Implications of the IMF arrangement with Argentina
Argentina - Sep 06 2018
The relationship between Argentina and the International Monetary Fund (IMF) has been complicated. It started in 1956 after Mr. Peron’s Government, and it continued through many periods until 2006 when Mr. Kirchner refunded all the debt (USD9.8 billion). He claimed that “the attitude of the IMF has caused pain and injustice” to the country.
However, current President Mr. Macri is more optimistic regarding the IMF. In fact, he took advantage of his invitation to participate in the G7 meeting to take some pictures with Ms. Lagarde and to announce that negotiations to sign a Stand-By Arrangement (SBA) for about USD50 billion is almost confirmed. According to the government’s officers, this agreement will allow Argentina to have more buffers against possible financial turmoil, to strengthen the economy and to protect well-being of most vulnerable sectors.
Conditions (or objectives) of the SBA are mostly clear: to reduce the primary deficit from 2,7% to 1,3% between 2019 and 2020, and to diminish the inflation rate from 17% in December 2019 to 5% in December 2022. The maximum duration of the SBA is 36 months and the first disbursement could be in July 2018 (these new inflation targets are softer than those presented in the in the Monetary Policy Report of April 2018: 15% in 2018, 10% in 2019 and 5% in 2020).
Monetary Policy Rate vs. Inflation: The Argentine Puzzle
Some political analysts argue that this is a strategic policy in which the President needs to finish his first mandate with a healthy economy that increases his popularity, to later be able to present himself in the next presidential elections. As political motivation always has many layers, it is difficult to know what the true motivation behind a political act is. However, what is also interesting to analyze is the economic mechanism Argentina intends to use to control inflation and deficit. Furthermore, it is important to explore some potential political and social concerns that could impact sovereign risk.
In the last years, the Central Bank of Argentina (CBA) has been monetizing public finances which has increased the debt of the government vis-à-vis the CBA (according to the Balance sheet of the CBA it achieves 5.4% of the GDP). The use of the monetary authority as one of the public finance sources has prevented the CBA to control inflation that is currently around 25%.
One objective that comes into the USD50 billion package is to reform the CBA to give this institution more independency to accomplish target predicted inflation. Financial assistance to the treasury will be forbidden and it must pay its total debt to CBA, i.e., about USD 25 billion. The mechanism of the monetary policy to achieve target inflation will need to the treasury to absorb the surplus liquidity of the economy. In fact, if the treasury finances its activities in the financial market based on bonds, then the treasury must use part of the money obtained to pay back the CBA. If financial markets need funds, then financial agents could sell these bonds to the CBA. The objective at the end is to have less CBA bonds (LEBAC) and the necessary funds to fulfil the market’s necessities LEBAC interest rate was used as a temporary monetary interest rate in 2016 in the process to change from a quantity monetary policy to an explicit inflation targeting monetary policy. In May 2018, more than USD 600 billion of LEBACs reached their maturity. The CBA negotiated with LEBAC holders an increase of the interest rate to 40%.
Fiscal policies will also be adjusted to contain fiscal deficit. Until now, the government reduced its spending (including public enterprises) and it will approve a decree which aims – among other things – to forbid further services contracts (employees and consultants) in the public sector.
Social aspects will also be impacted by this new reform. If the government applies an austerity policy that diminishes accounts to social assistance, then more vulnerable sectors in the economy will be very exposed and inequalities would rise (in the last years there was an increase in inequality, reversing the downward path it had in the last decade). However, the IMF argues that Argentina must rationalize social assistance spending and reduce administrative costs to better target assistance spending and avoid double programs.
Finally, governance obstacles must be considered. Opposition in the Congress has not seen the good side of the deal with the IMF and when set of policies (included the new legal framework of the CBA and the Budget for 2019) will be presented to the Congress many difficulties and issues could emerge.
Argentina has a huge opportunity to strengthen its economy and overpass cyclical turbulences. Even though, social challenges must be taken with the same responsibility since human capital (health and education), inequality and labor conditions will play an important role in the medium-term.
Gabriela Aguilera-Lizarazu, Analyst – Sources: Beyond Ratings, INDEC, IMF, Stat. Office of Buenos Aires