Argentina Is Investors’ Groundhog Day

Argentina Is Investors’ Groundhog Day

Capital controls, a controlled exchange rate and an outright default may prove to be the country’s best option

They say humans are the only animals to trip twice over the same stone. This is the ninth time international investors have tripped over Argentina.

Argentina’s government is renegotiating the terms of its $57 billion bailout package with the International Monetary Fund. A 30% slide in the Argentine peso against the U.S. dollar this year forced President Mauricio Macri to impose capital controls this week, as part of a bid to avoid the ninth default in the country’s 194-year history as a sovereign nation.

The capital flight has worsened since Mr. Macri lost a primary vote in August. The government has pledged to extend the maturity of $100 billion of debt, in a sign that it may work with the IMF to incrementally “reprofile” the paper so it can be paid at later dates.

The lesson for investors should be that a pro-market, IMF-friendly government isn’t enough to justify optimism on Argentina—and may give them a dangerous sense of security.

Mr. Macri’s pro-business agenda after coming to power in 2015 reopened the country to financial markets after a 15-year battle with creditors over its 2001 default. Foreign-currency debt surged by 50% as investors piled into the country’s new paper, including a now-infamous 100-year government bond.

Mr. Macri convinced investors that the debt would be manageable if enough pro-market reforms were implemented. However, this isn’t how things work in developing countries, where capital invariably rushes out the door as soon as the global investment environment deteriorates, regardless of domestic policies. This scenario has unfolded over the past year and a half, hitting the peso hard.

Currency falls trigger a dangerous feedback loop, because the prices of imported goods surge and workers push for wage rises to match. Higher labor costs fuel inflation further, making the currency worth less—and so on. This dynamic is particularly entrenched in Argentina, data shows, because unions are very strong and utility prices are dollarized.

The IMF, which tends to pin too much blame for inflation on budget deficits, hasn’t helped. This time, in exchange for the loan, it demanded tight monetary and fiscal policy, fueling a wave of discontent that is likely to topple the government. Argentine officials themselves—such as the previous central-bank president—have played down the role of the currency and higher energy bills.

The IMF faces a conundrum, because Argentina does indeed suffer from the short-term cash crunch that the fund is best suited to fix. The central bank and government need to roll over more than $30 billion in short-term foreign-currency debt every month, which is half of their reserve pot.

However, the country’s total external debt pile may be too large to grow out of, especially amid fiscal austerity and runaway inflation. In July, the IMF increased its debt forecast to 60% of gross domestic product by 2024, due to slower growth and higher interest rates.

The IMF’s new policy of choice for cases in which the sustainability of a country’s debt is in question is to “reprofile” it by pushing back the payment schedule. However, in the case of Argentina, this is likely to prolong the pain until the debt is eventually deemed unsustainable and restructured. It would be preferable to do this right away, as part of an effort to permanently reduce the country’s dependence on overseas money.

As much as it may feel like Groundhog Day for investors, capital controls, a controlled exchange rate and a ninth default—as contentious as that could prove to be—is probably the best way for Argentina to climb out of its hole. es un sitio web oficial del Gobierno Argentino