Why is Argentina experiencing an economic crisis and high inflation? – 06/10/2023 – Market

Some would venture to say that the atmosphere of deep euphoria that stopped Argentina from celebrating the World Cup, last December, was more than a relief from the long hiatus without lifting the cup, but a collective catharsis that finally allowed us to forget our problems.

After all, Argentines are experiencing their third major crisis in 40 years of democracy, and not by coincidence: issues unresolved in the past help to explain the persistent deficit, the high external debt, the currency without credibility and the lack of dollars that cause inflation. explode.

Below, understand why money melts and poverty grows in the nation that was once richer than Germany, Italy and France. See also why the country, which remains Brazil’s third largest trading partner, after China and the United States, has not yet collapsed, being a few months away from the presidential election.

Why does inflation keep rising in Argentina?

The most palpable facet of the Argentine crisis is inflation, which has surpassed three digits since February and causes prices to rise almost every week. It is mainly caused by the abundance of pesos on the streets: the more the currency is on offer, the less it is worth, and this is visible in the wads of banknotes that Argentineans and tourists alike have to put in their pockets every day.

But why is there so much currency in circulation? The main reason pointed out by economists is that Argentina has accumulated fiscal deficits for over ten years, that is, it spends more than it collects. A large part of these expenses correspond to subsidies, such as electricity, water and transport bills, very cheap services compared to Brazil.

To finance its expenses, the government issues public bonds to be sold in the financial market (which allows these weights to be absorbed again, controlling inflation). But, in a country without credibility, the measure became insufficient, and the Peronist president Alberto Fernández simply started to print pesos, to the point of hiring mints in Brazil and Spain.

In the last 20 years, the circulation of money has grown at a much faster pace than the GDP (Gross Domestic Product), and the result is a rapid devaluation of the currency. If a year ago US$ 1 bought about 200 pesos in a clandestine exchange office, today it buys almost 500.

It is said to be clandestine because, in 2019, the government once again imposed a limit on the number of dollars that can be purchased by each Argentine (today at US$200 per month) and maintained the official exchange rate. The parallel dollar market, called “blue”, then grew. In practice, it is this exchange rate that governs the day-to-day life of Argentina.

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Why are there several types of dollars and their purchase is limited?

Argentina is experiencing a historic shortage of dollars in its coffers, mainly due to the high external debts contracted throughout its various crises. The country currently has just over US$ 30 billion in international reserves — to give you an idea, Brazil, for example, has more than US$ 340 billion.

What was already bad got worse due to several recent factors. Without credibility to attract foreign investment, the nation depends heavily on agricultural exports for foreign currency to enter, but a drought considered unprecedented hit the last crop of soybeans, corn and wheat, bringing production down.

In addition, exporters are reluctant to sell their stocks because the official dollar used in these transactions is worth much less than the parallel one, which determines their daily prices. In addition, the government imposes high taxes on exports to increase revenue (that of soybeans, the most important product for the country, is 33%).

To encourage them to sell and promote the entry of dollars, the government has created parallel quotations for each sector, more advantageous than the official one. There are already more than 15. In March, for example, a new agro dollar appeared, so instead of receiving 200 pesos for each dollar equivalent sold, the producer receives 300. There are also Coldplay dollars, for international shows, and Netflix, for streaming.

Why does the country need to reserve dollars?

First, because the lack of dollars makes imports difficult. To alleviate the problem, Argentina recently signed an agreement with China to carry out transactions in yuan, and has been negotiating with Brazil to create lines of credit to support Brazilian companies that export to their neighbor.

Second, because more than half of the country’s debts are, precisely, in dollars. This debt exploded in 2018, when, lacking the credibility to obtain foreign credit, Mauricio Macri’s management made the largest loan in the history of the IMF (International Monetary Fund), which was reformulated several times and totals US$ 45 billion.

To honor the pact, the nation needs to meet a series of goals that are periodically checked, such as reducing spending, the fiscal deficit and inflation, but so far it has failed to meet many of them. A tug of war was then installed: on the one hand, the government wants the fund to release resources and extend payment deadlines, on the other, the fund pressures the government to balance the accounts.

To complicate matters, this all takes place in a highly politicized economic environment, on the verge of a presidential election in October. Until then, there should be no shock reforms, only palliative measures (such as, for example, the price freeze, which has already caused a lack of products on the shelves) to hold the ends until the new president takes over.

If it does not pay the IMF, the country can say goodbye to any international financing. Due to the history of defaults, Argentina is no longer able to be attractive or raise its interest rates repeatedly. The peso has even lost credibility internally, so Argentines save and pay rent in dollars.

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What is the relationship between the current crisis and the past ones?

Weight weakness today is a consequence of past crises. If current inflation above 100% is considered extremely high, in 1989 it exceeded 3,000%, as a result of high debts contracted during dictatorial governments in the late 1970s and early 1980s.

While Brazil, which was experiencing a similar scenario, created the real and sought to strengthen it over the last 30 years, Argentina took the opposite path, pegging its currency to the dollar. In 1991, the so-called law of convertibility fixed the parity between them, that is, 1 peso became worth 1 US$.

At first, the plan worked, causing inflation to fall and GDP to grow. But in the long term, to maintain it, it was necessary to have US currency reserves that could not be sustained. With crises in the region and Asia, Argentine products became more expensive and investors left. The solution was to go deeper into debt, leading to another collapse in 2001.

With a new strong devaluation of the peso, the government decreed the freezing of savings (the “corralito”) and limited bank withdrawals. A wave of protests took to the streets for three months, President Fernando De la Rúa resigned, and the government defaulted billions on its creditors. To this day, Argentines are afraid to keep money in the bank, and investors don’t trust the country.

The main consequence is always an increase in poverty, which today has once again reached almost 40% of the population, 8% of whom are indigent. To soften the impacts of the crisis on these people, the government spends more on aid and pensions, feeding the revolving wheel of inflation.

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Why has Argentina not collapsed yet?

Mainly because wages and pensions, in general, increase along with inflation, with quarterly readjustments or when deemed necessary — the most affected are informal workers, who are increasingly voluminous. Unemployment closed at 6.5% in 2022, lower than in the pre-pandemic and against 9.5% in Brazil.

This, added to the fact that nobody wants to keep their weights burning in their hands, makes consumption and the economy spin. The growth of tourism also helps, since it is increasingly cheaper for neighbors like Brazil and Chile and for Europeans and Americans to travel to the country.

Analysts also cite a behavioral factor. Argentines already think it’s normal to live with rising prices for decades, so don’t despair. The social protection structure created after the 2001 crisis and the current government’s strong links with trade unions and social movements also minimally contain social chaos. At least until now.