Argentina’s IMF Debt Restructuring: Another Crisis, a New Opportunity
Executive Summary
Argentina is once again facing an economic and financial crisis of already historic proportions. The IMF forecasts an 11.8% decline in GDP for 2020, the official to unofficial exchange rate gap is at a record of 120%, and the monetary base is increasing at a monthly rate of 12% to finance social spending. In this context, the country is negotiating a new deal with the IMF to restructure $44 billion in foreign debt, shunting repayments far into the future. This is a unique opportunity to not only prevent an imminent peso devaluation and deeper recession, but also tackle structural and chronic macroeconomic imbalances. Three main policies are proposed to avoid yet another currency devaluation and implement critical structural adjustments: 1) Consolidate an Extended Fund Facility (EFF) agreement with the IMF to muster the political support required to implement structural changes; 2) Reform Argentina’s pension system by mitigating the asymmetry between contributions and benefits; and 3) Reform Argentina’s federal fiscal system by establishing a counter-cyclical stabilizer underpinning social spending. It is vital that Argentina learns from its past mistakes in order to work towards sustained growth and economic stability.
Problem Statement
Argentina’s current crisis is the result of chronic macroeconomic imbalances, which have been exacerbated by the COVID-19 crisis. After successfully restructuring $65 billion of debt with private creditors in August, Argentina is currently in negotiations with the IMF over $44 billion of debt, part of a record $57 billion bailout program extended during the currency crisis in 2018. Persuading the IMF to grant Argentina an EFF program will roll-over repayments for at least four-and-a-half years while also requiring the implementation of necessary medium-term structural reforms. Committing to a sustainable economic plan will lead to reaching an agreement quickly, thus restoring investor confidence at a time when capital markets are exerting tremendous depreciationary pressure on the peso.
Diagnosis
1) Argentina is running out of time and instruments’ options to prevent a peso devaluation. The gap between the official and unofficial exchange rates — often associated with investor confidence — has reached 140%, the highest level in decades (Figure 1). Historically, each of the five episodes when this spread has been wider than 100% (1948, 1951, 1955, 1974, and 1989) has led to devaluations of the peso, reserve drains, severe recession, high inflation, and drastic changes in economic programs.[1] Thus far, policies have focused on containing deprecionary pressures by draining reserves, raising interest rates, issuing new bonds, and implementing progressively tighter capital controls. This has resulted in record-low levels of foreign currency reserves and the creation of five different exchange rates.
Figure 1- Narrowing Gap. Spread Between Argentina’s official and unofficial fx rates pares after hitting record.
Importantly, the lack of unified exchange rates have had various detrimental and immediate repercussions: i) at the macroeconomic level, trade deficits worsen as foreign trade becomes highly speculative, as importers (exporters) have incentives to overbill (underbill) their imports anticipating a future devaluation;[2] and ii) at the microeconomic level, it encourages private savers to resort to buying dollars as a store of value and/or to arbitrage at parallel markets. This exerts further deprecionary pressure on the exchange rate, leading to a downward spiral of higher volatility where the costs of sustaining the gap become progressively more difficult, as net liquid reserves and financial instruments become depleted. Only the presentation of an integral economic plan with coherent fiscal and monetary goals can calm investors and reduce exchange rate volatility.
2) A chronically high fiscal deficit becomes once again the core driver of financial instability. Because of the pandemic, this year’s deficit could swell to 10% of GDP, a level not seen since 1982[3]. Further, as tax revenues continue to decline, tax burden is already highly confiscatory, and Argentina’s eroded external credibility has precluded it from financing its fiscal expansion with debt, leaving few potential alternatives to navigate the crisis.
Although the fiscal imbalance has been particularly high because of COVID-19, even prior to the pandemic, there were no serious consolidation efforts made in response to the growing deficit. At the bottom line, 20% of Argentina’s population in private-sector jobs sustain an unviably generous social security system that covers their own benefits as well as those of the remaining 80%.[4] The pandemic will likely bring it closer to 15/85%, raising social spending for the very poor while in the process undermining an already stumbling productive sector. These distortions are self-reinforcing: fiscal deficits which are perceived as future taxes curtail investment in the modern sector, feeding into slower growth, a propensity for further crisis and, and in turn, a constituency of subsidy-dependent citizens with no prospects of social mobility[5]. Reducing Argentina’s primary fiscal deficit is a long overdue yet consistently neglected reform which has historically proven to be the core driver of economic and financial crises.
3) Argentina’s inefficient federal fiscal system leads to irresponsible procyclical social spending. Social spending in Argentina needs to be reformed not only in terms of its magnitude but also in terms of its timing. Effective compensatory social policies must protect those vulnerable to crises by saving resources during good times and then allocating them during recessions.[6] Yet, Argentina’s social system has been historically highly procyclical, especially at the province level (Figure 2). Since 2001, the main culprit of fiscal deterioration has been the federal transfer scheme of Coparticipación, which through perverse incentives encourages overexploitation of the common pool of national taxation[7]. Provincial governments benefit politically from increased spending and reduced taxation during boom periods, then lobbying for additional Coparticipación resources during recession periods.
Figure 2- Cyclical time-series of GDP, public spending, and social spending for Argentina 1986–2008. Source: Gatti, 2011.
Without access to credit, automatic budget stabilizers, or countercyclical instruments, Argentina is repeatedly forced to resort to money-printing in order to finance public spending. Since April of this year, the monetary base has been growing at an abrupt monthly rate of 12%, ultimately exacerbating inflation and increasing the likelihood of a devaluation and deep recession.[8] Countercyclical instruments that encourage fiscally-responsible social spending at the province level are imperative to stop Argentina’s penchant for printing money to finance its deficit.
Policy Recommendations
Three main observations emerge from the previous diagnosis: Firstly, the macroeconomic imbalances in Argentina are highly interconnected and stem from the same fundamental and chronic issues. Secondly, Argentina’s inability to implement the necessary structural reforms leads to economic crises that keep reappearing as unlearned lessons with almost identical ultimate drivers. Thirdly, renegotiating an agreement with the IMF is a historical opportunity to focus on the imminent currency devaluation while also addressing the deep structural imbalances which continue to put Argentina on the verge of collapse.
1) Argentina must promptly close an EFF agreement with the IMF in order to avoid an imminent devaluation and recession. The benefits of restructuring debt as EFF are significant: In the short-term, closing the program with the IMF would provide Argentina with a less restrictive debt-repayment program and more importantly, send a signal to the markets that restores investor confidence and prevents an imminent peso devaluation. In the medium-term, subscribing to the program’s conditions could embolden the government to finally implement long-overdue structural reforms. Importantly, the IMF’s conditions are precisely what make this policy politically supportable, as they would be the consequence of debt incurred by the previous administration. The opportunity to avoid an economic crisis, roll over debt, and displace agency over the required reforms is a unique opportunity that the government cannot miss.
2) Argentina must solve its chronic fiscal deficit by tackling its financially unsustainable and unjust pension system. Out of 190 countries, Argentina ranks 170th on the severity of its corporate tax burden,[9] meaning that raising taxes is not a viable option for deficit reduction and instead must focus on curtailing social spending.
The current pension system accounts for 10% of Argentina’s yearly GDP and is expected to increase to 15% in the next 30 years as life expectancy continues to rise. While there are many drivers behind its growing financial deficit, it is primarily the inequality of the scheme by which contributors finance non-contributors that render the system unsustainable and a strategic target for reform. Although non-contributive pensions were initially designed for highly vulnerable elderly citizens, political discretionality in implementation resulted in a significant leakage to other unwarranted population segments. These distortions must be eliminated to design a more just system where individual pension contributions are more closely aligned with the benefits received. In this sense, a menu of policies that increase revenue from new contributors, delay the currently outdated retirement age of 65 years old, and index pensions more sporadically, could lead to 2–3% reduction in public deficit.[10]
It is clear that the principal constraint to the implementation of this recommendation is social and political resistance. Technically, Argentina’s pension system is the most cost-effective way to mitigate its fiscal deficit. Administratively, modifying the pension system would require a legislative fix, and as the leader of the Congressional majority, only the President could muster enough support for passage. Politically, while these are likely to be unpopular reforms, they are defensible from a moral-hazard perspective (citizens understand that their benefits should be proportional to contributions and that free-riding creates distortions). Finally, as this is a shared concern with the IMF, political costs could likely be diffused.
3) Argentina should establish a fiscal stabilization fund (FSF) at the province level that regulates social spending and encourages fiscal responsibility: In order to reduce the frequency and depth of economic downturns, establishing an effective social insurance scheme that is fiscally sound and avoids relying on money printing will require the establishment of a countercyclical social safety net. While holistically reforming the Coparticipación scheme is vital in the long-run, establishing a countercyclical fund to be administered by each province is a more politically supportable solution which still accomplishes the goal of inducing fiscal discipline and autonomy, ultimately reducing debt and inflation. Importantly, transferring ownership of resources back to each province can skip the Congressional route and be validated by an executive order, guaranteeing a feasible implementation route.
The FSF would serve as a vehicle to transfer the management of social spending to each province, thus incentivizing financial responsibility by avoiding bailouts from the federal government during periods of distress. Regulating FSFs to ensure that social funds are allocated responsibly and sustainably during periods of economic growth will prevent spending from being hijacked for political discretion purposes. This is a critical first step towards an efficient fiscal federalism, and will likely gather enough political support since “well-behaved” provinces could reclaim responsibility over then own resources.
[1]Belini, Claudio, and J. C. Korol. “Historia económica de la Argentina.” Ed. Siglo XXI. Barbero, MI (2012): 1880–1983.
[2] Ffrench-Davis Muñoz, Ricardo. “Neoestructuralismo y Macroeconomía para el Desarrollo.” (2014).
[3] https://eleconomista.com.ar/2020-10-deficit-fiscal-en-argentina/
[4]Cohan, Luciano, L. Díaz Frers, and E. Levy Yeyati. “Lineamientos para una reforma previsional.” Documento de trabajo 50 (2010).
[5] Galiani, Sebastian, and E. Levy-Yeyati. “The Fiscal Spending Gap and the Procyclicality of Public Expenditure.” Buenos Aires, Argentina: Universidad Torcuato Di Tella. Mimeographed document (2006).
[6]Sturzenegger, Federico, and Rogério LF Werneck. “Fiscal federalism and procyclical spending: The cases of Argentina and Brazil.” Económica 52 (2006).
[7]Braun, Miguel, and Mariano Tommasi. “Subnational fiscal rules: a game theoretic approach.” Rules-Based Fiscal Policy in Emerging Markets. Palgrave Macmillan, London, 2004. 183–197.
[8]https://www.ft.com/content/74084442-f036-4759-a97c-5f107e714398
[9]https://www.infobae.com/opinion/2020/10/06/la-argentina-es-impositivamente-mas-cara-que-africa-medio-oriente-y-sudamerica/
[10]Hadad, Ignacio. La reforma previsional del 2008: un análisis de sustentabilidad. Diss. Universidad Argentina de la Empresa, 2014.
