Upon taking office in December last year, Argentina's new government faced pervasive macroeconomic imbalances, microeconomic distortions, and a weakened institutional framework. These encompassed unsustainably high consumption levels, historically low levels of investment, and large fiscal deficits financed by money creation, which led to high inflation. Distortions at the micro level included an extensive network of administrative controls (for example, trade barriers, foreign exchange restrictions, and price controls) and a business environment that eroded competitiveness and undermined medium-term growth. There was also an important weakening of the institutional framework for economic policymaking, perhaps most evident in the loss of credibility of the national statistics agency.

Abstract

Upon taking office in December last year, Argentina's new government faced pervasive macroeconomic imbalances, microeconomic distortions, and a weakened institutional framework. These encompassed unsustainably high consumption levels, historically low levels of investment, and large fiscal deficits financed by money creation, which led to high inflation. Distortions at the micro level included an extensive network of administrative controls (for example, trade barriers, foreign exchange restrictions, and price controls) and a business environment that eroded competitiveness and undermined medium-term growth. There was also an important weakening of the institutional framework for economic policymaking, perhaps most evident in the loss of credibility of the national statistics agency.

This is Argentina’s first Article IV Consultation in ten years. In that period Argentina was the only G20 member that did not open its books to the Fund’s scrutiny. That has radically changed. Since December 2015, Argentina’s statistics agency recovered its independence and its reports’ integrity. As I will explain below, Argentina is now looking its problems in the eye and tackling them decisively. It is also complying with its responsibilities with the international community, and as such, my authorities have consented to the publication of this Article IV report. I turn now to address the policies that are being implemented to redress Argentina’s macroeconomic imbalances.

Populism left the country in tatters. By December 2015 Argentina was running down its reserves, despite having imposed self-inflicting restrictions in access to foreign exchange. The country was bound to a balance-of-payment crisis, but the previous government kept kindling domestic demand by subsidizing consumption and over-staffing the public sector.1 Imports essential to the industry were delayed or simply blocked, putting firms and jobs at serious risk. Decadent public infrastructure, high transaction costs, and the practice of protecting cronies and using the tax-agency to bully “unruly” entrepreneurs made Argentina a “no-go” zone for investors. Productivity and competitiveness plunged2, the economy stagnated (since 2011) and entered in a recession cycle in Q4 2015. Fiscal deficits were handsomely financed by money-printing and deposits at public institutions. Inflation was close to 30 percent (according to private estimates, as nobody trusted the “Orwellian” official figures). The crisis was imminent. What has changed?

Change is everywhere. I do not want to sound self-complacent because problems are still looming large, yet it is only fair to note that in just 11 months in office President Macri’s administration has achieved much more than what we could have reasonably expected. To begin with, the crisis was averted and after 9 years of rigging statistics, economic agents are once again believing in the official word.

Disassembling the bomb. Foreign exchange controls were successfully dismantled. The country has now a single and floating exchange rate and access to foreign currencies is unrestricted. Export taxes were eliminated (except for those on soy-beans, which were reduced) and the litigation with creditors that had held-out from Argentina’s debt restructuring was successfully settled. This allowed the country to regain access to credit markets. In April 2016, for the first time in 15 years, Argentina could tap international capital markets issuing bonds for US$ 16.5 billion. The issuance was four times oversubscribed and the money was mostly used to settle the claims of the aforementioned holdout creditors, putting behind 15 years of litigation.

Bridling inflation. Just a few days after taking office the government pledged to bring down annual inflation to about 5 percent by 2019 (see target-band below) and, together with the virtually overnight removal of foreign exchange controls, the Central Bank of Argentina (BCRA) announced the transition to an inflation-targeting regime. The aforementioned regime was formally launched on September 26.3 As staff notes, the targets are ambitious, yet inflation is already slowing down rapidly. In September, consumer prices increased by 1.1 percent (a far cry from the 2.1 percent monthly average in 2012-20154) and wholesale prices just 0.4 percent. Perhaps even more telling is that consensus expectations for 2017 are currently at 19.8 percent, already very close to next year’s upper limit of the band.

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The Central Bank’s commitment to delivering lower inflation is very clearly shown in the reduction of monetary financing of the Treasury: BCRA transfers to the government were reduced by half in real terms in 2016 over the previous year, and are planned to be cut even further in 2017, when they will represent only a third of their 2015 amount in terms of GDP.

Markets are voting with their feet for tamed inflation. On October 13 the government launched a new series of local bonds, denominated in Argentine pesos, with 10 and 7-year maturity and with a fixed nominal interest rate. Thirteen bonds were placed and the issuance was comfortably oversubscribed. Given Argentina’s un-glorious record of high inflation, this was quite an achievement. However, the inverted yield-curve was even more remarkable showing that investors were ready to accept lower yields for the longer-term bonds (15.5 percent vs. 16 percent, respectively).

Gradual and relentless fiscal consolidation. In 2015 the fiscal primary deficit was over 5 percent of GDP, the economy was in recession, and (as I will explain below) about 1/3 of Argentineans did not have sufficient income to cover their very basic needs. This was a dramatic situation, yet the government had no choice. It rapidly set out a roadmap for fiscal consolidation and, as staff rightly notes, fiscal tightening will be relentless all over President Macri’s administration. One of the first measures was to dismount energy subsidies that overall amounted to approximately 4 percent of GDP (in 2015). Beyond being costly, these subsidies were economically, environmentally, and socially perverse. On the one hand, they created incentives for energy over-consumption; on the other hand, they benefited mostly the affluent and forced a country with abundant gas reserves to import an increasingly large part of the gas, oil, and electricity it needed. Prices are now being progressively reconciled with the actual cost of production. Admittedly, this painful process has been rather tortuous, as injunctions forced the government to temporarily reverse price increases. Nevertheless, energy subsidies are already being progressively phased out and in 2017 savings will come close to 1 percent of GDP.

The drop in output has bottomed out. Despite a short-lived uptick in 2015 fueled by pre-electoral fiscal stimulus, the economy had been stagnant since 2011 and started contracting in the last quarter of 2015. When the new administration took office it had little wiggling room for counter-cyclical fiscal policies. Rather, it had to face unpaid bills that had been pushed forward by the previous administration; urgently address the aforementioned perverse structure of energy subsidies; and remove the exchange rate controls. Moreover, it also had to pause ongoing public works to take a close look at the integrity of pending bills. As a result, the contraction was more prolonged and severe than expected. Nevertheless, output has bottomed out in the third quarter of 2016 and the year will end with a slightly positive growth rate. Activity is already picking up in several sectors; most notably in construction (anticipated by a 16 percent increase in cement deliveries in July and August) and the government’s growth projection for 2017 is 3.5 percent (from a negative rate of 1.5 percent expected for this year). It is worth noting that the government’s 3.5 percent growth projection is on the conservative side, as most private consultants (including some advising the political opposition) are much more sanguine.

Some differences with staff. I do not want to take issue with staff’s projections but will note a few points. Let me start by acknowledging staff’s difficulties in assessing changes in the quality of public expenditures. It is always difficult to discern how improvements in quality could affect the fiscal multiplier. The challenge for staff was compounded by the fact that Article IV consultations were interrupted for the last 10 years. Yet, it is important to note that whatever the “quality-enhanced” multiplier may be, the effect of public money spent on a road that is heavily overpriced could be dramatically different from that of public money spent on a reasonably priced road that is actually delivered.

It is also important to note that some of the staff’s projections bode ill with their assumptions. For instance, in a world with low or squarely negative interest rates, staff assumes that Argentina’s real interest rates will be between 4-5 percent until 2019 (Table 5). However, despite these unusually positive interest rates, gross national savings remain almost unchanged over the entire five-year period covered by staff’s forecast (Table 1).

Staff notes that Argentina’s banking sector is currently mostly “transactional”. This explains that credit to GDP ratio is unusually low (13.5 percent according to staff5 and just 12 percent according to BCRA estimates). Nonetheless, with such a low start, staff projects slightly less than a 1 percent annual increase (average) for credit to the private sector over the five-year period covered by the report (Table 1).

It is also important to note that staff is understating Argentina’s capacity to rebuild its gross international reserves. Without going any further, staff is projecting US$ 36.5 billion of reserves for end 2017, whereas by the end of October 2016 they were already standing at approximately US$ 40 billion.6

Finally, staff is also understating the government’s fiscal effort as it fails to mention its endeavor to re-capitalize the BCRA. Indeed, it has exchanged the non-transferable IOUs that the previous administration had used to “buy” reserves from the central bank, with tradable bonds that are actually paying interests (approximately US$ 1 billion since the government took office in 2016).

Argentina’s shame: a rich country with an impoverished population. In June 2015 the previous government pretended that poverty had almost been eradicated from Argentina (just under 5 percent of the population was deemed to be under the poverty line). As soon as the new administration took office it decided to truly eradicate poverty, but also the practice of tailoring official statistics to political expectations. Today, quite a different reality is exposed to the daylight. Almost one out of every three adults is under the poverty line and about 40 percent of children do not have sufficient means to cover basic needs. This is unforgivable in a rich country that is just emerging from a decade of record commodity prices.

The authorities know that a vibrant economy is the best way to create jobs, restore dignity and pull people out of poverty. However, the inherited reality is just too dramatic, leaving no time to wait-and-hope. President Macri has publicly stated that reducing poverty is his administration’s absolute priority and that by the end of his period he expects to be judged by how effectively he delivers on that objective. The government is implementing very active social policies, including many that come from the previous administration; nevertheless, for a change it is delivering hand-outs transparently and not exchanging them for political support. Moreover, it needs to be underscored that the government is putting special emphasis on training programs to revamp and increase the working skills of those that have been striving in the informal economy. All in all, Social Services will represent 64 percent of total public expenditures in 2017, which are about 15 percent of GDP.7 These transfers are indispensable to help the most vulnerable deal with this stage of relative price variations and macro-economic rebalancing.

1

From 2001-2014 the number of public sector employees grew by 70 percent, with provinces and municipalities being accountable for over 80 percent of this increase.

2

In the competitiveness index prepared by the Global Economic Forum, between 2005 and 2015 Argentina descended from 54th position to 106th position.

4

As recorded by the Statistical Agency of the City of Buenos Aires, which published its own CPI. It should be noted that in August, CPI as published by INDEC, was artificially low (0.2 percent) following a ruling from the Supreme Court that required reversing gas-price increases.

5

Paragraph 36 of the staff report.

6

During October 2016 they increased by approximately US$ 7 billion and by October 27 they were standing at US$ 39,841 billion. By October 31st they fell to 37.210 as the BCRA decided to pre-pay US$ 2.5 billion to the BIS.

7

Among the main social programs is “Plan Nacional de Primera Infancia” (National Plan for Early Childhood) which was launched at the beginning of 2016, whose objective is to eradicate malnutrition in children under the age of 4. In education, in 2017 the national system will include all children over the age of 3; this will benefit more than 638,000 children. Moreover, 3,000 new kindergartens will be built before 2019. Recently, a national survey “Aprender” was conducted to gain a broad picture and learn where the educational situation stands so that the education policy can provide adequate measures. It is also worth noting that the “Asignación Universal por Hijo”, a program created by the previous government that reaches 3.8 million children, is being maintained, enlarged, and enhanced and now aims to add an additional 1 million infants with increased benefits.

Other programs that transfer income to the poor will also continue, such as “Argentina Trabaja” and “Ellas Hacen”, albeit ensuring transparency and effectively ring-fencing transfers from all political interference. Moreover, a new law approved by Congress refunds low-income households and pensioners 15 percentage points on VAT collected on all debit card purchases, the minimum wage will also be increased by 33 percent in three stages, and important programs on housing, water, transport, and health are underway. SMEs are also benefiting from several measures and increased credit.