Default, devaluation likely

Argentina has launched the zero deficit policy at an ill moment of very high deficit and lack of credibility among markets, and a likely scenario is a debt default and a devaluation, economist José Luis Espert said.
The cuts in state wages and pensions required to achieve zero deficit in December may be as high as 65 percent, he added in remarks to the Herald on Thursday. He also fears that a "wrong consensus" may throw the economy in the hands of politicians like Radical Party Chairman Raúl Alfonsín or maverick Radical Deputy Elisa Carrió, which, he said, would cause the largest loss of financial and human capital in the country’s history.

What do think of the accord with the IMT?

There are two medium- to long-term issues which 1 believe positive, and a short-term one which is the most problematic. The first positive issue is that if a debt-restructuring is discussed in the future Argentina will no longer be seen as a loony irresponsibly deciding not to pay, because the US Treasury itself has acknowledged that Argentina’s indebtedness prevents sustained growth. The second is the possibility of opening the economy, to start trading not only with Brazil like so far but also with the First World. The third and most thorny is the zero deficit policy.

Why?

Because Argentina has decided to apply some- thing technically coherent but at a time when the deficit is very high and within a context in which the country has no credibility in capital markets.

Can you provide some numbers?

The nation has a deficit of about $10-$11 billion and a public spending budget of about $22-$23 billion, which implies a cut of about 50 percent per year. Provinces must also go to zero deficit. Considering they have a deficit of $3-$3.1 billion and expenditure of about $20-$21 billion, the implied cut in provincial primary spending would be about 15 percent.

The consolidated deficit of the nation and the provinces is about $14 billion over a consolidated public spending budget of nearly $42 billion. This implies cutting public spending by more than 30 percent, or 5,5 point in terms of GDP.

Where is such a big belt-tightening leading?

Surely to a deepening of the economic depression. And this can lead to a vicious circle since we have no credibility and the adjustment is monumental.

Does the $8 billion just amount to the government buying weeks of breathing room, as some have said?

In the hest scenario, the agreement stopped a run (on deposits), allowing the possibility of making the adjustment. Argentina was going down the drain. Over the last 50 days deposits fell at a days average of $300 million.

Is the 13 percent cut enough?

A 13 percent may be enough for August or September. But after that zero deficit will require increasing cuts. In December die cut would he near 65 percent.

What if zero deficit is not achieved?

First, let us make it perfectly clear that this is just a very preliminary hypothesis because the agreement has not yet been closed. 1 think the spirit of the deal is not to achieve zero deficit from the day of the signature but alter reaching the $6.5 billion fiscal gap agreed for 2001 in November last year.
I think $6.5 billion will be accumulated by the end of September. In principle, this implies the need to have zero deficit in October-December, not only due to the zero deficit policy, but also for the agreed target. Cavallo has also said that there must be zero deficit in 2002.

How do you see markets vis-a-vis Argentina?

At the end of the first quarter the deficit target agreed with the IMF had been exceeded by $1 billion. Instead of $2.1 billion we had a gap of $3.1 billion. In the second quarter we met the target. That means Argentina was abiding. by the IMF programme when the run on deposits started.
How come markets were sending it to bell when it was meeting the goals?
The first suspicion is that there may be a divorce between what the IMF says and what markets want. The Fund has proved too flexible in recent years. However, there could he an element explaining the difference between markets and the Fund: the markets began taking it for granted that Argentina would have a problem in the 4th quarter. The Fund had proposed a $400 million deficit for that quarter. But we were seeing a $1 billion shortfall per month and to go to $400 million was not credible because the economy was on the slump. That is why deposits started fleeing. Markets saw a default possible.

What is your forecast?

A likely scenario is default and devaluation. I don’t feel in a position to predict when. It could even be before the end of the year. I think that towards year-end we will start having problems, that before 12 months counting from today, debt restructuring is possible.

What should the government do to avoid this?

I fear that it is already too late to do what I think should have been done. I would not like to suggest today what should have been done before. What we have is like a truck without brakes heading smack into debt-restructuring. What 1 would have done six years ago was go to zero deficit, after Cavallo’s absurd five years as economy minister in 1991-96.
Since early this year I would have gone to a total opening of the economy with zero tariffs not only for capital goods but also for intermediate and consumption goods. I would also have introduced zero deficit and devalued and restructured the debt.

I would have implemented this four pronged policy – economic opening, zero deficit, devaluation, debt-restructuring – in order to use globalization as a market to sell what Argentina produces for export, to transform a "begging economy" into a "selling economy." But today this is no longer a viable recommendation, because for me nothing can stop deterioration.

There is no way out but the truck crashing…

Right.

And then being repaired and starting up again?

Countries are not unfailingly condemned to success or failure. It is up to what they do. I fear that there is a wrong consensus that we are doomed by orthodoxy, liberalism Harvard and Chicago and that the economy may end up in the hands of Carrió, Alfonsín, Moreau and "Chacho" Alvarez.

What would happen in that case?

Argentina would suffer a loss of physical, financial and human capital like never before in its history.