Argentina’s Milei faces narrow path to success

Investors are optimistic about Argentina’s prospects under Javier Milei, but serious challenges remain. Successfully tackling them will take a delicate balancing act

Argentina’s libertarian President Javier Milei is six months into his tenure, and while his accomplishments to date are impressive, his remaining agenda is formidable—and his path to success is uncertain.

On the positive side, his government has run twin surpluses—budget and current account—as he has taken a chainsaw to government spending. International reserves are up, and month-over-month inflation is coming down.

Investor interest is high as MSCI Argentina is up one-third since inauguration, based on total return in US dollars.

There are caveats, however. The surpluses stem in part from the government—by design—slow paying electricity generators, transportation companies, and oil and gas producers on the fiscal side and importers on the current account side. Authorities have also recently begun to hold down inflation by delaying planned subsidy cuts.

Gross reserves have grown from $21 billion to $29 billion, but with numerous central bank debts, such as an $18 billion swap line from China from the prior administration, net reserves may still be negative.

The reserves build-up comes from the central bank’s buying dollars by creating pesos. It sterilizes this money issuance by simultaneously issuing central bank peso debt (bond buyers give the central bank pesos equal to the pesos the central bank creates to buy dollars.)

This debt has grown faster than inflation, making the interest unaffordable. Bizarrely, this forced the central bank to prematurely cut interest rates. The 40% policy rate compares to 289% year-over-year inflation (monthly, the policy rate works out to 3.4%, while April’s month-over-month inflation was 8.8%.)

The managed exchange rate is 895 and devaluing 2% per month, more reasonable than its 364 level when Milei took office, but it still needs to devalue around 26% to match the parallel Blue Chip Swap Rate.

What remains? The government must pass omnibus spending and reform bills in the 72-seat senate where it controls only seven seats, continue reducing inflation, remain popular in the face of a steep recession so that its mandate to govern persists, eliminate central bank debt, resume subsidy cuts, pay importers and utilities on time, lift capital controls, unify exchange rates, and restart economic growth.

From an investment perspective, it’s the most fascinating political and economic reform story in the world today, but we are aware that initial progress can slow and reverse, as happened under Macri, the prior reformer, in 2018-2019.

Nick Padgett is Managing Director of frontier-markets-focused fund manager, Frontaura Capital