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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is professor at the University of California, Berkeley
The victory of Javier Milei’s La Libertad Avanza party in last Sunday’s election was met with jubilation in financial markets. Investors had feared that voters might reject Milei’s policies of fiscal consolidation and disinflation. When they didn’t, Argentine asset markets initially soared, and the peso strengthened.
Of course, 41 per cent of the vote is less than the “landslide” hailed by some commentators and some of the market moves have since been retraced. It is unclear, moreover, whether the result should be seen as an affirmation of Milei’s policies or a repudiation of the opposition Peronists, who failed to offer a coherent alternative.
The answer is probably both. But whatever the answer, the question is what Milei should do now.
No doubt he will be tempted to double down on present policies. These involve cutting budgets for education, health and infrastructure while laying off thousands of public-sector workers. They seek to speed disinflation by holding the peso within a band, initially 1,000 to 1,400 pesos per dollar, which is widened by a modest 1 per cent a month.
Staying the fiscal course is essential, as affirmed by the electorate even in the face of hopefully temporary increases in unemployment and poverty. The alternative is economic chaos. And a plurality of Argentine voters have clearly lost patience with the country’s long history of chaos.
But staying the monetary course also in fact implies more chaos, not less. Argentina needs a robust monetary and exchange rate policy, just as it needs a robust fiscal policy. There will inevitably be another economic shock, just like there will be another election. That the peso has strengthened is no guarantee of what will happen next.
To protect against renewed pressures, the central bank must rebuild its foreign reserves. To that end, the country needs to export more. Allowing the peso to fall by 20 per cent and then fluctuate more freely would go a long way towards achieving this end. A lower peso will make Argentine exports more competitive. It will make investing in the country more attractive, encouraging capital inflows. Not least, more foreign earnings will allow the country to meet its debt obligations.
Importantly, when the next crisis hits — whether because of a decline in beef and soyabean prices or a shift in the political winds — Argentina won’t again be at the mercy of the markets. It won’t again find itself in the untenable position of having to defend an indefensible exchange rate. Nor will the government’s political survival depend on having a friend in the White House.
Critics of this strategy say that permitting the peso to weaken will allow inflation to return, damaging the government’s credibility. They say that now is not the right time to abandon the currency peg.
Taken to its logical conclusion, this argument implies that it is never the right time to abandon the currency peg. Like it or not, Argentina would forever be saddled with a rigid and fragile exchange rate regime.
This problem is not new. I should know: I lived through it in the 1990s, when I was at the IMF. There was already a consensus then that emerging markets should move towards more flexible currency arrangements. But the time was never right.
So I wrote a paper for the IMF board on how and when countries should exit from rigid exchange rate regimes. It argued that they should do so when economic conditions and the government’s political support were strong. Under such circumstances, an exit would not be seen as forced. It would not be seen as a sign of weakness or damage confidence in financial markets.
Coming out of the election, Milei can claim strong political support. He should take advantage of this circumstance while it still exists. Taking advantage means allowing the peso to step down and then fluctuate more freely. It means reaffirming the central bank’s mandate to target inflation and, no less, the bank’s independence to pursue that target.
Yes, this will imply a more gradual decline in inflation. But the durability and persistence of disinflation, and not simply the speed, should be the priority.
Some will point to dollarisation as a superior alternative. But dollarisation will provide no flexibility when the next crisis strikes. It will make exporting more difficult, aggravating unemployment and poverty and undermining support for the government. Milei should understand this calculus, having resisted the siren call of dollarisation following his own election in 2023.
It is time for Milei and his exchange rate both to show some flexibility.
