Argentines overwhelmingly voted in favor of change by electing Javier Milei as their new president on November 19, handing him a comfortable 11-point edge over the incumbent. Both bonds and in particular stocks rallied in the aftermath of the vote. The bounce likely reflects the clear outcome of the election – polls were pointing to a very close race – as well as prospects for a shift towards a less interventionist economic model. Whether the market is right in beginning to price in a path towards sustained improvement, however, remains to be seen.
Investors in Argentina face an uncertain scenario of rapid policy change that could go a long way in putting the economy on more sustainable footing. Setting a new policy path in a context of severe macro imbalances, however, also involves high risks. After all, the conditions that the new administration is inheriting are very challenging, ranging from triple-digit inflation and unanchored expectations to stretched fiscal finances, no market access and an overvalued peso (see Figure 1). And despite his surprisingly large majority in Sunday’s election, that is not the case in congress where the incoming administration – which controls just 15% of the seats in the lower chamber and even a smaller share in the senate – will have to seek alliances to advance its agenda.
Argentina’s macro imbalances call for a multi-faceted, coordinated adjustment. The severity of these imbalances, moreover, supports the case for immediate action on several fronts, consistent with the president-elect’s observation that there is no room for gradualism. Many aspects of the path forward are uncertain – and may remain so at least until the December 10 inauguration – including policy priorities, some cabinet appointments, potential political alliances and other aspects of the agenda. While we wait for more clarity, we offer our first thoughts on the main challenges, potential policies to address them and signposts to assess if Argentina is shifting towards a more sustainable path:
Fiscal policy: at the core of Argentina’s macro challenges is its inability to live within its means. Accordingly, fiscal tightening is critical, likely involving a combination of cuts to spending, lower transfers to provinces and scrapping of recent tax cuts. On the spending side, any credible adjustment likely involves tackling costly energy subsidies – a move that would be both inflationary and unpopular – to open space to preserve more targeted social benefits and maintain public investment priorities. The new administration must draft a 2024 budget, which congress will then vote by the end of the year.
Exchange rate policy: an adjustment of the level of exchange rate is a likely early shift which, though inflationary, is necessary to address the hard-currency imbalance. Whether policymakers adopt a free float or a crawling peg (futures imply the latter), there is wide consensus that capital controls will stay to prevent a disorderly adjustment – and over time removed on new flows (and only later on stocks). Lacking international reserves, preventing an overshoot requires coherent shifts in the fiscal and monetary stances. Dollarization remains a priority, based on recent comments, but one that can be executed once imbalances are tackled and reserves rebuilt.
Monetary policy: the central bank’s main task is to credibly establish an anchor to avoid an overshoot in the exchange rate and in inflation expectations. Critical to this objective, as the president-elect indicated, is addressing its challenge with its stock of short-term paper (Leliqs) used to mop up liquidity. The central bank could temporarily offer sufficiently high interest rates to disincentivize demand for dollars. Members of the transition team are seeking external funding to engineer a less costly option that would still honor all existing contracts with banks and depositors. Any monetary policy shift, however, would only be viable with a credible fiscal adjustment.
IMF renegotiations: by breaking away from the policies of the incumbent, there is room for a new agreement with the IMF to avoid entering arrears and provide support for structural reforms. Whether any agreement involves new money or not remains unclear. Negotiations, if they are to succeed, will require a credible fiscal commitment and a devaluation – one sign of progress on the latter, we think, would be a meaningful narrowing in the gap between the official and parallel exchange rates (see Figure 2). In the past, the IMF has been open to the use of capital controls during an adjustment process.
Governability challenge: the next administration ran on a platform for change, which it will attempt to advance without a congressional majority. One implication is that its most radical proposals, such as immediate dollarization, are likely to face an uphill battle; the second implication is that it will need support from other parties to govern. His strong showing in the November runoff puts Milei in a better position to try to build consensus – with the political class and population – on the need for and viability of reforms. Prospective candidates for key positions and early cabinet appointments include experienced names that go beyond original political allies, suggesting an understanding of the need to build bridges.
Given the fragile starting point, the path for sustained improvement in Argentina is a narrow one. The outcome of the election was encouraging, marking a clear rejection of continuity in favor of a more pro-market policy stance. The wide margin of victory, moreover, gives the incoming administration political capital to seek the necessary broad consensus to support its reform agenda. The challenges of governability and severe macro imbalances, however, limit the room to maneuver and increases the cost of policy mistakes. Against this backdrop, markets will be looking closely for cabinet appointments, a coherent policy agenda and the ability of the new administration to both approve and execute it.
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