By Allison Fedirka
It seems to be a turbulent May for Argentina. On May 4, the country’s central bank raised interest rates to 40 percent, the third hike since April 27, when rates were just 27.25 percent. Then Argentina’s currency, the peso, continued to decline in value, reaching a historic low of 23 pesos to the U.S. dollar. This culminated May 8, when President Mauricio Macri announced that the government would seek a $30 billion loan from the International Monetary Fund to prevent an economic crash.
These events – particularly the request for IMF assistance – have revived memories of Argentina’s 2001 economic crisis. Argentina and the IMF have a complicated relationship that, for the better part of this century, has been combative. Many Argentines blame the IMF for the 2001 crisis and resent the institution for its insufficient response to it. Argentina was frozen out of international financial markets for more than a decade. Needless to say, these were times that no one in Argentina wants to relive.
But as bad as the headlines appear, the circumstances this time are different.
The backdrop for this is Macri’s massive systemic economic reforms, now entering their most difficult phase. The decade that preceded Macri’s time in office was defined by populist economic management, leaving future administrations to do things like removing foreign exchange controls, modernizing monetary policy and addressing market price distortions. When he came into office in late 2015, Macri was popular enough that he encountered little resistance to most of his reforms. More than two years later, the honeymoon is over. Macri’s reforms have improved Argentina’s macroeconomic conditions, but they have done so slower than either the public or the government expected. The biggest miss has been inflation, the bane of Argentina’s economy since 2001. Last year, the government pledged to keep inflation at 17 percent and to lower it to 10 percent in 2018. In reality, 2017 inflation totaled 25 percent (still lower than the previous year), and this year’s goal is now 15 percent.
Moreover, the time has come in Macri’s reforms to cut utilities subsidies for public consumption. The goal is to decrease government spending and create a more financially stable and predictable operating environment for energy companies, which the government hopes will attract much-needed investment. Removing subsidies is always difficult, but Argentina’s energy subsidies are even more entrenched than usual. Opponents have been thwarting the government at every turn and are now trying to pass legislation that would water down the price adjustments. Though Macri has said he will veto the legislation if it passes, the larger point is that he can no longer presume to govern with the support of the legislature. With his support dwindling in the effort to rectify government spending, Macri turned to the IMF.
The critical element here is that Argentina is pursuing an IMF loan pre-emptively, not as a last resort. The request means not that the reforms have failed but that the government is determined to continue pursuing them. Argentina already depends heavily on outside financing from investors and private creditors to fuel its economy, and this outside financing will become even more important as the government works to curb public spending. Though details of the loan are still being negotiated, a flexible credit line is an option – meaning Argentina would have the funds not to spend out of necessity but as a safety net for the government that in turn will reassure markets and investors.
Back in March, some investors reportedly suggested to Argentina’s finance minister precisely this course of action. The minister ruled out the move primarily because the political cost would hurt Macri’s re-election bid in 2019. The flip side, though, is that Macri staked his entire administration on economic reform. Failing to carry out reforms – either entirely or partially – would all but guarantee an end to his 2019 ambitions. An IMF loan won’t be popular, but failure’s not an option.
Argentina has a long, bumpy road ahead. The government will have to keep hacking away at inflation. It faces a growing public debt with a high level of dollarization, and the pace of its debt growth exacerbates the need for more external financing. And the economy remains highly vulnerable to factors beyond the government’s control, like U.S. interest rates, commodity prices and drought. Macri’s administration was under no illusions that this would be easy. Crisis may be ahead, but it’s not here yet.