An economic nightmare that’s politically painful to untangle.
By Bianca Fernet, Argentina:
When Argentine President Mauricio Macri took power, his economic team began to dismantle his predecessor’s heavy-handed policies — a process that had painful recessionary consequences for the Argentine population. Macri and his team repeatedly promised that by the second half of 2016, the pain would be worth it, the economy would recover and we would see some results.
In a press conference yesterday, Macri announced that his policies have successfully put the country’s economy back on track. He based this on three premises:
- “We have begun to reduce inflation”
- “We have made external commerce [imports and exports] more transparent”
- “We have launched a new plan to help small- and medium-sized businesses”
Based on these three successes, Macri claimed that while the starting point wasn’t easy, “we believe this is working.” And while the economy appears to have stabilized since the turmoil we saw at the beginning of the year, stability is a far cry from a return to growth.
Inflation: Still A Thing
Macri’s claim that he has begun to reduce inflation is not necessarily untrue, it just conveniently leaves out a whole lot of pretty damn important context.
Macri inherited an economy that was averaging annual inflation rates safely above 25% and then systematically lying about inflation via the National Statistics Agency (INDEC). A feather in his cap, Macri has restored legitimacy to the INDEC, which released official inflation figures for Argentina in May for the first time since he took office. The bad news is that inflation clocked in at 4.2% for the month, which would translate into annual inflation close to 50%. You don’t have to be a mathematical genius to see that 50 is bigger than 25.
In December of 2015 and January 2016, inflation was 5% per month. In February and March it fell to around 4.4% but then in April it kicked back up to exceed 6%. So by getting monthly inflation back down to 4.2% in May, yes, technically, Macri’s government has lowered inflation.
Private economists see the monthly inflation rate falling to between 2.5% and 2.8% monthly by July, which would put annual inflation around 30%. Which is exactly where it was when former President Cristina Fernández de Kirchner left office.
Are We Back Where We Started?
Now this is where the plot thickens. Macri’s government attributed the exorbitant inflation increases at the beginning of 2016 to the removal of utility subsidies and other circumstances specific only to the City of Buenos Aires. For that reason, before INDEC published inflation, it backpedaled on the promise to use a weighted estimate from different parts of the country to pay inflation-linked bonds. Instead of using the 3% to 4% inflation seen across Argentina, it used only data from the province of San Luis which showed a tidy 2.7% increase.
Following the logic that higher inflation was a blip in the radar confined to the City of Buenos Aires, the provinces should have remained below 3% and inflation across the country should be going down. This hasn’t been the case.
As you can see, Mendoza Province experienced inflation over 5% in May, and was followed closely by the City of Buenos Aires as well as the provinces of Cordoba, San Luis and Neuquén.
So again — inflation appears to have stopped increasing and economists predict it will stabilize back to the same level as when Cristina left office.
That’s A Little Better, Right?
Inflation may be back to under 30% annually, but Argentina’s economy is quite different. Macri’s economic team has abolished currency controls and along with it the de facto parallel currency system of “blue” dollars. It has returned Argentina to global capital markets by settling with the holdout “vulture” creditors and successfully issuing new bonds internationally.
These measures towards normalizing Argentina’s economy are certainly important steps in the right direction, but they are by no means complete nor sufficient. They are slowly chipping away at the gigantic ice block that has frozen Argentina’s economy for the past decade.
Argentina’s Economy Is Still Not Normal
To start with, Argentina’s interest rate is still well above 30%. For a point of comparison, the United States, United Kingdom and Euro areas have interest rates close to zero, China’s is around 4.5%, India’s at 6.5% and Australia’s at 1.75%. Interest rates directly influence a country’s money supply and in turn inflation and the exchange rate.
At the risk of being guilty of penning the oversimplification of the century, a low interest rate encourages economic growth and expands the money supply because people invest their money and buy stuff rather than saving. A high interest rate does the opposite, but also keeps inflation low and the value of the currency, or exchange rate, high. Since the end of the cepo currency controls and removal of other barriers, Argentina’s interest rate has had to go up and stay up to hold the ship steady.
It is critical to remember that inflation was never an intentional policy, it was an unintended consequence of the former administration’s relatively populist strategy of increasing employment via the public sector and more importantly, subsidizing primarily energy to an unsustainable extent. Following massive political backlash, Macri has frozen layoffs in the public sector through the end of 2016. Leaving public employment aside, Argentina’s energy sector remains largely unreformed since the new government took office.
Energy Is Still Really Subsidized, Guys
Energy subsidies need to be viewed in two major categories
- Subsidizing feedstock such as petroleum oil and gas that can be internationally traded
- Subsidizing electricity, which has been the political hot topic this year
On the feedstock side, Argentina is still currently subsidizing the extraction of petroleum for export to appease labor unions in the southern provinces of the country. Argentina is currently importing gas from five countries to satisfy domestic demand, and there are still regular shortages and cuts.
Let’s focus on electricity and natural gas, which were the subject of this year’s so-called tarifazo. The government removed many of the consumer-level subsidies on electricity and gas, causing consumer energy prices to increase by huge percentages at a time when inflation is cutting into purchasing power and the economy is in a recession.
Somewhere between the lines of heart-wrenching stories of little old ladies facing 200% utility price increases, the most important story about energy subsidies have gotten lost.
Consumer electricity prices in Argentina are still only about 30% of the cost of generating and delivering that electricity. Put another way, Argentina is still subsidizing electricity consumption by 70%. Direct consumer subsidies have been partially removed, but massive subsidies still exist at the electricity generation level and the transportation and distribution levels (how the electricity moves from power plants to homes and businesses). See the black line on the graph below. You see a substantial increase in January 2016, but it doesn’t come close to the full cost, depicted by the green bars.
Worryingly from a purely economic standpoint, the government backpedaled on removing energy subsidies, calling the price increases a “mistake.” While the government certainly made a mistake by being so cavalier and insensitive regarding the effect these utility increases have on the average Argentine wallet, the price increases themselves were a necessary evil. And in order to truly get inflation in check in the long term, further price increases are inevitable. Paradoxically, that is inflationary in the short term.
Argentina Needs To Stay On The Treadmill
As Macri is keen to point out at pretty much every turn, he did indeed come into an economic nightmare that is politically painful to untangle. Besides cutting the graft and shocking corruption out of the system, politically difficult measures with real consequences are necessary to get inflation down and encourage both local and foreign investment in the country.
The Argentine economy inherited by Macri is akin to a morbidly obese diabetic in need of long-term life adjustment, not a quick fix. Macri’s administration has done the economic equivalent of eating healthy and hitting the gym for a few weeks. It’s laudable, but hardly worth celebrating. The real challenge is keeping it up, and unless it continues, meaningful benchmarks like single digit inflation are still a long way off. By Bianca Fernet.
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