A devaluation by any other name would smell as… sweet?

Earlier this week, the Argentine Central Bank (BCRA) unexpectedly allowed the official dollar exchange rate of the peso to depreciate dramatically. On Tuesday, the peso depreciated by 3.4 percent and on Wednesday it fell by a further 12 percent, closing the day at 8 pesos/dollar compared to 6.84 on Monday, a 16.96 percent fall in just two days. Yesterday the peso fell to as low as 8.5 pesos/dollar before the BCRA intervened and brought its value back up to 8.2 pesos/dollar. This morning, Cabinet Chief Jorge Capitanich and Minister of the Economy Axel Kicillof announced that the government would lower the tax for obtaining dollars from 35 percent to 20 percent beginning Monday, a significant loosening of the capital controls that have choked off legal access to dollars to many Argentines and fueled a black market whose exchange rate is nearly 60 percent higher than the official rate.

There are a number of reasons why this happened when it did, but it essentially boils down to the fact that the government could no longer afford to maintain its previous policies. Specifically, Argentina’s currency reserves dropped below $30 billion this month for the first time since 2006 while a $15 billion debt payment looms and, because of a convoluted web of subsidies and frozen prices in the energy sector, the energy deficit could be around $10 billion this year. There is little expectation that there will be any influx of new reserves this year, leaving the Central Bank unable to continue depleting the reserves in an attempt to engineer a series of microdevaluations until the gap between the official dollar and the “blue” dollar was closed, or at least tolerably narrow.

The problem for Argentina is that, while a devaluation was necessary and unavoidable, without accompanying measures to address the forces weakening the peso, it will just be the first of many. The fundamental problem is that the Argentine government is monetizing its fiscal deficit, injecting billions of pesos into the economy when there is no demand for them since the government can’t borrow to cover its deficit. This creates enormous downward pressure on the value of the peso which the government has combatted through a combination of capital controls—limiting access to dollars—and aggressive interventions in foreign exchange markets to prop up the value of the peso by selling its international reserves. It is also highly inflationary, which puts further pressure on the peso as Argentines try to protect the value of their money by converting their pesos to dollars as quickly as possible.  Since the currency controls limit the legal options for Argentines to obtain dollars, the blue, or black market, dollar emerged and, in recent months, has been trading at a value between 50 and 75 percent above the official dollar.

Argentine officials are likely hoping that this week’s devaluation and the loosening of the currency controls next week will bring the official dollar more in line with the blue dollar. Moreover, they also are hoping that a series of price control agreements with the major supermarket chains and the early and quick negotiations over salary increases for the major unions will act as a brake on inflation for the rest of the year. However, as Lucas Llach points out, this is very unlikely as the salary negotiations will likely be in the range of 30 percent—exacerbating a wage/price spiral already in effect—and become the monetary emission shows no sign of slowing. So long as monetary policy remains so expansionary the inflation pressures will remain and the pressure on the peso will remain. This is why, despite the devaluation, the gap between the official and blue dollar remains in the same range it has for the last several months; no one sees this as addressing the root problems and therefore expect further devaluations.

What happens going forward is highly speculative. Some of this speculation is that the suddenness of the measures and the dearth of explanation by the government indicates that the government is planning major changes. This is certainly possible, though what those changes would be is difficult to guess as Kicillof and other prominent policy makers continue to essentially deny the facts on the ground in their public statements, meaning any serious changes would be a major about-face. In the more likely event that these were measures taken in desperation and not as part of a broader economic strategy, things look fairly bleak. The inflationary spiral will continue unabated with the ever-lurking possibility that it will spiral completely out of control as further ad hoc heterodox measures to contain it fail.

At the end of November, I was able to attend at the Inter-American Dialogue a meeting of the Latin America Economies Roundtable (LAER). The general consensus at the meeting, by a number of very intelligent and well-informed people was that Cristina Kirchner’s government could probably muddle through the last two years of her term without a crisis so long as inflation stayed below 25 percent, the deficit didn’t exceed 3 percent of GDP and commodity prices didn’t fall dramatically. According to the Billion Prices Project, year-on-year inflation is above 24 percent so far this year and the budget deficit last year was right at 3 percent. Commodity prices—particularly soy—appear unlikely to fall in the coming year, but the potential for further devaluations could encourage farmers to delay selling their product, putting a severe strain on government revenues, widening the fiscal deficit and feeding into the inflationary loop. In other words, while these are relatively arbitrary conditions, they are useful as rough benchmarks for the stability of the Argentine economy and Argentina is already pushing the upper bounds on them with plenty of factors there to push the country well beyond them.

Argentina may not be on the verge of a crisis yet, but low growth and high inflation seems like a relatively optimistic scenario for the rest of the Kirchner presidency.


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