Buenos Aires — Argentine President-elect Javier Milei’s bid to reprivatize state-controlled companies such as YPF is likely to be met with investor appetite, although lingering doubts about the country’s policy volatility over the next 15-20 years “could be a little bit of a question mark that will probably demand a little bit of a discount,” according to Alberto Ramos, head of the Latin America macroeconomic research team at Goldman Sachs.
In an interview with Bloomberg Línea, Ramos also assessed the key points that investors will be looking at to determine whether or not Argentine stocks and bonds keep rallying in the short term.
The economist also weighed the pros and cons of a full dollarization for Argentina, something which Milei has seemingly placed on ice, at least for 2024.
The following conversation was edited for length and clarity.
Bloomberg Línea: How are gauging investor interest in Argentina following Milei’s win in the election, with Argentine assets rallying non-stop since then?
Alberto Ramos: The rallying asset prices answer your question. There is a certain sense of hope that we’ll see better policies, capable of addressing the very large macroeconomic imbalances that are currently plaguing the economy. But also there is a lot of uncertainty, not necessarily on policy direction, but in terms of implementation risk. Most investors are well aware of the headwinds that the Milei administration will face in terms of governability, given the limited political representation in Congress. They did not elect a particularly large bench, so political support will be key for some of these policy initiatives. And the other one is the social component and whether there is scope for pressure on the streets that could undermine the government. But there is some hope. Again, the asset prices tell you we may see a more front-loaded fiscal adjustment, progress on removing all sorts of capital, financial and price controls, and reducing the level of financial repression that you have in the system. That’s where we are.
There is a lot of uncertainty still. What do you think the market wants to see from Milei for this rally to continue?
I would say basically three things. One is more clarity on the policy mix. Milei campaigned on spending cuts. But, when? By what amount? What type of measures are needed? What are you going to do exactly with the central bank? Are you dollarizing or not? There are important decisions that need to be made in the very short term. Number two is key appointments. Who is going to be in the key posts? We still don’t know the individuals who will be running the central bank and economy ministry. And third is whether Milei will be able to broaden political support for his administration, whether he’s able to stitch together some level of understanding with other political forces that he could rely upon in order to move his policy agenda.
Eighty percent of the primary deficit is attributable to socially sensitive areas of spending such as subsidies, tariffs, salaries and pensions. Where do you expect to see Milei trying to cut spending?
Subsidies are a key one. There are a number of them where goods and services have been provided below the cost of production. That’s not right, because someone is paying for that. Even though you may not feel it, you pay through worse microeconomic performance, inflation, recession and loss of employment. Even though you think that you’re riding buses almost for free. The other one is transfers to the provinces. We expect Milei to take a deeper look and enact some cuts. In life, one does not do what one wants, but what one can. The fiscal issue is the mother of all macroeconomic problems. If you think that 80% of spending is social spending, then social conditions should have been great in Argentina, but they’re not. Even if you have to eventually compromise, rationalize and better focus social spending in order to advance fiscal consolidation and create conditions for a more robust social inclusive growth cycle, that also pays dividends. We have to think about this in a more realistic view. Can we focus all these subsidies and social spending on the really needy so that you allow for the economy to recover, for inflation to come down? Because inflation coming down is also social policy.
Regarding inflation, the general consensus is that we’re going to see higher inflation in 2024. Could that spike spook investors, or are they aware that this would be part of a process of trying to stabilize the economy?
That is inflation that is already trapped in the pipeline, because we know the currency is misaligned, overvalued. We know many of the prices are not market-clearing prices, starting with the exchange rate. A number of the price agreements need to be reset, or the tariff, which are an increasing fiscal burden. Once you recognize that there is a lot of pent-up inflation, I don’t think the market will be spooked by that. I would even say that the market sees that finally we’re addressing and recognizing the true dimension of the problem, because we’re going to move the currency to a level that is more aligned with the fundamentals. We’re going to move tariffs in line with the cost of producing and supplying those goods and services. It’s cleansing, from that standpoint. The currency is highly misaligned and that’s why international reserves are negative. It’s already pretty well internalized that things will get worse before they get better. It’s part of the healing process. It’s as if you were limping. You have surgery, you are bid-ridden for two days, and then you start to walk better.
Do you think foreign investor appetite will be there for Milei’s plans to privatize companies like YPF?
Sure, if he’s really capable of privatizing some of those assets, that will be interesting. Of course, there is a fair amount of uncertainty about the operating environment. If you want to buy a stake in one of these companies, you have to make a calculation for the next 20 years. What is the direction of this economy over the next 10, 15, 20 years? It’s a big, big question, and I’m not sure that anyone fully knows the answer. What we know is Argentina’s macro economy has been extraordinarily volatile and the political cycles have also been very noisy. That will be in the price. There will be a bid. Everything sells. Even third-hand cars have a price. Those are probably interesting assets, but the operating environment over the long term could be a little bit of a question mark that will probably demand a little bit of a discount as if those assets were in a country with lower macro and political volatility.
The noise isn’t just about the political cycles. It’s also about the trauma of past attempts to normalize the economy. With Mauricio Macri, a lot of foreign investors got burnt. How heavy does that weigh on the mind of the global investment community when looking at Argentina now?
I’m sure it’s an issue. It weighs on how you approach a market. This is a country with a track record of capital controls. You buy an asset and then you basically are not free to eventually set prices. You may not be free to transfer profits and dividends abroad. This is a country with a track record of nationalizations or political interference through regulation in the operations of these companies. If that was not an issue, the prices would be different. Nobody can define the future, but there is always the risk that the operating environment will see the return of episodes like that. When you buy them, you’re probably going to have a discount in order to cover that risk.
Luis Caputo, a former finance minister, is in the US right now with Milei. How is Caputo perceived by Wall Street currently, after his experience issuing peso-denominated debt at an annual yield of 18%?
Caputo has a lot of experience at the central bank and as minister of finance, and prior to that by working abroad in capital markets. From that standpoint, he will soon realize that Argentina will be struggling to regain market access and to raise funding, because the relationship with the IMF is quite difficult at this stage and Argentina does not have access to voluntary funding markets. An experienced pair of hands can be very useful. He did issue local debt at the yields that you mentioned, but I think in the end, the demise of Argentina was a political shock, where about four years ago, during the primaries, people came to realize that there would be a regime shift and it would go back to more populist heterodox policies, as we did. I think that is what eventually unraveled things, not Caputo. Ideally, you would be raising debt at lower yields. If you knew that would be a regime shift and the policies would veer in a more interventionist, populist way, maybe you shouldn’t have issued at those yields, but nobody could have anticipated that.
How challenging do you expect 2024 to be in terms of Argentina rolling over or paying debt?
It’s hard to tell. There are so many things. We cannot really answer that question in isolation. It really depends on the policy signals, how we see governability and policies moving forward. There is a path on which president-elect Milei is able to deliver on some of his promises, and if he comes up with a credible fiscal adjustment, he’ll able to pass a few things in Congress, and sentiment will start to improve. And then we go from there. It’s a big question mark at this stage. There is no doubt about it. The challenges are very, very significant. Part of the challenge is related to the legacy conditions. Milei is going to inherit an economy in pretty bad shape: two years of recession, negative international reserves, no market access, and core inflation running at close to 150% and counting. It is going to get worse before it gets better. The relationship with the IMF has grown increasingly distant and you have to eventually address that.
Sometimes I suspect that once the adjustment starts, given that the imbalances are so big, so pervasive, the capacity of policymakers to guide the adjustment will be limited. The adjustment then will follow a little bit of a life of its own. The speed at which it will propagate throughout the economy and spread through the economy is going to be determined by forces that may be outside the control of the authorities. That being said, adjustment needs to take place. The sooner it takes place, the better. There is nothing to be gained by delaying the adjustment even further. It’s going to be painful economically, socially, and politically, but that’s the crossing of the desert that we need to go through to get to a better place. That’s the price we need to pay to rebalance the economy and then a more sustainable, socially closed, inclusive growth cycle. Otherwise, we’ll never get out of this funk of financial repression, high inflation, and high levels of poverty and low employment. Those are the issues that we need to sort out.
When you refer to the adjustment taking a life of its own, what do you mean exactly in concrete terms?
If you have to deal with inflation at 15%, and we just have a few price agreements, you can remove them and you can tighten monetary policy and then the economy starts to adjust gradually. We know how to fine-tune and guide that, but when the imbalances are so big like in Argentina, once you allow the currency to depreciate, the pass-through is a big unknown. You lose a little bit of the capacity of the currency, and there may be an overshoot in the short term. It’s usually the case, but not a worry. It doesn’t overshoot sky-high. It eventually comes down. My two favorite analogies with that is, if you have a balloon and you inflate it, but it’s not very inflated and you want to release the pressure, you can poke it with a needle and the pressure starts to flow out, but the balloon is not structurally compromised. If you have a highly inflated balloon and you poke it, the balloon explodes. It works, but that is a lot of collateral damage. This is a little bit like the situation in Argentina. You have so many controls that you need to get rid of. When inflation is running at such a high level and we need to develop by a significant amount, not by a small amount, once you release all that energy, all those forces, where these variables end up settling in the short term is really unknown. Inflation could go to 250%, or it could be less.
Milei’s dollarization plan has seemingly been put on ice. It’s not looking likely at all in 2024. From where we are today, does Argentina have more to gain or to lose if it were to fully dollarize eventually?
It depends if they meet the preconditions. Dollarization is an FX regime, and in itself is not an advantage or disadvantage. Dollarization can solve some of your problems, or cannot solve any of them at all. It depends. For dollarization to work for you, you need to do your homework. What is the homework? Reforms to make the economy more productive and more flexible to shocks; wage formation, capital markets. If you have a decent fiscal picture and a somewhat flexible economy, then dollarization will not necessarily hurt you. But then if you do that, at the end of the road, maybe you don’t need dollarization. If you deliver the fiscal adjustment that is structural, deep, and permanent, and you approve some reforms to make the economy more flexible to shocks, then in the end, it would be nice to have currency flexibility. But if you don’t do all of that, dollarization hurts you.
If you’re not able from a political-economic standpoint to deliver that type of adjustment and those types of reforms, it’s better not to dollarize. Now, the logic of dollarization is also the following: Knowing Argentina, the cynical view is it’ll never be able to deliver a strong, permanent structural fiscal adjustment unless you have no other option. If you are that pessimistic, this will never happen unless you take the punchbag away, which is the ability of the central bank to print money. So if this will never happen, you’ll continue to be hurt by fiscal profligacy. If you don’t dollarize, but you don’t fix the fiscal, this is going to hurt you as well. If you dollarize and you don’t do the fiscal adjustment, dollarization will hurt you as well. So if you don’t make the fiscal change, you are hurt whether you dollarize or not. So the view is that if you’re not able to as a precondition to deliver the required fiscal adjustment, then dollarization could be the force that leads you to do the fiscal adjustment that otherwise you’ll never do. So that’s kind of the logic of Milei. I mean, dollarization is just another FX regime.
If we were to dollarize, one of the main critiques is that there would be competitiveness issues in the case of a weak Brazilian real or a very strong US dollar. How could that be addressed during such a regime?
If you dollarize, you don’t have currency flexibility to deal with shocks. If there is a devaluation of the Brazilian real, a main trading partner, or if we go through a period of a strong dollar in global markets, that erodes your external competitiveness. No doubt. Therefore, that’s why it is very important to have a very flexible economy. The way you gain competitiveness is what we sometimes call an internal devaluation, through flexibility in wages, for example. It’s a known fact that there is a high degree of unionization in Argentina, that wages are quite rigid. So it doesn’t jive well with the flexibility you need under dollarization. If you get rid of that potential instrument to help you deal with a shock like a bad harvest… the exchange rate as a smoothing mechanism, then we have to have flexibility in internal prices to guarantee that you remain competitive.