Argentina: Alberto Fernández's slippery tightrope

Bnamericas Published: Thursday, January 02, 2020

The million-dollar question facing Argentina is whether President Alberto Fernández will pull the country out of the mire or compound its economic woes. 

A key plank in his strategy is boosting consumption and putting debt payments on hold for a few years to give the economy room to recover. 

Against this backdrop, BNamericas spoke with academic and economist Walter Bazán-Palomino to find out more about the Argentine government’s debt and spending plans and what authorities need to do to finally steady the ship, and more.

BNamericas: Argentine economy minister Martín Guzmán plans to suspend Argentina’s debt payments for two years. What do you think about this plan?

Bazán-Palomino: To start with, Martín Guzmán is a scholar who criticizes the role of the IMF and has little experience as a policymaker. On top of that, if Mr. Guzmán suspends Argentina’s debt payment for two years, then this is the beginning of the end. In the best case scenario, Argentina resumes paying its debt after two years. However, risk averse investors don’t believe in the Argentinian government – the country has a long history of sovereign defaults. The spike in short rates reflects the fact that the perceived risk of Argentina defaulting on its debt has increased.

The increase in the cost of debt has two major implications. The first implication is the depreciation of the Argentinian peso, which is the main problem. If you look at the currency composition of Argentina’s international assets and liabilities, the liabilities (short-term and long-term bonds) are denominated in US dollars. The former president [Mauricio] Macri partially replaced the peso-denominated debt held by the central bank with dollar-denominated debt held by local and international investors. On the other hand, the external assets are denominated in a mix of foreign currencies and Argentinian pesos. This means that when the peso decreases in value, the external assets will remain more or less unchanged, while the value of its external liabilities will spike dramatically. In the end, the market value of the debt is going to rise and with it, the probability of default. And the cycle starts again: high interest rates, depreciation and bigger market value of the debt.

The rise in the interest rate will lead to the second implication: Argentina is losing – and will lose – money overnight which is not related to fundamentals. Argentina had bought American bonds (assets) that pay negative interest rates while it had issued high-interest-rate Argentinian bonds (liabilities). The return on assets is below the cost of debt.

On the real side of the economy, the peso depreciation will create more inflation and plunge the real income causing a reduction of private expenditure and a recession. Argentina was in a recession in 2019 and it is expected to contract in 2020.

BNamericas: Meanwhile, President Alberto Fernández has indicated that he will increase spending. What is the root cost of this for Argentina / what are the implications?

Bazán-Palomino: If Mr. Fernández wants to spend more to get his country out of recession, then he should do it wisely. The fiscal deficit is the root cause and cost for Argentina’s debt problem because it produces the current account deficit and the persistent need for foreign money. Compared to advanced economies, the debt-to-GDP ratio is relatively low. But the main problem is the credibility of the Argentinian government to pay its debt. Investors hesitate to finance Mr. Fernandez's government due to the composition of the fiscal expenditure. 

If debt is used to finance projects that boost productivity (such as investing in infrastructure, education and health) and the government can use the proceeds from these investments to pay off its debt, then borrowing is worthwhile. We do not yet know if this is what will happen, and this is what I mean by saying “do it wisely.” If the spending is not done wisely, the increase in fiscal expenditure will have a domino effect: high inflation, recession and a debt crisis. The market will require high spreads, which could push Argentina into a liquidity crisis by the same market forces that produced the high spreads in the first place.

ALSO READ: Ricardo López Murphy: “If debt policy clarity is restored, this will produce a sharp drop in country risk”

BNamericas: Macri made progress in terms of reintegrating Argentina into the global economy. Do you think Fernández will do the opposite – and what would the implications of this be for the economy?

Bazán-Palomino: Historically, Argentina has been less integrated into the world economy than other Latin American economies. Macri was moving in the right direction but I am afraid that Fernández will undo most of the pro-market policies. As I said, the sovereign debt default is really likely to happen; especially after Martín Guzmán’s message of suspending Argentina’s debt payments for two years. A default on its debt will cause a rise in poverty, a longer recession, capital controls, bank runs (the nationalization of private savings), social upheaval and political instability.

Also, Argentina’s debt problem will have large impacts in other Latin American countries. In particular, the country risk premiums will increase with Bolivia, Ecuador, and Chile being the countries to pay the most for foreign credit. 

BNamericas: Are there any reasons to suspect that Alberto Fernández may not last a full term in office (for example, if inflation increases significantly)?

Bazán-Palomino: It’s difficult to tell, but inflation causes political instability and political instability causes inflation. In addition, a bank run and/or a nationalization of private savings will feed political instability because citizens could overthrow Mr. Fernández. The odds of this scenario are not low.  

BNamericas: In a nutshell, how can Argentina finally resolve the deep economic problems that have plagued it for decades?

Bazán-Palomino: There is no unique answer. The first strategy is to generate higher public revenue, not necessarily with higher tax rates. The second tactic is to reallocate government expenditure from final consumption to gross capital formation. This, in turn, can help to restore investors’ confidence, causing a reduction of future debt cost. Other benefits are the control of the depreciation and inflation rates. The third step is to make investment (private and public) more efficient. Last but not least, strengthening public debt management is crucial to attract investment in the long-run.

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