beyondbrics

Argentina’s inflation is a problem – a problem for investors, consumers and the country’s image. Something must be done. This is the widespread market view.

But from the government’s standpoint, double-digit inflation for the past four years has turned out to be a nice little earner.

As could be expected with a populist government seeking reelection in October, the government is spending money like water: in May, public spending rose 34.5 per cent year-on-year, the third month running that it has outstripped revenue (which in May rose 31.3 per cent year-on-year), as this table drawn up by consultancy EconViews illustrates:

Which is what makes inflation so handy. According to a report by Quantum Finanzas, a Buenos Aires consultancy, Argentina raised $6bn, or 1.6 per cent of GDP, through inflation tax last year – a gain of $7bn, or 1.9 per cent of GDP, if seigniorage (the revenue derived from the issuance of currency) is taken into consideration.

In effect, printing money is a form of interest-free financing for a government which still faces hurdles to raising money on international capital markets. “If they could (issue debt) they wouldn’t need this level of inflation,” notes José Echagüe, one of the authors of the Quantum Finanzas report.

As the report says:

The government cannot consider lowering inflation without reformulating the direction of key aspects of economic policy. In a context of moderate fiscal deficit and without recourse to voluntary credit markets, lowering inflation poses the problem of financing or fiscal rebalancing: how to align spending with the new income situation.

The possibility of continuing to raise the current levels of inflation tax depends on the capacity to continue to sustain a particular level of demand for money, which is today linked to the process of real exchange appreciation.

So status quo will only be maintained for as long as people think that the erosion of the peso’s value will be less than inflation, Echagüe says, that is, that they would be better off sticking with the peso than switching into dollars. The peso has slid nearly 3 per cent against the dollar this year but the central bank says there will be no devaluation. Inflation expectations for the next 12 months are stable at 25 per cent, according to a monthly survey by the Universidad Torcuato Di Tella.

The problem with that is that people seem to be finding it increasingly appealing to get out of pesos. Capital flight – a well-known problem in crisis-prone Argentina and a classic in the run-up to presidential elections – is accelerating and could reach $10bn in the first half alone, similar to the total for the whole of 2010, as this article from El Cronista Comercial notes:

After the announcement of Amado Boudou, the economy minister, as running mate to Cristina Fernández in her bid for a second 4-year presidential term, all eyes will be on the economic team put in place if, as polls suggest, Ms Fernández wins.

The government refuses to entertain that inflation may be a problem, despite the constant erosion of purchasing power and salary demands of 30 per cent plus.

When it is raising $7bn a year by having inflation, it becomes easier to see why. But the government shouldn’t get too comfortable. Echagüe reckons the status quo “can’t be maintained for much more than another year”.

But for now, inflation is a dirty word for the government and a non-event in the election campaign in a country blasé about inflation after its hyperinflation past. Unless policies change, Argentina looks on course for some kind of painful readjustment.

Related reading:
Argentine inflation – even lower than you thought, beyondbrics
Argentina: fighting fires on inflation, beyondbrics
Argentina: no inflation here, beyondbrics
Argentina: inflation blame game, beyondbrics
Argentina threatens inflation analysts with fine, FT