Policy Clash Makes Argentina Its Own Worst Enemy on Inflation

(Bloomberg) -- Argentina is pulling out all the stops to put the brakes on inflation. The trouble is that it’s also hitting the gas.

The country’s two core policies to appease investors -- a tight monetary policy and a faster rollback of subsidies -- are at odds with each other when it comes to slowing down annual inflation that surpassed 49 percent in January. That’s created a dilemma for President Mauricio Macri, who faces re-election in October in a vote that hinges on reviving an economy mired in recession.

While this paradox has existed to some extent since Macri took office in 2015, recent developments make the policy clash more extreme now. The central bank drastically increased its interest rate last year in the aftermath of a currency rout, while a deal for a $56 billion credit line with the International Monetary Fund requires Argentina to balance its budget this year. In essence, the government has been dragged into a war on two fronts.

"It’s a real policy dilemma, and there’s no getting around it," said Fiona Mackie, regional director for Latin America at the Economist Intelligence Unit. "This inflation adjustment is going to take a while to happen and it’s going to increase political risk heading up to the election."

Macri’s administration has no easy way out. To cut public spending and appease the IMF, the government is slashing subsidies on subways, buses and trains, as well as on utility bills, causing prices to spike. Electricity and gas will rise 35 percent on average nationwide this year for homes and small businesses. Public transport will go up about 40 percent.

Other factors are also putting pressure on inflation in Argentina. Prices on everything from food to mobile phones are being raised so businesses can recoup some of their losses, while salaries and pensions get an inflation-adjusted boost too. Still, regulated price hikes are expected to be the leading cause of high inflation through May.

For its part, the central bank is freezing the amount of money in circulation, maintaining the world’s highest interest rates and enforcing a currency band to stabilize the peso and help head off more price pressures. Monthly inflation eased between September and December. But, prices then rose 2.9 percent in January, a reading higher than both analysts’ expectations and December’s figure.

The central bank has cautioned that consumer prices will remain elevated. Still, economists point out that concentrating the pain at the start of the year gives the government a better shot at showing tangible advances against inflation closer to October’s election.

"It will help in the future. A lower deficit in the long term helps reduce money printing and helps inflation," said Sebastian Rondeau, an economist at Bank of America Merrill Lynch. "It’s a conflict in the short-term between fiscal policy and inflation."

©2019 Bloomberg L.P.