Amid the adjustment, reforms and governability
Far from the campaign proposals which, without access to credit, ranged from a “mini Bonex plan” to dollarize the economy or a reduction in interest rates and complete liberation of capital controls, assuming that the market would find the new equilibrium, the current program prioritized avoiding breaking contracts and appealed to “heterodox” and coordinated tools aimed at putting the balance sheet of Argentina’s Central Bank (BCRA) in order.
Unorthodox tools that coexist with an aggressive fiscal adjustment to abruptly cut off monetary financing to the treasury. This fiscal adjustment, initially carried out by accelerating the dilution of spending through a “controlled” shock, while devaluation and the PAIS tax shored up the Nation’s revenues. This was not the case for the Provinces, where a 20% real drop in federal tax sharing in the first quarter was compounded by a cut in discretionary transfers of over one percentage point of GDP. The fiscal adjustment tends to quickly dissipate as revenues erode with the recession, and spending dilution moderates with the decrease in inflation, the lagged recovery of pensions (included in the increase and monthly indexation starting in April by last months decree), and the necessary negotiation that will have to be carried out to pass the laws it needs through Congress (including the recomposition of income tax in a context of real wage collapse).
Among the unorthodox components, the following stand out: 1) The exchange rate shock not only maintained capital controls but tightened them with RG 990 when the increase in the exchange rate gap began to be coordinated by importers trying to access the CCL to pay off pending debts with foreign suppliers, taking advantage of the fact that 20% of exports supplied that market; 2) Far from opening up the economy, it effectively increased effective protection, through the implementation of installment payments for new imports (30/60/90 and 120 days), the increase in the PAIS tax from 10% to 17.5%, and the perpetuation of VAT and Income Tax withholdings that were no longer “credited” during Massa’s administration. For now, the exchange rate lag that is starting to be coordinated (the dollar is currently 3.7% above the $14 level when Macri left office, but the advantage tends to narrow quickly with the 2% crawling) coexists with an economy that remains extremely closed; 3) The Central Bank lowered the interest rate twice (from 11% monthly to 6.8%), seeking to accentuate the dilution of the overhang of pesos against an inflation rate that jumped to 25.5% in December and is starting to decrease simultaneously with the readjustment of utility service rates being implemented: 20.6% in January, 13.2% in February, 12.5% in March, 11%/12% in April to reach single digits only in May?. Negative rates that, given the current country risk, can only be sustained with capital controls; 4) After an abrupt deregulation of the price system with the signing of the DNU, the economic team began to “negotiate” with the various sectors involved (supermarkets, mass consumption companies, refineries, and prepaid health services), aiming to moderate the impact on the CPI of the price increases. All this, while the private sector begins to look with concern at the collapse in sales and the rise in costs.
For now, the apex of the program is “working out well” in a context of return of global liquidity that buys into the story behind the adjustment, leading to a collapse in country risk from 2,600 basis points (bps) to below 1,300 bps and a new financial party that today is not enough to open up external credit. At the cost of a brutal recession, inflation is decreasing somewhat faster than expected, the Central Bank continues to buy dollars, and fiscal numbers showed a financial surplus in January and February, approaching balance in March, while political capital measured in polls remains stable. Net reserves are less negative, but still negative, and remunerated liabilities fell by 40% in real terms compared to last October.
The combination of the status quo (capital controls) and dilution adopted in the kickoff program to avoid a contract breach is exacerbating both: dilution and, paradoxically, also the status quo. For now, it’s going well within the cepo, but the path ahead is far from clear. We have revised downward the inflation in the “everything works” scenario to 175% annually, given the somewhat faster deceleration observed, but we still believe that the best possible scenario given the increasing indexation of the economy is for inflation to return to early 2023 levels. 2023 started at 6% monthly and ended at 25.5%, 2024 started at 20.6% and could end around 5% monthly (80% annualized). In the scenario (a bit stubbornly and because we believe the narrative is not linear, after all, Milei always changes his mind), we gradually accelerate the crawling to inflation that decelerates and stop lowering the interest rate. We do not change the growth projections (3.4% average decline in the “everything works” scenario, 4.5% if we do not count the crop recovery).
Whether Argentina is a trade (very fruitful for now) or an investment is today an unanswered question; the risks of the “it doesn’t work” scenario are postponed but present, and there is the background that so far Argentina has always been only a trade (short term business). The second and third axes of the triangle we have been using (Reforms and Governability) are not resolved in real life, only in the virtual reality that currently supports the polls. Meanwhile, the program that started pragmatically begins to be conditioned by its own narrative, fiscal adjustment via dilution finds limits, and the correction of relative prices continues to damage the incomes of families and companies affected by the collapse in sales and the increase in costs, coordinating an increase in unemployment.
