The dangerous interaction between the fiscal deficit and exchange controls before and after the change of government

ARGENTINA - Report 12 Jun 2023 by Domingo Cavallo

The significant monetary issuance of the past two years, the high stock of Central Bank debt (LELIQs), the tendency towards an increasing fiscal deficit despite the commitment to the IMF's EFF program and the exchange rate gap all form a slippery slope scenario in which a devaluation jump in the official market could trigger a substantial acceleration of inflation. This complex interaction between the fiscal deficit and foreign exchange controls can significantly complicate the functioning of the economy during the time between the primary elections (PASO) in August and the outcome of the electoral process in November, as well as during the beginning of the new government's administration.

The government's position, practically led by Sergio Massa as Minister of Economy, depends on how his plans to become the candidate for president of the current governmental coalition unfold after the PASO. In the case that Massa is not the government’s candidate, he will have no incentive to smooth the path for the next president toward a non-traumatic resolution of the complex economic and social situation that will prevail at the time of the change of government.

Whatever the level of inflation in the transition between the PASO and December, when the new government takes office, the new government will only be able to avoid a devastating inflationary explosion if it decides to undertake a fiscal adjustment through well-designed structural reforms, including privatizing loss-making state-owned enterprises and opening the economy before eliminating all exchange controls.

It may seem paradoxical, but if attempting to avoid the inflationary inertia caused by exchange controls, the next government decides to immediately eliminate them for all types of transactions without allowing time for fiscal adjustment and for the economy to digest all the excessive monetary issuance of the past, the result could be an inflationary explosion—extremely costly socially and devastating politically.

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