Report Nº: 93907/12/2021
The government comes out of the elections politically weakened. To regain the initiative it has to reduce the fiscal deficit. The most urgent issue is to lower the energy subsidies that finance the utilities’ prices freeze. If it insists on freezing, the economic crisis will worsen, deepening the political weakness.
Now that the elections are over, questions point out the government’s reaction to the economic crisis in a context of political weakening. Attention is focused on the possible government’s behavior regarding the official exchange rate. Its huge gap with the black market exchange rate and the low level of reserves suggest that devaluation is closer.
Does a devaluation solve the problem? Argentina accumulates a long tradition of fiscal deficits that the current administration accelerated. With limited access to credit, these imbalances are financed with money printing. The excess of the money supply over people’s demand generates pressure on prices. It is no coincidence that the money held by the public (cash, checks, and saves accounts and deposits) has been growing at a rate of 50% yearly, a level similar to the inflation rate. The excess of pesos is also putting pressure on the black market exchange rate, which is now above $200 (official is $100).
The dynamics of key economic indicators allow a more objective assessment of the situation. According to official data between December 2019 and November 2021, it is observed that:
These data show that there is a lag in the official exchange rate relative to inflation, but the energy utility prices suffer a much larger distortion. This is a key issue since a large part of the fiscal deficit is explained by the growth in energy subsidies. In 2019 energy subsidies represented 1.1% of GDP, while in 2021 they are estimated at 2.4% of GDP. Taking the Ministry of Economy’s projections, which expect to end the year with a primary fiscal deficit of 4.3% of GDP, energy subsidies represent more than half that deficit.
The official exchange rate devaluation with utilities’ prices frozen will increase subsidies. As they are financed with monetary issuance, which people reject, inflation pressures will increase. Therefore, the lag in the value of the dollar regarding inflation will persist despite the devaluation. Thus, devaluation, instead of correcting the dollar’s overvaluation, will accelerate inflation which will re-establish the overvaluation. Therefore, the government’s priority is not the dollar, but to give a clear sign that it is serious about reducing the fiscal deficit. While the agenda is lush, the most urgent issue is to take political control of the energy regulation department. The government’s credibility depends on starting a process of decreasing energy subsidies with social tariffs for lower-income families. Besides reducing money printing, it will increase the probabilities of an agreement with the IMF on good terms and good chances of success.
Strategic thinking recommends seeing that tariffs freezing, far from strengthening the government thanks to its popular tinge, will aggravate its political weakness. It is unpleasant to reduce subsidies to middle and high-income families. But it will be politically more costly to subject the entire population to the traumatic experience of an inflation spiral when it is already above 50% per year. The only way for the government to regain legitimacy is by controlling inflation, which is not achieved with price controls and utility freezes, but by reducing the fiscal deficit.
Addressing the urgencies is enough to stop deepening the economic and political crisis, but not to reverse economic decadence. A comprehensive reorganization of the State is essential to put an end to Argentina’s involution. This is much more complex than reducing economic subsidies and requires a strategic vision that neither the ruling party nor the opposition has shown to have so far.
