Financial Deficit for 113 Years in Argentina... Swallowing the Bitter Pill of '54% Currency Value Drop' [Seungseop Song's Financial Light]

Worsening Fiscal Deficit with High Inflation and High Debt
Argentina in Severe Economic Crisis

New Government's Top Priority: 'Fiscal Deficit Resolution'
Attempting to Boost Exports by Devaluing Peso

Possibility of 200% Inflation Impact by Year-End
Determined to Endure Despite Hardships

[Image source=Yonhap News]

"We must now break free from the addiction to fiscal deficits."

Argentina has taken drastic measures to resolve its chronic fiscal deficit. The key move is a sharp devaluation of its currency. The government has instantly reduced the peso's value by more than 50% compared to its previous level. What problems has Argentina faced, and why has it introduced such measures?

On December 12, Argentina time, as the foreign exchange market closed, Finance Minister Luis Caputo appeared on TV. Caputo is a financial official in the government of Javier Milei, who was inaugurated as Argentina's new president two days earlier. Caputo announced ten bold measures to overcome Argentina's economic crisis. The first among them was adjusting the official exchange rate from 366.5 pesos per dollar to 800 pesos per dollar.

Fiscal deterioration, rising inflation, and debt... Nothing is stable in Argentina

A sign indicating that payment in dollars is accepted is posted in front of a store in Buenos Aires, Argentina. [Image source=Yonhap News]

To understand why Argentina devised these measures, we need to look at the reality it faces. Argentina is in a severe fiscal crisis. Its fiscal deficit approaches 5.5% of its Gross Domestic Product (GDP). Out of the last 123 years in Argentina's recent history, 113 years have been marked by fiscal deficits. The central bank's reserves are also in deficit, and two-fifths of the population live in poverty.

The people are suffering from hyperinflation. In October, Argentina's inflation rate reached 142.7% year-on-year. This means prices have increased about 2.5 times compared to October 2022. Despite the central bank raising benchmark interest rates by tens of percentage points to curb inflation, the situation has worsened rather than improved. Due to the poor value of the currency, shop owners demand payment in dollars instead of the local peso.

There is also a debt problem. Since joining the International Monetary Fund (IMF) in 1956, Argentina has received bailout funds 22 times, making it the IMF's largest debtor. In 2018, it borrowed $44 billion (approximately 58 trillion won) due to a financial crisis, and it must start repaying this debt from September next year.

The triple burden of fiscal issues, inflation, and debt began with the populist politics of past presidents. For a detailed story, you may refer to the following article: (Reference article: [Song Seungseop's Financial Light] 'Benchmark interest rate 118%'... Where did Argentina go wrong?)

To resolve the economic crisis, fiscal deficits must be addressed... Peso devaluation boosts exports

Luis Caputo, Argentina's Minister of Finance, speaking on the 12th. Photo by La Nacion YouTube

The peso devaluation (exchange rate increase) was primarily implemented to correct the fiscal deficit. This is evident from Caputo's candid remarks during his speech.

"Our main problem is the fiscal deficit. Everyone attacks only the consequences of the economic crisis, but no one attacks the root cause, which is the fiscal deficit."

He voiced that to solve Argentina's difficulties, the core issue of the fiscal deficit must be addressed somehow.

The peso's value actually helps in resolving the fiscal deficit. The lower the currency value (the higher the exchange rate), the better the exports, which increases foreign exchange reserves. Imagine the exchange rate is 1,000 won per dollar. If a Korean company produces a product priced at 1,000 won, it is priced at 1 dollar in the international market. But if the exchange rate rises to 2,000 won per dollar, the same product is priced at 0.5 dollars internationally. With prices halved, exports become much more competitive. Since Argentina's exchange rate changed from 366.5 pesos per dollar to 800 pesos per dollar, it is expected that price competitiveness will improve and export volume will increase.

Attempting structural reform despite pain... Must endure 200% inflation

A bundle of 1,000 peso banknotes, the high denomination currency in Argentina that could be exchanged for 100 dollars [Image source=Yonhap News]

But why didn't Argentina devalue the peso earlier? If it were a good policy, they could have devalued the currency sooner to solve the problem. The truth is, devaluation causes price increases. While it benefits exports, it is disadvantageous for imports. Previously, you could buy 1 dollar worth of goods for 1,000 won, but now you need 2,000 won to buy the same 1 dollar worth of goods. Considering Argentina's triple-digit inflation, implementing devaluation was difficult.

Therefore, the devaluation measure to reduce the fiscal deficit is expected to worsen Argentina's inflation problem in the short term. JP Morgan forecasts that Argentina's inflation in December will rise 210% compared to the same month last year. In fact, after the devaluation announcement, Aerolineas Argentinas raised domestic airfares by 50-100%, and the state-owned energy company YPF increased fuel prices at gas stations by 37%.

The suffering of the Argentine people, already burdened by high inflation, will inevitably increase. Credit rating agency Fitch analyzed in a report that "(Argentina's) adjustment will be painful, and the road ahead is full of economic, political, and social risks." Nevertheless, Caputo believes these necessary measures must be implemented. In his speech, he emphasized that although difficult, these policies are essential.

"We must speak the truth, even if it is uncomfortable, rather than pleasant lies."

"Bold measures" praised by IMF, but peso's future remains uncertain

On September 25, during the height of the Argentine presidential election (local time), supporters of Javier Milei, one of the presidential candidates at the time, participated in an election rally held in San Mart?n. Milei, classified as a far-right candidate, pledged to abolish the internal combustion engine and introduce the US dollar.
[Image source=Yonhap News]

The IMF gave a positive evaluation of Argentina's currency devaluation. They said it would help stabilize the economy and lay the foundation for more sustainable, private sector-led growth. IMF spokesperson Julie Kozak praised Caputo's announcement as a "bold initial step," stating that "the decisive policy implementation by the Argentine government will establish a foundation for economic stability and more sustainable private sector-led growth."

However, questions remain. The future direction of monetary policy is still unclear. President Milei, during his campaign, advocated not just devaluation but abolishing the peso entirely. He proposed adopting the US dollar as the official currency. However, Minister Caputo opposes dollarization. Since he is focusing on lowering the peso's value, it can be seen that the dollar adoption has been effectively abandoned or postponed.

Some interpret this as an intermediate step toward transitioning to a dollarized system. To introduce the dollar as promised, Argentina needs to build up a certain level of foreign exchange reserves. To do so, exports must increase significantly, which explains the peso devaluation.

Editor's NoteEconomics and finance are complex due to complicated terminology and background stories. Financial Light delivers easy-to-understand economic and financial stories every week. Even without prior knowledge, these stories will ignite your interest in economics and finance.

This content was produced with the assistance of AI translation services.