Monday, April 2, 2007

Cry for Argentina: Price Controls and Pegged Exchange Rate

It seems that economic authorities in Argentina have forgotten the Austral Plan. This is so because the policy makers’ response to mounting inflationary pressures is to suppress them rather than to deal with their root causes. To that end, utility price increases have been postponed, distorting price controls have been introduced, and export restrictions, most notably on beef exports, have imposed. Besides, the official inflation figures are now blatantly being fudged. This is all done with a view to making sure that recorded inflation does not surpass 10 percent at a time when most analysts consider that Argentina's underlying inflation rate is more of the order of 15 percent and rising.
On the exchange rate management, it is clear that Argentina has a pegged exchange rate to the dollar. Given the recent disaster with the Convertibility Plan, it comes as a surprise that policy makers are still insisting on a pegged exchange rate, especially given the large amount of capital movements. The Central Bank is intervening aggressively in the FX market to prevent any revaluation of the peso.
The expansionist monetary policy shows that the Argentine Central Bank simply does not have the policy tools at its disposal to effectively sterilize the large foreign exchange inflows. As a result, Argentina's broad money supply continues to race ahead at high double digit annual growth rates giving rise to considerable inflationary pressure.
It seems clear that very little will change until the October presidential elections. Clearly, a cheap currency is seen by the politics/populists/peronists as a highly effective way to keep economic growth ‘alive and kicking’.
We can only hope that once the October election is out of the way, the incoming president will change Argentina's macro-economic policy mix. We all know that artificially keeping the currency too cheap usually leads to higher inflation (especially countries that experienced hyper-inflationary situations). This in turn, tends to decrease the country's international competitiveness and leaves the country with the burden of high inflation.

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