There is never a quiet time in Argentina, even in a year in which the conditions were ripe for smooth sailing. Back in December all the evidence was indicating that Argentina was going to grow, that it would enjoy a significant reduction in country risk with the prospects of regaining access to the international financial markets, that it would accumulate international reserves and that the only dark cloud in the horizon was the risk of a small rise in inflation.
The Government’s disorderly attempts to accelerate the approval of the Bi-Centennial Fund and to remove Martín Redrado as President of the Central Bank changed the political mood and generated a large degree of uncertainty about fiscal policy and about the overall economic outlook for 2010.
The new Central Bank president, Mercedes Marcó del Pont, is much more aligned with Kirchner’s policies, meaning that she does not believe that inflation is even vaguely related to aggregate demand and monetary policies. The prevailing view in the Government is that the best way to deal with inflation is to increase domestic credit as a way to stimulate investment and growth. The main misconception in this view is that as long as nominal demand grows at rates of about 25 or 30 percent per year the bulk of it will be reflected in higher prices, as an increase in investment can at best increase supply by one percentage point, and with a large lag.
What do the recent changes imply for 2010? First, we still believe that the economy will grow at around 3.5%, thanks to a great soybean crop, large exports to Brazil and low domestic interest rates and large levels of liquidity. Besides, expansionary monetary and fiscal policies will add momentum to economic activity, especially during the first half of the year.
Second, we do believe that there is a risk of higher government expenditures, but we don’t think that it will lead to a large fiscal imbalance, as the fiscal deficit most likely will remain between 0.2% and 0.5% of GDP. As a result, the financial gap (once we include all the identified sources) is expected to be around 5 billion dollars, which will be financed through domestic sources (namely the Central Bank, Banco Nación, the ANSES y possibly through voluntary financing in the banking system).
Within this environment, and despite more capital outflows, the Central Bank will maintain a policy of a managed float for the exchange rate, perhaps with a slight bias towards maintaining a weak currency. This policy will face challenges towards appreciation in the second quarter as soybean producers sell their export proceeds, while high rates of inflation will tend to move the nominal exchange rate in the opposite direction. On the whole, we expect moderate depreciations of the currency, at least till July.
The main casualty in the Central Bank saga is likely to be inflation, which is on the rise and while we still expect it to remain around twenty percent, the risks of moving upwards have certainly increased. The main reasons are that the wage increases that are being negotiated are already in the low twenties, while nominal Government expenditures could well rise at rates of around 25 to 30 percent.
In addition, the change in the Central Bank is likely to imply a shift from a policy of accommodating inflation (Redrado) to another that could fuel inflation (Marcó del Pont). The main changes are that the Central Bank is now likely to provide large amounts of financing to the Treasury while it is unclear how much of it will be sterilized through different monetary instruments, while it will pursue a policy of lowering interest rates at a time when inflation is on the rise.
A second casualty has been the reform of the INDEC, which was high in Boudou’s agenda early on and that has now moved to the back burner. Of the two committees that were going to make proposals for the reforms in the statistics office, one is likely to be dissolved in the coming months while the other was never created. In addition, the hope that the INDEC issue could be resolved through a reduction in the actual rate of inflation (a thesis that we never adhered to), has fully vanished.
A third casualty has been the attempts to reach an agreement with the Paris Club to address the debt that it is still in default and the possibility of reinserting Argentina among the “civilized” countries by accepting an IMF macroeconomic review (the so called Article IV revision).
These three casualties have erased most of the components of the economic agenda that Boudou proposed back in July when he became Minister of the Economy. The only hope that he has is the completion of the deal with the holdouts, which is moving very slowly and has now been complicated by the rise in Argentine credit spreads that makes it much more costly to raise new money.