Argentina Election Draws Wider Attention to Embattled Economy
Argentina has an incredibly high rate of inflation, now well over 140 percent, and that rate is rising. Its currency, the peso, doesn’t trade at one price relative to the U.S. dollar (or any other currency), but many: there is an official rate, a black market rate known as the “blue dollar,” and special rates for specific sectors of the economy. The current official rate isn’t really tenable for much longer, so the peso will almost certainly experience another depreciation. Argentina is also out of liquid foreign currency reserves.
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The central bank has no dollars apart from those on deposit from the banks as part of their required reserves, which cannot be used for other purposes. The government has taken to making payments in Chinese yuan when possible, as China has been willing to let Argentina leverage a standing swap line, which allows Buenos Aires to exchange pesos for yuan. This has helped Argentina conserve its real dollars, as it can now pay, say, the International Monetary Fund (IMF) in Chinese currency.
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Meanwhile, the economy is short of foreign exchange, in part due to prolonged drought conditions and a poor harvest. According to the IMF, importers have added about $15 billion to the country’s external borrowing to keep the stores stocked. And Argentina has no plausible way of paying back either its $67 billion in international bonds or the $45 billion or so it borrowed from the IMF in the next few years.
What urgent decisions does the next president face?Inflation reduction. Finding a way to bring inflation down is top priority. But the shortfall of foreign exchange makes this much harder as the government will have to allow for the peso’s depreciation, which will push prices up. Solving the inflation problem requires, among other things, restructuring the balance sheet of the central bank.
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The central bank has issued a lot of short-term, peso-denominated treasury bills into the market; the outstanding stock of bills is about 15 percent of gross domestic product (GDP). And many of the assets that the central bank holds are special low-interest rate dollar bonds known as non-transferable treasury securities.
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The bank thus doesn’t have sufficient interest income to cover its interest bill, and it often fills the gap by printing more pesos, a move that is unsustainable and contributes to the inflationary treadmill. While one candidate, libertarian economist Javier Milei, wants to dollarize the economy and the central bank’s bills, this wouldn’t really solve the problem. (His main opponent is Economy Minister Sergio Massa.) The central bank would still lack the liquid dollar assets to pay its new dollar liabilities—and it would have to pay the dollar rate on its bills while it receives a very low rate on its non-traded securities. A more realistic solution would be for the central bank to swap its dollar bonds for peso bonds. But this would raise the government’s interest bill and make the already large fiscal deficit even bigger.
Spending cuts. The government also needs to tighten its purse strings and reduce spending (and raise certain taxes). This will be painful, but it is the only lasting cure to inflation in a country that lacks the capacity to borrow; fiscal deficits that measure 10 percent of GDP are unsustainable, and they won’t come down without severe cuts.
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Exchange rate alignment. Additionally, the new president will need to unify Argentina’s exchange rates—the distortions with a different exchange rate for different economic activities have become impossible to manage.
IMF renegotiation. It is paramount that the government renegotiates its IMF program. The current program is off track, and the government needs the IMF to lend new funds to repay its existing IMF loans. This is part of Argentina’s core problem, as the country has already reached its capacity for external borrowing. The Argentines are looking to the IMF to find a way to reduce the extra charges that it imposes on countries that have borrowed large sums and on countries that haven’t repaid the lender in a timely manner. And they have a point: the current interest rate on Argentina’s IMF loan is about 8 percent, which is steep. The penalties that made sense when the IMF’s basic charges were low don’t make sense now, when the fund’s basic lending rate is close to 5 percent.
Bond restructuring. Finally, the Argentines will need to develop a plan to restructure, once again, their sovereign bonds. The last restructuring in 2020 was built around the assumption that Argentina could return to the market in 2025 to refinance a portion of its bonded debt. That isn’t a realistic outcome anymore.
Why do Argentina’s problems with debt matter to the rest of the world?In some sense, they don’t have an outsized global effect. Argentina’s $67 billion in outstanding international bonds trade at around 30 cents on the dollar, so the market only values them at around $20 billion. A restructuring is clearly priced in; it won’t be a shock and will not cause contagion to other emerging markets.
But Argentina still matters. Not the least, it matters to the IMF, which has around $45 billion or so outstanding to Argentina, far more than it has lent to any other country. For the IMF’s sustained health, the fund needs Argentina to have a realistic repayment plan. IMF difficulties in Argentina also seem to have made it more cautious about lending out large sums, so the country casts a shadow over the design and size of the fund’s other large lending programs around the globe—with mixed results.
Argentina also could set an important example for the international bond market if it acts proactively and carries out a restructuring of its bonds in 2024 ahead of the wall of maturing bonds in 2025. The 2020 exchange terms didn’t work for Argentina or its bondholders—the bonds have “traded down” since the exchange, in part because of Argentina’s own policies and because global interest rates have increased. The new restructuring needs to combine a significant reduction in the bonds’ face value with an increase in the contractual coupon (the interest rate) that the bonds ultimately pay and a reprofiling of the bonds’ maturity dates. A 5 percent coupon may have made sense in 2020, when U.S. long-term bonds traded at a 2 percent yield. But it is clearly too low for 2024, when these bonds are expected to trade at rates of between 4 and 5 percent.
Argentina’s creditors have a long history of pioneering new legal innovations in sovereign debt enforcement—this is both because it has so much debt and because it has frequently defaulted. (My former colleague, Greg Makoff, has a book about the epic legal battle between Argentina and holdout bondholders that will be out next year.) Even if Argentina doesn’t directly matter all that much to the bond market these days, it still indirectly matters, as it has the demonstrated ability to set important legal precedents.
Finally, Argentina has tended to be a good crucible for testing theories of what determines a country’s debt carrying capacity. The IMF’s 2019 program was premised on the argument that Argentina’s public debt wasn’t especially high, but that analysis failed to take into account the country’s modest export capacity and minimal stock of foreign exchange reserves, both of which limited its ability to repay its external debt. If Milei wins the election and proceeds with his proposal to dollarize Argentina’s economy, his experiment will test whether actual dollar reserves are in fact needed to dollarize, and help assess whether dollarization helps limit the risk of default. My bet is that dollarization raises the risk of a deep default, as dollarization turns all domestic debts into a claim on Argentina’s non-existent dollar reserves.
Michael Bricknell made the graphic for this article.
