Inconsistencies in stocks, exchange normalization and political transition

The exchange stocks had the objective of protecting real wages, redistributing income towards low-income sectors and ensuring foreign currency to finance growth. None of these objectives is met because:

1. The stocks subsidize imports and tax exports with a negative impact on employment, domestic production and the net supply of foreign currency;

2. The exchange gap resulting from the stocks implies a redistribution of income in favor of those who have assets in dollars or income in dollars;

3. The expectations of devaluation implicit in the gap are incorporated into the family basket prices harming the most vulnerable sectors;

4. Foreign currency is delivered at the official exchange rate to private debtors abroad and to companies that collaborate with the Fair Prices Plan; the beneficiaries are generally large companies, while rationing hits squarely in the SME sector.

5. The gap induces under-invoicing of exports, smuggling and over-invoicing of imports -capital flight mechanisms associated with increased informality-.

6. Multiple exchange rates (soybean dollar, Vaca Muerta, Malbec) represent subsidies to export sectors that are generally large companiess in concentrated sectors.

7. The replacement cost uncertainty -extremely rationed- generates price remarks based on subjective estimates of cost and/or substitution by more expensive and inefficient local inputs; This constitutes a structural factor that reduces efficiency and welfare.

In a context of high inflation and political transition, and aggravated by the extreme drought, the official response has been to tighten the stocks. This deepens the foreign exchange restriction, giving rise to a backward multilateral real official exchange rate -25% compared to the end of 2019. Import rationing improves the margins of less efficient local suppliers, facilitating the emergence of local “monopolies”.

Despite a fiscal program agreed with the IMF, inflation continues to rise, eroding real wages and increasing poverty; the participation of workers in the distribution of income fell from 51.7% in the first half of 2016 to 45% in the first half of 2022. The drop in wages and the real value of social and retirement plans has worsened since then . The distortions generated by the exchange rate are partly responsible for this trend.

The disincentive to invest in the foreign exchange-generating tradable sector is proportional to the exchange rate gap. The exchange rate delay induces a decrease in investment in dynamic export sectors with competitive advantages (agriculture, energy, mining, automotive, etc.). The result is lower growth due to lower investment in competitive sectors and lower availability of foreign currency that limits the supply of imported inputs required by industry and the services branch.

Who benefits? In addition to those mentioned, inefficient business sectors benefit which, due to the foreign exchange restriction to import, improve their position in the local market. The inefficient assembly sector of Tierra del Fuego receives, in addition to protection and relief from income tax and VAT, the implicit exchange subsidy of imports. Also, tax debtors who declare their income and assets in the official dollar and pay their obligations by selling foreign currency on the free market. The lack of transparency in the allocation of import permits and dollars is a source of corruption that benefits better-connected sectors and companies.

Even in an electoral situation of high inflation and uncertainty like the current one, there is an opportunity to make the exchange rate more flexible accompanied by an exchange rate correction; the record drought that affects agriculture – the main supplier of foreign currency – in any case, justifies it. The magnitude of said correction could be softened by resorting to a Special Facility of the IMF to cover extraordinary situations with a negative impact on the balance of payments and the budget balance. The crawling exchange rate system should a posteriori prevent further arrears of the real exchange rate.

The cost of making the trap more flexible is less than that of making it hard. He pass though The inflation of a devaluation can even be lower than the defensive remarking of prices resulting from multiple and uncoordinated subjective expectations and an uncertainty premium that in the end can even imply even higher inflation.

The alternative of generating a new agricultural dollar for a determined term generates new distortions and regressive income transfers. The ephemeral nature of said measure will generate substitutions (export settlements are anticipated, which implies fewer settlements later) or the sale of grains is awaited in silos in the expectation of exchange rate unification under a probable change of government.

On the other hand, the abrupt lifting of exchange restrictions could lead to strong increases in the exchange rate through the market and (at first) in the domestic interest rate. By restoring the free mobility of capital and a single and crawling exchange rate, the domestic interest rate becomes the main instrument to restrict the demand for dollars and/or regulate the quantity of money in the economy. Under such circumstances, and especially in the absence of an implementable and credible stabilization plan, a gradual exit from the stocks is preferable, avoiding a sudden devaluation.

Under the proposed devaluation and gradual easing scheme, the official commercial exchange rate should allow the BCRA to accumulate net reserves. The restriction on the sale of foreign currency for non-commercial purposes would be maintained, at least as long as the level of net international reserves is close to zero. In parallel, it is proposed to enable a free financial exchange rate market to channel financial operations, in fact doubling the exchange market. Debt service transactions, tourism and capital movements would be channeled through this means, minimizing the current trickle of international reserves.

With dual markets, after the initial devaluation, the need for high interest rates would decrease. The supply of goods would improve due to the greater competitiveness of domestic production and the gradual normalization of the ability to purchase critical imported inputs for the industry.

In the current electoral context, the prevailing expectation is an electoral setback for the ruling party; for exchange rate policy, this means the eventual lifting of the stocks. To the extent such probabilities become certainties, markets will surely anticipate capital inflows while the currency gap is high and asset prices are depressed in dollars.

This boundary condition possibly implies a greater supply of dollars in the market and a real appreciation of the free exchange rate. This, in turn, facilitates the implementation of the proposed policy by reducing the devaluation pressure of the commercial exchange rate as the exchange rate gap narrows. During the political transition to the new government, and in order to mitigate the volatility of the gap between the commercial and free markets, the authorities could implement restrictions on short-term capital inflows and outflows.

The gap between the free and commercial markets runs the risk of replicating the problems generated by the stocks, including under and over-invoicing of commerce abroad, expectations of devaluation, etc. For this reason, the segmentation of the market into a commercial and a financial strip can be, at most, a temporary solution. In the medium term, the single exchange market is the most efficient alternative; how to get there will be the challenge of the next government.

The precondition for converging to a single exchange rate is a stabilization program with strict fiscal and monetary anchors, together with the exchange rate and rate normalization program. The credibility of the plan requires basic agreements between the opposition and the government within the framework of a renegotiation of goals with the IMF. The agreements should later include reforms to improve Argentina’s insertion in the world, to formalize employment and private activity and to recover incentives for investment and to sustain budgetary stability in the long term.

It is unthinkable that in an election year the IMF would renew the Extended Facilities Agreement without consulting the opposition. For the current government, ending the term in an orderly fashion would be a major political achievement. For the opposition, it would mean starting to fix the problems earlier. It is not a zero sum game where what one wins is lost by the other. Society is powerless in the face of the lack of basic agreements between the main political forces. Maybe the anti-establishment challenge will wake them up this time.

In summary, the gradual lifting of the stocks is the most convenient option to recover the capacity to generate foreign currency and facilitate the sustainable recovery of activity. The program must be part of a comprehensive stabilization and growth plan within the framework of agreements with the opposition and must be framed in the context of a renegotiation of the Extended Facilities Agreement with the IMF. The absence of inter-party agreements and the “taking” of the State by corporate interests is the fundamental cause behind the virtual destruction of the currency; the original sin.

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