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Argentina's Deal with the IMF: Will "Expansionary Austerity" Work?

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Argentina's Deal with the IMF: Will CEPR CENTER FOR ECONOMIC AND POLICY RESEARCH Argentina's Deal with the IMF: Will "Expansionary Austerity" Work? By Mark Weisbrot and Lara Merling* December 2018 Center for Economic and Policy Research 1611 Connecticut Ave. NW tel: 202–293–5380 Suite 400 fax: 202–588–1356 Washington, DC 20009 www.cepr.net * Mark Weisbrot is Co-Director at the Center for Economic and Policy Research (CEPR). Lara Merling is a Research Associate at CEPR. Contents Executive Summary ........................................................................................................................................... 1 Introduction ........................................................................................................................................................ 4 Debt Sustainability and the IMF Program ................................................................................................... 10 Conclusion ........................................................................................................................................................ 15 References ......................................................................................................................................................... 17 Acknowledgements The authors thank Joe Sammut, Jake Johnston, and Matt Templeton for research assistance, and Dan Beeton and Rebecca Watts for editorial assistance. Executive Summary Since July of this year, the International Monetary Fund (IMF) has disbursed more than $20 billion of a $56.3 billion loan package to Argentina. The Argentine government is now the largest holder of the IMF’s General Resources Account (GRA) funds. This paper looks at how the policies that the Fund and the Argentine government have agreed upon in their June Stand-By Arrangement (SBA) are expected to lead to an economic recovery; and whether they are likely to succeed. The IMF program is based on what it calls “a credible and ambitious plan” to “restore market confidence.” But by October, just a few months after the IMF agreement was signed, the economy’s main indicators fell far below what the Fund had projected. For 2018, the IMF projected positive real GDP growth of 0.4 percent; it now projects negative 2.8 percent, a very large difference of 3.2 percentage points. For 2019, a similar downward revision of 3.2 percentage points has been made, from positive 1.5 percent to negative 1.7 percent. Consumer price inflation was projected in June at 27 percent for 2018 and 17 percent for 2019. The new estimates are 43.8 percent and 20.2 percent, respectively. The forecast for interest rates for these two years shot up from 37.2 percent and 22.5 percent to 69.6 and 32 percent. And the projected federal public debt as a percent of GDP, another fundamental target of the Fund program, jumped from 64.5 and 60.9 percent for 2018 and 2019, to 81.2 and 72.2 percent, respectively. These are enormous changes to the IMF’s outlook for Argentina in just a few months. It is possible that the IMF, and also the current government of Argentina ― which in its Letter of Intent to the Fund, stated that the recent plan is “designed by, and fully owned by, the Argentine government” ― have a flawed understanding of the impact of their policies. In the October review of the Stand-By Arrangement, the program was revised to double down on fiscal consolidation as a means of restoring market confidence. Instead of running a primary deficit of 1.3 percent of GDP in 2019 as in the original SBA, the revised plan has a balanced primary budget in 2019 and a 1.0 percent primary surplus in 2020. This is a sizable fiscal consolidation, comparable to the average year of austerity in Greece or Spain during their years of budget cutting following the 2009 World Recession. Using the IMF’s estimate of the structural primary budget balance, it amounts to a fiscal tightening of 3.9 percent over two years. With a multiplier of 1.3 percent, we would expect this to reduce real GDP growth over the next two years by about 5.1 percent. Argentina's Deal with the IMF: Will "Expansionary Austerity" Work? 1 The October review also tightened monetary policy severely, with the Central Bank switching from an inflation targeting regime to targeting the monetary base. The monetary base must grow at 0 percent monthly until June 2019, and 1 percent per month for the rest of the year. In the June agreement, the IMF had forecast that the economy would already be recovering by now. As noted above, those projections have now been lowered substantially, with negative year-on-year growth for 2018 and 2019. The IMF now projects that the economy will return to growth in just a few months, in the second quarter of next year. However, this also seems over-optimistic. The recovery for 2019 is based entirely on net exports, and there are numerous downside risks to the global economy. These include continued rate hikes by the US Federal Reserve — which contributed to the crisis this year and also in Argentina and many other countries from 1994 to 1997 — and trade frictions between the US and China, as well as volatility in financial markets. Furthermore, there are no signs of a nascent recovery. Industrial production has declined sharply since May. Consumer confidence has fallen over the past year and has continued falling in recent months. Real wages have fallen sharply. The IMF warns that both of the latter problems are “likely to continue to hinder consumption.” Domestic investment is also projected to be weak in this recovery, falling from 13.8 to 11.5 percent of GDP as the economy is projected to return to growth from 2018 to 2019. Private investment is forecast at just 8.5 percent of GDP in 2019. For comparison, investment was at 14.6 percent of GDP in 2016, when the economy was in recession. For the 13 years from 2002 to 2015, investment averaged 16.1 percent of GDP. The relatively low level of investment projected for 2019 and 2020 casts further doubt on the multiyear growth projections in the IMF’s forecast recovery. It seems clear that the government made a number of mistakes that contributed to the crisis. The first was the rapid pileup of foreign currency debt, which increased from 35 percent of GDP in January of 2016, a month after President Macri took office, to over 60 percent of GDP in April of this year, just before the financial crisis exploded. Then, when the crisis hit, the government spent about $16 billion trying to prop up the peso, which lost about 52.3 percent of its value against the dollar by September 28. The IMF states that Argentina’s public debt “remains sustainable, but not with a high probability.” This is debatable — as shown below, before this year’s crisis, the burden of Argentina’s federal public debt was not particularly worrisome, and was projected to decline. But in any case, the fiscal consolidation in the IMF’s revised program contributes proportionately very little to reducing Argentina's Deal with the IMF: Will "Expansionary Austerity" Work? 2 Argentina’s debt — just 2.7 percentage points of GDP in 2018, and 1 percent in 2019 — from a debt that is projected to increase by 23 percentage points of GDP this year. Thus the program contributes very little to debt reduction, while hoping to inspire confidence in the economy by demonstrating the government’s commitment to deficit reduction and tight monetary policy. In the process, it appears to be aiming to reduce inflation and the current account deficit by shrinking the economy with procyclical fiscal and monetary policies. But in so doing, the program adds the risk that the recession may actually undermine market confidence and result in a recession that is longer and deeper than anticipated — as it already has. The economy can also face a situation where the debt burden relative to the economy grows as GDP falls, and the fiscal targets become increasingly difficult to meet — as happened to Greece, for example, after 2010. The Stand-By Arrangement and the October review both emphasize that one of the principal objectives of the program is to “protect Argentina’s most vulnerable citizens from the burden of this needed policy recalibration.”1 However, given the loss of revenues during the recession and the pressure for expenditure cuts to meet the program’s primary budget targets, this is almost certainly not going to happen. There will be increased suffering and hardship for millions of Argentines as unemployment and poverty increase with the recession. For all of these reasons and more, the macroeconomic policies prescribed in this program are not worth the risks and human costs that they introduce. Argentina would be better off implementing policies that do not rely on recession to resolve some of the current imbalances while worsening others. 1 IMF (2018a), p. 8. Argentina's Deal with the IMF: Will "Expansionary Austerity" Work? 3 Introduction On October 26, the International Monetary Fund (IMF) announced that it would augment its lending to Argentina under its June Stand-By Arrangement (SBA) by an additional $6.3 billion, bringing it to a total of $56.3 billion, some $20.4 billion of which has already been disbursed.2 Argentina is now the largest holder of the IMF’s General Resources Account (GRA) funds, with 27.9 percent of outstanding credit (Greece, with 16 percent, is a distant second).3 This is an enormous investment of IMF resources, by any historical or international comparison. Will these funds, and the conditions attached to them, help Argentina recover from its current economic crisis and recession? In this paper, we will briefly examine how the policies that the Fund and the Argentine government have agreed upon since the Stand-By Arrangement was signed are expected to lead to an economic recovery; and whether they are likely to succeed. The IMF Stand-By Arrangement signed on June 20, 2018 provided for $50 billion in IMF lending to be disbursed over 36 months. The program is centered on “a credible and ambitious plan” to “restore market confidence”: The government has committed to a clear macroeconomic program that lessens the federal financing needs and puts public debt on a firm downward trajectory.
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