Argentina in Turmoil: Can Dollarization Save the Nation from Economic Collapse?

In recent years, influenced by myriad factors encompassing global economic and financial vicissitudes, the COVID-19 pandemic, and Argentina’s domestic upheavals, the economic and social quandaries of Argentina have intensified perceptibly. The specter of currency crises, financial upheavals, and economic convulsions, reminiscent of historical episodes, appears to be looming once more. In November 2023, the ascension of the far-right luminary Millay to the presidency epitomized a seismic shift in Argentina’s political landscape. Upon assuming office, Millay initiated a slew of radical reform endeavors, with designs to effectuate a comprehensive dollarization of the economy in the foreseeable future.

What underlies Argentina’s economic and financial tribulations? Can the doctrine of dollarization truly extricate Argentina from its predicament?

The economic vitality of Argentina has been markedly enfeebled.

The ascendancy of Millay mirrors the palpable disenchantment of the Argentine populace with the prevailing societal milieu, coupled with their yearning for transformative leadership capable of ameliorating the prevailing economic and financial malaise bedeviling the nation. Since the 1980s, Argentina has been besieged by a succession of crises including the Latin American debt crisis, the subprime mortgage debacle, and the COVID-19 pandemic, all of which have substantially eroded its economic growth prospects. Presently, the Argentine economy is characterized by rampant inflation, burgeoning foreign indebtedness, persistent devaluation of the domestic currency, and capital flight.

Primarily, the trajectory of economic expansion is gradually stagnating. Argentina’s economic landscape is marked by a high degree of diversification, with exports heavily reliant on commodities, and an industrial framework plagued by the scourge of “deindustrialization.” From the 1970s through the 1990s, Argentina experienced two successive waves of “deindustrialization,” precipitating a decline in the proportion of manufacturing within the gross domestic product (GDP) from 29% in 1975 to 17.1% in 1998, a figure which presently hovers around 16%. Presently, Argentina relies heavily on imports for a multitude of industrial goods, bereft of an autonomous industrial infrastructure. Against this backdrop, the Argentine economy remains susceptible to fluctuations in international commodity prices, as well as the specter of trade protectionism, rendering its overall resilience precarious. Political volatility further exacerbates Argentina’s protracted economic stagnation. Argentina’s domestic political landscape is marked by frequent regime changes, with divergent factions and ideological orientations adopting disparate economic paradigms, thereby impeding the continuity of economic progress. Over the past four decades, Argentina’s economic trajectory has been beset by torpor, with an average annual GDP growth rate of a mere 1.8% (Figure 1). In the aftermath of the COVID-19 pandemic, compounded by adverse externalities such as the global economic downturn, Argentina’s economic prospects continue to deteriorate. Preliminary estimates indicate a contraction of GDP by -2.7% in 2023, marking a precipitous decline of 7.7 percentage points from the preceding year.

Second, the exchange rate continued to depreciate significantly, and domestic price levels soared, showing hyperinflation. The Argentine peso exchange rate against the U.S. dollar has depreciated from around 38 pesos per U.S. dollar at the end of 2018 to 366.5 pesos per U.S. dollar on December 12, 2023. After Milais announced exchange rate adjustment measures, the peso exchange rate further depreciated and has now depreciated to 826. The cumulative depreciation rate in the past five years has exceeded 95% (Figure 2). At the same time, according to data from Argentina’s National Statistics Institute, the cumulative inflation rate in 2023 will be as high as 211.4%, the highest value since 1990. Affected by this, Argentina’s domestic market confidence dropped sharply, and the peso selling wave continued to spread. Currently, Argentina is experiencing a vicious inflation cycle of “high inflation – selling of pesos – panic buying of daily necessities – further stimulating inflation – and continued decline in market confidence”. In order to control inflation, the central bank will raise interest rates six times in 2023, raising the benchmark interest rate from 75% at the beginning of the year to 133%. However, in the context of internal and external difficulties, the government will find it difficult to stabilize exchange rates and inflation by relying solely on measures such as interest rate hikes and foreign exchange controls in the short term.

Third, foreign exchange reserves continue to decline and the risk of foreign debt defaults increases. Severe inflation and sharp currency depreciation led to massive capital outflows. In July 2023, a report released by Argentina’s National Statistics Institute showed that the overseas assets of residents and companies reached US$428.6 billion, which is approximately 1.5 times the size of foreign debt. Against the backdrop of continued capital outflows, Argentina’s lack of international reserves has become increasingly prominent, and its foreign debt solvency has declined. As of the end of 2023, Argentina’s international reserve assets were only US$23.07 billion, a decrease of 48.3% from the end of 2022 (Figure 3). Among them, foreign exchange reserve assets are approximately US$16.8 billion, a decrease of 52.5% from the end of 2022. In order to repay maturing debts, the Argentine government not only sought U.S. dollar loans from the International Monetary Fund and promoted debt extensions, but also adopted a series of unconventional means, including using RMB swap lines to repay U.S. dollar foreign debts to the International Monetary Fund.

Reasons for the crisis

The current economic and financial difficulties faced by Argentina are not accidental, but a concentrated expression of structural problems, cyclical factors and long-term government wrong decisions.

First, Argentina’s economy is severely under-diversified and vulnerable to external market fluctuations. Argentina’s economic structure is single and over-reliant on the export of agricultural products and resources. According to data released by Argentina’s Agricultural Development Foundation, agricultural sector exports accounted for 67% of the country’s total exports in 2022. Affected by the global economic downturn, agricultural product prices will gradually fall from their high point in 2023. Data released by the Food and Agriculture Organization of the United Nations show that the global food price index will average 124 points in 2023, a decrease of 13.7% from the 2022 average. This has largely affected Argentina’s agricultural exports, worsened trade balance and fiscal balance, and dragged down economic growth. In 2023, Argentina’s exports dropped by 25.4% year-on-year, and the trade balance also turned from a surplus of US$8.08 billion in 2022 to a deficit of US$6.93 billion.

Secondly, the debt problem is serious, and the Fed’s tightening monetary policy has increased the pressure of capital flight and exchange rate depreciation in Argentina. Currently, Argentina has a serious debt problem, with its external debt expanding from US$43.8 billion in 1982 to US$283.52 billion in the third quarter of 2023, an increase of about 5.5 times. In view of the fact that Argentina has experienced nine sovereign debt defaults in its history, Fitch International Credit Ratings Co., Ltd. downgraded Argentina’s U.S. dollar-denominated debt rating by two notches to “C” in 2023, which seriously affected Argentina’s financing in the international market. At the same time, affected by the accelerated pace of interest rate hikes by the Federal Reserve, Argentina’s domestic problems of capital outflows and exchange rate depreciation have worsened, exacerbating the economic and debt crisis.

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