Argentina controls won’t stop capital flight

It’s fall in Buenos Aires. As much as I travel, it is still a shock when I cross the equator and arrive in another season. It is also still a shock when I arrive in a city capital where government protesters fill key squares in the city opposing government economic policies.

Argentina has experienced a difficult decade. May 25 marked the tenth anniversary of NĂ©stor Kirchner’s inauguration as president of the country. His wife Cristina took over in 2007 and was re-elected in 2011. Now, a year and a half into her second term, inflation is climbing about 25% per year, and Argentines, fearing an official devaluation of the currency, are selling their pesos for dollars at half the official value on the black market that has emerged.

Observing this situation, I am reminded of the recurring debate on currency manipulation and controls and their usefulness. This discussion has intensified lately, especially in the wake of the currency controls put in place by Cyprus, during its recent crisis.

Argentina has repeatedly used currency devaluation as a means of propping up its economic growth, and for Argentina, this technique has worked time and again. When the peso falls, relative to the currencies of neighboring countries, Argentina’s exports increase. This export effect is exactly one of the benefits being touted by IMF economists, who had been the most ardent opponents of such controls. Most recently they said various forms of currency control can be a valuable tool to avoid currency devaluation and protect the export sector at times when that sector is crucial for economic growth. We have seen both China and more recently Japan successfully employ this tactic. And I would expect, based on past experience, Argentina’s economy will indeed get a boost from a weaker peso.

But, it is also likely that plan may backfire in the longer term, for Argentina, anyway. If investors feel Argentina has made too many trips to the well, and if they have grown weary of the cycle of growth, inflation, collapse, devaluation and recovery, they may try to take their business elsewhere. When investors lose confidence in the country’s currency, they flee.

Over the years, Argentina has tried to curb this flight with capital controls. In 2001, when Argentina’s peso was pegged to the US dollar, slow growth sparked a capital flight. In response, Argentina put in place what was called a corralito, or little fence, to curtail withdrawals and foreign-exchange transactions, before finally devaluing the peso. While those controls ended in 2002, money continues to leave Argentina and is invested in dollar-denominated assets or in the assets of South American countries whose governments have followed policies that promote growth and suppress inflation. Investors loath inflation and any capital movement restrictions. Capital insecurity, in Argentina, as in many countries that try to fix their more structural problems with the band-aid of currency control, hurts growth and discourages foreign investment.

Populist governments, like that in Argentina, can sometimes mean well when implementing these unfriendly business policies. Their goal is often to help the poor, but instead the policies spur inflation, which ravages the spending power of this class who can barely make ends meet. These short-sighted strategies rarely achieve their intended aims. Instead of growth they spur capital flight by way of secret bank agreements and through sealed suitcases moving at night.

No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.


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