Fiscal deficit is explained by subsidies to companies

Through a norm thought to be used only in case of emergency –a decree of necessity and urgency– the government made ​​explicit that the public spending is growing out of control. The fiscal deficit is one of the main causes of inflation, which put pressure on the exchange rate. Even with some mitigating measures, such as the introduction of a multiple exchange rate system, the pending problem is still the high fiscal deficit. Since it´s no longer possible to increase the tax burden, the only solution is to reduce subsidies to public and private companies.  

The high volatility in the foreign exchange market demonstrates the high uncertainty about the health of the economy. The most illustrative evidence is the dollar in the informal market remains around AR$10, far above the AR$6 listed on the official market. This inconsistency explain the growth of foreign turism at official dollar, the loss of competitiveness and the vertiginous fall in Central Bank reserves. Under this situation, the alternative appears to be the introduction of a multiple exchange rate system.

Nonetheless, the most important and complex challenge is not the exchange rate policy but to fix the fiscal mismanagement. The massive monetary emission is caused by the rapid growth of public spending which can’t be financed by traditional sources such as taxation due to the already high tax pressure. The abundance of pesos leads to an increase of the demand of foreign currency which carries to a surge in the value of the dollar in the informal market. This is why is not possible to bring stability in the exchange rate market unless the fiscal imbalance is corrected.

The growth of total fiscal deficit, this means excluding transfers from other public entities (such as ANSES, BCRA and others), has several causes. One of the main are the subsidies to private and state owned companies. According to information provided by the Ministry of Economy:

· In 2009, the total fiscal deficit was AR$29 billion while the subsidies to state owned and private companies reached AR$33 billion.

· By the year 2012, the fiscal deficit had risen to AR$90 billion and the previously mentioned subsidies were almost AR$100 billion.

· Up to August of 2013 (the latest available data), the total fiscal deficit was AR$58 billion whereas the subsidies to state owned and private companies soar to AR$79 billion.

This official data shows that the fiscal deficit could be eliminated if the public sector wouldn’t have to take care of the financial problems of state owned companies (such as Aerolineas Argentinas, AySA, the rail operators, Yacimiento Rio Turbio, etc.) and of private companies which provide utilities at artificial low tariffs (electricity, public transport, etc.). In other words, subsidies destined to state owned and private companies explain the fiscal deficit.

The fiscal deficit unlashes a chain of events which starts with monetary emission, followed by inflation and finally it put pressures on the dollar`s exchange rate. First, because the rise of internal costs discourage exports and exacerbate imports (the most illustrative examples is the surge in foreign tourism at the official exchange rate). Second, because inflation raises the demand for dollar to protect savings against rising prices. Both factors ensure the failure of the measures implemented by the government, like price controls, wage moderations, legal prohibition to buy dollars and restrictions to imports.

Reducing subsidies is of vital importance since they lead to an enormous waste of public resources. In some cases their elimination depends on the political decision to stop promoting unviable companies like Aerolíneas Argentinas. In others, the elimination of subsidies is much more complex since it requires updating tariffs (electricity, gas, water, public transportation, etc.) therefore it would be necessary to install a transparent and well-controlled scheme of social tariffs to avoid harming the poorest families’ budgets.

The government will introduce changes in foreign exchange regulations. Most likely it will be a multiple exchange rate to make foreign tourism and imports costlier and capital inflows more attractive since it could be made at a higher dollar. Nevertheless this is a temporary solution. More than massaging the exchange rate policy the true solution is to improve the public sector management. The most important and urgent step is to dismantle the archaic and regressive policy of subsidizing state owned and private companies.