The deepening of the Argentine economic crisis, as underlined by the recent resignation of Daniel Caputo, its central bank president, is likely to expose two myths about the emerging market economies.
The first is that the widespread adoption of floating exchange rates by the emerging market economies in the wake of the 1998 Asian currency crisis provides them with a fail-proof safety valve to insulate them against future economic crises. The second is that large-scale IMF programs are always effective in stabilizing a country’s currency.
It would be an understatement to say that the Argentine economy finds itself once again in very serious trouble despite record International Monetary Fund (IMF) support. In the three months since announcing a $50 billion IMF stabilization program in June 2018, the Argentine peso has managed to lose around a further third of its value.
This has contributed to a renewed spike in inflation to over 40 percent and to ever-increasing signs that the Argentine economy is yet again succumbing to a serious economic recession.
In an attempt to prop up the currency, no effort seems to have been spared by the Argentine economic authorities. Interest rates have been raised to 60 percent, new budget belt-tightening measures have been announced, and the IMF has been implored to front-load the disbursements under its lending program.
Yet, to date, the Argentine peso shows little sign of recovering much if anything of the more than 50-percent loss in its value since the start of this year.
A primary reason for Argentina’s present currency woes is that the country is no stranger to major currency crises. Indeed, as recently as 2001, a major currency crisis forced the country to impose capital controls, declare a bank holiday and default on its external debt.
Little wonder then that Argentine residents rush to trade in their pesos for dollars at the first sign of economic weakness and of political instability. This has been made all the easier for them by the premature and ill-advised removal of exchange controls in December 2015 at the start of President Mauricio Macri’s term of office before first stabilizing the Argentine economy.
The main reason for doubting that the Argentine currency will stabilize anytime soon is the likelihood that the draconian measures being taken to support the currency will deepen the country’s economic and political woes.
No country’s economy would be able to withstand the combination of 60-percent interest rates and renewed budget belt-tightening without succumbing to a serious economic recession. Similarly no Argentine president can expect to maintain his popularity after having to be forced to go to the IMF hat-in-hand and then have the economy still sink.
A renewed economic recession in turn is bound to damage the country’s public finances by eroding its tax base and to further weaken President Macri’s tenuous grip on power in the run up to next year’s presidential election.
In that context, it is hardly a good sign that the country’s unions are already taking to the streets to protest the adoption of further austerity measures.
The chances that a larger and more front-loaded IMF program would now allow the Argentine currency to claw back much of its losses would seem to be fanciful.
It is not simply that this would seem to be a case of the triumph of hope over experience in the wake of the mega-IMF program’s recent failure to prevent yet another period of extreme currency weakness. Rather, it is that the IMF is unlikely to allow its resources to be used for the purposes of currency intervention.
A standard feature of IMF lending programs is that they are made to be conditional on the country not being allowed to let its international reserves drop below a pre-specified floor. The IMF does this to protect its own resources and to prevent them from being used to finance capital flight.
However, if the IMF’s resources cannot be used for exchange rate intervention, it is difficult to see how increasing the size of its program and frontloading its disbursements will do very much to arrest a renewed fall in the currency if exchange rate pressure was once again to occur.
All of this does not bode well for Argentina being able to avoid the renewed imposition of capital controls in the run-up to next year’s presidential election. Sadly, if that were to occur, it would constitute a further setback for the rest of the emerging market economies as an asset class.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.