Why Is Country Risk Rising in Argentina?

Argentina has faced a series of currency crises in recent months. In June, it reached an agreement with the International Monetary Fund (IMF) and revealed a more aggressive policy for reducing its fiscal deficit and inflation rate. And yet, somewhat surprisingly, Argentina’s country risk has increased following the announcement. As of the end of August, it is at a four-year high. If Argentina is finally heading in the right direction, why is its country risk rising?

There are a few reasons. First, the IMF agreement expires in two years.That leaves much doubt about Argentina’s long-term strategy and, in particular, whether the debt outstanding when the agreement ends will ever be repaid. Second, efforts to reduce the fiscal deficit may have come too late to avoid an eventual default. Third, Argentina lacks credibility. It is not enough to say you’re changing course. To have a positive effect, such promises have to be believed.

The IMF agreement is intended to facilitate lending to the treasury, such that there is no need to go to the international credit markets in a context of increasing interest rates in developed economies and a liquidation by financial institutions of emerging economies’ assets. The agreement has two main components (discussed in more detail below), a fiscal target and a base-money target. Both targets are revised periodically, and, if policy is on track, funds are transferred from the IMF to the central bank. The agreement is also intended to reduce uncertainty, and therefore volatility and depreciation, in the exchange rate market. The government has not made clear yet how it will service its debt after two years, when the fresh funds from the IMF won’t be available anymore.

In addition to the new IMF agreement, Argentina has put forward a new monetary policy in which the exchange rate is free to float within an upper and lower bound. Given that inflation exceeded 40 percent last year, te Argentine central bank has also committed to leaving base money constant on average between October 2018 and June 2019 (with the exception of December and June seasonality).

In terms of fiscal policy, the Argentine treasury has committed to reach a balanced budget (before paying interest on debt) by the end of 2019.The budget deficit stood at 3.8 percent of GDP last year.

The new plan certainly looks like an aggressive  approach to getting the economy back on track. But is it enough?

Recall that Argentina has committed to a balanced budget excluding interest payments. But interest payments exceed the spending cuts required to balance the budget, meaning that the total deficit (i.e., including interest payments) will continue to rise. The additional debt required to finance a growing deficit, coupled with an anemic Argentine economy, suggests the current measures do not go far enough.

As if all of that were not enough, Argentina’s history exacerbates the problem. Defaults have been all too common. Past economic plans have been too quickly abandoned when political needs conflict with economic rationality. And one need not look too far into the past to find examples. After just three years in office, Mauricio Macri’s government has abandoned a failed inflation-targeting regime and compromised central bank independence (e.g., on December 28, 2017, the president’s office forced the central bank to deviate from its own policy to reduce interest rates). These past events, and many others, call into question the credibility of current commitments.

While the rise in Argentine country risk may look puzzling at first sight, a more careful look lets us make sense of it. The agreement with the IMF helps to buy time. It is a transition plan, with the hope that a long-term solution will be developed. But, to date, no long-term solution has been developed. And the uncertainty of Argentine politics, with presidential elections next year, only adds to the perceived risk that Argentina may fail to honor its debt obligations once again.

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