Lessons from Recurrent Financial Distress

Robert Mundell Global Risk Annual Lecture Argentina: Lessons from recurrent financial distress

Guido Sandleris

Johns Hopkins University, SAIS Bologna February 20th, 2020

Argentina, one of the worst performers in the region

Crecimiento en LatinoaméricaAvarage annual GDP growth

Country 2012-2019 Bolivia 4.9 Peru 3.8 Paraguay 3.7 Colombia 3.2 Chile 2.9 México 2.3 Uruguay 2.3 Ecuador 2.0 Brazil 0.2 Nota | Promedio geométrico; Países seleccionados del subgrupo de Latinoamérica Argentina y el Caribe; 2019 proyectado. Fuente | BCRA en base a datos de WEO – FMI -0.4 Venezuela -11.1

• Argentina average inflation in the last eight years was 35.2% (in Latam was 5%) Source: WEO database - October 2019

2 Latin America’s growth was dismal in the last eight years

Crecimiento en el mundoAvarage annual GDP growth Group of countries 2012-2019 Emerging and developing Asia 6.6 Emerging market and developing economies 4.7 Sub-Saharan Africa 3.6 World 3.5 Middle East and Central Asia 3.0 Emerging and developing Europe 2.4 Advanced economies 1.9 Nota | Promedio geométrico; 2019 proyectado. Fuente | BCRA en base a datos de WEO – FMI. G7 1.8 Euro area 1.2 Latin America and the Caribbean 1.2

Source: WEO database - October 2019 3 Years of low inflation and growth were the exception

Argentina: Years with inflation below 5% and positive growth

4 • Only in 5 of the last 40 years Argentina had inflation below 5% and positive growth • Argentina spent 17 of the last 40 years in recession

1 • Only in 17 of the last 75 years, Argentina had inflation below 10% 0 0 80s 90s 00s 10s

Note: sample size 194 countries Source: WEO-IMF

4 Agenda

1. The starting point (2015)

2. The chosen path (2016/17)

3. Financial distress (2018/…) 3.a. Sudden stop and adjustment (04/2018-07/2019) 3.b. Elections and confidence crisis (08/2019-?)

4. Issues for discussion

The starting point (2015)

Public spending was soaring and the fiscal deficit increasing

Increase in size of public sector

% of GDP % of GDP e of e 5 of 4.3 increasing45 Primary expenditure provinces and 41,5 public local governments 4 expenditure40 2.7 Primary expenditures central 3 2.4 35 government 17.5 2 30 22,8 14.7 1 25 -0.2 0 20 -1 10.7 -2.3 15 -2 Primary fiscal 19.6 24.0 10 -3 deficit -3.8 5 12.1 -4 0 -5 2005 2011 2015 2003 2004 2006 2007 2008 2009 2010 2012 2013 2014 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

• Passive 2016 primary deficit: 5.3% • Government in default without access to international credit markets

Source: Treasury – NFPS (national).

7 Distorted prices: overvalued XR and capital controls, utility prices

Price Distortions: FX and utilitiesExchange rate and FX controls % Blue chip swap gap Real exchange rate (right axis) Index 12-17-15=100 90 160 80 140 70 DEPRECIATION 60 120 50 40 NovAvg-11/16 gap: 40.6% -Dec-15 avg.: 100 40.6% 30 80 20 APPRECIATION 10 60 0 -10 40 15 - Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Dec • Energy and transport prices covered between 10 and 25% of their cost of production • Expenditures in subsidies to utilities’ prices had been increasing year after year and amounted to 5% of GDP in 2015 Source: Central Bank of Argentina.

8 Current account deficit and few international reserves

CurrentExports and current account balance account deficit and reserves depletion despiteInternational reserves (USD bn) FX and trade controls Index % of GDP 2004=100 60 4% 130 FX and 50 FX and 3% Imports 125 Imports 2% Controls 120 40 Controls 1% 115 30 0% 110 26 -1% 105 20 -2% 100 10 -3% 95 0 -4% 90 Jul-10 Jan-04 Jun-09 Oct-13 Apr-07 Feb-05 Sep-12 Dec-15 Aug-11 2005 2006 2009 2010 2011 2012 2013 2015 Nov-14 2004 2007 2008 2014 Mar-06 May-08 Current account balance Exports (rhs) Gross reservas

Source: INDEC Source: Central Bank of Argentina.

• Third more closed economy in the world ((X + M)/GDP les than 25%)

9 Monetary overhang and CB financing to the Treasury

Monetary Aggregates (M3) CB financing to the Treasury

% of GDP s.a. (USD bn and % of GDP) 25% Monetary financing 35 Use of reserves 6% Total as % of GDP (rhs) 30 4.4% 5% 18.7% 20% 25 4% 20 3% 15 15% 2% 10 5 1% 10% 0 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Jul-10 Jan-04 Jun-09 Oct-13 Apr-07 Feb-05 Sep-12 Dec-15 Aug-11 Nov-14 Mar-06 May-08 Source: Central Bank of Argentina. Source: Ministry of Treasury and Central Bank of Argentina

• Inflation was around 25%

10 The political constraints

• Non-Peronist Presidents hadn’t finished their terms since 1945

• 2015 election was defined in a tight runoff (51% vs. 49%)

• Cambiemos was in minority in both houses of Congress

The chosen path (2016/17)

The chosen path in a nutshell

Monetary Fiscal Supply side and FX

Gradual fiscal Inflation Lower taxes on adjustment targeting exports

Financing in Higher utility Free capital international prices to mobility credit markets producers

Drastic reduction Spending in in CB financing to infrastructure the Treasury

13 Little fiscal adjustment at the beginning

Primary fiscal deficit By 2019 % of GDP 0 -0.4

-1 -2.3

-3.8 -3.8 -2 -4.2

-3

-4

-5 2015* 2016 2017 2018 2019 • In 2016 public expenditures went up, the adjustment began in 2017, but only gradually

• Tax cuts affected revenues Source: Treasury – SPNF (national).

14 Unchartered waters: Inflation targeting with high inflation

Inflation. Chile Inflation. Peru Inflation. Argentina

y.o.y. % chg. y.o.y. % chg. y.o.y. % chg.

Inflation Inflation Inflation 55 targeting 55 targeting 55 targeting regime regime regime

45 45 45

35 35 Monetary 35 aggregates regime 25 25 25

15 15 15

5 5 5

-5 -5 -5 19 19 - - 19 - Jul-92 Jul-97 Jul-02 Jul-07 Jul-12 Jul-17 Jul-92 Jul-97 Jul-02 Jul-07 Jul-12 Jul-17 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15 Aug Jul-92 Jul-97 Jul-02 Jul-07 Jul-12 Jul-17 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15 Aug Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15 Aug

Source: Central Bank of Argentina; Central Bank of Chile; Central Bank of Peru.

15 Inflation targeting

y.o.y. % chg. 60 Monetary IT regime 53.8 IT annoucement IT change annoucement 50 annoucement 42.7 40.5 40 New target annoucement Inflation

30 Initial targets (defined in sep-2016) 24.8 25.5 New targets (defined in dic-2017)

20 Sudden stop 15.0 10 10.0 5.0 0 Jun-16 Jun-17 Jun-18 Jun-19 Jun-20 Oct-16 Oct-17 Oct-18 Oct-19 Oct-20 Apr-17 Apr-18 Apr-19 Apr-20 Feb-17 Feb-18 Feb-19 Feb-20 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Aug-16 Aug-17 Aug-18 Aug-19 Aug-20

Source: Central Bank of Argentina.

16 Large adjustment in utility prices

Increase in price Public services of utilities Prices relative to CPI

Jan-01=1 Average variation - fares 2.0 Services 2016/2015 2017/2016 1.6 Gas Electricity Water Water 301% 23% 1.2 Transport Trains 51% 0% 0.8 Local buses 66% 0% 0.4 Gas 102% 130% 0.0 19 - Electricity 176% 82% Jul-13 Oct-11 Oct-18 Apr-15 Feb-14 Jan-10 Jan-17 Jun-16 Sep-14 Sep Dec-12 Mar-11 Mar-18 Aug-10 Aug-17 Nov-15 May-12 May-19

Source: INDEC.

17 CB remunerated liabilities

LEBACs to absorb monetaryCentral Bank remunerated liabilities overhang

% of GDP 12 Net repos 10.6 10 LELIQ LEBAC 8

6 5.2

4 Sudden stop 2

0 19 - Oct Jun-16 Jun-17 Jun-18 Jun-19 Sep-16 Sep-17 Sep-18 Sep-19 Dec-15 Dec-16 Dec-17 Dec-18 Mar-16 Mar-17 Mar-18 Mar-19

Source: Central Bank of Argentina.

18 Early results

• The policy mix lifted the economy out of the recession in Q3 2016, and the economy grew almost 3% in 2017

• The current account deficit widened to almost 5% of GDP in 2017

• Inflation went back to 25% in 2017 after an initial spike in 2016

• But the strategy entailed risks

Financial distress Sudden stop and adjustment (2018-Aug 2019)

The big risk

A sudden stop before the fiscal correction had concluded

• It happened. Financing for emerging markets dried up in Q1 2018

• And to make things worse, this came together with the worst draught in a decade that pushed the economy back into recession

• The sudden stop generated a run on the currency as LEBACs investors rushed for an exit and a spike in inflation

• The government sought IMF support to avoid a default (USD 50bn + 7bn, faster fiscal adjustment, tight monetary policy)

21 IMF agreement: early results

• Despite some political noise from the forthcoming presidential elections, the program managed to stabilize economic activity at the end of Q2 2019 and the economy grew 0.9% qoq in Q3 2019

• Inflation came down during 4 consecutive months between April and July

• But…

Financial distress Elections and confidence crisis (Aug 2019-…)

The primary elections results came as a shock

Lack of consensus and confidence crisis Confidence crisis

Nominal S&P Merval Index Country Risk: Private Deposits in Exchange Rate EMBI Argentina USD

ARS/USD ARS b.p. US D billion 60 45,000 2,600 34

40,000 32 55 2,100 30 35,000 28 50 30,000 1,600 26 25,000 24 45 1,100 20,000 22

40 15,000 600 20 19 19 - 19 19 - - - 11 12 - 11 12 - - - 09 09 07-12-19 07-19-19 07-26-19 08-02-19 08-09-19 08-16-19 08-23-19 08-30-19 09-06-19 07-11-19 07-18-19 07-25-19 08-01-19 08-08-19 08-15-19 08-22-19 08-29-19 09-05-19 09 07-11-19 07-18-19 07-25-19 08-01-19 08-08-19 08-15-19 08-22-19 08-29-19 09-05-19 07-12-19 07-19-19 07-26-19 08-02-19 08-09-19 08-16-19 08-23-19 08-30-19 09-06-19 09

PRIMARY ELECTIONS

Source: Central Bank of Argentina; Bloomberg.

24 A confidence crisis triggered a domestic sudden stop

Peso-denominated Debt Private Roll-over rate of Treasury Bills (LETE) Policy Issues %

160 PRIMARY EL ECT IONS 140 134 119 120 114 114 109

100 90 93 79 80 80 70 69 65 60 53 41 40

20 5 0 0 Jul-19 Jul-26 Apr-12 Apr-26 Feb-08 Feb-22 Jan-11 Jan-25 Jun-14 Jun-28 Mar-15 Mar-29 Aug-16 Aug-28 May-10 May-24

Source: Treasury.

25 Capital controls had to be reintroduced

Competitive FX, but FX controlsExchange rate and FX controls Confidence crisis

% Blue chip swap gap Real exchange rate (right axis) Index 12-17-15=100 90 160 80 140 70 60 120 50

40 Nov-11/16-Dec-15 avg.: 100 30 40.6% 80 20 Sep-19/Oct-19 avg.: 10 18.3% 60 0 -10 40 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Source: Central Bank of Argentina. 26 The aftermath

• The economy went back to recession

• Inflation jumped up following the large FX depreciation

• Argentina once again struggling to restructure its debt

Issues for discussion Economic legacy

• The imbalances and distortions have been resolved (not as planned), but unable to achieve growth and lower inflation while doing so • Confidence crisis leading to new debt restructuring

resultado primario Primary Balance (% of GDP) (% del PIB) 5 4

3 2007 2008 2 Currentresultado Accountde cuenta corriente (% del PIB) Balance (% of GDP) 1 2010 2009 2011 0 -6 -4 -2 0 2 4 2019p -1 2012 2018 -2 2013 -3 2015 2014 -4 2017 2016 -5

29 No more monetary overhang and positive real interest rates

Low monetizationMonetary Aggregates Interest Rates

% GDP s.a. % TNA 100 20% 90 80 70 15% 60 50 40 10% 30 20 10 5% 0 Jul-17 Jul-19 Jan-15 Jun-15 Oct-18 Jan-10 Apr-16 Jun-11 Sep-16 Feb-17 Jun-14 Dec-17 Aug-19 Sep-10 Sep-13 Feb-15 Feb-18 Nov-15 Dec-12 Aug-16 Mar-19 Nov-15 Nov-18 Mar-12 May-18 May-17

BM M1 Policy Rate BADLAR

Source: Central Bank of Argentina

30 Lessons and issues for discussion

• To leave populism behind both consistent economic policies and some consensus about them are needed • Corollary: an economic plan without some political consensus is not a real plan

• Reducing the costs of the transition is key for consensus, but…

• … it might create risks

• Beware of “partial equilibrium” best practices

• IMF (It’s Mostly Fiscal)

• Beware of Gresham law for economists

Thank you