Argentina: Zero deficit 16 Jul 2001 The shift of focus from growth to fiscal balance may represent the government's last chance to buy time Facing what he called a massive crisis of confidence in Argentina, the economy minister, Domingo Cavallo, announced on July 11th a US$1.5bn cut in federal spending until the end of the year. The cuts will start this month under a new "zero deficit" policy, which, according to Mr Cavallo, will force domestic interest rates to fall and raise the economy from a three-year recession.

The cuts will affect the wages of some 250,000 state employees (including police and security forces), state procurements, and pension payments to 2.5m retired people with monthly earnings exceeding US$200. Exceptions to a recently introduced 0.6% tax on bank transfers will be eliminated. Payments of wages and pensions will only be allowed through bank accounts, a measure designed to improve detection of evaders. The government will urge provincial administrations to take similar measures, adding up to US$3bn to the savings.

Zero deficit means that the government will simply adjust its monthly spending to match tax revenues. Debt service payments will be honoured first, followed by transfers of federal taxes to the provinces. The remaining expenses will be paid only if cash is available. "The public debt will not increase", Mr Cavallo said. He added that the cuts would soon be reversed, since the government expected tax receipts to increase over the coming months. The policy means that the state sector will no longer be in the market for fresh funds. According to Mr Cavallo, this will bring a sharp fall in interest rates.

The package marks a significant policy shift. When Mr Cavallo came to office four months ago he suggested that the economy should be allowed to start growing before a new attempt was made to cut the budget deficit. He implemented a "Competitiveness Plan" and gave tax refunds to middle-class consumers in an attempt to revitalise economic activity (see BLA March 26th 2001). But the financial markets have remained sceptical, and this week the country risk indicator reached an all-time high of more than 1,320 basis points, second only to Nigeria and Ecuador among emerging markets. Interest rates at the government's July 10th auction of Treasury bills hit a record 14%, prompting Mr Cavallo to say that "we don't have credit".

He seems now to have acknowledged the message that investors are sending him, and is trying another course: get the fiscal house in order first, and grow later -- the same formula that led to the demise of the previous economy minister, Ricardo Lopez Murphy, after just 16 days in the post.

Last roll

The financial markets are unlikely to find this any more convincing. The temporary nature of the cuts undermines their credibility, while the government will face huge political problems in extending the savings to the provinces. With mid-term elections scheduled for October, few governors will be willing to order wage and pension cuts. Opposition to the measures by the unions and large political groups can also be expected.

Political opposition will be strong even among the parties which, in an increasingly nominal fashion, make up the ruling Alianza: the centre-left Frepaso and the Union Civica Radical (UCR).

Financial fears are growing against a backdrop of political tensions and rising social unrest. The administration of President Fernando de la Rua is extremely weak, challenged by dissent within its own ranks as well as from the opposition Partido Justicialista (Peronists), which controls all the key provinces as well as the Senate. Within the Alianza, factions are split between those who would give Mr Cavallo greater power to salvage the economy, and those who would rather see him fail and thereby derail his presidential ambitions. Mid-term elections scheduled for October are complicating the scenario.

This policy package may be the last opportunity to buy time for Mr Cavallo and the de la Rua administration. The latter is in increasing danger of going the way of the last UCR government: that of Raul Alfonsin (1983-89), which was forced to truncate its term as the economy foundered.

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-- Martin Thompson (mthom1927@aol.com), July 15, 2001