Why Milei might not be the solution to Argentina’s problems

Argentina has been described as an “over-diagnosed and under-executed country”.¹ There is broad consensus about the reforms needed to boost a natural resource-rich economy with high growth potential such as Argentina. However, numerous attempts to boost GDP growth have been disrupted by short-term populist measures. In the words of Argentinean economist Eduardo Levy Yeyati, Argentina’s economic cycles have become so tightly spaced that it is hard to distinguish when the economic rebound starts to take effect before the next crisis occurs, see Chart 1.²

Chart 1. Argentina’s economic cycles have become tightly spaced

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 January 2024.

At the end of 2023, Argentina held a new Presidential election as it grappled with over 130% inflation, 40% poverty rate, a primary balance deficit equivalent to 3% of GDP and an expected contraction in activity of 1%. For many years, export restrictions have been in place to control domestic food prices and limit inflation. Subsidies for utility bills and transport, and the introduction of exchange rate controls have also distorted domestic prices for goods and services.

Javier Milei’s election as President represented a new attempt to implement the necessary changes to kickstart a recovery. Over the years, plans for deep economic reforms have crippled by bureaucratic red tape and the lack of leadership that would be needed to implement unpopular austerity measures. That is why this time could be different. Being an outsider, Milei has no previous political capital to lose.

His electoral victory embodied a desire for change. It represented the ability of his team to forge agreements with opposition parties to beat the incumbent Peronist party. However, it says little about his ability to govern a politically polarised country.

Shock therapy

“There is no money” said Milei in his inaugural speech to supporters outside Casa Rosada, the President’s office in Buenos Aires. He warned there is “no alternative to a shock fiscal adjustment”.

After taking office on 10 December, Milei’s team submitted an emergency decree including over 300 measures to deregulate services and industries such as commercial air travel, agriculture, mining, and energy. Additionally, he proposed a 660-article reform bill to Congress in an attempt to profit from an expected short honeymoon period.

Some of the articles in the bill include increases in export tariffs for meat and agricultural products, privatisation of some state-owned companies, prevent organised road-blocking protests, end discretionary pension increases, allow the registration of undeclared assets at preferential tax rates, and grant some legislative powers to the President.

With less than 15 percent of the seats in the Lower House and less than 10 percent in the Senate, the chances of this reform bill being approved in Congress without meaningful changes are slim. At least some of the more controversial ideas on privatisations, legislative powers of the President, and workers’ rights are likely to be removed. Milei’s pledges to dollarize the economy and close the central bank, which were key pillars of his electoral campaign, do not feature in this bill and are no longer a priority.

Milei also promised a plan of spending cuts equivalent to 5% of GDP, a shock fiscal adjustment which will face strong backlash from workers’ unions and opposition parties. To implement this, he appointed Luis Caputo, a market-friendly economist, as Finance Minister.

Caputo swiftly announced a devaluation of the peso, reductions in energy and transport subsidies and cuts in the number of Ministries from 18 to 9, among other measures. These spending cuts are aimed at reaching a primary balance surplus of 2% of GDP in 2024, which was one of the conditions recently set by the IMF for a disbursement of USD 4.7 billion to meet Argentina’s short-term obligations.

However, these are just the first in a series of measures that will be needed and, in the short-term, will cause a further depreciation of the local currency, a rise in inflation, and a subsequent contraction in economic activity. According to consensus estimates, GDP is expected to fall by between 2 and 3% in 2024. Therefore, the economic situation in Argentina is likely to get worse before it gets better. This will test voters’ patience.

Chart 2. Volatility in Argentinean stocks increased sharply following the election results

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 January 2024.

Going forward, we envisage three possible scenarios: 
 

1. Milei succeeds in passing the necessary reforms and after a tough 2024, GDP growth starts to recover in 2025. In this case, also thanks to successful cuts in fiscal spending, inflation declines to double-digit figures by the middle of his presidential term. A reduction in export tariffs would stimulate agriculture and mining exports and boost GDP growth.
2. Milei’s reforms fail in Congress, as his shock therapy is rejected. This would weaken his position and he would attempt to call a non-binding referendum on the bill, aimed at putting additional pressure on Congress. Meanwhile, the economy would deteriorate further given lack of progress in fiscal consolidation and the continuous drain of international reserves to support the peso, driving the government to another default. This would likely to increase social tensions and Milei would end up resigning before the end of his term.
3. Milei’s rhetoric softens as he is forced to play the political game in Congress. After learning he cannot rule through Presidential decrees, he concedes on many of his reforms but manages to reduce the fiscal deficit. Inflation subsides marginally and the IMF agrees to continue providing short-term funding. Economic activity declines in 2024 but gradually starts to pick-up by the end of Milei’s term. This could be the most likely scenario.

Proposals to cut fiscal spending, reduce inflation and deregulate the economy are welcomed orthodox solutions for an economy in crisis. Argentinean assets rallied following the election result in support for these announcements. Spreads in Argentina’s 5-year CDS contracts narrowed from over 7,000 basis points in November to under 4,000 basis points in January. Domestic stocks are up 23% in local currency terms since Milei’s inauguration in December, despite one-year volatility rising to historical highs, see Chart 2. However, Argentina remains preferred as a short-term trade, for those willing to take on the volatility of its assets, rather than a long-term allocation in portfolios. As stressed by Levy Yeyati, Argentina’s problem is not in the diagnosis but in the execution.

1 Eduardo Levy Yeyati, Brookings Institution, January 2021.
2 https://go.pardot.com/e/931253/ntinas-inertia-is-it-possible-/3wlg5/320918287/h/M2_beUpmoCjn0WKrr8bXtfBEew2QFyWU01H53UjE3us