What went wrong?
In a recent Brookings Paper, the former governor of the Argentina
Central Bank (BCA) argues that the fiscal adjustment was too gradual, and the BCA was not granted enough independence.
This stance is difficult to reconcile with the facts. Notwithstanding violent popular protests, in the first months of Macri’s term, the government increased public utility prices by 100-300 per cent, an adjustment equivalent to 3 per cent of GDP over 2016-17 even though at 53 per cent of GDP, the public debt was moderate. The BCA freed the exchange rate and opened the capital account rapidly leading to a 40 per cent devaluation in the first few weeks of Macri’s term and unbridled external borrowing thereafter. The BCA also had sufficient autonomy to let real interest rates rise to 10-15 per cent in a world with real rates near zero. The interest cost of the public debt rose from 1.6 per cent of GDP in 2015 to 4 per cent of GDP in 2019 thus pressuring the fiscal accounts.
From the beginning, the Treasury opposed the central bank's anti-inflation programme, arguing that the inflation targets were excessively ambitious, the required real interest rates excessive, inflation targeting ill-suited to the volatility of an economy with high inflation. Such an approach has worked well in economies where inflation has already been controlled. In addition, the economic logic of inflation targeting is to increase interest rates to contain demand when there is evidence that the inflation targets will not be achieved. With the ongoing recession, this did not make sense. It was only after two years of dismal results that the president moderated inflation targets, thereby ending BCA independence.
In fact, the problem with Macri’s economic programme was not excessive gradualism or insufficient central bank independence but faulty design in at least three respects.
Contraction of the public sector, supply side reforms, and liberalised capital flows were assumed sufficient stimulus for increased private investment and growth in an economy with high unemployment and excess capacity. It was naïve to expect entrepreneurs to invest in an economy with such significant slack and so much relative price volatility.
Misdiagnosing the cause of inflation was also devastating to the plan.In a country as dollarised as Argentina, floating exchange rate and open capital account, inflation is not driven by excess demand, but by expectations of exchange rate devaluation. The unit of account ceases to be the domestic currency and becomes the dollar. Inflation expectations lose their anchor and reflect the expected evolution of the exchange rate. Interest rates had to reach extraordinarily high levels to prevent depreciation of the currency and contain inflation. High and unstable interest and exchange rates further depressed rather than stimulated private domestic investment.
High real interest rates with an open capital account made it easy to attract foreign capital. Excessive borrowing has meant
Argentina has once again gone through an over-borrowing spree. The 2017 100-Year Argentina bond is now trading at half its value. IMF data suggests that the 50 per cent increase in external indebtedness in four years financed capital outflows of residents needing to protect their assets from the uncertainty brought about by high inflation and an erratic exchange rate.
There are many to blame for this dismal outcome, but the burden will be borne by those parts of Argentine society least able to afford it. Argentina’s economic debacle came from a plan whose strength was its anchor in economic orthodoxy rather than a sound diagnosis of the problem. Rigidity in implementation reinforced the costs of design flaws. Hopefully these lessons can inform the economic programme of the new president, Alberto Fernández.
Luque and Silber, both professors at the University of Sao Paulo, Brazil, and Zagha, a former World Bank Director for India and Secretary of the Growth Commission, contribute opeds to the Brazilian newspaper Valor Econômico where several articles on the Argentina debacle were published last December