Signals needed to calm the waters

Credibility, in the life of every person, is a very important attribute. In economic policy, it is almost everything. The more credible a government is, the lower the interest rate the market is willing to give. The more credible a central bank, the easier it is to reduce inflation. And vice versa. The election campaign
Alberto Fernandez he had words and gestures that could help him win the title
choicebut they will surely create the need to generate a significant confidence shock in order to govern without falling into crisis.

On July 28, he stated that his intention was to stop paying the interest of the Leliq (liquidity letters from the Central Bank) and that he was proposing to provide free drugs to pensioners, which would cost each year what the Central Bank pays ten days. He then clarified that he did not think to fault the Leliq, as many have interpreted, but that he was referring to a reduction in the rate of this instrument. In any case, it was a complex signal for savers. This signal complemented previous statements on the exchange rate. By the end of June, he had stated that "this is not the price of the dollar", while the peso was trading at $ 43.7 per dollar.

Although he and several economists in his economic environment promised that they would no longer tax the exchange rate and that they would respect debt commitments, some of these statements were ambiguous. Fernández said, for example, that the actions seemed less damaging than the debt contracted by the government of Mauricio Macri. "It's harmful, but much less harmful." Moreover, it is worthwhile that the economists who have managed the stock or aggressively renegotiated the debt in the past stand out. The fact that his partner is Cristina Kirchner does not contribute to the credibility. Máximo Kirchner, in a recent speech, suggested that the International Monetary Fund should not be paid.

It is not surprising then that when Fernández surprised everyone with a victory over 15 points on Macri and after having exceeded the limit of 45% in the primary elections (STEP), the markets collapsed last Monday. The initial shock led President Macri to talk to Fernandez, who tried to calm the waters. On Thursday, he said that a dollar at $ 60 seemed fine. The impact, however, was done. This dynamic, which can help Fernandez finish the elections in October, will be detrimental to him if he badumes the presidency.

When Fernandez said that a dollar at $ 60 seemed good to him, it was probably referring to the inflation-adjusted exchange rate. That is, the $ 60 dollar with current prices, what economists call the real exchange rate. After the depreciation this week, the real exchange rate was very high: at values ​​similar to those at the beginning of 2007, 33% lower than the historical average against the dollar since 1997 and 70% lower than the previous dollar . in the first two years of the government of Cambiemos.

The candidate forgets, however, that the dynamics largely triggered by his words will slow down the rate of inflation. Indeed, after doubting the possible reimposition of stocks, the Argentines rushed to move from the peso to the dollar after the STEP. Lower demand for money, higher inflation. Food prices would have jumped 2% the previous week; those of home appliances and other goods, many more. In other words, whoever wins the election and will be president will surely have a high real exchange rate. But if it does not help to increase the demand for money, you will also receive rising inflation, averaging 80% a year. A process of acceleration of inflation would make the new government the most difficult task.

The second problem that Fernández would face, if he wins, is financing. Government bonds in dollars fell 30% after the STEP. In most cases, these bonds represent half of what investors paid a few months ago. In the case of peso bonds, the loss was even greater. Who will want to finance a country that burns half of your capital in such a short time? Without financing, it will be almost inevitable that a new government will start by restructuring (that is, default) the debt. The type of restructuring will be discussed in the financial environment, rather than knowing whether there will be a restructuring or not.

The lack of clarity about future policies has another hostage: the campaign. Uncertainty about the future of source deductions will likely result in reduced summer grain planting, increased soybean planting at the expense of corn, and lower fertilizer use. Fernandez would also face problems he did not have when he was Chief of Staff at Nestor and Cristina Kirchner. On the one hand, the prices of major export products such as soy are low and continue to decline, in the context of a world facing a possible recession. On the other hand, lack of rainfall in southwestern Buenos Aires may affect the wheat crop this year.

There is still time to prevent this dynamic from deteriorating further, but it must give strong signals. The model to follow is provided by Ignacio "Lula" Da Silva. When the market realized that Lula could win the presidency in the Brazilian elections of October 2002, he panicked. The real, which traded at 2.30 for a dollar in March 2002, reached 2.84 in June. Country risk (a measure of the additional interest rate paid by a country above the US equivalent rate) increased from 770 points (7.7%) in early March to 1700 points June 21st. On June 22, Lula published his "Letter to the Brazilian people" in which he signed his commitment to honor contracts, control inflation and have the necessary fiscal discipline.

From then on, the country risk has decreased and the exchange rate has calmed down somewhat. The two had a new escalation in August and Lula reiterated her commitment to a new letter on the 19th of this month. The real was already at levels close to what it has today, 17 years later, about 4 dollars per dollar. Although the markets did not return to pre-election levels after Lula's letters, they were decisive in preventing a further deterioration of the economy. They also marked a before and after in the perception that had employers and the Workers' Party (PT) market.

A letter to give certainty

One possibility is that there is a "letter to the Argentine people" to calm the waters. The letter must guarantee that the shares will not be reimposed (if you want to stabilize money demand); badert that retentions will not increase (if one seeks to prevent agricultural production and investments in Vaca Muerta from falling); confirm that Argentina's international commitments will be fulfilled (if you want to prevent the government and the Central Bank from running out of dollars); argue that the budget accounts would be improved, resulting in a primary surplus of the government, and would guarantee the continuity of key institutions such as the Central Bank and the National Institute of Statistics and Census (Indec), among other items. This letter could help change the perception that entrepreneurs and markets have of the coalition it leads, thus helping to facilitate the transition, if any.

The example of the Letter to the Brazilian people also gives us an idea of ​​what can happen with monetary policy in case Alberto Fernández wins the presidency. Like Fernandez a few weeks ago, Lula criticized the high interest rates that existed in Brazil in his letter of 2002. However, during most of his government, Brazil's interest rates were among the highest in the world in real terms (adjusted for inflation). In fact, they were as high as during the period of his predecessor, Fernando Henrique Cardoso. It was this effort that allowed the neighboring country to reduce inflation by 14.5% in January 2003, when Lula badumed, to 3.3% in October 2006, when he was re-elected. In other words, if Fernandez wants to succeed and be reelected, he must be even more orthodox than Macri.

The author is an economist. PhD (University of Pennsylvania); He was chief economist for Latin America at Bank of America Merrill Lynch. Co-author of
Why do all governments fail? c / Sergio Berensztein