Argentina – a persistent external imbalance

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By IGNÁCIO JUNCOS*

Javier Milei's rise must be understood in the context of Argentina's extraordinary inflation over the past two years

In August 2023, a week after winning Argentina's primary elections, now-president Javier Milei publicly declared that the Argentine peso was “worth less than excrement.” Over the next two days, the parallel dollar-peso exchange rate rose almost 20%, intensifying the already rapid devaluation of the currency. Such extreme proclamations were common for politician Javier Milei. Here is the candidate, now elected and sworn in, who combined libertarianism with global right-wing extremism; At the center of his campaign, he presented proposals to abolish the Central Bank and to dollarize the national economy.

Javier Milei's rise must be understood in the context of Argentina's extraordinary inflation over the past two years. In 2022, annual consumer price inflation was 72,4%, placing Argentina among the five countries in the world with the highest inflation.[I] In 2023, the situation has become dire – the annual CPI has risen to a staggering 142,7% in the latest measure from Argentina's National Statistics Office.

A similar trend can be observed in the dollar-peso exchange rate, which went from US$173 in December 2022 to US$357 in November 2023.[ii] The decline of the peso in the parallel exchange rate is even more pronounced. In December 2023, both the financial and informal exchange rates were around US$1.000, representing an increase of more than 185% compared to December 2022.

The weakness of the peso and spiraling inflation spurred popular support for Javier Milei's dollarization proposal. The instability of the economy, however, is linked to a fundamental external problem in the Argentine economy. Argentina's external account challenges are not due to weak commercial or economic competitiveness. Instead, they can be attributed to long-standing financial constraints in the country; it is a byproduct of Argentina's role in the global economic hierarchy.

Argentina's external accounts

Several studies trace the roots of Argentine financial liberalization to 1976, when the military regime overthrew Martínez de Perón and commandeered control of the government. In 1977, the regime implemented a financial reform that included the liberalization of interest rates, the free allocation of credit and the easing of restrictions on entry into the financial market. This reform accompanied greater opening to capital and goods markets.

The fall of the military government in 1983 and the return to democracy led to Raúl Alfonsín being elected president. In a period characterized by the Latin American debt crisis and the lack of external financing for the region, Raúl Alfonsín's economic policy focused on solving the external debt problem. His administration largely kept the military government's financial reforms in place.[iii] At the end of Raúl Alfonsín's government, in 1989, the economy was experiencing hyperinflation and stagnation.  

It was in this context that, in 1990 – under the recommendations of the Washington Consensus – the State reinforced neoliberal policies of deregulation and liberalization. After renegotiating its external debt through the Brady Plan, Argentina regained access to international markets. This access was used to sustain the peso-one-dollar parity. During the following decade, the magnitude of capital flows to and from Argentina began to grow rapidly.

The average annual gross capital flows to and from Argentina was US$29,9 billion between 1990 and 1999, a growth of more than 800% compared to the previous decade. Portfolio investment – ​​of a speculative nature with a short-term horizon – gained more prominence in flows to Argentina during this period.[iv]

However, in 1999, capital began to flee Argentina as a result of international financial conditions, after several financial crises wreaked havoc in emerging countries around the world. This reversal of capital flows forced Argentina to break the one-peso-one-dollar convertibility in January 2002, with the peso devaluing more than 300% in eighteen months.

From 2003 to 2015, Argentina's mode of accumulation changed, focusing on production and distribution. During these twelve years, the economy's average annual growth rate remained around 5%, with growth fueled by an expansion in the production of goods, specifically industrial goods. Domestic demand also increased, witnessing the recovery of real wages after the default and devaluation of the peso in 2001-2002.

It is important to highlight that, during this period, the external debt was renegotiated with the aim of achieving reductions in principal and interest. But a change occurred in 2008, with the onset of the global financial crisis. From 2003 to 2007, Argentina expanded investments, exports and fiscal and commercial surplus. From 2008 to 2015, the financial crisis caused capital accumulation to slow down, the effects of which can be seen in the resurgence of external debt restrictions in recent years.[v]

In 2015, President Mauricio Macri – a former mayor of Buenos Aires who won as head of the “Alianza Cambiemos”, a center-right conservative coalition – reintroduced deregulation policies and began to liberalize external accounts. In the first year after liberalization, between 2016 and 2017, net inflows of direct and portfolio investments plus loans to the public and private sectors totaled more than US$40 billion. However, most of these inflows were short-term speculative capital.

In March 2018, global financial conditions tightened through an upward shift in US interest rates and these flows stopped abruptly – net flows turned negative and Argentina had to request assistance from the IMF. In 2019, Argentina had a huge external debt (mostly denominated in foreign currency) and received the largest IMF loan in history.[vi] 

The government introduced capital controls – a measure of last resort that, although successful in stopping the continued devaluation of the peso, only came into effect after the peso had already devalued 40% between July and October 2019. When Mauricio Macri left office in 2019, after a failed re-election attempt, the country was on a path of crisis.

The exchange balance

The shortage of foreign currency in the country since 2019 has laid the foundation for the current dilemma. In 2021 and 2022, Argentina accumulated a current account surplus of almost US$10 billion,[vii] but international reserves grew by just US$1,6 billion.[viii] The difference can be attributed to the difference between the official exchange rate and the parallel exchange rate.

With capital controls in place, the official real exchange rate appreciated and the economy received a huge cash injection due to pandemic-era social protection measures. But imbalance arose in the parallel exchange rate and as a result, major exporters engaged in tax evasion to escape to the official foreign exchange market. The payment of debts and interest on loans and bonds from the public and private sectors, as well as the remission of public services, also drained foreign currency from international reserves.

To convey these developments in detail, we turn to the “exchange balance” of the Argentine Central Bank (BCRA). The graph below shows the evolution of purchases and sales of foreign currency carried out by private entities through the foreign exchange market and operations carried out directly by the Central Bank. The chart breaks down the main items that make up the current, capital and foreign exchange financial accounts.

Main components of Argentina's exchange balance, 2021-2022. In millions of US dollars.

Source: Own preparation with data from BCRA.

The figure above demonstrates that, even in periods with favorable trade in goods and services, the financial components of external accounts drain the trade surplus. Although the country recorded a trade surplus of more than US$22 billion between 2021 and 2022, the BCRA's international reserves grew by only US$6,8 billion during these years. Furthermore, the increase of US$6,8 billion can be explained almost entirely by the growth in international reserves in 2022, the year in which Argentina received net loans from different multilateral organizations.

Two financial components stand out in this analysis of the trade surplus: net interest payments and loans and private bonds. Net interest payments include government and private sector payments. Private loans and bonds represent the net debt of the private sector. These results demonstrate that the huge private and public sector debts from 2015 to 2019 still influence the external account through interest and capital payments.

The private sector was responsible for the majority of capital payments during this period, despite the fact that between 2020 and 2022, the BCRA implemented different measures to limit the impact of private sector capital payments on international reserves. These included requiring companies to refinance at least 60% of debt maturities for a minimum average term of two years and requiring companies to use their own foreign currency (net foreign assets deposited abroad) before being allowed to purchase foreign currency in the official foreign exchange market to pay debts. The BCRA also restricted the payment of debts from one company to another related company.

This precarious balance plunged into full-blown crisis in 2023, after a severe drought hit wide swaths of the country. Commodity exports – especially soybeans – fell drastically, with effects across the entire economy. In the first ten months of 2023, Argentina exported US$56,5 billion, compared to US$75,2 billion in the same period of 2022. The drop in exports significantly reduced the trade surplus, making it difficult to contain the exchange rate and maintain of international reserves by BCRA. The chart below shows the main components of the exchange balance for 2023.

Main components of Argentina's foreign exchange balance, January to October 2023. In millions of US dollars.

Source: Own preparation with data from BCRA.

The 2023 financial situation closely resembles 2021-2022 with regard to net interest payments and private loans and bonds. The sum of net payments of interest and loans and private securities in the first ten months of 2023 led to a drag of US$11,4 billion on Argentina's external accounts, a similar amount to 2021 (US$10 billion) and 2022 (US$11,95 .XNUMX billion).

Even so, between January and October last year, the BCRA lost more than US$20 billion in international reserves due to the shrinking trade balance (which fell to US$5,7 billion) following the drop in exports. The trade balance fell by US$16 billion in a single year, from 2022 to 2023. Another factor that contributed to the drop in reserves: between January and October, Argentina saw net capital outflows from multilateral organizations, a stipulation of the program negotiated by the IMF and the Argentine government in March 2022.

The financial constraint

The results demonstrate that Argentina's structural problem is financial, not commercial. Huge private and public sector debts, interest and capital payments drain the trade surplus, while capital inflows tend to be short-term, speculative and therefore volatile. This has important implications for corrective economic policy going forward. Although exports are significant, focusing only on reestablishing the trade balance through increased exports will not be able to resolve the financial component of external debt.

Argentina's external financial constraints may be linked to the transformations in global finance that have occurred since the fall of Bretton Woods. As the literature on financialization has long argued, the unprecedented growth of capital flows has increased their influence on the external accounts of peripheral countries in recent decades.[ix] In this sense, the vulnerability of the peso can be framed within what post-Keynesian literature calls “monetary hierarchy”.[X]

Currencies at the bottom of the hierarchy are used as “investment currencies”, while currencies at the top are “reserve currencies”. As a consequence, capital flows to countries whose national currencies are at the bottom of the hierarchy – a category that contains most of Latin America – are more volatile, pro-cyclical and dependent on international financial conditions. Reducing the external vulnerabilities of peripheral countries would require reform of the dollar-based international monetary system.

At the same time, peripheral countries differ depending on distinct structural characteristics of their economies, such as the level of financial openness and stocks of international reserves.[xi] Argentina – characterized by a high degree of liberalization of external accounts and decreasing international reserves – must then adjust its internal economic policies accordingly, implementing internal financial reforms that allow it to accumulate international reserves and strengthen the peso. Such internal changes could occur alongside global monetary reform, saving nations like Argentina from deepening financial and social crises.

With this objective, Argentina could reintroduce exchange control policies adopted by Nestor Kirschner's government between 2003 and 2010, such as the minimum stay requirement for the entry of foreign capital, maintaining the competitiveness of the exchange rate. Although domestic assets are necessary for the success of these policies, Argentina's elite actors tend to safeguard their gains abroad. 

Domestic financial reform must therefore also include restrictions on peripheral countries' capital classes, including a limit on foreign exchange held as savings or transferred abroad by companies. It is clear that the adoption of such measures would imply a challenging political project, especially after the triumphant reaction of the Argentine right.

*Ignacio Juncos is a PhD candidate in economics at the National University of Córdoba.

Translation: Eleutério FS Prado.

Originally published on the portal Phenomenal world.

Notes


[I] Data from the World Bank, available at https://www.worldbank.org/en/research/brief/inflation-database

[ii] Data from the Argentine Central Bank (BCRA), available at https://www.bcra.gob.ar/Pdfs/PublicacionesEstadisticas/com3500.xls.

[iii] Basualdo, E. (2001). Political system and model of accumulation in Argentina. National University of Quilmes. Buenos Aires, Argentina.

[iv] Juncos, I. (2021). The international dimension of subordinated finance: The Argentine case. Buenos Aires Political Economy Magazine, (22), 47-72.

[v] Manzanelli, P. D., & Basualdo, E. M. (2016). Accumulation regime during the cycle of Kirchnerist governments: A preliminary balance through new empirical evidence from national accounts. Economic Reality, (304), 6-40; Cantamutto, F. J., Schorr, M., & Wainer, A. G. (2016). The external sector of the Argentine economy during the Kirchnerism governments (2003-2015). Economic Reality, (304), 41-73.

[vi] In June 2018, the IMF approved a three-year Stand-By Arrangement (SBA) for Argentina worth US$50 billion (about 1.110% of Argentina's IMF quota). Look: https://www.imf.org/en/News/Articles/2018/06/20/pr18245-argentina-imf-executive-board-approves-us50-billion-stand-by-arrangement.

[vii] Data from ECLAC.

[viii] Data obtained from the Central Bank of the Republic of Argentina (BCRA).

[ix] Kaltenbrunner, A., & Painceira, J. P. (2018). Financierization in Latin America: implications of subordinate financial integration. Studies on financing in Latin America, 33-61.

[X] Bortz, P. G., & Kaltenbrunner, A. (2018). The international dimension of financialization in developing and emerging economies. Development and change, 49(2), 375-393; De Conti, B., Biancarelli, A., & Rossi, P. (2013). Currency hierarchy, liquidity preference and exchange rates: A Keynesian/Minskyan approach. Congrès de l’Association Française d’Économie Politique, Université Montesquieu Bordeaux IV, 1-22; De Paula, L. F., Fritz, B., & Prates, D. M. (2017). Keynes at the periphery: Currency hierarchy and challenges for economic policy in emerging economies. Journal of Post Keynesian Economics, 40 (2), 183-202.

[xi] Carneiro, R., & De Conti, B. (2022). Exorbitant privilege and compulsory duty: The two faces of the financialized IMS. Cambridge Journal of Economics, 46 (4), 735-752.


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