Why investors are cheering Argentina’s ‘shock therapy’

Caputo is but the hatchet man for Javier Milei, the chainsaw-wielding, right-wing economist who swept into Argentina’s presidential office last month on a promise of radical reform to cure the country’s economic ills.

Those problems are spectacular. Inflation is running above 140 per cent. GDP is set to shrink by around 2.5 per cent this year. Argentina defaulted on its debts yet again in 2020, adding to its failures to pay creditors in 2001 and 2014.

Establishment cheers bold reforms

A permanent reliance on borrowing is at the root of the problems, Milei argued. And his solution is to cut back hard.

While on the campaign trail, Milei was viewed as something of a crank. But in office, the establishment is now cheering his bold reforms.

Investors rushed into Argentinian bonds this week, pushing down the country’s borrowing costs. This is the type of positive spiral that Milei will need if his plan is to work – spending cuts pushing down market interest rates and so further saving the government money.

“While further details on the measures announced by Mr Caputo are yet to be known, our first impression of the announcement is positive,” said Sergio Armella, an economist at Goldman Sachs.

“Fiscal profligacy is the root of Argentina’s macroeconomic problems and moving swiftly with the fiscal adjustment is most important.”

Perhaps most importantly, the International Monetary Fund is supportive. Argentina is the IMF’s biggest borrower, with more than one-quarter of all its outstanding loans given to Argentina.

The IMF has struggled to gain traction with past governments in Buenos Aires when it comes to reforming the economy. Hence, Milei’s chainsaw economics is appealing – he looks like a man the IMF can do business with. The institution would quite like to know there is at least a prospect of getting its money back one day.

“These bold initial actions aim to significantly improve public finances in a manner that protects the most vulnerable in society and strengthen the foreign exchange regime,” the IMF said in an assessment.

“Their decisive implementation will help stabilise the economy and set the basis for more sustainable and private sector-led growth.”

Milei hopes the sharp break with the past will amount to shock therapy in the service of liberalising the crisis-stricken economy. An inspiration is Milton Friedman, a Nobel prize-winning economist so idolised by the president that he named one of his dogs after him.

Radical change on this scale has a mixed history. Friedman’s policies inspired much of the economic reform in Chile in the 1970s and ’80s, which transformed the economy even as human rights suffered under the dictatorship of General Augusto Pinochet.

The term “shock therapy” has also been applied to the liberalisation of the Soviet and Eastern Bloc countries after the fall of the USSR. Nations such as Poland have prospered spectacularly, even as Russia tumbled into gangsterism.

Initially, crisis could get worse

Milei’s reforms are not guaranteed to work. Credit ratings agency Fitch has noted that his party is not in a strong position in parliament, making pushing through radical change difficult. It is also tough to remove capital controls without unleashing large flows of cash out of the country.

Fitch’s analysts still believe “a restructuring or other default event of some sort is more likely than not in the coming years”, not least because Argentina faces a wave of foreign-currency bond repayments in 2025.

Armella, at Goldman Sachs, agrees that the economic crisis may get worse before it gets better. A weaker currency will make imports more expensive and inflation was “likely to accelerate in the coming months”.

But the IMF’s backing could hold lessons for plenty of other countries. Caputo says Argentina has an “addiction” to debt. While not yet in such dire straits, plenty of other countries have been dabbling with the same poison.

The IMF’s Fiscal Monitor warns that “for all countries, it is becoming hard to balance public finances” as “debts are generally elevated around the world, and borrowing costs are rising”.

Milei, the shaggy-haired Argentine outsider, may not be the small-state messenger the world economy expected, but his chainsaw-wielding warning that there is no money left resonates far and wide.

The Telegraph London