Argentina’s foreign relations have recently garnered attention due to a significant increase in Spanish investment. However, the political tension has overshadowed this economic connection. President Javier Milei’s controversial comments about Pedro Sánchez’s wife and the mostly positive reception of Milei’s economic measures by various Spanish right-wing parties have intensified the spotlight. During his recent visits to Spain, Milei was notably awarded the Medal of the Community of Madrid by Isabel Díaz Ayuso, who praised him for implementing “fresh measures” with courage and firmness.
In this backdrop, the Bank of Spain has released a semiannual report on Latin America’s economy, which provides an in-depth analysis of Milei’s fiscal consolidation program and Argentina’s key macroeconomic variables. The report highlights both the improvements and the potential risks linked to these measures, underscoring an increase in uncertainty surrounding the economic policies.
According to the Economic Policy Uncertainty (EPU) index, uncertainty in Argentina surged to 176.3 points in January 2024 following Milei’s inauguration, remaining elevated above 100 points in subsequent months. This level of uncertainty exceeds that of other major Latin American countries, impacting medium-term economic decisions and potentially hindering economic growth. This uncertainty is understandable given the magnitude of Milei’s plan to address inflation.
On a positive note, the Bank of Spain notes improvements in major Argentine financial variables since the new government took office, albeit with some volatility influenced by ongoing legislative developments. The report pointed out that Argentina achieved its first public accounts surplus in 16 years by January 2024, earlier than analysts had expected and without fully implementing all adjustment measures. In late June, a fiscal package aimed at increasing revenue through tax modifications was approved.
However, the Bank of Spain has expressed concerns about the rapid fiscal adjustment and the ongoing high inflation, suggesting that the crisis is unlikely to resolve quickly. The surplus was primarily achieved through significant cuts in government spending, including halting public works financed by the central government, reducing discretionary transfers to provinces, and limiting the increase in public salaries and pensions to rates below inflation.
Moreover, this robust fiscal consolidation has had adverse effects on economic activity, which deepened its decline in early 2024, with GDP contracting by 2.6% from the previous quarter and 5.1% year-over-year. The International Monetary Fund (IMF) anticipates a 2.8% GDP decline for the entire year, a sharper drop compared to the 1.6% reduction in 2023. The ongoing recession means GDP has fallen below pre-pandemic levels.
The decline in GDP carries significant social consequences, reflecting issues such as poor performance in various productive sectors, job losses, and reduced family spending. While the Bank of Spain’s report does not explicitly address the potential rise in poverty due to reduced public spending and inflationary pressures, the most recent data from Argentina’s National Institute of Statistics and Censuses (Indec) indicated that poverty skyrocketed to 41.7% in the second half of 2023, up from 40.1% in the first half and 39.2% during the same period in 2022. Private studies suggest that this figure could rise to around 50%.
The primary aim of the fiscal consolidation program is to eliminate the public accounts imbalance without resorting to monetary issuance due to the inability to cover it with debt issuance. The Bank of Spain highlights that the increase in money supply, in a context of economic slowdown, has exceeded private sector demand significantly, fueling high inflation.
Milei implemented a devaluation of the official exchange rate after taking office, but inflation skyrocketed to 25.5% in December 2023, effectively doubling from November’s rate. This surge in inflation reflects market reactions as they anticipated depreciation.
Despite experiencing a marked decline in monthly inflation rates from January onwards—falling from 20.6% to 4.6% by June—the Bank of Spain remains skeptical about whether these adjustments will suffice. The IMF projects that inflation could rise from an average of 133.5% in 2023 to 249.8% in 2024 before dramatically dropping to 59.6% in 2025 and 31.8% in 2026, indicating persistently high rates.
The stabilization of inflation in Argentina hinges on future public finance developments, pending adjustments, regulated prices, and fluctuations in the exchange rate. The Bank of Spain warns of risks, especially concerning rising public service prices, which might contribute to inflation, and expresses substantial uncertainty regarding future exchange rate behavior.
Currently, the Argentine government has yet to announce its future monetary and exchange rate regime, contributing to higher inflation expectations than those projected by the administration. The Bank of Spain recommends resolving uncertainties regarding the prospective monetary and exchange rate regime to help reduce inflation expectations.
Researchers Ernesto Talvi and Sofía Harguindeguy recently noted that the fiscal adjustments made thus far are insufficient to align market expectations with government guidelines, emphasizing the need for measures that justify the significant sacrifices being made by the Argentine public.
Image and News Source: https://www.infobae.com/espana/2024/07/25/el-banco-de-espana-senala-las-luces-y-las-sombras-de-la-politica-economica-de-milei-que-la-derecha-espanola-admira/
