Dollarization does not remedy the chronic fiscal deficit

The INDEC reported that the monthly increase in consumer prices in March was 7.7% and in some regions, it exceeded 8%. Beyond the statements of some officials, there are no grounds to expect that inflation will slow down in the coming months. On the contrary, the implementation of the dollar-soybean III will aggravate inflationary acceleration since paying a higher exchange rate to exporters, while maintaining a lower official exchange rate for importers, increases monetary issuance.

In this context, ideas related to the possibility of the next government resorting to dollarization are gaining prominence. The argument is that in this way the Central Bank will not be able to issue pesos, which is the main generating factor of inflation. The closest experience is that of convertibility which, by prohibiting the Central Bank from issuing pesos without dollar backing, managed to overcome hyperinflation and eradicate inflation for a decade. 

To evaluate the possibility of dollarization, it is necessary to analyze the Central Bank’s balance sheet. In particular, it is necessary to compare the Central Bank’s liabilities –which is the accumulated monetary issuance– against the net dollar reserves. According to Central Bank data it is observed that

• The monetary base amounts to AR$5 trillion and Leliq –money sterilized by the Central Bank– amounts to AR$12 trillion.
• The net dollar reserves in the Central Bank amount to US$ 1.8 trillion.
• This implies that dollarization should be done at an exchange rate equivalent to almost $10,000 per dollar.  

These data show that if the Central Bank wanted to redeem all the pesos issued and deliver dollars in exchange, it would have to do so with a mega devaluation. If the reserves were to be reinforced, for example, with some international credit contracted by the Argentine State, the redemption value could be reduced. But the chances of this happening, in the magnitudes necessary to avoid a large devaluation, are remote. Therefore, in order to dollarize, a very traumatic devaluation is needed. This is a consequence of the accumulation of recurrent money issuances in the past to cover chronic fiscal deficits. 

The most important thing is that dollarization does not guarantee that the public sector will stop being chronically in deficit. The legal impossibility to resort to monetary issuance to finance itself does not prevent the State from spending in excess of its revenues and covering the differences with bank loans, delaying payments to suppliers, or accumulating lawsuits, as it has happened several times in the past. It should not be forgotten that the persistence of fiscal indiscipline –and not a flaw in its design– was the main cause of the collapse of convertibility. 

In other words, there is a stock problem –originated by the accumulation of fiscal deficits in the past– and a flow problem –originated by the poor organization of the State that leads it to always spend more than its revenues–. The change in the monetary regime addresses the stock problem. But to address the problem of the flow –overcoming the chronic financial and management deficits of the public sector– an integral organization of the State is needed. 

Because it is simple and drastic, dollarization looks very attractive. But it misses the fact that the State will not stop being in deficit if there is no integral and deep reengineering of its organization. Therefore, even though these are complex and “politically incorrect” changes, the next government needs to prioritize the unification of taxes, the elimination of co-participation, the elimination of the functions overlapping between national, provincial, and municipal public bodies, and the re-organization of the social security system.