Just last year, Argentina and its President, Mauricio Macri, were investors’ darlings. After years of being shut off from international markets, the country largely settled lingering disputes with creditors, embarked on a gradual reform programme, and attracted substantial capital inflows. The central bank cut interest rates and Argentina issued a 100-year bond – an instrument that even the highest-rated sovereign issuers would rarely contemplate selling.
Since then though, despite the government largely sticking to its reform plan, the value of the US dollar in Argentine pesos has doubled, its bonds have sold off, the central bank has hiked rates to a record 60%, and Argentina has asked for a previously unthinkable IMF assistance programme. Facing an accelerating fall in the currency, the government asked the IMF to speed up loan disbursements and announced an even more restrictive fiscal plan.
So what went wrong? And what can Argentine policymakers do to stop the economic slide?
First, Argentina is not the only country to be facing currency weakness and capital outflows. Most emerging market (EM) currencies sold off in 2018, as higher US yields, concerns over unwinding quantitative easing in the West, and outflows from EM-dedicated funds sent EM assets lower. But the Argentine peso has sold off even more sharply than the currency in Turkey, where the government prefers unorthodox policies, or Brazil, where uncertainty over a general election outcome adds to the already high risk of a fiscal crisis.
Second, the Argentine reformers are failing to convince their own citizens that the changes – however gradual – are needed. In policy speak, the ‘ownership’ of the programme is low. With the memory of the 2002 crisis still in Argentines’ minds, sentiment and trust in government is low. This, together with next year’s presidential elections, have limited the government’s appetite for radical reforms.
Third, the reforms, request for IMF assistance, and latest currency sell-off have damaged Macri’s re-election prospects. Also, the chances of a moderate Peronist victory in 2019 have increased following new corruption accusations against another 2019 contender, former President Cristina Fernández de Kirchner. That, in turn, is damaging external sentiment towards Argentina. But that sentiment was likely too rosy to start with – buying a 100-year bond from any EM issuer requires an optimistic outlook.
Finally, Argentina is falling into a vicious cycle of a liquidity and confidence crisis causing a real economic crisis. The problems are not new, but they have become more threatening as the currency has sold off. This adds to persistent and high inflation, increases public debt (a large portion of which is in foreign currencies), and amplifies currency mismatches in the corporate sector. Record high rates are damaging growth, and in turn are requiring deeper fiscal cuts to meet targets. These damage sentiment even more and lead to more capital flight, perpetuating the vicious circle. And foreign investors can’t help much – they already own a lot of Argentine assets and don’t want to buy more, so can’t meet demand for hard currency.
So what could stop this vicious cycle?
Better sentiment towards emerging markets would definitely help. But Argentina can’t count on that alone. Also, we believe that the sentiment is unlikely turn soon – the Fed is raising rates and unwinding quantitative easing, and investor worries about global and EM growth have resurfaced.
The other option is for the current government to try to rebuild domestic sentiment. Asking for higher IMF assistance should help, as it cuts the risk of radical measures: government default, debt moratorium, or forced conversion of foreign currency debt into pesos. This has worked to some extent and the peso has now stabilised.
Better communication could help, too, even if it carries political costs. To avoid the constant trickle of increasingly negative news, the government could communicate upfront that the weak peso and fiscal measures will push the economy into recession in late 2018 and early 2019, and use the new IMF disbursements to roll-over funding and prop up the currency, before getting back to work.
A strong commitment from the Peronist parties to orthodox measures could also help alleviate the fears of Argentines over another default or a bank accounts freeze. This would also be a very positive signal for the foreign investors who are concerned about policy continuity. But the Peronist parties are yet to commit to strong reforms – during our recent visit to Argentina they preferred to talk about even more gradual pace of change.
Finally, a non-orthodox step like a debt moratorium combined with capital controls could stop a liquidity and confidence crisis turning into a full-blown economic crisis. But while international lenders like the IMF now recognise that drastic steps like this are sometimes needed, their long-term cost is high (as Iceland’s example shows). And their success depends on consistent policies and commitment to reforms, including on the wider public side. This would put Argentina back at square one – without voters realising that these changes are needed, Argentina may not be able to get out of its low growth, high inflation, high debt, and depreciation quicksand.