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07/10/2007 | Argentina: inflation rise may force unpopular measures

Oxford Analytica Staff

EVENT: The National Statistics Institute (INDEC) is to announce September inflation figures today.

 

SIGNIFICANCE: Although INDEC is expected to announce a month-on-month inflation figure of around 0.7%, private economists put the figure as high as 1.7%. Despite the fact that official statistics appear to show that inflation is slowing, private estimates point to a worrying upward trend, despite the battery of measures employed to keep prices under control.  

ANALYSIS: At a conference in London in mid-September, Argentine Central Bank (BCRA) President Martin Redrado admitted his concern over the pace of Argentine inflation, which has risen by an annual average of 9.4% for the last three years. Although part of the increase was accounted for by factors beyond the government's control -- such as high food prices, whose impact in developing countries is more significant owing to the greater weight of these items in the consumer price index (CPI) -- he also affirmed that the only way to deal with inflation is to coordinate fiscal, monetary and wage policies.  

Growing inflation concerns. These declarations had a substantial impact in the Argentine media and in the government itself:  

.On the one hand, Redrado's speech was interpreted as a kind of self-criticism -- as president of the BCRA, he is responsible for sustaining the value of the currency. However, in recent years the BCRA's main priority has been to prevent nominal appreciation of the currency, at the expense of rapid growth of the monetary base, which rose by 46% in 2006.

.On the other hand, Redrado has been repeatedly identified as one of the candidates to become economy minister if the government's candidate in the October 28 presidential election, Senator Cristina Fernandez de Kirchner, is elected. His words thus also had a political impact, as the mention of inflation has become a virtual taboo in Fernandez de Kirchner's electoral campaign, owing to the government's failure successfully to tackle the issue.  

Slowing inflation?

According to the National Statistics Institute (INDEC), in August 2007 annual inflation reached 8.7%, down from 10.7% in the same month of 2006 and 9.7% in August 2005. During the first eight months of 2007, cumulative inflation reached 5.0%, down from 6.1% and 7.7% in the same periods of 2006 and 2005. Food prices showed the highest increase, with a cumulative increase of 6.7%, followed by household maintenance and equipment (6.4%) and by housing rental and services (6.1%).  

The CPI is subdivided into three components:  

.an index for prices subject to some type of regulation;

.an index for prices of goods affected by seasonal variations; and

.the remainder (denominated "rest of CPI"), which represents underlying inflation.  

The cumulative rise in this last component reached 6.3% in the first eight months of 2007, 1.3 percentage points higher than the overall CPI.  

Unreliable statistics.

However, INDEC's CPI is regarded as misleading, owing to the government's intervention in this agency in early 2007:  

.INDEC's CPI takes into account only inflation in the metropolitan area of Buenos Aires, although the agency also measures inflation at the national level.

.Although there should not be a significant difference between the two indexes, in August, year-on-year inflation in the metropolitan area reached 8.7%, while in the provinces it reached 11.0%  

It is important to note that, prior to the INDEC intervention, the difference between the two estimates was negligible. Moreover, in September, the statistics agency for Mendoza province reported month-on-month inflation of 3.1% for August, while INDEC reported the monthly estimate for that province as 1.5%, adducing methodological differences.

This incident -- in which Fernandez de Kirchner's running mate, Mendoza Governor Julio Cobos, supported the provincial agency's figures -- further undermines the credibility of inflation figures, and raises the suspicion that the government is seeking to camouflage the true rate of inflation.  

As INDEC's CPI is perceived as unreliable, private analysts now calculate their own indexes. Private estimates of annual inflation ranged between 15.0-20.0% for August 2007, much higher than the 8.7% reported by INDEC. Its officials have also claimed that poverty statistics are now unreliable, owing to the difficulty in calculating the cost of subsistence in the light of changes to inflation calculations.  

Fiscal benefits of lower inflation .

. Apart from the perceived political benefits of claiming success in lowering inflation, the government is indirectly benefiting in other ways from the underestimation of inflation:  

. Nearly 45% of public debt is adjusted by inflation through the Reference Stabilisation Coefficient (CER, which replicates past inflation).

. As such, private analysts estimate that, owing to the underestimation of inflation in the first eight months of 2007, the government will save around 4.6 billion dollars in debt payments, of which 2.2 billion correspond to payments that should have taken place before 2011 (when the next presidential mandate ends).  

Expansionary fiscal policy.

The inflation surge is largely accounted for by expansionary economic policies. Growing public expenditure (motivated by the electoral campaign) has fuelled domestic demand and thus prices. In July-August 2007 primary expenditure rose by 12.3% over the same period of 2006, driven by:  

.a 34.0% rise in the wage bill (due to higher public salaries); .a 50.0% rise in social security spending (driven by the increase in pension payments);

.an 83.5% increase in subsidies to the private sector (such as transport and energy sectors); and

.a 47.4% increase in capital expenditure.  

Remarkably, the fiscal surplus also increased during this period. However, this was due to the extraordinary revenues obtained through changes in the retirement system, under which contributors to the privately run pension system were given the option to return to the state pay-as-you-go system.

This implied a transfer of funds to the state of around 5 billion pesos (1.6 billion dollars), it has been estimated. Analysts estimate that, in the absence of the social security reform, the primary surplus may fall to 1% of GDP, down from the expected 3%.  

Difficult choices.

The government seems to have fallen into a vicious circle:  

.on the one hand, in an attempt to reduce inflation, it is resorting to price agreements, subsidies, frozen tariffs and apparent manipulation of official statistics; while

.on the other hand, it continues to fuel domestic demand through increased public spending aimed at improving prospects for a first-round victory for Fernandez de Kirchner.  

There is no easy exit from this situation. The next government will have to implement unpopular measures such as the renegotiation of utilities tariffs (frozen since 2002), the reduction of subsidies and the end of price agreements, which will inevitably boost inflation further. In that scenario, it will have to adopt further unpopular measures to curb inflation, such as fiscal adjustment and monetary tightening.

Economic growth will suffer, and social conditions will worsen. The scenario could deteriorate even more if the current turmoil in global markets lasts longer than expected.  

CONCLUSION: Given the failure of the heterodox approach to inflation, the next government will have to implement tough orthodox measures to bring down inflation. This implies a difficult political panorama for the incoming president, whose 'honeymoon' period will be brief at best.

Oxford Analytica (Reino Unido)

 


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