The result of the elections that took place on October 26 was very positive for the functioning of the Argentine economy. Previously, there was great financial tension that polluted the real economy (and this tension has only partially subsided thanks to aid provided by the US government). Exorbitant interest rates on the peso were not enough to prevent the exchange rate from reaching the ceiling of the floating range, and this had consequences for the level of activity and some consumer decisions.
It has been recognized that there is an increased political risk since the Buenos Aires election result on September 7, as well as the consequences of some errors in economic policy decisions. The result of the elections that took place on Sunday the 26th of this month not only gave the government more power than expected in Congress, which should help achieve more robust reforms, but it also significantly reduced the prospects of a political force returning to power at the end of 2027, which still heralds the need for a new default and does not deny its mistakes that led to fiscal deficits financed by emissions and, consequently, astronomical inflation rates.
This low probability of a return to populism should help drive investment. No one sinks a large amount of capital into an economy if he expects the rules of the game to change arbitrarily soon. Price freezes, adjustments to the free availability of foreign exchange sanctioned by law, and adjustments to tax stability are some examples of the opportunistic behavior of vernacular populism in the not-so-distant past.
The election result should also support approval of more ambitious structural reforms. In the area of employment, there are problems related to contractual inertia, termination costs, litigation, and tax and non-tax costs. The problems of gridlock do not only involve collective bargaining, which imposes the same conditions on a very different reality between regions.
Argentina has little flexibility when it comes to taking on part-time or temporary contracts. End-of-service benefits, which are calculated on the basis of one month’s salary for each year of seniority, are high by international comparison, but lawsuits push them higher, and the same applies to job risks.
A possible solution is to merge the labor judiciary with the commercial judiciary, but provinces must also resolve problems that arise within their jurisdiction. Moreover, it is necessary to establish more limited and precise standards to reduce the margins of interpretation of the law.
Argentina suffers from the largest gap between labor costs and net wages in the region, but reducing this gap requires alternative financial resources. Furthermore, unions receive abnormally high incomes, without receiving any worker compensation. Reducing this “tax through privatization of collection” should be a reform priority.
In tax matters, problems affecting “competitiveness” arise from taxes on financial transactions, withholdings, gross receipts tax, stamp duty, and safety and hygiene tax. The problem is that these institutions collect about 7% of the GDP and that the three levels of government interfere.
Reducing the number of taxes is not a relevant reform; What is important is not the amount of taxes, but the problems each creates. Just imagine that Argentina’s tax system might be worse than the current system if all taxes were replaced by a large tax on total revenues.
Amendments to the personal income tax that reduce the weight of the tax do not reduce costs for companies, but rather reduce their collection and affect the distributive ability of the tax.
Risks and needs
Finally, the election results significantly reduced political risks. But the economy needs to return to pre-July 15 interest rate levels. This may not lead to an exchange rate lower than the current one if we take into account only the supply and demand flows for the particular currency.
But the central bank’s reserves still need to be improved, and this will require, as stipulated in the agreement with the IMF, that the monetary authority purchase foreign currencies within the floating band. The advantage is that there is enough room to re-monetize the economy starting from very low levels of the amount of transaction funds.
Foreign currency purchases to make debt payments could be reduced or no longer necessary if access to capital markets were gained, which now appears possible because of US aid. In this context, the options involve a move towards a float without bands, without net reserves and with a swap negotiated with the US government as a temporary alternative to that fragility in BCRA assets.
Alternatively, adjust the bands by raising the ceiling and especially the floor to try to avoid the temptation of the peso strengthening before exports and investments rain.
As we can see, the challenges are still great, but it seems that the government has learned from some of its mistakes. Hopefully, the door will open on October 26th to begin reclaiming much of the lost ground
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