, this will contribute to further worsening the fiscal balance, as opposed to the administration intentions, as lower confidence in the government increase tax evasion and capital outflows. (The tax forgiveness to repatriate capital outflows recently passed for this purpose is not likely to work; only marginal effects may be seen as my previous post suggests.) All this will be exacerbated by the economy’s slowdown. Furthermore, this reduces the country’s availability of international credit. The more so if you take into account the increasing number of provinces moving into fiscal deficit—including the heavy weight province of Buenos Aires, which given its unskilled labor-intensive manufacture sector is likely to be hit the most as the crisis spreads into the country. Let’s also mention that for 2009 and 2010 the federal government’s fiscal needs are in the order to of $ 20b per year. Thus, the willingness to lend to Argentina looks strong in the downside risk. Consequently, at a minimum, the entire outlook signals caution.