Argentina’s Inflation Rate: In the Eye of the Beholder?

When Argentine President Cristina Fernandez de Kirchner launched “Milanese Cutlets for Everyone,” a plan through which one kilogram of beef cutlets is sold at 21 pesos (US$5.25) at the Buenos Aires Central Market, she emphasized that prices can be distorted, and consumers need to shop around.

The traditional dish is especially popular among children, who love to eat them with crunchy fried potatoes. “They brought me a one-kilogram carton of ‘Milanese Cutlets for Everyone.’ Our family tried it out. Maximo [her son] asked me if things will be the same for everyone. It tasted great, and I ate it,” she said at a news conference. What she didn’t say is that the Buenos Aires Central Market, the central distribution point for the nation’s fruits and vegetables, is located in the suburbs, a 40-minute bus ride from downtown Buenos Aires, and that anywhere else in Argentina the price would be at least 30 pesos (US$7.50).

Meanwhile, prestigious private consulting firms including Ecolatina and the Foundation for Latin American Economic Research estimate that inflation in Argentina will be about 25% this year, far higher than the government’s estimate of 10.9%. Such a differential is nothing new. It has existed since October 2006, when the government of President Nestor Kirchner, the current president’s late husband, intervened in INDEC, the National Institute of Statistics and the Census. At that point, INDEC changed its methodology for measuring the Basic Food Basket and the Consumer Price Index — and began to lose credibility locally and globally.

According to Enrique Dentice, a professor and researcher at the National University of San Martin, the result is that “official statistics are no longer used in basic decision-making processes concerning salaries and investments.” To illustrate INDEC’s loss of credibility, Argentina’s courts now use information collected by private-sector consultants when writing their decisions. In a note published in the daily newspaper La Nacion, civil court Judge Lucas Aon said that to fix public-assistance subsidies for food, “We take into consideration the notorious increase in the cost of living, which has nothing to do with official statistics, but with real inflation.”

According to Carlos Olivieri, director of management sciences faculty at Austral University of Buenos Aires, the distortion created by INDEC has two types of effects: “The impossibility of adjusting the economy to the real movements of prices, and the distortion in bonds that are adjusted to Argentina’s inflation rate. This fact leads to important ‘savings’ for the government, but has a harmful impact on investors.”

The Causes of Inflation

For years, inflation has been a scourge of Argentina’s economy, with annual rates reaching 5000% in 1989. Things changed drastically in 1991 under then-Economy Minister Domingo Cavallo’s Convertibility Plan, which established parity between the peso and the U.S. dollar. The system unraveled amid economic crisis in 2001, and high inflation reappeared.

Many factors have contributed to the latest wave. One frequently cited is Argentina’s monetary expansion. According to Belen Pagone, an economist at Austral University, this involves “maintaining the sort of competitive exchange rate that obliges BCRA, Argentina’s central bank, to buy dollars — more than US$3.5 billion in 2010 — while issuing sizable amounts of currency that are only partially neutralized. Without doubt, the trade surplus that the government requires absorbs a great deal of cash that would otherwise lead to a significant reduction in the exchange rate.”

Another variable tied to inflation is increased consumer spending, the causes of which Dentice says are numerous and region-specific. These include “strong demand spurred by loans and special offers; rising prices for agricultural products; businessmen’s expectations that they will increase their profits without investing in installed capacity; and [increased] family consumption at a time when there are few instruments for saving.”

Olivieri argues that consumers have an incentive to spend, not save. “The negative real rates of interest that one obtains in the local banking system are an incentive for consuming durable goods that also promote inflation.” Televisions, laptops, airline tickets, cars and clothing are just some of the products often marketed in installment plans that, occasionally, offer consumers more than 24 months of interest-free payments.

During Argentina’s year-end holiday season and summer vacations in December and January, cash was in short supply because of increased consumption. Inflation lowers the value of money in circulation, so more pesos were needed to buy the same amount of goods. At a time when people were buying holiday gifts and paying for vacations, there wasn’t enough money available. In both Argentina and Brazil, Argentina’s largest trading partner, governments had to issue more paper currency than had been planned.

People aren’t the only ones who “waste” what they earn; the government itself has increased spending at a remarkable rate. According to Dentice, spending on retirement, on social security and on public-sector employment, among other things, “is growing at an annual rate of almost 35%, and it has to be financed. To cover those costs, the government depends on the profits of the BCRA and allocations from ANSES, the country’s national social security agency, but this only increases the risks over the longer term.” Trade unions are also playing a part by pressuring employers for 20% increases in workers’ salaries.

According to Ernesto A. O’Connor, director of analysis at the economics department at the Argentine Catholic University, the main causes of inflation are “monetary policy, including issuing new cash and negative real interest rates; fiscal policy, which is very expansive; income policy that exacerbates salary disputes; and pressure in the economic structure for the GDP to grow above its potential.” In this scenario, he notes, “the sole anchor against inflation is the exchange rate, which continues to remain behind.” In other words, the central bank continues to buy foreign currency to maintain the exchange rate. Not doing so would send the dollar sharply higher and the peso sharply lower.

Argentina Is Not Alone

Inflationary pressure isn’t exclusive to Argentina. Other countries in the region are also susceptible. Venezuela’s was more than 26% in 2010. Nevertheless, Brazil (at 5.9%), Chile (3%) and Peru (2.8%) all managed to maintain inflation at much lower rates than Argentina last year. Even in those countries, economists are concerned that inflation could impel central banks to raise interest rates in coming months. Such a prospect could make things particularly difficult in Brazil, where policymakers want to contain inflation and to lower interest rates, which are currently at 11.25%.

Why have rates gotten out of control in Argentina and Venezuela? Explains Pagone, “In recent years, Brazil, Chile and Peru have managed to generate a positive investment climate in order to avoid the sort of production bottlenecks that the Argentine economy suffers today. At the same time, these countries have been prudent in making decisions about public spending and issuing currency.”

Adds Olivieri, “Argentina has a high component of commodities in its consumption basket, which means that its prices strongly depend on what happens on an international level. Countries such as Brazil have more diversified exports, in contrast with Chile and Peru, where consumer products play a much smaller role in their basket of exports” and minerals play a greater role.

On the other hand, notes O’Connor, both Argentina and Venezuela have “economic policies that do not assign their central banks a stabilizing role. They are very interventionist governments, and that means they need to keep inflation high, and then justify redistribution” of wealth.

For the most part, the constantly rising prices for basic needs hurt the lowest social classes, whose incomes are reduced systematically. “Evidently, unregistered people who don’t earn salaries are affected the most. They are the equivalent of 36% of the labor force, including a good portion of the population below the poverty line. Private-sector economists disagree about their importance to the economy, issuing estimates that range from 25% of the country’s poorest population to 40% of those people.”

The business world, forced to delay investment, is also damaged by inflation. “Without doubt, companies face uncertainties, which lead them to wait and see, or take advantage of the installed capacity they have, since they don’t know how long the current level of demand will last,” Dentice says.

Pagone stresses that “the most important impact is the lack of incentive for making investments. International capital fears inflation because of the havoc produced by the decline in the real value of investments, particularly if they have no experience in inflationary economies. In recent years, increases in the fixed assets of publicly traded companies have been lower than their real value when amortized for the current value of the currency.”

Elections, and Then What?

Although inflation concerns economists, Argentine society shows little impatience, at least for now. According to a survey at the beginning of the year by Poliarquia, a consultancy, inflation is not the main problem for Argentines. The problems of most concern are insecurity (34% of respondents), unemployment (15%) and inflation (8%).

Experts don’t believe that inflation is going to play a definitive role in presidential elections at the end of this year. However, the political landscape continues to surprise, especially after the unexpected death in October of former President Nestor Kirchner. Although Cristina Fernandez de Kirchner has not officially declared her candidacy, all signs seem to indicate that she will run for reelection.

It remains to be seen if the next government, which will take office December 10, will take measures to alleviate inflation. In Brazil, a little more than a month after assuming the presidency, Dilma Rousseff announced spending cuts of US$30 billion, the equivalent of 7% of all central government expenditures. The explicit reason: inflationary pressures were moving ahead faster than the fixed target of 4.5% for the year.

O’Connor advises Argentina’s government to emerge from elections with a “shock policy; an independent central bank; an agreement with the International Monetary Fund to review the way its economic indices are measured; and a restructured, independent INDEC. Following that, take appropriate monetary and fiscal measures within an approach that involves single-digit inflation goals in a couple of years.”

Pagone argues that government first should “balance the budget, and then limit spending to funds that flow from its own genuine revenue collections.” On the other hand, conditions for legal security must be established. “Short-term, today’s Argentina lacks such conditions for increasing productive investment or for creating incentives so that investment can increase the supply of goods and services.”

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