Is there a way out for Argentina

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Monica de Bolle (PIIE)

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Photo Credit: REUTERS/Adriano Machado

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The sweeping victory of Javier Milei, a little-known far-right libertarian economist, as the next president of Argentina, reflected voters' rejection of the failed policies of the country's Peronist past. On the surface, the voters' preference appears predictable and somewhat understandable. But it is extremely unlikely that Milei will deliver a way out of Argentina's chronic record of hyperinflation, debt defaults, recessions, and unemployment-conditions likely to continue for many more years.

It is no surprise that Argentina's 46 million citizens feel that they have had enough of the status quo. Although Argentina's per capita GDP is second only to Chile's and 40 percent higher than Brazil's, its current inflation rate surpasses 140 percent per year. The fiscal deficit is more than 4 percent of GDP, and the debt-to-GDP ratio has reached 80 percent. Importantly, Argentina has only $21 billion in international reserves in its central bank while facing an upcoming $4 billion payment to the International Monetary Fund (IMF).

Milei takes office on December 10. While campaigning against Sergio Massa, the Peronist candidate and economy minister, Milei vowed to shut down the central bank and officially dollarize the economy-that is, to substitute Argentinean pesos with US dollars. Railing against "socialism," he also vowed to cut spending, lower taxes, reduce regulations, privatize state industries, consolidate federal ministries, and transform public education and health care by shifting toward vouchers and private insurance.

Since his victory, these plans have become, if not completely unfeasible, at least distant. Milei has admitted that dollarization will not happen "any time soon," perhaps realizing that shutting down the central bank and officially adopting the dollar as Argentina's currency would require constitutional changes. He lacks the votes in Argentina's Congress to pass legislation or amend the Constitution. (The first round of elections in Argentina in October reelected several Milei opponents.)

Some of those elected, including supporters of the former presidential candidate Patricia Bullrich and former president Mauricio Macri, formed an alliance that backed and helped elect Milei, but they oppose dollarization. To govern, Milei needs not only their support but also the backing of disaffected Peronists, that is, those who proclaim themselves as members of the Peronist movement but are staunch opponents of a still powerful faction led by former president and outgoing vice president Cristina Kirchner. These Peronistas also do not want dollarization.

Peronism is a term that may confuse outsiders. It dates, of course, from Argentina's crisis-plagued economic history in the immediate postwar period when, under the leadership of Juan Domingo Perón, the country staggered through a disastrous push toward industrialization and modernization. Today Peronism is neither a political party nor a coherent movement but a phenomenon that mutates as circumstances change. Perón remains widely revered as the father of modern Argentina, but Peronists can be from the right or the left, supporters or opponents of Kirchner, defying a unified definition. Milei could arguably adopt a "libertarian" version of Peronism to gain support, as reflected by his new alliance with the governor of Córdoba, Juan Schiaretti, and his allies in Argentina's Congress. Milei's newly announced cabinet thus includes anti-Kirchner Peronists, allies of Macri, and associates of Bullrich. To say that such an alliance is fragile is an understatement.

A History of Financial Crises

To better understand Argentina's cycle of economic crises, it helps to trace the history of Peronism from its original goal to turn away from the nation's largely agriculture-based economy, which was overly dependent on international fluctuations of commodity prices, and toward industrialization using whatever means necessary: protectionism and subsidized credit for selected sectors, combined with targeted government social welfare spending for favored population segments. Adopting the advice of so-called dependency theory advocates, Perón also created labor protections for the new urban-industrial labor force, as well as several state-owned enterprises. In a pattern that was to be repeated over many decades, enactment of these policies between 1946 and 1955 increased Argentina's budget deficits, its external debt, and balance of payments vulnerabilities, laying the groundwork for future boom and bust cycles.

By 1977, the country was suffering its first bout of hyperinflation, with an annual rate of over 300 percent. In 1978, an inflation stabilization plan was attempted, and it succeeded in halving the inflation rate for a short period. But in 1981, the country had a severe balance of payments crisis, which led to a debt default accompanied by a banking crisis. By 1985, inflation had spiked to more than 670 percent, forcing the adoption of the Austral Plan. The currency's name was changed from the peso to the austral, wages were frozen, the exchange rate was fixed, and spending was slashed for a brief period. Ultimately, the Austral Plan failed, and by 1989, inflation had reached more than 3,000 percent. Argentina's attempts at stabilization involved several IMF programs generally calling for tough austerity measures, including budget cuts, deregulation, and a floating currency.

In 1991, Argentina adopted the so-called Convertibility Plan following several reforms, including some designed to rein in the budget deficit, which succeeded in eliminating the country's hyperinflation and restoring stability for a time. Over the next decade, Argentina fared somewhat well despite a banking crisis in 1995. By the late 1990s, other problems associated with growing domestic imbalances were aggravated by external shocks stemming from emerging-market crises of that period. Spurred in part by commodity price fluctuations and financial panics, these crises took their toll on the economy.

When Brazil was forced to devalue its currency in 1999, Argentina's fixed parity with the dollar accentuated its lack of competitiveness, further weakening its already fragile economic situation. In 2001, Argentina finally faced its demons, abandoned the Convertibility Plan, and suffered its worst financial crisis in modern times. The crisis involved a complex debt default, a collapse of the banking system, and a deep recession. By 2003 the outlook had improved significantly as a result of rising commodity prices in international markets.

During the worst of the turmoil in 2001, Argentina became famous for its revolving door of five presidents in only 12 days. Eduardo Duhalde, appointed as interim president by Congress in January of 2002, would see the country through the aftermath of the crisis, handing the presidency to Néstor Kirchner in 2003 following his victory in the 2003 elections. During his time in office, Argentina grew at an average clip of about 8.5 percent annually fueled by high commodity prices as well as some domestic reforms. In 2007, Néstor Kirchner's wife Cristina Kirchner was elected president. Néstor had planned a comeback to power, but he died in 2010, one year before Cristina was reelected for a second term.

Cristina Kirchner's time in office, from 2007 until 2015, became the hallmark of what is now known as Kirchnerism, a mixture of ad hoc government interventions in the functioning of markets-including setting or freezing certain prices-and tinkering with Argentina's statistics, particularly with official inflation data. Her tenure was plagued by fiscal irresponsibility and corruption scandals. Argentina did manage to avoid a major financial crisis during her time in office, helped by high commodity prices and investments from China, but it remained vulnerable to crises. Cristina's successor, Mauricio Macri, failed to resolve inherited and newly created problems, helping to lead the economy to its current state.

The Path Forward

If Argentina's problems were confined to high deficits and debt, Milei might be able to accomplish "the end of decadence," as he put it in his victory speech, with reforms similar to those tried in the past. But Argentina now has to contend with hyperinflation as well. Hyperinflation is far from a run-of-the-mill inflationary problem. It reflects a complete breakdown in trust of the institutions responsible for preserving the value of the currency.

Put differently, hyperinflation dooms faith in a country's currency, which is why Milei put dollarization on the table. But his proposed path is not viable or desirable. Dollarization deprives Argentina of the ability to conduct its own monetary and exchange rate policies, a severe handicap for an emerging-market economy afflicted by external shocks. Moreover, dollarization is not credible if the government had failed to retain enough international reserves to deploy to protect against such shocks. At the moment, Argentina's dollar-denominated liabilities exceed its dollar-denominated assets. Its net reserve position is thus negative-it owes more in dollars to foreigners than it has possessed.

The only realistic solution to Argentina's problems lies in a combination of deep fiscal, institutional, and monetary reforms along the lines of what Brazil did in 1994 with its Real Plan, which led to the end of over 20 years of hyperinflation. Following six attempts to change its currency, Brazil succeeded in its seventh try. Argentina tried this route at least twice in the 1980s and failed. It needs to try again, only this time with institutional reforms that instill trust in the new currency. Such reforms would entail a massive fiscal adjustment, which the incoming government has pledged to undertake, as well as limits on spending and borrowing by provinces and new laws that would prevent the central bank from issuing money to finance fiscal deficits. Such a plan would not require the abandonment of Argentina's sovereignty over monetary and exchange rate matters in a program of dollarization.

A plan of this magnitude needs enormous political coordination and alignment of various interests, not least the buy-in of debt-burdened provincial governments that possess autonomy on fiscal matters undercutting the central government's ability to manage overall fiscal policy. To undertake reform, Argentina's governors would need to agree to abandon this autonomy-a political impossibility. Milei also lacks the votes for other reforms needed to create a new domestic currency.

The IMF has stepped into Argentina's affairs no less than 21 times to date, enforcing certain reforms in exchange for help. Can it do so again? Because of this long and fraught history, however, Argentineans do not trust the IMF and believe it to be partly responsible for economic strife. Politically, Milei will have an extremely hard time selling yet another IMF program to the population, even if some of the policies he defends are ones that the IMF would likely request.

China has acted in the past to bolster Argentina's dwindling reserves. Would it play a role in rescuing Milei's government? One vehicle could be the New Development Bank (NDB) established by BRICS countries (Brazil, Russia, India, China, and South Africa) to support development projects. But the NDB has never been called upon to aid a country in financial distress. Still the bank is led by the Chinese and headed by former president Dilma Rousseff of Brazil. Additionally, China has interests in Argentina, notably in the mineral sector, and the country could be willing to ignore Milei's anti-China antics during the campaign in favor of providing much-needed financing. Financing would evidently come with strings attached, particularly with respect to critical minerals sectors such as lithium extraction. Argentina is the world's fourth largest lithium producer.

In conclusion, the legacy of crises confronts Milei with tough choices and little room to maneuver, despite his populist appeal. Dollarization is unlikely to happen, but stabilizing inflation requires painful policies that the political system is not yet prepared to undertake. The next few months will be challenging and interesting in equal measure.

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