Economic Policy Agreed Between Argentina and IMF -Killing the Messenger-
- April 19, 2019
ECONOMIC POLICY AGREED BETWEEN ARGENTINA AND IMF
Killing the Messenger
The doctor told me I am very overweight, that I must start a diet.
By Gabriel Sullivan
BA in Economics (University of Buenos Aires, UBA), International Tax Program (Harvard Law School).
Last week, the Managing Director of the IMF, Christine Lagarde, made a statement on the policies that the Argentine government, together with the international organization, is implementing, and said that "The authorities' policies (...) are bearing fruit. (...) there are signs that the recession has bottomed out, and a gradual recovery is expected to take hold in the coming quarters"[1]and she addressed future candidates for president, by stating that “Protecting the most vulnerable from the impact of the recession and from high inflation remains a key priority. The authorities have taken a series of actions to improve the coverage of the social safety net and to provide greater resources to the poor. Continued work will be needed to address the remaining gaps in coverage of the social safety net and to make social programs more effective in reducing poverty” [2].
Likewise, the Director of the Western Hemisphere Department at the International Monetary Fund, Alejandro Werner, pointed out that the IMF “has a major confidence in the fact that if Argentina abides by the guidelines, which are the basis of the program, the country will be able to correct macroeconomic imbalances”. Nevertheless, the Director stated that it is “a long-run process”.
Regarding those statements made by the Managing Director and the aforementioned Director, some of the possible candidates for the presidency election taking place this year made the following comments:
· "Argentina is a sovereign country and the Argentine people have to decide how they will move forward. The IMF only lent money to Argentina, it did not buy the country".
· "The only things that are picking up are debt, inflation, the closing of SMEs, unemployment and price hikes".
· . "The economic program is not working because the government has chosen a wrong path, in association with the IMF, and that path is affecting the Argentine people. The Argentine people is sovereign, and we will elect a new government in October, we will build a new majority and renegotiate the agreement with the IMF".
· "The Director of the IMF's Western Hemisphere Department stated that this is a 'long-run process' for Argentina. Maybe the time has come to explain in a civilized and technical manner, that our society has experienced an economic decline for the past eight years. It will not bear -as it was applied in Greece - a ten-year adjustment program".
What is the IMF?
Two weeks ago, the Danish Minister of Finance visited the country. In an interview he was asked how he sees the economy of Argentina, and he stated that he has confidence in the future of such economy and that, in fact, his country was one of the member countries that approved, by means of the IMF, the granting of the USD 57 billion loan that Argentina has received from the international organization.
The IMF is an international organization consisting of 189 countries, i.e., almost all the countries in the world. It is governed by an Executive Board, made up of representatives of 24 countries (some countries permanently represented and others that alternately represent the other member countries, grouped by regions). The Executive Board is chaired by a Managing Director, currently Ms. Christine Lagarde.
The Executive Board reports to the Board of Governors, composed of a representative from each of the 189 member countries, which meets once a year.
As for the funds administered by the IMF, they come from the quotas contributed by its 189 member countries. The quota for each country is established based on the relevance of their respective economies, considering the value of their GDP.
Among the different functions of the IMF, we find the provision of assistance to those member countries that face difficulties in their balance of payments. The balance of payments of a country is a record of all transactions made between one country and the rest of the world. In a very simplified way, we could say that the balance of payment states the sources of foreign currency inflow and outflow of a country.
A country faces difficulties in the balance of payments when its foreign currency outflow exceeds inflow thereof.
Basically, a country has three sources of currency:
1. Loans, mainly obtained through the placement of public securities issued by the Government (whose aggregate value is what is commonly referred to as "external debt"). They also include, among others, loans granted by international development banks, such as the IDB or the World Bank.
2. Foreign Direct Investments, which consist of investments made by foreign investors in the country through the purchase of existing companies or the creation of new ones. When a foreign investor invests in companies in the country, it brings foreign currency which is exchanged into pesos. That is to say there is an inflow of foreign currency.
3. Positive balance of the Balance of Trade. The Balance of Trade is the record of exports and imports of a country. If exports exceed imports, it is said that there is a trade surplus. Trade surplus means a foreign currency inflow for the country.
Argentina's Balance of payments
In recent years, Argentina's balance of payments has shown the following characteristics:
1. An inflow of foreign currency aimed at the acquisition of public securities, whether securities issued in foreign currency or pesos. Securities in Argentine pesos were very attractive because they had high rates against the value of the foreign currency whose increase was less than the increase of inflation. That is, when investors collected their capital and interest in pesos, and repatriated them to their countries of origin, they had obtained high dollar yields compared to those that they could have earned in most of the rest of the world.
2. Outflow of foreign currency to meet the payment of capital and interest on public securities issued in the past by the Government (the Treasury or Central Bank of the Argentine Republic).
3. A decrease in foreign direct investment. Argentina, after being the third destination of such investment in Latin America for decades (after Brazil and Mexico), has dropped positions since 2001, being fifth since 2008, after Brazil, Mexico, Chile and Colombia. That is to say, our country has lost its attractiveness for investment in productive activities (either in already existing companies or through the creation of new ones).
4. Negative balance of trade. That is to say, imports exceed exports (in USD billions, 2017: – 8.3; 2018: -3.882).
5. A negative tourism balance (outflow for trips abroad exceeds income from foreign tourism in the country). In billions, 2011: -US$ 1.124, 2012: -US$ 4.648; 2013: -US$ 8.694; 2014: -5417; 2015: - 8404; 2016: -US$ 8289; 2017: -US$10.456.
The interaction of these elements resulted in a balance of payments that required more and more indebtedness (issuance of securities) to finance the outflow of US dollars. Thus, the country has become increasingly dependent on external debt to meet past debt payments, imports that exceeded exports and tourism abroad. In other words, the country increasingly demanded more foreign currency than it generated. This increased the already bulky foreign debt defaulted and renegotiated in a timely manner. Currently, it is estimated that the external debt of the national government is approximately USD 330 billion (equivalent, according to ECLAC, to 97.7% of the Argentine GDP, i.e., the equivalent to the value of goods and services that Argentina produces in a year).
This continuous increase in indebtedness through the issuance of public securities was verified until last May. At the time, those who purchased our securities (bonds) began to realize that our country was increasingly dependent on external financing, which did not increase the generation of actual US dollars, deriving from productive investments or exports that exceeded imports. This meant that our country had to start offering an increasingly higher rate for the funds it borrowed and even that other investors decided to sell their Argentine securities. Thus, it started to become evident that Argentina may have what we described earlier as balance of payments problems.
In this context, Argentina resorted to the IMF. One of the functions of this international organization is, as aforementioned, to assist countries facing balance of payments problems. As a result of this, the IMF decided to grant Argentina a loan of USD 57 billion which is periodically disbursed in a partial manner.
That said, the IMF granted us this loan, but its intention is not to extend the crisis of the balance of payments but rather to avoid the latter, for the sake of the Argentine economy itself and of global financial stability and also in order to recover the borrowed funds arising from the contributions of the 189 member countries of the organization.
To that end, the IMF imposed the application of several economic policy measures, among which we can mention, very briefly, the following as the three key ones:
a) To control the growth of the monetary base. In other words, to control the increase of the amount of money existing in the economy. The goal is to contain the inflationary process that, among other causes, is due to such increase of money in the economy.
b) To achieve a balanced fiscal budget. That is to say, a tax revenue collection that matches the expenditures of the tax authorities. This is paramount, since the Government cannot continue borrowing and financing through monetary issue would put more pressure on inflation. In this regard, the IMF has learned from past experiences, and seeks to ensure that its demands in the control of government expenditure do not affect the items allocated to social assistance for the most vulnerable sectors of the population.
c) It establishes a floating exchange rate, that is, a minimum and maximum value between which the value of the dollar will fluctuate.
c.1) With the minimum value, the IMF seeks:
c.1.1.) to avoid the dollar from having a "cheap" value that favors imports and hinders exports. In other words, the IMF seeks a dollar value that allows a surplus in the balance of trade, the only actual source the country currently has to generate the foreign currency it needs to meet its external obligations. Foreign direct investments, another source of foreign currency, will be the result of a more stable and reliable future economic environment.
c.1.2) A growth of exports that fosters the growth of the economy, so as to overcome recession, generate employment, business profits and an increase in tax collection as a result thereof.
c.2.) With the maximum value, the IMF seeks to avoid an escalation of the dollar value that leads to lack of trust and a destabilization of the economy, with a resulting repercussion on inflation (by means of a pass-through of prices). In this context, the supply of foreign currency that the Argentine Central Bank (BCRA) can make as a result of the funds contributed by the international organization plays a major role.
Implementation status and results of the measures
In this regard, it can be mentioned:
1. That the expansion of the monetary base has been controlled and the fiscal deficit reduced. The latter has affected the level of economic activity and tax revenue collection. It is expected that this control of the monetary base and reduction of the fiscal deficit will begin to show results in terms of reducing inflation.
2. A large reduction in the trade deficit between 2017 (-USD 8.3 billion) and 2018 (-USD 3.882 billion), which is expected to be reversed through a trade surplus that is estimated to reach USD 6 billion in 2019. In this regard it should be noted that if we compare the months of February 2018 and February 2019, the trade deficit has gone from -USD 892 million in 2018 to a surplus of USD 460 million in 2019. Among the causes thereof, we can mention a 6.7% increase in exports despite the 2.9% decrease in the average prices of exported products if we compare those two periods of time. This surplus is expected to be even higher in 2020, thus producing a virtuous circle that will result in the recovery from economic recession.
Based on the above, we can conclude that while some of the measures promoted by the IMF have not yet shown the expected results, others are doing so. It is believed that if the application of such measures is pursued, it may be possible to contain inflation, generate actual dollars in order to meet our external obligations and achieve a recovery of the economy that generates employment, corporate profits and, as a result, a tax collection increase (that contributes to a fiscal deficit reduction).
Taking into account the aforementioned, it is possible to see what the IMF Managing Director, Christine Lagarde, meant when she asked presidential candidates not to undermine the efforts already made (deficit reduction and a currency market that, in a difficult international context, managed to remain relatively stable, thus favoring the conditions for a trade balance that generates actual dollars originating in the productive activity of the Argentine economy).
Conclusion
From all of the above we can conclude:
1. That Argentina was financing a growing outflow of foreign currency with an indebtedness whose continuous increase was not sustainable over time.
2. That the fact the country did not generate "actual dollars of its own" was a sign that there were problems in the balance of payments.
3. That the IMF, pursuant to one of its goals, responded to the request for assistance from the Argentine government.
4. That the IMF is an organization consisting of 189 member countries, which based on the size of their economies, contribute funds to the IMF in order to assist member countries facing balance of payments problems.
5. That the IMF granted Argentina a loan of USD 57 billion.
6. That as a counterpart, the IMF required a limitation on the growth of the monetary base (amount of money in the economy), a reduction of the fiscal deficit and a floating exchange rate. By means of these measures, the IMF seeks to avoid a balance of payments crisis, lower inflation, generate an economic growth and enable the country to meet is debt obligations (including the repayment of the loan granted, funded by the contribution of the 189 member countries of the organization).
7. That although the results in terms of inflation of the measures agreed upon with the IMF are not evident yet, they can be seen in the successive surplus monthly balances of the balance of trade which are taking place since last September. Thus, it is evident that the country is generating dollars of its own, as a result of its own productive activity.
8. That it becomes clear that the increase of exports will eventually result in a recovery from economic recession.
In other words, it is understood that if the policies fostered by the IMF are pursued, it should be possible to revert the inflationary process and economic recession. It should be noted that the need to take measures to contain inflation, prevent the Government from spending more than it collects and reactivate the economy is a fact, regardless of whether the IMF points it out to us or not. Deep down, I already know that I have to lose weight. I didn't need the doctor to tell me so. Let's not kill the messenger.
Original text in Spanish: https://betovaldez.com.ar/matando-al-mensajero/
[1] https://www.imf.org/en/News/Articles/2019/01/24/Statement-by-Christine-Lagarde-on-Meeting-with-Argentina-Economy-Minister-and-Central-Bank-Governor
[2] https://www.reuters.com/article/us-argentina-imf/imf-says-argentina-economic-policies-bearing-fruit-unlocks-10-8-billion-in-funding-idUSKCN1RH2AH