Argentina’s gamble on economic gradualism is working, so far

AT THE height of summer, workers bundled up in blue snowsuits are hauling boxes of ice lollies in and out of freezers at a small factory near Buenos Aires, Argentina’s capital. The lolly-maker, Guapaletas (“pretty popsicles”), is almost exactly the same age as the business-friendly government of Argentina’s president, Mauricio Macri, who was elected in 2015. His victory was a “relief” for the company’s founders, says Federico Manzuoli, who is one of them. On a visit to the factory last March, Mr Macri praised its franchise business model and its pistachio-flavoured lollies.

Mr Manzuoli has much to be grateful for. Mr Macri promised to open up Argentina’s isolated economy and end controls imposed by his populist predecessors, Cristina Fernández de Kirchner and her husband, Néstor Kirchner, who governed for nearly 13 years between them. Under Mr Macri, Guapaletas has better access to credit, says Mr Manzuoli. A new online platform, Export Easy, makes it simpler to get export licences. Guapaletas started selling through three shops in Argentina and has now expanded to 69. It plans to start exporting to Chile, Colombia, Paraguay and Uruguay in March.

But Mr Manzuoli’s confidence is tinged with unease. Mr Macri’s reforms have run into resistance. A protest against his plans to reduce spending on pensions led to the firing of tear gas and rubber bullets and tied up traffic in Buenos Aires on December 14th, delaying deliveries by two lolly-laden lorries. After a fast start, Mr Macri has slowed the pace of reforms. If he cannot finish the job, Mr Manzuoli fears, Argentina’s economy will not prosper.

After taking office in December 2015, Mr Macri floated the peso, scrapped most taxes on exports and reduced energy and transport subsidies in an effort to restrain a rising budget deficit (see chart). He introduced targets for public borrowing, settled a long-running dispute with foreign creditors, which restored Argentina’s access to international capital markets, and gave his blessing to inflation targeting by the central bank.

The economy is now moving in the right direction. It has recovered from a recession that began in 2015 and is expected to grow 2.5% this year. Inflation has fallen by more than a third from its peak of around 40% in July 2016. The IMF predicts that the primary budget deficit (excluding interest payments on debt) will shrink from 4.8% of GDP in 2016 to 1.9% by 2020.

Last October, Cambiemos, Mr Macri’s party, won a decisive victory in legislative elections, giving the government the courage to continue reforms, albeit at a cautious pace. In November it signed a deal with provincial governors in which they promised to reduce their budget deficits (eventually). Despite the delivery-disrupting demonstration in December, congress changed the way pensions are indexed to inflation to make them more affordable. It cut taxes to encourage companies to give formal jobs to the 30-40% of workers who are paid off the books.

This month Mr Macri allowed the expiration of a 16-year-old economic-emergency law, which gave the president special powers over debt, taxes and the exchange rate. Its demise is supposed to be a quiet signal that the ruinous decades of populism and instability are over, and that Argentina means to reclaim the European-level prosperity it enjoyed a century ago.

A balancing act

With the government still knee-deep in the mess made by the Kirchners and their predecessors, that goal seems far away. Midway through his first term, Mr Macri has barely begun to solve some of the biggest problems that enterprises face, points out Gabriel Brener, the boss of Cher, a chain of clothing shops. Decades of protection have sapped the competitive energies of Argentine industries. Trade barriers are seven times higher than the average for emerging markets, according to the IMF. Mr Macri’s government scrapped a system that subjected all imports to licences, but left them in place for about a fifth of imports. Despite the recent tax cut, high taxes on investment and labour and burdensome rules continue to discourage firms from growing, constrain their productivity and keep workers in low-paid informal jobs. Labour productivity has hardly grown since 1980.

Courts are corrupt and schools are mediocre, Mr Brener complains. Unions are beholden to their bosses rather than to their members. (This month police arrested Marcelo Balcedo, head of a union for workers in education and child services, on suspicion of money-laundering and tax evasion; at his mansion in Uruguay they found a half-million dollars in cash and a small zoo. He denies the allegations.) Mr Brener wants the president to say more about how he will deal with these issues.

But Mr Macri has put off some of the hardest decisions for his second term, which he hopes to secure in elections to be held in 2019. His advisers say that the reforms so far are just a “first draft” of the changes he will eventually bring about. The labour reform that he plans to enact this year, which will make it easier to sack workers and hire part-timers, is a timid version of the overhaul Argentina needs. Improvements to education, more ambitious tax and pension reforms and a shake-up of the judiciary will also have to wait.

To give himself a chance to write the second draft, Mr Macri is pursuing policies that seek to balance economic stability with the need to placate groups that could disrupt his presidency and thwart his re-election. Argentina pays an economic price for this caution in the form of high interest rates, weak exports and a rising debt burden. If Mr Macri misjudges, and lets the price rise too high, he could undermine the economic revival that he has promised to bring about.

His main macroeconomic decision has been to reduce the budget deficit gradually rather than abruptly. The word “adjustment” is taboo, says an official in the treasury department. The pension reform, which provoked shoving on the floor of congress as well as clashes with police outside it, is expected to save the government the equivalent of 0.5% of GDP this year. That is a good start, but the government has to go further, for example by making sure that contributions cover a bigger proportion of benefits, argues the IMF. Mr Macri did not offset the corporate tax cut with revenues from other sources.

His reluctance to slam on the fiscal brakes has shifted responsibility for controlling inflation, still a painful 25%, onto the central bank. Its high interest rates have slowed economic growth and encouraged foreign investors to buy Argentine bonds, drawing in capital that has pushed up the value of the peso. That in turn has made exports less competitive and widened the current-account deficit. A relatively strong currency has discouraged foreign investors from risking money in job-creating enterprises or the infrastructure that Argentina desperately needs. The IMF has urged the government to set a more ambitious fiscal goal of eliminating the deficit before interest payments by 2019.

Rather than do that, the government has decided to accept a higher inflation rate than it had planned. On December 28th the treasury announced that the central bank’s inflation target in 2018 would be 15% rather than 8-12%, which means that interest rates can be lower than they would have been. The peso quickly dropped by 4% (though it has since recovered a bit).

The central bank’s original target was too ambitious, so it makes sense to revise it (even the new one may be hard to achieve). But there is a cost. Inflation hurts the poor most. Some economists worry that the government is teaching people to expect higher inflation, which often causes it to happen. The central bank shares that worry. On January 9th it lowered rates by 0.75 percentage points, a bit less than markets had anticipated, to 28%.

Although orthodox economists grumble about Mr Macri’s gradualism, Argentine investors seem to endorse it. Private investment is recovering after a decline in 2016, though it is still lower than it should be. It rose 16% last year and is expected to grow by 14% in 2018. Foreign investors often follow the lead of local ones, points out Dante Sica of Abeceb, an economic consultancy. Before Cambiemos’s election victory in October, the rate of return demanded by foreign investors in Argentine infrastructure and energy was double what projects in other Latin American countries paid, Mr Sica says. It has since dropped to the same level.

Investors are betting that Mr Macri and his party can win again in national elections in 2019. There is a good chance of that, in part because more voters still blame the Kirchners for Argentina’s economic plight than blame Mr Macri. He will then have a chance to use the final term he is allowed in office to modernise Argentina’s economy. Mr Manzuoli, sitting beside menus that display Guapaletas’s 41 flavours, sounds more optimistic than fearful. Mr Macri “showed that it was possible to have a normal country”.

This article appeared in the The Americas section of the print edition under the headline “Getting warmer”