from Follow the Money

No more Lavagna. What’s next for Argentina?

November 28, 2005

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Two weeks ago I would have expected Brazil's Finance Minister to be forced out before Argentina's Finance Minister...   However, Palocci is a close ally of Brazil's Lula; Argentina's Lavagna has never been all that close to Argentina's Kirchner.  Rather, Lavagna has long been both a key ally and a potential rival to President Kirchner.   After today, he is just potential rival. 

Lavagna predated Kirchner in some sense; he started in the Economy Ministry before Kirchner was elected President.  After Kirchner's big (proxy) win in the fall elections, Kirchner apparently decided he no longer needed Lavagna.  The new Finance Minister -- Felisa Miceli - lacks Lavagna's independence.  She clearly is Kirchner's choice.   The governor of the central bank (Redrado) is a Kirchner pick too.  

I do not follow Argentina as closely as I once did.  But I have a bit more confidence in Lavagna than Kirchner, so, like many, I am interested to see if Kirchner and Miceli will adopt different policies than Kirchner and Lavagna.

Yes, Lavagna took a hardline in Argentina's restructuring negotiations.  But after Argentina's quaisi-currency board collapsed, Argentina had far more debt than it could realistically pay.   Realistically, Argentina needed to both reduce the stock and reduce the coupon on that debt.   And I also think Lavagna's (and Kirchner's) core calculation was right: after Argentina's default, the international sovereign bond market was not going to be central to financing Argentina's future development.

But Lavagna's tough line in the debt negotiations was combined with a vision that potentially allowed Argentina to exit from its cycle of debt and default.    Under his leadership, Argentina consistently took in more in tax revenues than it spent on items other than interest (i.e. Argentina ran a primary surplus).    That was an enormous change.   Back when Argentina was the market's darling in the late 90s, it never ran primary surpluses.   Sustained primary surpluses -- along with continued growth -- offered the prospect of sustained reductions in Argentina's debt levels.

In broad terms, under Lavagna. Argentina reduced the cash that it promised to pay bondholders through its restructuring, but it also adopted policies that increased the odds that they would get paid what they were promised. 

Lavagna also deserves immense credit for helping to stabilize Argentina's economy in the dark days after Argentina's devaluation and default.  The IMF at the time more or less expected that Argentina would start running the printing presses.  Argentina did not do so, largely because of Lavagna's fiscal policies.  Yes, not paying its bonds helped.  But default hardly guaranteed basically balanced budgets, let alone significant primary surpluses.   For more on this period, see my recent paper (with Anna Gelpern) on Argentina's Pathway through its 2000-02 crisis; a paper I did for a project sponsored by University College Oxford's Global Economic Governance Programme. 

Lavanga of course did not act alone - Kirchner deserves credit here too.  But  Lavagna seemed to understand that Argentina's recovery was based on both on some relatively heterodox policies (Argentina's aggressive negotiating stance in the debt restructuring) and some rather orthodox policies (conservative fiscal policy).  Without Lavagna, the balance between heterorthodox and orthodox may change. 

And while Kirchner's new team faces some real challenges.   

Finding a coherent response to rising inflation is likely to be the most urgen challenge.   The recent rise in inflation doesn't stem fundamentally from loose fiscal policies -- or greedy supermarket owners.  Rather it has been fueled by Argentina's policy of resisting upward appreciation of the peso.

 Argentina's central bank has been buying up dollars all year, in part because capital has been flowing into Argentina.  But it has resisted sterilizing (selling local currency bonds) its rising reserves, since sterilization risks driving local interest rates up.  Rather it has been adding to the stock of pesos. (see this Wells Fargo report for basic data on Argentina)

The not entirely surprising result of a weak peso and (relatively) loose money has been rising inflation.    Argentina's central bank governor may not think it is raining pesos -- see his letter to the Wall Street Journal - but it does seem that inflation is heading up, not down, in Argentina.

Letting the peso rise a bit is an obvious policy response, one that makes more sense than trying to convince the supermarkets to keep prices down.   And Argentina could let the peso rise a bit without returning to its old policy of keeping the peso systematically over-valued through the peg as a bulwark v. any inflation.  Remember, Argentina's real exchange rate is getting stronger right now because of high inflation even if the peso is not getting any stronger ...  

Ironically, if Lavagna's ouster reduces confidence in Argentina and capital stops flowing in, that might ease pressure on the central bank.  Today the central bank seems to have intervened to keep the peso from falling - not to keep it from rising.

Figuring out Argentina's future fiscal policy course is challenge two.   Before the elections, spending was rising faster than revenues a trend, that if sustained, would gradually erode Argentina's post-crisis fiscal framework.  The FT:

One uncertainty concerns Argentina's fiscal performance. Under Mr Lavagna, the country posted record primary surpluses (before taking into account debt interest payments). He told the FT recently that he had done so by "saying no to the vested interests". Some analysts worry that Mr Lavagna's successor may not be as tough, particularly given mounting pressure from trades unions for wage rises.

Government spending has risen 24 per cent this year, a jump that many associate with Mr Kirchner's long and expensive political campaign ahead of legislative elections last month. Mr Kirchner's supporters in the centrist Peronist party scored a big victory at the polls, increasing their representation in the legislature. 

And I would argue that finishing the restructuring remains a key policy challenge.  This has several dimensions:

  • The big debt restructuring in the spring took care of most of Argentina's external sovereign debt, but there is still roughly $20 billion (face) in unrestructured bonds outstanding.   The post-restructuring deal with Argentina's holdouts (assuming there is eventually a deal that lets the initial holdouts go into the exchange at a discount) will be one of the largest sovereign bond restructurings on record, exceeded only by Argentina's earlier restructuring and Russia's 2000 restructuring.  
  • Argentina still needs to reach agreement on final "restructuring" terms with its domestic utilities.  That means reaching agreement on current prices, and in a sense on how large the utilities losses during the crisis will be - and figuring out how future investment will be financed.  Argentina won't be able to rely on the infrastructure that was built before its crisis forever - at some point future growth will require new investment in some basic infrastructure (power, gas, water and the like).  And getting that investment required doing a few deals ...
  • And less obviously, I think that over time, the terms of the post-crisis restructuring of the debt held by banks will need to change.   That can happen naturally, if old bonds are refinanced with new bonds.   Argentina's banks will remain hobbled so long as their primary asset is Argentine government bonds that pay real interest rates of 2%.   

Argentina's domestic bonds often are indexed to inflation, with the inflation indexation added to bonds principal value.  That reduces the amount of cash the government has to pay on its bonds.  It also leaves the banking system in a weak position should domestic deposit rates rise.    And at some point they will need to rise.   

Addressing this problem need not involve a formal restructuring - a fair amount of Argentina's domestic debt needs to be refinanced in any case, so its terms can evolve naturally.  But it does suggest that Argentina still has plenty of difficult decisions to make - higher real rates on Argentina's domestic debt or higher cash payments and less capitalization, for example, both would have implications for Argentina's budget.

And many of these decisions will be made in a broader political context where Latin America's disillusionment with Washington is obvious - and in many places, that disillusionment seems to extend to Washington consensus economic policies.   I don't think the Washington consensus has worked as advertised.  But I also don't think that heavily indebted Latin economies can easily abandon relatively prudent fiscal policies without paying a price.

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