When they meet Tuesday to discuss the currency crisis, senior officials from Argentina and the International Monetary Fund will seek a response that strikes a balance between domestic policy changes and external financing aid, a task that has been complicated by political and trust issues. While Argentina is almost certain to get some concessions from the IMF, a decisive solution will be far more difficult and will require a lot of courage and skillful risk-taking on both sides.
Argentina’s currency woes have deepened in recent weeks despite determined policy responses on the part of the government and the central bank (after some missteps), as well as a $50 billion financial package from the IMF. A large part of the reason for the lack of success is the insufficient initial acknowledgement of the adverse technical and illiquidity forces that have been battering the emerging- market asset class, and have yet to play themselves out. As a result, Argentina’s economic slowdown will worsen, the inflation rate will spike, debt-servicing tensions will increase, the banking system will come under greater pressure and the risk of disruptive capital flight will grow.
Recognizing this risk, Argentine President Mauricio Macri on Monday armed Finance Minister Nicolas Dujovne with additional domestic adjustment measures to present to IMF Managing Director Christine Lagarde in Washington on Tuesday. While full details haven't been disclosed, taxes on exports and cutbacks in government ministries appear to be the biggest elements of a policy package aimed at further reducing the budget deficit and providing a better context for the IMF to, at a minimum, accelerate the scheduled disbursements under the existing financial arrangement.
You’d think markets would be impressed with this carefully choreographed effort to combine further domestic policy adjustments with further external financial support. But instead of rebounding from its brutal depreciation last week, the Argentine peso weakened further after the proposed policy package was announced Monday, threatening to set a new record low.
There are understandable economic, political and technical reasons for this.
On the economic front, markets are worried about the combination of further -- and, especially, excessive -- austerity and insufficient pro-growth structural reforms. Together, these steps could hit the domestic corporate sector with a demand collapse that would aggravate rather than alleviate the impact of the currency crisis on its ability to raise fresh capital and meet debt service obligations. Moreover, unless it is very skillfully crafted, the return to export taxation could undermine the country’s ability to generate the foreign exchange it needs to limit its external funding gap at a time of tougher global financial conditions for emerging countries as a whole.
Politically, the additional austerity could further erode Macri’s popularity and undermine his prospects for re-election next year. This would increase the probability of Argentina being governed by a party that is a lot less inclined to embrace conventional policy responses, the IMF, external creditors and foreign investors.
Technically, there is still sizable foreign capital that, for both portfolio-performance and reputational reasons, feels trapped in Argentina and is itching to get out. Any favorable development risks being viewed as an opportunity to exit rather than remain, let alone increase exposure.
On paper, the best way to deal with this combination of factors would be for the IMF to increase aggressively the overall size of its financial support in exchange for greater structural reforms. Although this would be another exceptional financial step for the fund, which has already committed to substantial funding for Argentina, it could be justified not just on domestic economic grounds but also by the need to contain and reverse emerging-market contagion that harms other countries, including the better-managed ones. It is also likely to get the support of some of the IMF's major shareholders.
Provided it is large enough, this kind of increased funding from the IMF could serve as the much-needed circuit-breaker through both its direct and indirect effects. It would immediately reduce the amount of foreign capital that Argentina needs to secure from other sources. And it would improve the prospects for crowding in additional private capital, including investors who are sidelined even though they feel that this is a classic case of an EM overshoot with remunerative risk-return characteristics -- that is, the country’s underlying fundamentals do not justify such high interest rates and such a sharp currency depreciation.
But beyond the serious policy implementation risks and the tricky program design issues, the IMF is operating with the legacy of a complicated -- and at times, very unhappy and highly contentious -- history with Argentina.
The multilateral institution is still scarred by the December 2001 Argentine default that was preceded by a controversial round of increased lending for an unsustainable and ill-designed domestic policy stance. The IMF’'s activities and intentions are still often met with suspicion in Argentina today. In addition, the fund has undergone another painful and brand-eroding experience -- with Greece -- where the support package was excessively tilted in favor of domestic demand compression and insufficiently in favor of external debt relief and growth, a mistake the IMF itself has recognized, albeit belatedly.
There is no easy and risk-free way out of Argentina’s currency crisis. While the temptation will be to just accelerate the already-committed disbursements, significant courage and perseverance, together with quite a bit of luck, may be needed by all parties. And this is before taking into account a global economy facing greater uncertainty with respect to growth, trade, policy coordination and financial conditions.