Argentina: The risk of transforming a currency crisis into a financial crisis Alejandro Vanoli

Despite past experiences, the recent agreement between Argentina and the IMF includes unrealistic projections. On Friday, July 13th, the IMF staff report on its Argentina agreement was released. There, the staff has sought to protect itself, warning of the risks inherent in the dynamics of the Argentine situation. But the tango between the IMF and Argentina is inconsistent and unsustainable  because of the unrealistic projections incorporated in the agreement, the rigidity generated by the limitations in the use of monetary and exchange rate instruments to face the crisis, and the validation of policies that will aggravate the crisis.

The agreement with the IMF repeats old ‘mistakes’ of both the Agency and the country. It must be remembered that in 2001 the IMF had to create an Independent Evaluation Office (OEI), owing to the very serious errors it committed when supporting an unsustainable program in Argentina during the 1990s.

It is interesting to recall some of the criticisms that the OEI made in its report of June 30, 2004 about the role of the Agency in the supervision of Argentina during 1991-2001. Many of the lessons of failure continue to be repeatedly ignored, with the Argentine Government and the IMF being jointly responsible.

Indebtedness and ability to pay.

One of the lessons of this report that the IMF continues to ignore is the underestimation of the problem of debt sustainability. According to Lesson 2 of the OEI Report, the level of sustainable debt with the full opening of the capital account is lower than in an economy with financial regulations.

According to the Institute of International Finance, Argentina’s total external debt is 90% higher than in the 90s. The dynamics of the debt are potentially dangerous, not only in terms of the total amount but also because there is a growing dollarization of the debt which exposes the country to the high vulnerability implicit in a fluctuating exchange rate.

The increasing issuance of BOTES (dollar denominated public bonds) to finance the Treasury and to exchange them for LEBACs (local currency denominated Central Bank liabilities), involves dollarizing the debt, with short maturities that are difficult to renew.

In addition, public intra-sector creditors are replaced by foreign creditors, making it difficult and expensive for future renewal in a context of rising US rates and greater risk aversion with respect to the emerging indebted countries. There is also greater exposure of banks to the public sector. There are warnings in the staff report that did not prevent the approval of the agreement, despite the doubts of some developed-country members of the IMF.

This context makes it more difficult to return to voluntary financing since it is perceived that the risk is greater and that the funds committed by the IMF are not enough to restore solvency. As recognized by the OEI in 2004, “financial engineering” does not replace adequate policies.

In this regard, international experience shows that the adjustment programs with the IMF for the largest debtors with the Agency reduce the financial deficit but increase indebtedness, significantly reduce growth and increase unemployment and inequality.

In Argentina the fiscal deficit has been reduced slightly but the financial deficit increases significantly. The interest on the debt has gone from an average of 7% of the National Budget until 2015 to 15% at present.

The 2001 experience also shows that an adjustment that aims to reach zero deficit is deeply recessionary and deepens the imbalance in public accounts due to the loss of revenue. Besides an adverse international context, it is difficult to recreate trust in a scenario of growing imbalances.

Thus, the IMF cannot ensure that the capacity to repay the debt is sustainable and reduce the risk of transforming a currency crisis into a financial crisis when the debt is repaid.

The IMF cannot validate accounting the sale of assets of the Sustainability Guarantee Fund (SGF), or public pension fund scheme, as current income. This is reminiscent of the painful use of privatization income to dress up fiscal accounts in the 1990s – an unsustainable criterion validated by the IMF and criticized by the OEI.

The SGF must be preserved and not be de-funded by changing the taxation that feeds it, in order to privatize the system, as was done in the 1990s, aggravating in the process the fiscal deficit and leaving many Argentines without pension coverage or with miserable retirement benefits and with a greater public debt.

Loss of instruments: The wrong diagnosis and the trap

Another lesson not learned by the IMF and by Argentine neoliberalism is that giving up policy instruments takes away degrees of freedom to administer the crisis. It is well known that the developed countries could get out of the crisis by easing the finance to the Treasury and by using monetary policy.

The limits to the use of reserves for foreign exchange intervention and to monetary policy are a ‘corset’ that forces the Government to resort to debt. The Government is in a trap. If the exchange rate stabilizes, it encourages the inflow of speculative capital and inflationary pressures will increase and the current account deficit will worsen. If it allows free floating, the inflationary pressures aggravated by the indexation mechanisms in tariffs and energy will deepen.

It is necessary to opt for a managed float complemented by other policies that separate the external equivalent of the domestic prices and the exchange rate. Only in this framework would interest rates be reduced and productive credit lines that stop the bankruptcy of the productive apparatus be returned.

It must be understood that the main problem is not the fiscal one. The main problem is from the external sector. An increasingly protectionist world forces a return to trade administration mechanisms, which include tariff and para-tariff measures and the use of licenses that protect the national industry. And financial regulations must be imposed to prevent the free entry and exit of speculative capital.

There is life for the agreement and after the agreement. Alternatives

The IMF cannot statutorily finance the flight of capital. To avoid this problem, measures must be taken to prevent hemorrhaging in the form of a record and growing capital flight that adds to the current account deficit. It is clear that devaluation cannot be an efficient tool in a dollarized country.

Only the reversal of import opening and recovery of demand will genuinely improve the fiscal solvency via a recovery in tax collection. It should be complemented by reintroducing or increasing income taxes in the sectors that are concentrated and those that benefited the most in these years, in order to distribute the adjustment costs more equitably.

You can still manage the debt to improve your profile, stop dollarizing it and thus alleviate the fiscal accounts. The margin is exhausted; if policies are not changed, the exchange crisis that overwhelms the real sector and has a high social cost can be transformed into a financial and debt crisis.

By way of conclusion and starting point

There is no guarantee that the agreement that has been objected to from sustainability, efficiency and equity points of view, and has inconsistencies and lacks support from most political parties and society, will be maintained after 2019. Moreover, it is highly probable that higher inflation in 2018 will force the government to revise its terms as established in the Letter of Intent.

If the IMF does not review the lessons of its failure in Argentina and the Government does not reconsider the course, the economic problems will be further aggravated.

The responsibility of an opposition that can emerge as an alternative in 2019 is central. It cannot validate any proposal from the Government and / or imposed by the IMF as the Argentine Congress did in 2001. Nor can it accept structural elements that go against growth and equity, to avoid validating major evils not only in the provinces that it now governs, but also the heavy legacy at the national level that will remain in the new Government.

* Alejandro Vanoli is a Professor of International Finance University of Buenos Aires. Former Chairman of Central Bank of Argentina 2014-2015 and Chairman of Securities and Exchange Commisssion 2009-2014.