Could Argentina’s toxic relationship with the USD turn into a successful marriage?

Por Pedro Javier Funes

Licenciado en Relaciones Internacionales

Comité de Agenda Publica

Palabras Clave: Argentina, Dólar, Economia.

Argentina’s long-standing relationship with the American dollar has been a topic of discussion in domestic politics since the hyperinflation of the 80s and has increasingly been on agenda in the past two years after the Macri administration (2015-2019) restricted citizens' access to the currency in October 2019.

As a result of the peso’s historic loss of value and the volatility of the Argentinian economy and its inflation rates; economic stakeholders and citizens have resorted to the dollar for price setting and maintaining purchasing power. During the present year, the economic crisis and the pandemic intensified the demand for dollars creating a higher pressure for devaluation on the Central Bank (monetary authority).


Argentina’s inflation rate has been on the rise since 2017 and Argentina has a history of economic crises and poor fiscal discipline which has led to a decrease in the demand for pesos (Argentina’s national currency), meaning that citizens have switched towards a stronger currency (US dollar) for the safeguarding of purchasing power. This tendency has been an issue for the government as the foreign currency reserves on the Central Bank have been decreasing since the last presidential elections, leading to a series of restrictive policies and the taxation of currency exchange for citizens.


Domestic prices tied to the Dollar


In Argentina, although increasingly the case, prices are not shown in US dollars (with the exception of real estate); however, an increase in the exchange rate usually follows a comparative increase in the price of goods; showing a correlation between depreciation of the peso and the inflation rate.


“Higher inflation rates (or higher deflation rates) makes foreign currency pricing more attractive. The reason is that foreign currency pricing is a way of indexing prices to inflation. The higher the inflation rate, the larger the erosion of local currency prices relative to foreign currency prices, and the larger the incentives to choose the foreign currency” (Drenik, Pérez, 2020; 10).

How much is a Dollar in Pesos?


Argentina currently has different dollar exchange rates due to the restrictions that citizens have to face when exchanging pesos to foreign the currency. The baseline is defined by the Central Bank and is officially published every day. This would be the exchange rate that people who have dollars but want to buy pesos would get.


In addition, after Fernandez assumed power (2019), a 30% tax on buying foreign currency and foreign currency operations was added on top of the 200USD/month quota defined during Macri’s government (Comunicación “A” 6815/2019 BCRA). This created what is informally called as “dollar solidario”, taking the name from the tax “for a more inclusive and solidary Argentina” (Impuesto PAÍS - Resolución General 4659/2020 AFIP). This impulsed the already strong black market of currency exchange, increasing the price of the “dollar blue” (black market dollar) which has no restrictions or control from the government.


Foto: Julieta Ferrario


The exchange rate of the dollar kept rising but that only increased the demand for dollars, pressuring for a devaluation of the peso. Instead, in the means of preventing a loss of reserves from the Central Bank, the Government decided in September to add a 35% tax on top of the 30% tax on currency exchange and deduce international purchases by card from the 200USD/month restriction already in place (Resolución General 4815/2020 AFIP). Which means that now, whenever someone buys something in foreign currency, that amount is discounted from the available quota to buy currency in the following month. This tax is deduced from the “income and property tax” (impuesto a las ganancias y bienes personales), which means that workers who do not pay this tax can request a refund, although it will be refunded at the end of the year and requires an extra bureaucratic procedure that most people will probably not want to go undertake.


In the case of streaming platforms, an “added value” tax (IVA, 21%) is included, but the “PAÍS tax” is lower (8% instead of 30%), which makes it a very good example of Argentina’s complicated relationship with the dollar (Ley de Solidaridad Social y Reactivación Productiva Nº 27.541).


Although a devaluation would officially mean that the peso lost value, this taxation path only decreases the chances to expand currency reserves by making Argentinian commodities more competitive in the international market; and creates the problem of leaving the taxation behind and devaluing the peso in the future without creating a shock in inflation.


Another issue to take into account is that this taxation did not by any means prevent an inflation shock, due to the fact the people take the unofficial dollar exchange rate as a benchmark for price setting. Hence, a future devaluation will be added on top of the inflation produced by the increase in the unofficial exchange rate, which would have been avoided with a devaluation if that path had been taken from the beginning.


Is switching to the Dollar worth it?


Considering the historic loss of value of the peso, the instability of the economy and the fact that most citizens and economic stakeholders resource to the dollar as a way of maintaining purchasing power and setting prices. Why does Argentina not use the Dollar as the official currency to solve the issue with inflation and the lack of demand for pesos?


PROS


Bogetic (2000) analyzed the benefits of a dollarization and concluded that “the most obvious benefit of dollarization is that it eliminates transaction costs of exchanging one currency for another and greatly reduces domestic currency risk (or risk of devaluation of domestic currency) and, with it, the risk of currency crises. [...] By reducing exchange risk, dollarization can reduce the financial system's need for reserves” (2000: 201). A dollarization would also “reduce real interest rates, which contain premiums for expected inflation or devaluation” (ibídem: 202); meaning that entrepreneurs and companies would have more incentives for investment.


Argentina’s history of default and external debt renegotiations mean that the country has difficulty accessing debt; “dollarization can [also] make long-term financing available where it currently is not” (ibídem:202). Another benefit for Argentina could be the improvement of “government finances by increasing real revenue [and] foster[ing] fiscal discipline (ibídem: 203)”, which is achieved by reducing the Olivera Tanzi effect (reduction of tax revenue as a result of inflation) and restricting public spending.


“In some cases official dollarization may have favorable distributional benefits [because] shifting assets from domestic currency to dollars, or among different kinds of investments in domestic currency, requires time and effort, and there is often a minimum threshold level of transaction, which leaves the poor the captive payers of inflation tax” (ibídem:203).


CONS


But, if dollarization is so beneficial, why is it not widely adopted? “The reasons include the political symbolism of a national currency, historical patterns of use of domestic and foreign currency, and economic factors such as the perceived costs of dollarization, primarily in terms of the loss of independent monetary and exchange policies, seigniorage revenues, and domestic lender of last resort” (Bogetic, 2000: 182).


The transition is also costly because there are one-time expenses associated with the conversion of cash registers, software and ATMs that most people do not want to cover; and the cost of re-negotiating contracts and legislation. “At the level of foreign policy and diplomacy, preservation of the national currency is useful to governments' way of external dependence or threat” (Cohen, 2000: 5); which might be another reason why countries prefer to keep their own currency.


The Ecuador example


Ecuador was under a context of high inflation rates before dollarizing its economy. The central bank was not independent from the government (like the American Federal Reserve is), which meant that it responded to the will of the politicians, making it harder for it to restrict the money supply and maintain a lower inflation rate. “People adopted dollars informally at first in an effort to avoid losing their purchasing power” (De Ampuero, 2015; s/d)). But then the government decided to make it official and take Panama’s example of dollarizing the economy in a pursuit for lowering instability and high inflation rates.


“Using the U.S. dollar now means that Ecuadorian politicians cannot print more money whenever they want. That is what led to all the inflation. But when their economy is in a recession, that is when you want to be able to print more money to get the economy moving again, like we did in this country during the financial crisis. Ecuador can't do that. So its recessions might be deeper and might last longer when things start going bad.” (Smith Vanek,2018: s/d)


The political side of the discussion


In Argentina the Central Bank used to be independent until 1946 when “the nationalization of the Central Bank, its deposits, monetary supply and credit regulations turned into a responsibility of the National Government” (Settini, Audino, 2012: 233).


The monetary entity follows its duty within the framework of the policies established by the national government (Ley N* 24.144). Hence, there is a controversy between a monetary entity which main purpose is to maintain currency stability, and a national government with a tendency of overspending, which in a context of low real economic growth, requires an expansion of the monetary supply to balance that spending, creating a higher supply of pesos that push the citizens towards a stronger, more stable currency like the US dollar for their savings and price setting.


Foto: Ricardo Ceppi


The Dollarization of the economy would mean less flexibility for the national government to support its spending, thus requiring fiscal austerity, which is politically costly.


The question is whether the dollarization has already taken place informally, as domestic prices are tied to the dollar and Argentinians keep exchanging their pesos to dollars for saving purposes. Keeping the peso, currently, only means creating a more volatile environment for investment and high inflation rates that primarily affect people from a lower social stratum.


Conclusion

The argentinian people have already dollarized the economy, but the government is still reluctant to this reality, creating restrictions to currency exchange and taxation over taxation to avoid the unavoidable, a decrease in the demand of pesos due to the overflow of monetary supply in an overinflated economy that does not produce enough foreign currency to balance the increasing demand for US dollars.


This brings to the table how a transition would take place with a central bank that lacks enough foreign currency reserves and an enlarged State used to overspending. A path to a successful dollarization happens to be very similar to a path towards a more stable economy and a stronger peso.


Fostering fiscal austerity, stronger institutions and an independent Central Bank would make a more stable economy that could benefit Argentina’s foreign policy and long term development; but first it is important to recognize that that comes with a political cost and a need for political leadership.


Dollarization can be the cure to Argentina’s unstable economy, but it is not the only way to solve its issues. Either way, not recognizing citizens’ preference for the dollar and creating short term solutions is not the way to change people’s behavior towards the peso or to prevent another economic crisis in Argentina’s history.

El artículo se encuentra bajo licencia de Creative Commons para Estela Sur.

La organización atribuye lo expresado en el artículo a los autores del mismo.

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