Informe completo en PDF

How to change relative prices and not die trying


Resumen Ejecutivo

The Treasury is the biggest loser

The myth of Sisyphus and the impact on rates 
Consumption: Why doesn't it reactivate yet?
Relative prices: eighteen months later

The previous administration used and abused the foreign exchange rate and utility rate anchors in order to manage an inflation rate a bit higher than 20% annually over the last ten years. There was a feeling of welfare while the economy had plenty of US dollars, combined with wages that exceeded inflation rates year after year. This was influenced above all by the US dollar, together with the two-fold increase in retirees receiving pensions and the creation of the Universal Child Allowance Benefits program that covered over four million children. All of the former brought about an unprecedented increase in consumption. Towards 2011, per capita consumption rose to record-breaking levels and imports per capita at constant prices doubled the best level recorded during the convertibility regime.  But this record-breaking level of imports, together with a decreased dynamism in exports, reactivated external restriction.

It was precisely that shortage and the political impediments to international loans that broke the system’s “short-term virtuosity”. But, while “sustainable populism" stopped being sustainable when commercial dollars ran out and, luckily, funding remained inaccessible, the practice of administration via exchange market restrictions and price control allowed for adjustments to be postponed. It is true that between 2011 and 2015 the economy did not grow and that in per capita terms, it shrunk by 5%, but it is also true that much was left undone for the next administration to solve (relative price distortion, fiscal gap and trade deficit). The only valuable asset was a debt-free economy and this was the factor that, in a highly liquid world, allowed the government to choose the gradual path.

A gradual path of varying intensity: more aggressive as regards utility rates and lowering export duties as a clear signal to correct the trade deficit, but at the same time, not aggressive enough regarding taxes. Indeed, to the contrary, since the lowering of taxes with funds reimbursement to the provinces and the dynamics of expenditure (with rates that assist the power industry balance sheets rather than reducing the fiscal effect of subsidies, the historic reparation in the pension system and the decision to boost the economy in 2017 through public works) brought about an increase in fiscal deficit before debt interests. An increase in deficit that was offset in 2016 and 2017 by the extraordinary income stemming from the tax amnesty on previously undeclared assets.

The improvement in real wages stemming from the virtual freezing of rates since the end of the convertibility regime reached 20%; in other words, should rates have risen between 2001 and 2015 in line with average prices, all other items remaining stable, salary buying power would have decreased by 17%. This compounds the fact that the closing of the economy allowed for prices of goods to greatly exceed international prices, since said protection allowed transferring most of the increase in costs to internal prices (at least to the list prices which are included in cpi).  In November 2015, while regulated utility rates in US dollars were 67% lower than those at the end of the convertibility regime, the prices of goods and services were 33% and 27% higher. This becomes even more complex when considering that, between 2001 and 2015 core goods inflation in the USA was virtually null, while services inflation rose to 43%.

At that time, without assessing indirect impact stemming from cost pressure, the normalization of relative prices created an increase in inflation and a drop in real wages, whose degree depended on the margin compression in goods-producing sectors in a very closed and/or very low- tax-burden economy. Between November 2015 and May 2017 regulated prices rose 85% in US dollars and an additional 70% increase remains in order to revert to the price level recorded before the end of the convertibility regime, while goods and non-regulated utilities prices in US dollars dropped 3% and 1.5%, respectively. The outcome was: 1) a 66% accumulated inflation rate, 40% in the first year and a rate closer to the projected 20.5% for 2017 with rates that would contribute half (3.5 percentage points instead of the 6 percentage points recorded in 2016), a stable US dollar after the initial increase and wages that last year lost 6 percentage points compared to the inflation rate reported by the INDEC (National Institute of Statistics and Censuses) and which this year, also on average, would recover over half of the drop; and 2) wages in US dollars which after the decrease are starting to quickly catch up. But even if they managed, with a more open economy similar to that of the convertibility regime, to keep up the margin compression (or the lower transference from costs to prices) depending on the distance to the equilibrium point of each company’s balance sheets, this would bring about, to begin with, an increase in unemployment rates. Should it be done by lowering taxes, fiscal deficit would increase.

In short, it's a short-blanket syndrome situation. And here is where the title gains a double meaning: How to change relative prices and not die trying? On the one hand, it may be the typical self-help book, if ever written, that any government should use as its primary reference if trying to restore relative prices without losing governability faced with the characteristics in Argentina at the beginning of this administration. On the other hand, from a microeconomic standpoint, what does every company from every sector do in order to survive the increase in costs stemming from relative price adjustment. This is what we as economists call the distributive struggle. While favored sectors (utilities, certain power segments, agriculture and agro-industry) celebrate after years of political oppression, businessmen from the remaining sectors seek to maintain and/or limit the drop in their margins (in some cases in order to compensate for the drop in quantities), and wage earners seek to preserve the buying power of their wages. Should everyone attain their goals, relative price adjustment will not take place and the result is only an increase in inflation.

The outcome, in macroeconomic terms, of maintaining the status quo is a chain of inefficiency that results in very expensive goods prices, not only compared to international prices, but mainly compared to 2001. Taking just one sector into consideration; should gas prices end up doubling international prices (nowadays, the importation parity is US$6.5 per million BTU and the US price is US$3) and it is injected into gas pipelines through pipes that are 50% more expensive than imported pipes in order to sustain local employment; this will be passed along creating an increase in petrochemical costs which, plus power prices, becomes an increase in container prices, which, plus their own margins and beverage manufacturers' costs and the whole supply chain (logistics, labor, real state, financial and tax costs) ends up explaining why a bottle of soda costs twice as much as in any European store. This is just one example that may be extrapolated to nearly all sectors.

The decision to implement an aggressive disinflation scheme with a very stringent monetary policy helped moderate the inflationary leap associated with relative price adjustment, although it entailed short and mid-term consequences. The first one is that, without closing the fiscal gap, the change in the funding system alone generates pressure on the exchange rate appreciation that eventually moves the economy farther from the goal of correcting the trade imbalance. But, also, as we have been stating in our reports, aggressive disinflation hinders fiscal adjustment since it damages the increase in tax resources within a context where half the expenditures are indexed based on past values. The second one is the necessary interest rate to coordinate an aggressive disinflation, which brings about an increase in savings that by definition remains at the BCRA (Argentine Central Bank) (40% of savings in pesos have been invested in BCRA swaps and bills of exchange). The third one is that the decision to adjust rates on a biannual basis forces the economy to keep interest rates high for the duration of the process. Just like Sisyphus with the stone, every time utility rates increases stop and inflation rates go down, the margin of the monetary policy aimed at lowering interest rates clashes against the next increase in rate six months later (coinciding with the lags estimated by the BCRA to impact monetary policy).

The election year is full steam ahead and parties are expected to go all out. Unlike the prior administration, part of the long-term agenda continued into the election year (rate increase and high interest rates). This explains the weak and uneven impact on consumption stemming from a salary that (despite efforts to use it as an anchor) is partially gaining the ground lost in 2016 in a context of a surplus of financial US dollars. Weak increase in consumption offset by an extremely high increase in public works and lack of fiscal adjustment. In light of 2018, 2017 growth drivers no longer exist and the economy would grow only due to statistical carry-over and some boost indexed mortgage debt may create. Compensating the impact on distribution of income resulting from the change in relative prices with more fiscal deficit lasts only while credit is available. For the time being, debt remains low and the world continues to loan us funds and is expected to continue to do so for a while longer, even enough to let the next government, and why not the one after that, sort the situation out once again. What is evident is that the regulatory frameworks of the 90s with much higher global energy prices and a much more precarious infrastructure, a closed economy and Argentine unions are not consistent and much less manageable with only monetary policy in a context of a high fiscal deficit.

Acceda al informe completo aquí: Informe completo en PDF