Since Javier Milei took office on 10 December 2023, Argentina’s central bank has been diligently buying reserves. However, this trend has now reversed. In June – a month typically favourable for reserve accumulation – the government faced its first run against the peso, forcing the Banco Central de la República Argentina to shed some of the reserves it had accumulated since May.
The trigger may have been the BCRA’s eagerness to ‘deflate’ its liabilities by pushing interest rates into negative territory. However, after decades of struggling with inflation, Argentines have developed agile defences. Savings moved quickly into dollars, widening the gap between the official and the ‘free’ (market) exchange rates to close to 60%. Argentina’s country risk premium rose from 1,200 basis points to 1,500, signalling a looming balance-of-payments crisis.
The government responded to these warning signs by digging in its heels. It ruled out any changes to the official exchange rate policy, committing to a monthly ‘crawling peg’ depreciation of 2% – a rate that is only a fraction of the country’s falling, yet still high, inflation. It also refrained from outlining a roadmap for the elimination of multiple currency practices despite the International Monetary Fund’s recommendation to do both.
Rather, in a joint press conference held on the evening of 5 July (Friday evenings are normally used to announce important changes in economic policy), the minister of economy, Luis ‘Toto’ Caputo, and the president of the central bank, Santiago Bausili, formally declared the initiation of the ‘second stage’ of the economic programme.
More noise than substance
Their grand announcement boiled down to transferring the central bank’s short-term liabilities with commercial banks to the Treasury. Moving liabilities from one pocket to another strengthens central bank balance by weakening the Treasury’s. Markets were disappointed and with good reason.
Commercial banks value central bank debt more highly than Treasury debt – the BCRA has never defaulted while the Treasury has a history of nine defaults. Consequently, banks will most likely demand higher compensation, making it even more difficult for the government to meet its zero overall fiscal target.
Despite the announcements, markets remained jittery, prompting another grand announcement from Caputo on 13 July. The central bank would no longer issue pesos to buy dollars. Instead, after buying dollars from exporters (who are obliged to surrender their hard currency to the central bank) it will ‘sterilise’ the newly printed banknotes by selling as many dollars as necessary at the market exchange rate. This half-disguised intervention in the foreign exchange market will force the central bank to give up almost two-thirds of the dollars it had previously bought from exporters at the lower official exchange rate.
Not surprisingly the unofficial exchange rate dropped, but this came at the cost of increasing Argentina’s risk premium.
So far, the government has successfully focused on keeping inflation on a downward trend, and these half-backed measures clearly indicate that combatting inflation remains the government’s number one priority. Milei has also achieved two significant legislative accomplishments. Despite holding only a small minority in the low chamber (38 of 257 seats) and in the Senate (7 of 72), he managed to get approved two significant pieces of legislation: the ‘Ley de Bases’ and a tax package.
The ‘Ley de bases’ includes some structural reforms, such as adding flexibility to labour contracts, removing obstacles for competition and creating incentives for large investments – more than $200m. The fiscal reform includes exceptional tax and asset regularisation regimes and the reimposition of income tax for high salaries, a measure eliminated by the former government with Milei’s enthusiastic support.
However, the government needs to get the economy out of its rut. A contraction of about 4% is projected for 2024, making it a third consecutive year of decline, and fiscal revenues are falling accordingly, dropping by 14% in June in real terms.
Argentina desperately needs to entice private investment. Yet before investors pour their dollars into the country, the government must remove the web of red tape that restricts capital and dividend remittances.
The government is taking baby-steps in that direction, but clings to its 2% monthly crawling peg out of fear that, with reserves still in negative territory, adding foreign exchange flexibility (as the IMF suggests) could trigger a run on the peso and rekindle inflation.
Where could dollars come from?
Milei is shopping for credits. He is getting some encouragement from the billionaires he courts. He is also knocking at the IMF’s door.
Both the government and the IMF are ready for a new programme. However, they are approaching the subject from different angles. While the IMF wants to support Milei’s efforts to reform the country, it is not keen to front-load financial support that Bausili could freely use to arm-twist the market – as Caputo attempted during his tenure at the central bank, when Mauricio Macri and Donald Trump were both in office.
Argentines believe that the IMF is not much more than a US agency and Milei is lighting candles for Trump. Yet, even if Trump gets elected, he would only take office in January 2025 and it could take a few more weeks before his administration becomes fully operational – a long time for Argentina. Moreover, the IMF prides itself for having a ‘learning culture’. Would it want to step on the same stone again?
Hector Torres is Senior Fellow at the Centre for International Governance Innovation and a former Executive Director at the International Monetary Fund.
Image source: World Economic Forum