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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is director at the Georgetown Americas Institute and a non-resident senior fellow at the Peterson Institute for International Economics
On June 28, after several weeks of pressure in currency and bond markets, Luis Caputo, Argentina’s finance minister, uttered the words heard time and again in Latin America from many of his predecessors — I will not devalue. In 1981, José López Portillo, Mexico’s then president, made his famous claim that he was going to defend the Mexican peso like a dog. What followed was the start of Latin America’s debt crisis and lost decade.
Unlike previous governments in Argentina and the region, President Javier Milei’s administration has done many things right. Now Argentina and the IMF must redefine success in order to succeed, moving the focus from the sustainability of the currency’s quasi-peg to the dollar and a rapid disinflation process. Macroeconomic policy should focus on economic recovery and slower but sustainable disinflation.
Since coming to power in December, Milei has eliminated the public sector deficit, a titanic adjustment of more than 4.5 percentage points of gross domestic product. He has corrected the real values of many regulated prices, artificially set by the previous government to hide some effects of its horrendous policies. He has adjusted the real exchange rate to a more realistic level and initiated an impressive deregulation and modernisation agenda.
As expected, the first months of his presidency were harsh. Monthly inflation surpassed 25 per cent, economic activity collapsed and poverty increased. On the positive side, inflation dropped by much more than expected and the government’s commitment to correcting the deficit remained intact. Milei has maintained his approval rating, and some important legislative initiatives have been approved, paving the way to a successful first year for the economic programme.
The Achilles heel has been the anchoring of the exchange rate policy to a 2 per cent rate of crawl per month, significantly below the average inflation rate. The negative real interest rate is also now a liability. This combination was smart and useful in the initial stages, as it allowed for rapid disinflation, a quick accumulation of international reserves and a reduction of the real value of central bank liabilities. But now, as the real exchange rate is reaching pre-devaluation levels, it is not providing the financial incentives for exporters and other economic agents to turn their dollars into pesos.
This in turn is generating significant pressures in Argentina’s financial markets. Confronted with this situation, Milei’s government is committed to defending the 2 per cent crawl and continues to equate success with large drops in monthly inflation rates. Previous Latin American governments felt compelled to exaggerate their commitment to a fixed exchange rate because their will to adjust economic fundamentals was mild or non-existent. However, in this case, Argentina has set the fundamentals in place and is mistakenly putting its achievements at risk through a disorderly currency adjustment.
To regain market confidence and redirect its stabilisation efforts, the government needs to move to the second stage of its programme. In this phase, disinflation will happen at a slower pace and the government will focus on economic recovery instead. By doing so, Argentina will be able to follow a more sustainable stabilisation path, such as the ones its Latin American peers experienced in the 1990s.
The Milei government needs to set out a clear commitment not to dollarise the economy and to support its currency competition strategy by strengthening the institutions and policies that will allow the peso to overcome the dollar as the currency of choice of Argentines. To do so, the government should send an amendment of its fiscal responsibility law to Congress as soon as possible. This update should establish a zero deficit as its fiscal target for the years to come and should enshrine the central bank’s independence.
The government also needs to announce a correction path for controlled prices. The central bank should let the official currency adjust to a more realistic level and move to a more flexible official exchange rate mechanism. Together with a modern monetary policy framework, this will deliver strongly positive real interest rate policy.
On the back of these strengthened policies, the IMF should support Argentina with a new and larger financial support programme. With these elements in place Argentina will be ready to lift its capital account controls and freely float its currency. Together with the renewed financial support of the IMF, these will provide the best conditions that Argentina has had in generations to escape decades of instability and economic decay.
https://www.ft.com/content/e047de2e-2015-4864-9ae5-e9edc9ce4f62
