President Mauricio Macri unveiled an austerity plan on 3 September 2018 designed to accelerate fiscal deficit reduction from a prior primary deficit target of 1.3% of GDP in 2019 to primary balance.

• The government will reinstate some export taxes on agribusiness and deepen spending cuts, including reducing the number of ministries, in the context of renegotiations with the International Monetary Fund (IMF), seeking early disbursement of program funds.
• The peso reached a new low in August of ARS40/USD1, leading the Central Bank of Argentina to increase interest rates to 60%, but that has failed to trigger any meaningful recovery in the peso, now quoted at around ARS39/USD1.
• The IMF's anticipated support is likely to cover Argentina's debt commitments and funding program for 2019, but the lack of a longer-term development plan and failure to make significant cabinet changes will hinder regaining business confidence, delaying investment plans and weakening President Mauricio Macri's political standing ahead of the 2019 general election.

On 3 September 2018, Argentine President Mauricio Macri unveiled an austerity plan aimed at stemming recent severe pressure on the peso and reducing the fiscal deficit faster than initially planned under a three-year Stand-by Arrangement (SBA) with the International Monetary Fund (IMF) signed in June 2018. Macri announced plans to eliminate the primary fiscal deficit entirely in 2019, a significant acceleration versus the 1.3% target initially agreed with the IMF. The radical approach has been forced by extreme peso weakness: this depreciated 15% last week, reflecting growing doubts by investors over the government's ability to honor sovereign debt commitments due in 2019.

In efforts to regain market confidence, the government launched a package including a combination of tax increases and expenditure cuts. To raise fiscal revenues, Macri reintroduced export taxes ('retenciones') on agribusiness exports that had either been eliminated or were being phased out. Macri acknowledged that export taxes were a "very bad idea", but that given the seriousness of Argentina's fiscal position, which in turn has caused severe peso instability, he said he had no other option but to bring them back temporarily. To trim public expenditure, the government announced that the number of ministries would be cut by half to just 10 cabinet posts; investment in public infrastructure will also decrease. Other measures comprise reductions in operational costs of the public administration and further cuts in energy and transport subsidies.

Peso run has deepened political instability risk

Despite the announcement, market sentiment remains highly nervous. During the day following the announcement, the peso depreciated a further 1.22%. On 29 August, the peso reached a low of ARS40/USD1. The Central Bank of Argentina (BCRA) responded by increasing interest rates to 60% (from the already high 45%), and establishing a new 'encaje' (increasing the proportion of bank deposits that need to be placed with the BCRA), in order to reduce financial-sector liquidity, but without any major recovery in the peso. The additional measures reflect that prior policy actions have failed to resolve investor distrust. However, according to our sources in Argentina, two fundamental items are still lacking: a solid long-term economic development program, and significant changes to Macri's economic team. Following the latest announcement, our sources commented that there was significant business and political expectation that important figures of the government would be rapidly removed to restore confidence, and that the government would reach a deal with moderate opposition Peronists in order to increase governability. Figures expected to be removed included the chief of staff, Marcos Peña, who is seen as unduly involved in economic management, along with the economic team, notably Finance Minister Nicolás Dujovne and BCRA Governor Luis Caputo.

However, Macri's cabinet changes have been only superficial. Apart from reducing the number of ministries, he only removed Peña's two deputies, Mário Quintana and Gustavo Lopetegui, part of Macri's inner circle. He resisted removing his "right hand man" Peña, despite calls even from within the ruling Let's Change (Cambiemos) coalition for his removal.

Outlook and implications

The government estimates that export taxes should provide additional revenue worth 1.3% of GDP, subsidies cuts will represent 0.5%, and operational costs are estimated to save 0.2% of GDP. This, together with the cuts in public investment (0.7%), will produce aggregate total savings of 2.7% of GDP, which the government sees as sufficient to bring the primary deficit to zero next year. The increased fiscal austerity is a positive indicator for securing additional IMF support granting Argentina immediate access to approximately USD29 billion. This would permit Argentina to honor its debt obligations during 2019. If such IMF support is granted, and deemed sufficient by the markets, this would indicate reduced pressure on the peso with capital outflows being contained. However, the tighter fiscal stance increases the threat of deeper economic recession, while the lack of significant changes in Macri's cabinet indicates political continuity: both factors are likely to hinder a recovery in business confidence. Our sources report that business sectors view Macri to have reacted inadequately and too slowly to the adverse economic developments, and that there is a need for a stronger figure in the cabinet who would dare to undertake painful measures (such as significantly reducing pensions), but that would come at a very high political cost. The resulting nervous sentiment is likely to delay peso stability, recovery in investment, and overall economic recovery.

Economic contraction thus is likely to be deeper than expected in 2018, and recession prolonged by lower construction activity, as the government downsizes public investment. Such slowdown will negatively affect tax revenues. Furthermore, sharp peso depreciation has increased the external debt burden, increasing the cost of unhedged foreign-currency liabilities. The deeper austerity measures will hurt public purchasing power and weaken social programs. Although the government has announced mitigating measures (such as additional cash transfers for the poor), Macri has admitted that poverty will continue rising, increasing the risk of large-scale protests and strikes, and lowering support for the government ahead of the 2019 general election when Macri is expected to run again.

A significant reshuffle in the government's economic team including members of the moderate opposition Peronist movement would be a positive indicator of stronger governability and improved domestic investor confidence, but would risk positioning leading Peronist figures as serious political contenders for the elections. A good harvest in March 2019 would be a positive indicator for Argentina's economic trajectory: the agribusiness sector was severely affected by drought this year, significantly contributing to economic contraction.