If you’ve noticed a dramatic increase in prices this month, allow me to assure you that it is not your imagination. Inflation has accelerated dramatically since President Mauricio Macri took office on December 10. That’s a fact. The big question is whether this is a short-term consequence of removing currency controls and reunifying the Argentine peso, or a long-term trend that could spiral out of control. Argentina has an unshakable problem with inflation, or persistently rising price levels and the subsequent deterioration of the value of the currency, that will be hard for the new government to shake.
The Struggle Is Real
Estimates for how much prices have gone up vary, but this is undeniably the highest inflation in two years, since the major devaluation when Axel Kicillof became Economy Minster in 2014.
According to the Buenos Aires City Government, December inflation clocked in at 4.22 percent as measured by the increase in a basket of basic food goods calculated based on the necessities of a family of four. Anecdotal and independent estimates of inflation both in the City and across the rest of the country show increases within a similar range, so for simplicity’s sake let’s take Buenos Aires City official statistics as a reasonable starting point for addressing the problem:
Price increases were led by inflation in the price of meat, which increased by a whopping 13 percent.
Besides food, almost every aspect of the economy experienced a price increase with a striking 12.23 percent increase in the price of healthcare-related expenses.
While there is no contention over December’s high inflation, the story diverges when we get to January.
The government claims that December’s high inflation numbers were a short-lived phenomenon in response to expectations of price increases resulting from the end of currency restrictions. In other words, a self-fulfilling emotional prophesy unavoidable in disentangling the currency web weaved by former President Cristina Fernández de Kirchner. Secretary of Commerce Augusto Costa and Minister of Production Francisco Cabrera point to the fact that prices rose by 1 percent the first week of December, but only 0.9 percent the second and 0.6 percent the third as evidence.
Economy Minister Alfonso Prat-Gay stated that the increases were just a “sensation” and that, “we are coming down in the first 15 days of January to inflation levels more or less similar to what we experienced in October [1.5 percent] and September [1.7 percent].”
Private estimates of inflation during the first 15 days of January show a figure between between 2.5 and 4 percent for the month, or double the number estimated by the Economy Minister.
Prat-Gay goes on to estimate that by February the impact of lifting the currency controls will have run its course, and inflation will be below 1 percent per month. Most private estimates suggest that in 2016, inflation will be between 25 and 30 percent.
Methinks Mister Prat-Gay would benefit from a calculator and a healthy dose of reality.
The Political Impossibility Of Fiscal Readjustment
In a phrase, Prat-Gay’s economic strategy consists of monetary shock combined with fiscal gradualism. In plain English that means he is moving quickly to remove controls related to the currency, which have a comparatively minimal impact on the average person, whereas the government is slowly reducing government spending, which can make or break someone’s day-to-day economic well-being.
Mauricio Macri’s government inherited a macroeconomic nightmare consisting of three entangled areas:
- A Central Bank (BCRA) with no cash that owed billions of dollars to importers and holders of bogus futures contracts
- A system of parallel currency rates characterized by a market (blue, “blue chip swap,” contado con liquidation) rate that exceeded the official rate by margins of up to 70 percent
- A bloated public sector in which the state employees close to 25 percent of the population across the country (closer to half in some provinces), and the general population has come to rely on energy subsidies and price controls to get by
The first two concerns are part of monetary policy, while the third and most complicated is part of the country’s fiscal policy. Taxes don’t come close to paying for the third, so Argentina’s government spends far more money than it takes in. Even when you strip away the alleged shameless graft of the previous administration, there simply isn’t money to pay for number three.
Macri’s economic team led by Prat-Gay has been quick and unapologetic in addressing the country’s monetary problems. Within weeks of taking office they removed the myriad of currency controls and allowed the Argentine peso to float, regardless of the jarring impact this has on the Argentine business community who are coping with continuing unpredictability as the various mechanisms and workarounds that developed in response to the controls slowly unravel.
This “rip the bandaid” strategy cannot be applied to fiscal spending, which in addition to being politically unpopular to cut, must pass through legislative budget approval processes in Congress. To make matters worse, we are in the midst of the baffling annual union wage increase bargaining sessions known as the paritarias. Labor leaders smell the looming fiscal cuts especially in light of the recent controversial firing of thousands of public workers and are demanding salary increases between 28 and 35 percent to compensate for the upcoming year’s expected inflation.
Will Inflation Stay High?
By removing currency controls and allowing the Argentine peso to float without also correcting the fiscal imbalance so abruptly, Argentina is left with two options:
- Monetize the fiscal deficit by printing money to cover the expenses, AKA inflation
- Finance the fiscal deficit by raising debt, AKA selling bonds, and attracting investment
Option 1 is not good. High inflation deters investment, exacerbates poverty and leads to instability.
Option 2 is off the table in a real way until the Macri administration finds a way to settle with the holdout creditors known as the “vulture funds.” As of last week the prospects were not as rosy as we would like; however, Cronista reported today that JP Morgan sees the negotiations moving in the right direction and predicts a resolution that pays the holdouts between 70 and 80 percent of the face value of the defaulted bonds in the form of additional bonds. Until a settlement is reached, President Macri can go to as many meetings at the World Economic Forum in Davos as he wants, it won’t change the fact that the majority of global capital is risk averse capital and will avoid Argentina like the plague.
Furthermore, global conditions are not on Argentina’s side when it comes to attracting international investment. While the government has predicted a 0.5 percent increase in GDP for 2016, international banks and the IMF have adamantly contradicted this figure, predicting a recession of -0.7 percent in 2016 and meager growth of 0.2 percent in 2017. This is due to China’s slowdown, low commodity prices and a deteriorating situation in Brazil, a major destination for Argentine exports.
Give It To Us Straight
Argentina grew tired enough of former President Cristina Fernández de Kirchner’s economic fantasy land to elect Macri, partially based on his promises to restore reliability to Argentina’s economic statistics agency INDEC and to end the bombastic and downright dishonest management style of his predecessor.
Admitting that inflation would temporarily rise upon the removal of capital controls and realignment of the currency was laudable; calling dramatic price increases a sensation and claiming they will be over by February is not so much. While INDEC understandably will need until September to publish official inflation statistics, in the meantime the Government should either outsource the task to a reliable third party or establish a less-than-perfect estimate based on private sources.
Currently, Economy Minister Prat-Gay’s minimization of the real problems that high inflation causes in the lives of Argentines makes him come off as dismissive, flippant and disconnected. Like when he dismissed monthly electricity cost increases of AR$350 as negligible, or only “the cost of two pizzas,” he runs the risk of losing touch with the economic needs of the people that it is his responsibility to promote and protect.
Inflation’s latest tear is a real reminder that just because people can now buy dollars and imported goods doesn’t mean Argentina’s economic woes are over.