Argentina. A Short Blanket for the Coronavirus Long Night

This article was first published by Ambito Financiero. Read the full op-ed (in Spanish) here.

The coronavirus has arrived, and Argentina has played its cards. First life, then the economy.

While it is non-debatable that the consequences of the pandemic will be enormous throughout the world, the magnitude of the impact is still uncertain. Argentina is a special case on three key dimensions: the health system, measures of social distancing and containment of the virus, as well as the state of the economy and public debt prior to the coronavirus.

An advanced health system…but not so advanced

The country has a health system with good resources overall, both material and human. The quality of health service provision, however, is uneven at the national level.

Comparing with countries in the region, the system is relatively advanced, but when it comes to international standards, the conditions in Argentina lag far behind the health systems of first-world countries, many of which are being overwhelmed by the coronavirus.

Beyond the relatively high health expenditure and the high number of doctors and beds per capita, the most relevant indicators today are the number of intensive care beds (available and equipped with a respirator), the availability of specialized personnel and the number of tests available. In all cases existing limitations will become more pronounced as the epidemic accelerates.

The resilience of the health system will depend, to a large extent, on the effectiveness of the social distancing measures implemented to flatten the infection curve and prevent the system’s collapse.

Social distancing: rapid government reaction

In fact, a distinctive feature of the Argentine case is the speed of action in adopting social distancing measures. While other countries adopted similar measures at the same time, they were already at more advanced stages of the epidemic when they did so.

It is not clear yet how effective these measures will be in tempering the process of contagion and ultimately reducing the number of fatalities. At the same time, while their impact on the economy is inevitable, the magnitude of such an adverse effect is still uncertain.

The economy and debt, the weakest links

The package of measures announced by Argentina to date includes emergency transfers to people engaged in informal and domestic work as well as low-income self-employees; extension of unemployment insurance; exemption from payment of employer contributions; and a rent freeze and suspension of evictions and service cuts for non-payment for the most vulnerable sectors. While the IMF estimates the initial cost of these measures to amount to 1% of GDP, the extension of the restrictions and their adverse effects are likely to make the final cost, although uncertain, exorbitantly higher.

The spirit of the economic measures is in line with those implemented in the rest of the world: trying to minimize the inevitable impact on the economy, prioritizing the most disadvantaged sectors and protecting the sources of employment. In this case, Argentina is not so much distinguished by the magnitude of the economic measures or the speed of reaction as it is by the ex-ante situation of the economy.

Before the corona crisis, the country was already in a delicate economic situation. In recession since 2018, Argentina had an unemployment rate of 10.6%, with an informal sector accounting for about 40% of total employment, a poverty rate of 35.6%, a (gross) public debt of 88% of GDP and an annual inflation rate estimated at 40% when the crisis hit. In the economic race against the pandemic, the nation does not run like the others, it runs from behind with the virus having a head start.

The available tools to weather the storm are few; the uncertainty is great. Fiscal space is almost non-existent. Argentina has a high tax burden (about 32% of GDP, compared to 25% in Latin America on average) and a high rate of informality. Therefore, the margin to resort to a tax increase is negligible. At the same time, fiscal space will be further reduced by the collapse in economic activity and its impact on the country’s public coffers; an effect that would be exacerbated if the taxpayer prioritizes other urgent expenditures and defers tax payments. In other words, the taxpayer’s behavior will be a key determinant of the actual fiscal impact.

To regain access to capital markets, Argentina is negotiating a refinancing of its public debt. An agreement based on a moderate reduction of the present value of its debt with extended payment terms – and an initial grace period – would create additional room for manoeuvre. Such an agreement would push away the ghost of a default. Moreover, it would allow Argentina to stop repaying net debt, lower the country risk, grant financial relief to the private sector and recreate a credit market in pesos, destroyed by forced reprofiling. Against this backdrop, the government should seek to become an active beneficiary of the support programs in the fight against the coronavirus that are currently being pushed by the IMF, the World Bank and other multilateral organizations. It would also be desirable to promote an extension of the IMF’s special drawing rights (SDRs) to increase the liquid reserves of member states, as was done during the 2009 crisis.

The central bank, with its hands tied by high inflation, will find some freedom to support the new economic policy objectives. In fact, it will be the ultimate financier of the health crusade although, unlike in the first world, it will do so without the guarantee of good collateral and in a country on the verge of default. The existence of capital and price controls prior to the epidemic may contain the inflationary effect of the initial increase in net issuance in pesos. In the immediate term, banking restrictions and the quarantine itself will cut the speed of money circulation and could even trigger an extra demand for cash to cover everyday expenses. To the extent that the private sector liquidates savings in foreign currency to meet urgent obligations in local currency, such an increase in issuance would be compatible with a relative calm in exchange rate markets. But this would be a unstable equilibrium since eventually the demand for money will be reduced by the sharp fall in production and transactions. With an ostensible deterioration in the current fiscal situation, falling commodity prices and the indefinite postponement of the Vaca Muerta project, the medium-term exchange rate horizon will become even more complicated.

Minimizing fatalities without mortally hurting the economy, will it be possible?

The challenge is enormous. The night of the coronavirus will be long and the blanket very short. Without a doubt, the task of the government, given the scarcity of resources, is an almost impossible mission. “If the dilemma is economy or life, I choose life,” says President Fernandez. “Then we’ll see how to sort out the economy.” It is clear that the priority is to minimize the number of deaths and that society across the political spectrum are in support of this prioritization, but if there is one death that the health system cannot afford, it is the economy. Strictly speaking, the health of the economy will have to be taken into account at all times, even if the decision was made to choose life. The quarantine could be shattered if the payment and supply chain is broken by an avalanche of bankruptcies and an economic meltdown. And the challenge of the day after will be to deal with the consequences of the monetization of the crisis in a context of excess money supply, high inflation and an impoverished society, which after a huge sacrifice will emerge even poorer.