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A combination of a large fiscal deficit and the hike in previously regulated utility prices has led to continued high inflation in Argentina, experts say. Here Calle Florida in Buenos Aires. (Photo: Buenos Aires City Government)
Wednesday, April 25, 2018

Argentina: The Inflation Challenge

Argentina’s government struggles to tame still-high inflation.

Inter-American Dialogue

Economists raised their expectations for inflation in Argentina while shaving growth forecasts in a monthly central bank poll released on April 4, Reuters reported. The poll found median inflation expectations for this year rose to 20.3 percent, up from 19.9 percent last month and above the government target of 15 percent inflation this year. Meanwhile, economists’ median GDP growth forecast for 2018 fell to 2.5 percent from 2.7 percent previously. In more positive news, state statistics agency INDEC said last month that Argentina’s poverty rate fell to 25.7 percent in the second half of 2017, down from 28.6 percent in the first half of the year and 30.3 percent in the second half of 2016. What do recent economic indicators say about the outlook for Argentina’s economy? Why has the country’s inflation rate been so difficult to bring down? Are Argentine citizens feeling the benefits of President Mauricio Macri’s pro-business economic policies?

Alberto Ramos, managing director and head of Latin America economic research at Goldman Sachs in New York: We hold a constructive view of Argentina’s macro financial outlook, but that hinges critically on further tangible progress towards fiscal consolidation, for that is key to guarantee medium-term domestic (low and stable inflation) and external (moderate current account deficit) balance. Large fiscal deficits alongside high and sticky inflation remain the key macro imbalances of the Argentine economy.

They are interconnected and combine to keep the currency misaligned (overvalued) and the external accounts out of balance. The authorities are expected to continue to embrace an orthodox market and investment-friendly policy approach but are in the short term challenged to get a grip on the inflation dynamics and reinforce the credibility of the young inflation-targeting framework as the main nominal anchor for the economy. The stickiness of the inflation dynamics is first and foremost a reflection of inertial forces, pervasive indexation mechanisms, and the authorities’ effort to strengthen the public finances by reducing costly budgetary subsidies. Cutting subsidies has led to sizable increases in regulated prices/tariffs, pushing the annual inflation rate for regulated prices up to a high 38 percent. We expect the inflation outlook to improve going forward, supported by the fading impact from the large increase in regulated prices, a tight/conservative monetary stance, and further gradual progress on fiscal consolidation.

Disciplined, market-friendly and pro-investment policies are expected to support growth, employment and economic opportunity, and a stronger macroeconomic performance (solid growth and moderate inflation) should trickle down from the economic to the social sphere by empowering larger segments of the population.

Claudio Loser, senior fellow of the Inter-American Dialogue and former head of the Western Hemisphere Department at the International Monetary Fund: The new projections for GDP resulting from the pro-growth policies of President Macri for 2018 are debatable. Projections of 2.5 percent growth for the rest of the year are plausible, in part due to an ongoing drought. However, local economists usually tend to be too pessimistic.

Inflation is another story. Inflation expectations are higher than the Central Bank indicates (20 percent vs.15 percent), but still show a decline in the medium term.

The main culprits are the pressures of the powerful government and transportation  unions, the necessary correction of public prices, but most importantly, the large fiscal deficit. Public finances have improved, but even with a high foreign borrowing component, the high deficit puts pressure on inflation. Clearly, the economy is in a growth mode, with investment increasing. However, Argentines, particularly the middle class, have been hit by a sizable reduction in subsidies for electricity and gas, even if prices (at an over-valued exchange rate) remain below comparable values abroad. The resulting discomfort does not take into consideration the previous dismal quality of service, and the sharp increase in investment in and output of these products. The government has lost popularity, but views about the Peronists are even more negative, and at election time even those that are unhappy would not vote for the opposition. Still a lot of work lies ahead for this government if they want to succeed in getting out of the 75-year boom and bust cycle that characterizes the Argentine economy.

Miguel Kiguel, executive director of EconViews in Buenos Aires: The most recent figures indicate that the economy continues to move at a good pace despite the worst drought in decades, but that inflation remains high and will end this year well above the official target. Last year started with just green shoots, but towards the third quarter it was clear that the growth process was consolidating and that most sectors were benefiting. The biggest winners were construction, agriculture, energy and financial services, while the losers were some industries (especially textiles) and the retail sector. The initial figures indicate that growth continues unabated. True, it has been running at around 2.9 percent per annum, but there is a good chance that it will be sustained over many years, and in contrast to previous expansions investment is going to have a leading role in this process (last year it increased by 13 percent). The news on the inflation front has not been so positive.

During the first quarter it reached 6.7 percent, slightly higher than last year and, more worrisome, core inflation in March was 2.6 percent which was above the 2.3 percent headline rate of inflation. In April, we expect that inflation will remain above 2 percent due to the increases in some regulated prices and the tail effects of the depreciation in the currency. The central bank will maintain a tight monetary stance, and now it is unlikely to lower interest rates till June. May will be the critical month to evaluate the effectiveness of the fight against inflation because we don’t anticipate further increases in regulated prices nor a sharp depreciation of the currency. If inflation follows last year’s pattern and it drops to the 1.5 percent range, it could mark a clear turning point in the fight against inflation. If it does not happen, the government will probably need to re-think its stabilization policy.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor


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