November 26, 2014
Deficit beyond the bounds of the budget
When this columnist first arrived in Argentina in the closing stages of the 1976-83 military dictatorship, the steep learning curve he then faced in puzzling out an idiosyncratic economy was something called the quasi-fiscal deficit which was hugely important in that period. Budget deficits were a familiar enough concept (after all, those were the years when the United States was ruled by a president who said: “I never worry about the deficit; it’s big enough to look after itself” — Ronald Reagan and his supply-side economics) but what might a quasi-fiscal deficit be? Still trying to work it out, if truth be told, but the basic idea, in layman’s terms, seems to be shrugging off the usual deficit onto the Central Bank. As one economist has succinctly explained: “If monetized fiscal deficits produce inflation, quasi-fiscal deficits produce hyperinflation” and by 1989 this had proved true enough in the Argentine experience — since 1989 this term has seldom cropped up. Until now.
At the most basic level a quasi-fiscal deficit seems in the making when public spending rising 44-45 percent outstrips even a revenue surge of 37 percent, as announced this week with the April revenue haul of 92.7 billion pesos — the Central Bank has to print the difference. But the mechanisms are even more perverse — thus in the case of grain export duties, the same factor which boosts revenues and moderates the budget deficit actually worsens the quasi-fiscal deficit because the Central Bank has to produce the pesos to buy the soy dollars. In order to avoid hyperinflation, all this extra money supply has to be “sterilized” (to use a pet term of Martín Redrado when he was Central Bank governor) by issuing bonds to the tune of well over 20 billion pesos at interest rates of almost 30 percent — levels which have the economy grinding to a halt for lack of credit. Here we can see the origins of both halves of “stagflation.”
While the fiscal deficit seems tamed at least until the midyear bonus falls due, the clock keeps ticking for the quasi-fiscal deficit. If the Central Bank does not assume the fiscal deficit and absorb the extra pesos, these will either pressure prices or upset the fragile exchange balance of the last three months (with the dollar anchored at eight pesos) by chasing greenbacks in their “blue” version — although reports this week indicate that the Central Bank could be taking a break from “sterilization..” Quasi-fiscal deficits have a capacity to absorb liquidity in silence for several months, suffering huge differentials between the interest rates paid out and those received from the state, until they finally burst —hence hyperinflation as their classic ending.
There seems no alternative to cutting public spending — the only way to cut is to cut. If the fiscal deficit and the subsidies for transport fares and utility bills are almost identical percentages of Gross Domestic Product, then the solution could hardly seem simpler — just phase out subsidies. But it is not so easy. Firstly, the gas and water subsidy cuts already announced will not so much serve to soak up red ink as to pay off arrears to utilities long fighting insolvency (a similar situation applies to electricity where the subsidy cuts have yet to be made). Secondly, January’s devaluation caused a huge leap in the fuel import bill, which forces the government to run hard just to stand still with its subsidy cuts. Between these and other factors the government would be lucky to trim its subsidy bill by just two percent.
Deficit talk should not be limited to the national government, of course. Various think tanks have forecast that provincial debt will rise by anything between 35 and 43 billion pesos this year — which makes the 1.8-billion rollover announced by President Cristina Fernández de Kirchner in the brief week preceding the long May Day weekend seem highly relative (and also perhaps camouflage for the weightier 11-digit Fondear trust simultaneously announced — a package of soft credit lines amid the current tight money context whose destination will be decided by a ministerial committee and which has all the makings of a new slush fund). Neither national nor provincial governments have much more scope to tax without treading on each other’s toes — which means that the Central Bank will just have to print more money.
Conventional wisdom sees the dollar as the main battleground with most pundits forecasting that the government will lose its bet of riding the soy harvest until it can tap global capital markets (a process starting with the Paris Club negotiations at the other end of this month) and will be forced into another devaluation. But the real economy could bring matters to a head in a very near future with the current credit paralysis being unsustainable (10 million pesos lent in March as opposed to the 2013 monthly average of 10 billion) — especially with push starting to come to shove in the battered auto industry with short-time already evolving into lay-offs at some auto plants.
Quite apart from being bad news for what has been a motor industry in every sense of the phrase (a co-star of the “won decade” alongside soy), the implosion of assembly line activity (35.5 percent down last month from the previous April) is alarming because it shows inflation as advancing to the stage where it loses all its saving graces. Throughout the “won decade,” inflation (when it was admitted at all) was invariably presented as the price of growth and was also a much bigger factor in the car boom than generally acknowledged — people were encouraged to see wheels as a hedge against inflation when bricks started becoming problematic with dollars running dry. Until now it was always possible to find a bright side to inflation, which could almost be described as pleasant in the early stages (somewhat like terminal cancer in the first few weeks when the patient is free from both any responsibilities and pain). Now inflation is just pain without gain.
It has been a fortnight since the last column (due to May Day) but the economic limbo has barely changed in that period. Yet the next fortnight could prove decisive with monetary policy at a cross-roads — will the Central Bank be allowed to call the shots as in the last three months or will liquidity be allowed to flow in order to regain the growth path with all the risks entailed of those pesos feeding prices and parallel exchange rates instead?