Argentina: stop crying for me

Whether President Javier Milei can successfully transform Argentina’s economy is the crucial question for the country itself, for the IMF as its main creditor and for foreign investors who have been hit with a series of Argentinian defaults in recent years. We think Milei’s plans can work. It’s time to stop crying for Argentina.

Four types of economy

Simon Kuznets, who won the Nobel prize in economics in 1971, said there are four types of economies — developed, undeveloped, Japan and Argentina. The two main features that put Argentina in its special category are high inflation and weak growth but they are superimposed on structural weaknesses of the economy – notably its inability to make the most of its resource endowment and still high levels of perceived corruption.

High inflation

Argentina has a history of high inflation and, indeed, hyperinflation - which is generally taken as a rate of price increases above 50% per month. Argentina’s peak inflation rate was well above that rate  in July 1989 when it peaked at 197% month-on-month according to the Hanke-Kruz hyperinflation table (https://www.cato.org/sites/cato.org/files/pubs/pdf/hanke-krus-hyperinflation-table.pdf .)

At that rate, prices double every 19.4 days. President Milei’s top priority was cutting the inflation rate and it has already declined from 25.5% month-on-month in December 2023 to 2.4% in November 2024. But the introduction of a 10,000 peso banknote (worth about US$11) gives the impression of a country still in hyperinflation. And, indeed, memories of hyperinflation typically linger for a long time. Breaking an inflationary psychology is not easy.

High inflation has meant that the Argentinian peso has generally weakened against the US dollar over time but the depreciation is currently limited to 2% per month. This has meant the real value of the peso has appreciated recently (that is, its decline in value has been smaller than the inflation rate), hampering export competitiveness.

Dollarisation

Milei’s original plan for inflation control was dollarisation of the economy and abolition of the central bank. That plan has now been replaced with one which envisages “endogenous dollarisation”:  restricting the supply of pesos (which would become a “museum piece”) and thereby encouraging a shift to the dollar. The peso was pegged to the dollar for more than ten years (from April 1991 to January 2002) before that peg was abandoned, with dollar bank loans and deposits forcibly converted into pesos. That suggests only full dollarisation would eliminate currency risk. But there is no guarantee that such a move, if taken, would be permanent. Zimbabwe, for example, reintroduced its domestic currency after ten years of dollarisation. Dollarisation may not last.

In order to improve growth prospects Milei plans to roll back the size of the state. Initial results have been encouraging, with the government budget likely to be balanced this year. Initially, as is typically the case with such reforms, there has been an adverse impact on growth. GDP is expected to decline by 3.5% in 2024 according to the IMF’s October 2024 forecast. This follows a long period of decline relative to other Latin American economies and the rest of the world.

The World bank in its 2024 report https://tinyurl.com/yjrm27bj commented that the country was the seventh wealthiest nation in the world in 1918. Economic success was driven by an open economy and progressive immigration policies. Weakening economic performance in the last century caused its income to fall below high-income country levels, resulting in Argentina being demoted to middle income status in the 1960s. Persistent economic instability and inefficient policies have hindered development, with the country’s annual GDP growth rate averaging only 1.8% over the past half century, well below the Latin American average of 3.2%.

Argentina is rich in natural resources. Realising its potential has, of course, been Argentina’s perennial problem.

IMF programmes

On May 13th the IMF said Argentina had made better than expected progress in reaching its economic targets and plans to release USD800m of funds to Argentina. Argentina wants to borrow more to help finance the removal of strict capital controls. Presumably, that is because the removal of controls would lead to a capital outflow. Argentina has had 22 IMF loans since 1958 and currently owes the IMF $43bn.