The first month of Alberto Fernández’s presidency in Argentina was, as expected, defined by big policy announcements and the appointment of Cabinet members that satiated his allies, but raised concerns among observers as to his ability to fix the country’s economic woes.
Fernández was quick to establish his Peronist bona fides through a number of drastic policy changes. He also demanded “solidarity” from high-income individuals, the export sector and businesses by increasing their taxes to stave off painful spending cuts. He reinstated Kirchner-era price controls and implored consumers, and members of his cabinet, to denounce price increases.
Fernández also paid homage to the Peronist tradition of getting highly centralized corporatist organizations (unions and business associations) to share the burden of policymaking. Yet, these interventionist policies run against orthodox views of how to best manage an economic and debt crisis, raising the country’s risk.
As a result, Fernández faces a delicate balancing act, having inherited a wicked set of economic challenges. Argentina’s Jenga-like economy means a solution to one macroeconomic problem can create unintended knock-on effects that can destabilize another macroeconomic variable. Solving for this often leads to improvised stop-gap solutions that can make the situation harder to resolve and more complex to undo. Thus, Fernández will require a high level of policy coordination, but in a country as complex and expensive to govern as Argentina, this is a tall order.
An economic labyrinth
As head of state, Fernández is left to solve the economic puzzle that he, in large part, inherited from President Mauricio Macri. Fernández inherited a country with a set of social indicators at the worst levels they have ever been since the economic collapse of 2001, with poverty affecting 35 percent of the population in the first half of 2019. Increased poverty was caused largely by rising inflation that, in 2019, stood at 54 percent. Wages have not kept up, their value declining by almost 20 percent since Macri took power back in 2015. Macri also oversaw the continuation of Argentina’s arduous decade-long stagnation, with GDP shrinking five percent less than what it was in 2015.
But the most complicated legacy Macri left was debt. Under Macri, the nation’s debt increased by $74 billion, reaching a total of $314 billion. Argentina has the capacity to take on much of this debt, but the country’s dismal record at repayment means much of the debt is short-term with high interest. As a result, Argentina cannot borrow at its potential—it is debt intolerant. Because Argentina has a problem of liquidity, it does not have enough money on hand to pay off its short-term loans. In 2020 alone, the country is expected to repay $64 billion to creditors (for context, Argentina’s total exports in 2018 were $62 billion).
However, Macri did leave Fernández with some important advantages. First, after implementing austerity measures, by October 2019 the country’s primary deficit stood at 0.5 percent of GDP. Argentina also achieved a very large trade surplus, albeit mostly at the cost of a large reduction in domestic demand caused by the recession—arguably, there was no other choice as global trade remains stagnant. In the end, Macri paid the political cost for the painful fiscal adjustment and import compression.
Macri also laid the groundwork for the interventionist policies Fernández has deepened. These include utility price freezes, currency controls, export taxes and extending the maturities of domestic law debt. Although Macri saw these as emergency measures, Fernández views them as basic elements of his policy tool kit. The problem is, once these populist policies are implemented, it is very difficult to undo them and fiscally, they can be very costly.
The first sign of the populist trap occurred when Fernández vetoed an increase in gasoline prices demanded by the national oil and gas firm, YPF. The move is worrying as the government has frozen all utility prices until June 2020, but given Fernández’s reticence to allow for a small price increase now, it seems unlikely he will be willing to increase them in six months time. This will place a greater burden on the country’s already stretched budget and lower confidence in the country’s authorities.
Aware of the need to gain credibility with creditors and his progressive base, Fernández appointed Martin Guzmán as Minister of Economy. Guzmán is an acolyte of Nobel-prize winning economist Joseph Stiglitz—a well-known supporter of heterodox economic policies and their proponents, like Hugo Chávez and Cristina Fernández de Kirchner—and an expert on issues related to debt. As Carlos Pagni notes, Fernández “relies on the expertise of Guzman, author of several academic papers on sovereign debt restructuring. Nobody knows, however, if they value those papers on Wall Street.”
An op-ed authored by Stiglitz sheds light into Guzmán’s views on the economy: “one doesn’t solve the problem of excessive debt by taking on more debt. Nor does one solve a problem of recession and unemployment by imposing more austerity.”
Guzmán’s anti-austerity position found a ready audience with Fernández, who sought to retain high-levels of government spending, while also balancing the budget. In Guzmán’s first presser, he emphasized the country cannot “do more austerity,” but needs a path toward fiscal balance and economic growth as the only sustainable way to repay debt. Soon after, the government drafted the Law of Solidarity and Productive Development, which was swiftly approved by Congress. The law declared a “public emergency in economic, financial, fiscal, administrative, pension, tariff, energy, health and social matters.” The law also placed a hard to satisfy dual mandate on economic policy: “Create conditions to ensure the sustainability of public debt, which must be compatible with the recovery of the productive economy and improving basic social indicators.”
Among the most important reforms, the law imposed a 30 percent tax on all foreign dollar transactions, informally known as the dólar solidario. This tax imposes a hidden devaluation, making it prohibitively expensive to travel or buy goods from overseas. The government also changed the formula for calculating export taxes on agricultural goods, and in the case of soy, imposing the maximum rate without congressional approval. The law also increased taxes on assets that are located domestically and in the exterior.
In his inaugural address, Fernández provided the political justification for these tax increases: “until we eliminate hunger we will ask for greater solidarity from those who have more capacity to give it.”
Critics are less convinced. Writer Alejandro Katz says “talk of solidarity is a means to justify a redistributive policy.” Hiking tax rates in Argentina will only make the country less competitive. Investors already see Argentina as a risky investment, because income is perceived in pesos but costs are reflected in dollars. The multiple devaluations also put at risk the sustainability of their debts in dollars. Worse still, Argentina is also suffocating its economy further by having the world’s second highest rate of taxes on businesses. These additional taxes only make Argentina less appealing to investors. It remains a mystery how the government intends to grow the economy with these policies.
In addition, imposing higher taxes on sectors of the economy that are critical for repaying the debt, like the agro-export sector, is counter-intuitive. According to an analysis done by Néstor Roulet, the effect of the government’s taxes on soy exports shows that the average soy producer may actually lose money as gross income, and not profits, are subject to taxes. Worse still, provincial level tax increases, like in the breadbasket Buenos Aires province, will further erode profitability. There have been tractorazos (tractor convoy protests) in the countryside protesting against these measures. Projections suggest agricultural production will fall in 2020, as a consequence of a reduction in planted areas across Argentina..
Another unintended consequence of raising taxes on high earners, is the opportunities it creates for tax competition with neighboring countries. The election of a center-right government in Uruguay may become a thorn on the side for Argentine authorities, as president-elect Luis Lacalle Pou has signaled his intention to ease residency requirements with the intention of attracting “100,000 Argentines.” Lacalle Pou intends to make Uruguay’s regulatory and tax system even more competitive, which may turn into a major headache for Fernández who is trying to rekindle economic growth.
A pound of flesh
Most economists agree that raising taxes in a heavily taxed economy does not bode well for economic growth, especially for investment-led growth, which is what Argentina currently needs. So what explains these policies? The real motives are twofold: avoid default by capturing as many rents as possible and provide the government with the resources it needs to pay for social programs. But at this critical juncture, economic growth is not possible as long as there is uncertainty regarding the fate and sustainability of the debt.
Argentina’s country risk, the second highest behind Venezuela, shows that investors are pricing in a default. As a result, the world’s attention is placed on the negotiations with the International Monetary Fund (IMF) and with private bondholders. Fernández has placed a hard deadline for negotiations, March 31, which he claims has IMF support.
Learning the lessons of the 2001 default, Argentina’s debt renegotiations should be less onerous and disruptive than in the past. For example, international bonds have collective action clauses where if a certain number of creditors agree to a restructuring, all others must accept those terms—however, different bonds have different thresholds. Yet, this clause and other protections for creditors are absent from domestic bonds issued in Argentina. And as this analysis by Sebastian Grund notes, the legal risks for Argentina are high: “Foreign courts are, in the vast majority of cases, more reluctant to prioritize a foreign sovereign’s interests over bondholders’ property rights.”
An unforeseen and bad omen for creditors was Buenos Aires Governor Axel Kicillof’s threat to not pay a $250 million bond due on January 26. This decision came on the heels of mixed messages coming from the national government. Initially, President Fernández voiced his support for the province, but internal discussions inside the cabinet led Minister Guzmán to reject the province’s request for a bailout. It is unclear if this is due to serious divisions within the government, or a negotiating tactic to scare creditors that the federal government is willing to take a hardline on negotiations. These are high stakes decisions that have long-term consequences; so all stakeholders should tread lightly.
Argentina’s ninth life?
Should Argentine default on its debt, it would be the country’s ninth default since becoming an independent nation and it could see the fragile economy tumble down. Argentina’s record of default has left the country without easy access to credit, even when times are good. In a world where interest rates are at near historic lows, Argentina continues to pay exorbitant interest rates for its debt. Argentina’s penchant for punishing savers and investors through negative real interest rates, devaluations, confiscations of assets and excessively high taxes robs the country of the investment-led growth it so desperately needs.
The political coalitions and ideological predisposition of the current government makes it very unlikely that these tax increase and spending policies will be reversed anytime soon. In addition, given the expediency of the crisis and the contradictory demands from Fernández’s political coalition and creditors, holes in the economic program will likely begin to appear. Without an integral economic program to address the crisis, meaning a rules-based policymaking framework disciplining the government and stop-gap measures to appease allies or creditors, the government’s plans will leave the economy on wobbly ground.