/A Cautionary Tale on Macri’s Gradualism

A Cautionary Tale on Macri’s Gradualism

Argentine President Mauricio Macri enters a key mid-term period that will define his legacy. A conflictive domestic situation stands in stark contrast to the wave of cheer he has received from the international community. This optimism may be unfounded, for without reform, Macri’s gradualism endangers his vision of a once-again prosperous Argentina. After decades of being isolated from foreign affairs, Argentina has recently taken to the global center stage. The country hosted the latest WTO Ministerial Conference and will preside the G20 Annual Meetings throughout 2018, culminating in the Global Leaders Summit in December. But while global forums praise Macri’s claims that Argentina is now open for business, economic and social problems at home stand in the way of a true transformation. Pursuing “intelligent entry” into the global economy, Macri has aptly courted foreign business leaders and policymakers alike. He is betting on Argentina’s recent global ascendancy to facilitate domestic growth and development. An upgraded international image alone will not bring an avalanche of investments to the country, however, as some close to Macri have foretold. Investment is likely to stay below 17% of GDP this year, well below South America’s average of 22%. The government has yet to enact structural reforms that create favorable conditions for investment, and given the current pace of gradualism—Macri’s preferred approach to reforming slowly in order to facilitate governability—a cautionary tale is in order. After taking office in December 2015, Macri took important steps to turn the country’s troubled economy around. His predecessor, Cristina Fernández de Kirchner, left behind an economy in recession, burdened by growing inflation, an artificial exchange rate, and isolation from most of the world. During his first year in “Casa Rosada”, Macri reduced energy and transportation subsidies, floated the peso, and took steps to liberalize trade by scrapping taxes on exports and scaling down import restrictions. He also settled lawsuits with foreign creditors that had long barred Argentina from international capital markets, restoring access to long-term financing and boosting investor confidence.

A decisive win in October’s 2017 midterm elections for Macri’s Cambiemos coalition backs their mandate of institutional reconciliation and structural reforms. So far, the government has managed to keep the opposition fragmented within an adverse congress. But despite the admirable electoral outcome, and clever political maneuvering throughout his term, Macri is still bound by the country’s persisting social tensions and fiscal insolvency. In a vacuum, Macri’s gradualism would seem to be working. Inflation dropped from 40% in 2016 to slightly under 25% last year, and after a two-year recession the economy bounced back with 2.9% GDP growth in 2017. But Argentina is still far from a sustained growth path, and Cambiemos seems more concerned about building political capital to withstand painful reforms than in actually implementing them. Simply put, the numbers are unsettling. Argentina’s current account deficit is over 4% of GDP, and is expected to reach 5% this year. The government is spending far more than it earns, and instead of cutting spending, Macri is financing it. The fiscal deficit stands at 7% of GDP, including a 0.9% budget deficit in Provinces outside of Buenos Aires and a financial deficit of 6.1%, pushed upwards by debt service expenses—which are growing at a steep rate. In the last two years, Argentina’s debt to GDP ratio grew from 46% to around 60%, with a $96 billion total debt emission. The government estimates it will emit debt upwards of $30 billion, or 6% of GDP each year. This is part of the gradualist strategy, as a surge in foreign debt allows Macri to dodge fiscal austerity and appease a militant opposition. However, the country runs the risk of accumulating dollar-denominated liabilities—78% of total debt is listed in foreign currency—in a context of growing global interest rates. According to S&P, Argentina is one of the world’s most vulnerable economies to US Federal Reserve rate hikes. A broken public pensions system accounts for a large chunk of the fiscal deficit. Mostly to blame are Fernández de Kirchner’s efforts to boost her popularity by handing out pension benefits to non-contributors. GDP per capita remained steady since 2009, while benefits for retirees grew 24%. An initial reform set forth in December to save the government around 0.5% of GDP triggered violence on the floor of Congress as well as riots and clashes between the public and the police.

This shows the delicate social pressures Macri must confront to bring macroeconomic stability to a nation ravaged by decades of populism. There is no hiding from Argentina’s workers unions, militant Peronists, and Mapuche activists—authors of recent headaches for the government, as they protest energy investments in the colossal Vaca Muerta shale fields. For years, governments have caved to these groups’ demands. Macri must now choose between continuity and change. The latter will demand a recalibration of Macri’s gradualism that produces economic results strong enough to convince the Argentinian public, and validate the loss of social welfare. So far, weak fiscal compromises prevail. Despite announcing “overcompliance” with deficit reduction objectives—the primary deficit for 2017 was reduced to 3.9% of GDP, exceeding the 4.2% target—Argentina’s fiscal gap continues to hinder growth. Macri’s tax reform, set forth after October’s midterms, was praised by many, including US Secretary of State Rex Tillerson. Before departing on his recent Latin America trip he affirmed: “One week after the U.S. Congress passed landmark tax reform, Argentina’s legislature took action to overhaul their tax system as well. All of these efforts are making the second-largest economy in South America ripe for more investment and growth.” In reality, the “overhaul” was more of a compromise to reduce taxes in the future than a bold move to regain competitiveness. The government’s proposed 1.5% tax cut in the next four years, and an additional 1.5% cut from Province taxes, barely bring any short-term change. This year’s budget will cut 0.2% in taxes only. The rest are promises. According to Agustín Etchebarne, General Director of Buenos Aires-based think tank Libertad y Progreso: “It’s too little, and too slow.” Macri’s government will need more than compromises to reduce the world’s largest tax burden

To make matters worse, the Argentine Central Bank’s (BCRA) credibility has been weakened. On December 28, the Treasury Ministry announced the central bank’s inflation target in 2018 would be changed to 15% rather than 8%-12%. This fueled speculation that Chief of Cabinet of Ministers Marcos Peña, representing the more partisan branch of Macri’s camp, was pressuring the BCRA into lowering rates to the benefit of fiscal accounts. Combined with the government’s reluctance to slam on the fiscal brakes, this pushed expected inflation to 19.8%. Loose monetary policy and an unbending fiscal balance, both complements to Macri’s gradualism, put upward pressure on inflation. As long as Macri’s government avoids serious fiscal adjustment, the BCRA will struggle to tame structural inflation. In the past, high fiscal deficits and public borrowing in an inflationary context have not led to a happy ending for Argentina. Having endured hyperinflation in 1989 and the world’s largest-ever sovereign default in 2001, the country is no stranger to inflation and foreign debt. “As global quantitative easing programs unwind and interest rates rise, Argentina’s rapidly growing external and internal public debt—the BCRA’s bills (Lebacs) have bloated its balance sheet—brings significant risk,” said Etchebarne upon request for commentary. Liberal economists have proposed abandoning the BCRA’s inflation targeting policy in favor of controlling monetary aggregates. This would allow for a quicker tightening of monetary policy, with a parallel adjustment of the cuasi-fiscal deficitaround 2% of GDP— and fiscal expenditures. While there is no guarantee this would work (at least politically) a similarly bold, integral, approach is necessary to fix Argentina’s economic woes. In his pre-departure speech at UT Austin, Secretary Tillerson referred to Macri’s Argentina as an example: “We hope more countries take a similar path to help the entire hemisphere grow in prosperity.” Macri survived the first two years of his presidency. This is no small feat in a country where non-Peronist presidents have yet to complete a single presidential term. More than that, he began to reinsert Argentina into the world stage and the global economy. Strengthened by victory in the legislative elections, Macri has all but cleared his road to re-election in 2019. The question remains whether he can hasten structural reforms now to avoid economic downfall in his second term. Macri is stuck halfway between maintaining his political success thus far, and implementing key structural changes. Accelerating reforms could jeopardize governability in the next two years and his possible re-election. But for now, his faltering gradualism is compromising mid-term sustainability in Argentina.

Thanks to LAPO, and especially author Seb Maag,  for providing us with this insightful article.

Image Source: G20 Argentina