“Controlled” Shock and “Forced” Deregulation
The stabilization program implemented a month ago, far from the campaign proposals of “setting fire to the Central Bank,” includes a “controlled shock”similar to what we envisioned, albeit with some calibration differences.
Partly due to design considerations: reduced export taxes, higher PAIS tax, reintroduction of the blend exchange rate with a focus on controlling the exchange rate gap rather than the purchase of dollars by the Central Bank (BCRA), and a risky drop in the nominal interest rate to expedite the dilution of the peso overhang.
Partly due to delays in the regulations supporting short-term fiscal consolidation. The fiscal package was included in an omnibus law with 664 articles, including the approval of the Executive Order with another 366 articles, creating a high-stakes all-or-nothing situation. In fact, a month after announcing the economic program, the new export taxes are still not being collected, and if the omnibus law is passed (in whole or in part through negotiation), the deindexation of pension spending will occur after the inflationary surge impacting pension payments.
Fundamentally, because the initial shock is amplified by the regulatory decree that simultaneously opens up exports and liberalizes internal prices, without addressing the disorderly escalation of costs in a context where the impact on rates is still unclear. It’s not so much that they haven’t expressed the intention to halve the incidence of subsidies (to 0.7% of GDP), but it’s unclear whether the full increase requested in gas and electricity transportation and distribution hearings will be validated. If granted, the bill for a N3 user (30% without social subsidy) would increase tenfold, while a N1 user (40% currently paying without subsidy) would see a fivefold increase. It’s unclear what would happen with N2 users (currently receiving a social subsidy) or how it would impact the price index if they start receiving an explicit subsidy in energy quantities while paying the full price for the rest. A similar situation would occur with bus fares in the AMBA region, initially balancing with those in the interior of the country.
The magnitude of the inflationary surge and its moderation will depend on the distributive escalation, the ability to sustain the fiscal promise, the Central Bank’s continued dollar purchases, preventing an escalation of the exchange rate gap, and the tolerance of both policy and society towards the recession coordinated by the scheme. In the short term, the exchange rate anchor (crawling at 2%) aims to curb the coordinated inflationary surge (December’s CPI was around 25.5% monthly), projecting a decrease to 22.5% in January, 18% in February, 15% in March, and approaching single digits in May, aiming for convergence with the crawling peg and interest rates at a lower inflation rate. Currently, the exchange rate gap has reacted, and the transition from the 80%/20% scheme, crucial for the Central Bank to continue buying dollars, faces challenges with an official exchange rate that tends to lag and may require overcoming the delayed increase in export taxes to avoid a currency leap, complicating the fiscal anchor.
At some point, there needs to be a transition to a monetary program that includes a fiscal plan (not solely based on extraordinary taxes, a new disclosure, and/or a massive dilution of spending) and a financial program (not relying solely on recycling trapped pesos to the Treasury without perpetuating the perverse status quo of currency controls). The obsession with “milking” the peso overhang, partly through dilution and partly with Bopreal and Treasury debt, seems to be encountering some limits. Currently, Bopreal’s target is USD 5 billion (with USD 21 billion of debt already accounted for, and the registration closing on January 24), while the swap of remunerated liabilities for Treasury debt, used to zero out the Central Bank’s financing to the Treasury to pay dollar debt to bondholders, seems to have reached its agreed-upon limit with the IMF. The adjustment is framed by blaming the previous government, implementing capital controls, and lacking political competition that could undermine the financial program, as happened before. If the anchor is credible, remonetization will occur, and the economy should rebound at some point in the second half with a constrained exchange rate gap.
Upon navigating the complex agenda, Milei demonstrated pragmatism by shifting from campaign rhetoric to attempting a stabilization program. Whether he maintains this pragmatism in negotiating the Executive Order and the bill or opts for an all-or-nothing approach, risking governance and the stability program, remains uncertain. Negotiating with the established “caste” to prioritize the viability of the fiscal and financial program, and better distributing adjustment costs, particularly away from the middle class, poses a challenge. It’s too early to predict, especially considering that 2025 is an election year and dollar debt maturities are gaining momentum.
For now, in the short term, the chances of success are not zero. Five key points to monitor: How does the distributive conflict evolve amid the inflationary surge? What is society’s reaction to both inflation and the highly recessive adjustment? Will the Central Bank’s dollar purchases be sustained when the payment of new imports normalizes in May? What do the fiscal numbers show month by month? How does the treatment of the Executive Order and the omnibus law unfold in Congress?
