Argentina takes a radical political turn: what changes can we expect to see in its economy?

Argentina, after years of being immersed in a deep economic crisis, held elections on November 19 with inflation at 140%, a predicted drop in GDP of 2% this year and a poverty and destitution rate of almost 30%. Following the victory of Javier Milei, presidential nominee of the La Libertad Avanza party, the country will now embark upon a new era that could represent a 180-degree turn in the country's economic policy.

Milei won the second round of the presidential elections obtaining 55.69% of the vote, thus beating out the country's Minister of Economy and Public Finance, Sergio Massa, who scored 44.3%. Anticipated after the first round, the projections made by the MAPFRE Research Service forecast a possible increase in support for Milei due to the potential transfer of voters from Bullrich, the candidate of the traditional conservative right.

The major challenge now facing the newly elected president is to reverse the chronic weakness of the Argentine peso and bring inflation under control, which has remained extremely high for decades, going into two and even three digits. Performing this turnaround with a highly indebted country, with its international currency reserves at historic lows and in the midst of an IMF bailout will not be an easy task, as indicated by MAPFRE Economics.

“The complexity of the political and economic situation in Argentina requires meticulous and strategic attention in various areas, with an emphasis on financial stability, debt restructuring and possible fundamental economic reforms to restore confidence and sustainable growth,” according to MAPFRE Economics, which insists that the road ahead will not be easy “by any means.” Although there is a very wide scope for action, there are also major limitations, which will make the path slower than Milei himself would like.

Consequently, the current economic situation presents a significant window of uncertainty, which keeps investors cautious regardless of who won the next presidential election. The crucial topic on the economic agenda focuses on the vulnerability of public finance and possible need to restructure debt again.

Structural challenges

Milei has known how to capitalize on the protest vote, with a program of measures that differs significantly from Massa's, with a clear objective: reduce public spending and the size of the State.

In the economic arena, Argentina is facing considerable challenges, with GDP expected to fall 2% this year and a forecast of stagnation for next year. “The economy has experienced persistent stagnation for approximately 15 years, which is reflected in a structural crisis aggravated by inflation surpassing 100% annually, a problem that has persisted for the last three decades,” as indicated by MAPFRE's Economic Research.

In fact, there was a drop in GDP of 4.9% in the second quarter of the year, after having risen by 1.4% in the first quarter, with a 10.9% drop in exports, combined with an increase in prices of 138.2%. The “Economic and sector outlook 2023: perspectives for the fourth quarter” report emphasizes the significant impact of the country’s drought, which has reduced agricultural production. The forecast for inflation at year-end stands at 169%, up on the 141% estimated in June, with an increase forecast across all segments.

The economic analysis indicates an excess of public spending financed by issuing money and a misaligned exchange system, in a context of strict control of the capital account. MAPFRE Economics has highlighted that the only period of economic stability in recent decades was during the peso-dollar parity established in the 1990s, although its long-term unsustainability led to recession and deflation, ending with Argentines flocking to bank branches to withdraw their savings in dollars, the infamous “corralito.”

That failed stabilization plan draws comparisons to one of Milei's star measures: the closure of the country's central bank and the dollarization of the economy. This would mean adopting the US currency as a means of payment and delegating monetary sovereignty to the US Treasury. Argentina would be by no means the first country to make that decision: it would follow in the footsteps of El Salvador, Ecuador and Panama. This goal is “particularly ambitious and complicated,” especially considering that the economies of the United States and Argentina are in very different positions.

MAPFRE Economic Research explains that the problem is that Argentina is immersed in a vicious cycle in terms of deficit and the central bank: relinquishing fiscal dominance and recovering the independence and credibility of the central bank could well be an appropriate approach.

Milei wants to reduce the State’s deficit to 0%, in other words, not spend any more than it earns. This will be “very painful” in the short term, but moving forward, would allow for a greater balance.

Furthermore, Milei's victory stokes a variety of debates between financial analysts, in particular as regards support from the International Monetary Fund (IMF) and China in the country's financing is notable, with the IMF requiring fiscal adjustment measures and a restructuring of international reserves to stabilize the economy in the long term.

What can we expect in the coming months?

The first unknown will be the exchange rate, which has been practically frozen since the first round of the presidential elections. “Although we believe that fear will initially prevail, there may be a breather toward the end of the year while we wait for the first unknowns about the economic policies that we will see at the start of the President's term in office to be cleared up,” explains MAPFRE Economics.

We will then have to see how quickly these reforms take place. Argentina has IMF payments to make in December and January, so Milei "should offer a convincing, but sustainable first step that offers a guarantee to its external lenders," adds the Economics service. Likewise, he does not have a clear majority in Congress, so will have to agree on the new measures with the traditional right.

The third point will involve the recovery of economic orthodoxy. The need to make structural, deep-cutting adjustments will take the economy more time, and it will not be easy. However, being successful here would be one of the pillars in instilling trust and then retaining it.