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Argentina’s Central Bank on Path to Insolvency in Just Two Months

By: Iván Cachanosky - @ivancachanosky - Jul 24, 2014, 9:00 am
Para no debilitar el peso, el Banco Central argentino emite deuda remunerada. (Flickr)
To avoid hurting the Argentinean peso, the Central Bank must take remunerated debt. (Flickr)

EspañolEver-increasing government expenditure is becoming simply unmanageable for the Argentinean government. One does well to remember that in just the last 10 years, public spending went from 30 percent of economic activity to approximately 46 percent. This significant increase must be funded somehow, and after resorting to various tactics, the central government is running out of options.

First, an extremely high tax burden leaves no room for additional tax hikes, so there is not much to do from a tax-collection perspective.

Second, simple money-supply expansion to fund public expenses is a well-known alternative, and Mercedes Marcó del Pont, when in charge of the Central Bank, did use this tool to finance government. However, this ploy expanded the monetary base at a rapid clip, with a peak in February of last year. The annual expansion of almost 40 percent and its inflationary implications became too great. Monetary expansion has continued, but at a slower rate.

At present, the expansion hovers around an annual 20 percent. Despite the lessened monetary expansion, however, inflation remains high, and is vulnerable to decreased demand for the Argentinean peso. So this too limits the room for funding through what is known locally known as la maquinita — the little inorganic printing machine. Any surge in monetary expansion would cause inflation to surge beyond the current level, which is approximately 40 percent.

This is why Juan Carlos Fábrega, the new president of the Central Bank, has chosen a new strategy. On the one hand, he has restrained monetary expansion, but on the other, he is financing the central government through various debts: Central Bank Bills (LEBAC), Central Bank Notes (NOBAC), and reverse swaps. In effect, financing is done through domestic debt, but what is the limit to this strategy?

Of course, such short-term debt cannot be increased infinitely, since unpaid debt would put the Central Bank’s solvency at risk. In January, the value of these domestic debts equated to a 54 percent of the bank’s reserves (converted to Argentinean pesos at the official exchange rate of that moment). Through June, as this strategy was implemented, the debts burgeoned to almost 79 percent of reserves. In other words, there is only 21 percent left before the debts become impossible to repay.

Since the beginning of the year, the annual increase in domestic debt, held by the Central Bank experienced a slight acceleration on a monthly basis, from 15 percent in January to 17 percent in June. Still, the average monthly growth of domestic debt in the first half of 2014 has been 11.5 percent. With just a monthly increase of 10 percent in the following two months, the debt level will exceed total reserves.

Domestic debt as a percentage of reserves
Domestic debt as a percentage of reserves. Data source: Liberty and Progress Foundation, based on Central Bank of Argentina data and projections.

Besides this financial crisis, Argentina remains unattractive for investment. In fact, we have seen capital flight, an outflow of dollars due to institutional failure the country suffered through in recent years.

Domestic debt held by the Central Bank can be a short-term relief, but how will the central government obtain funding after this too comes to an end? No reversal at this point will eventually bankrupt the Central Bank.

An increased tax burden would simply promote higher levels of tax evasion, and monetary expansion would mean perilous inflation. Another alternative is to take external debt, but who would be willing to lend Argentina money and at what interest rates?

If Argentina wants to recover its solvency and become attractive for investments again, it simply must decrease government spending. Investors might then see that the country is able to repay her debts and maintain stability.

Meanwhile, without further reserves — amid deficits and weak institutions — it is going to be difficult to resort to macroeconomic tools without a severe impact on the people.

Translated by Adam Dubove.

Iván Cachanosky Iván Cachanosky

Iván Cachanosky holds a bachelor's degree in business administration and a master's degree in applied economics. He's currently an instructor at CMT-Group. Follow him on Twitter at @ivancachanosky.