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FT editor Roula Khalaf selects her favourite stories in this weekly newsletter.
The author is director of the Georgetown Institute of the Americas and Nonresident Senior Fellow at the Peterson Institute for International Economics
On June 28, after several weeks of pressure in the currency and bond markets, Luis Caputo, Argentina’s finance minister, uttered the words that have been heard over and over again in Latin America from many of his predecessors: “I am not going to devalue.” In 1981, José López Portillo, the then president of Mexico, made his famous declaration that he would defend the Mexican peso like a dog. What followed was the beginning of the Latin American debt crisis and the lost decade.
Unlike previous governments in Argentina and the region, President Javier Milei’s administration has done many things right. Now Argentina and the IMF must redefine success in order to succeed, shifting the focus from the sustainability of the currency’s quasi-peg to the dollar and a rapid process of disinflation. Macroeconomic policy must focus on economic recovery and a slower but sustainable disinflation.
Since coming to power in December, Milei has eliminated the public sector deficit, a titanic adjustment of more than 4.5 percentage points of gross domestic product. He has corrected the real values of many regulated prices, artificially fixed by the previous government to hide some of the effects of its horrendous policies. He has adjusted the real exchange rate to a more realistic level and initiated an impressive agenda of deregulation and modernization.
As expected, the first few months of his presidency were tough. Monthly inflation exceeded 25%, economic activity plummeted, and poverty increased. On the positive side, inflation fell much more than expected and the government’s commitment to correcting the deficit remained intact. Milei has maintained his approval rating and some important legislative initiatives have been approved, paving the way for a successful first year for the economic program.
The Achilles heel has been the anchoring of exchange rate policy to a minimum inflation rate of 2% per month, well below the average inflation rate. The negative real interest rate is now also a liability. This combination was smart and useful in the initial stages, as it allowed for rapid disinflation, a rapid accumulation of international reserves, and a reduction in the real value of central bank liabilities. But now, as the real exchange rate is reaching pre-devaluation levels, it is not providing financial incentives to exporters and other economic agents to convert their dollars into pesos.
This, in turn, is creating significant pressures on Argentine financial markets. Faced with this situation, the Milei government has committed to defending the 2% fixed exchange rate and continues to equate success with large falls in monthly inflation rates. Previous Latin American governments felt compelled to overstate their commitment to a fixed exchange rate because their willingness to adjust economic fundamentals was weak or non-existent. However, in this case, Argentina has established the fundamentals and is putting its achievements at risk through disorderly monetary adjustment.
To regain market confidence and refocus its stabilization efforts, the government needs to move to the second stage of its program. In this phase, disinflation will occur at a slower pace and the government will focus on economic recovery. In this way, Argentina will be able to follow a more sustainable stabilization path, like the one followed by its Latin American peers in the 1990s.
Milei’s government must make a clear commitment not to dollarize the economy and support its currency competition strategy by strengthening institutions and policies that will allow the peso to overtake the dollar as the currency of choice for Argentines. To do so, the government must send an amendment to its fiscal responsibility law to Congress as soon as possible. This update should establish a zero deficit as a fiscal goal for the coming years and should enshrine the independence of the central bank.
The government should also announce a correction path for controlled prices. The central bank should let the official currency adjust to a more realistic level and move to a more flexible official exchange rate mechanism. Together with a modern monetary policy framework, this will generate a very positive real interest rate policy.
Backed by these strengthened policies, the IMF should support Argentina with a new and expanded financial support program. With these elements in place, Argentina will be prepared to lift its capital account controls and let its currency float freely. Together with renewed IMF financial support, this will provide Argentina with the best conditions it has had in generations to escape decades of instability and economic decline.