The tipping point came with lettuce. The price index for the salad staple was showing an increase of 120%, and Argentina’s cantankerous Interior Commerce Secretary, Guillermo Moreno – famous for twisting arms with threatening phone calls to business people and regulators – was not happy.
It was January of 2007. Graciela Bevacqua, the mathematician in charge of the consumer price index at INDEC, the country’s statistics agency, received a visit from one of Moreno’s subordinates.
“‘Kirchner wants your head’, they told me,” says Bevacqua, referring to then-President Néstor Kirchner, who was responsible for Moreno’s nomination. Kirchner reportedly liked Moreno’s loyalty and attack-dog style.
Moreno’s deputy, Beatriz Pagliari, arrived at INDEC with two bodyguards. They installed themselves on the third story, where the directors sit, and rearranged the furniture by raking it across the floor, making as much noise as possible.
“Those were tense weeks,” recalls Bevacqua.
Eventually, Bevaqua and a host of technicians that had made INDEC a regional star were pushed out and replaced by Kirchnerite militants that began a wholesale reconfiguration of how inflation is measured in Argentina. Lettuce was temporarily taken out of INDEC’s calculations, and inflation for the month of January was recorded at 0.9%, roughly half of private estimates.
Perfumed and Dressed Up
The move was just the beginning of an almost six-year-long ruse that, these days, nobody believes. And it was symptomatic of a larger problem that the government has yet to address: the economy was again running at full bore after recouping idle capacity lost during the late-90s recession and 2001-2 crisis, and inflation pressures were rising. A sustained consumption boom fuelled by high commodity prices and expansionary monetary and fiscal policies was straining industrial output and pushing prices upward. Except for the 2009 slowdown, inflation would soon be entrenched above 20% for years to come.
In economic terms, it was the onset of demand-pull inflation, whereby aggregate demand surpasses aggregate supply, with prices rising as a consequence. The economists in the room might say there was too much money in the economy and not enough output. With few incentives to save, Argentina’s money supply was perfumed and dressed up with no place to go – except to consumption.
You won’t hear it from the government, though. Officials have blamed price increases on powerful business owners imposing price hikes in a highly concentrated economy. They have also referred to the phenomenon as “price dispersion” or “normal adjustments” rather than inflation. In a recent appearance at Georgetown University, President Cristina Fernández de Kirchner declared that “if inflation were 25%, the country would explode into pieces”.
Not Just Symbolic
For critics of the Fernández administration and that of her predecessor, the INDEC meddling was an example of the half measures and harshness employed in economic management when much more careful stewardship was necessary for sustained growth. It also compromised the supposed independent methodology of the statistics office, spreading fears of an encroaching executive.
“It was devastating,” says Manuel Garrido, a Radical party congressman from Buenos Aires, “for economists, for policymakers, for scientific investigations.”
Back then, Garrido was chief prosecutor for the Office of Administrative Investigations. He opened an inquiry into Moreno for falsification of public information at INDEC. The case went nowhere and, unexpectedly, Garrido’s budget and formal authority were pared down, leading to his resignation.
“How can you do public policy if you don’t have exact statistics?” he says. “It’s the basis of nearly all planning in the economy.”
A study from the Massachusetts Institute of Technology compares online supermarket prices to the prices reported by INDEC and finds a divergence of 65% over a three-and-a-half year period, meaning “huge implications for poverty and GDP”. A study by the Universidad Católica de Argentina, for instance, estimates poverty in Argentina at 21.9%, compared to the 6.5% reported by INDEC. Inflation also eats away at the purchasing power of the government’s marquee social welfare programme, the Asignación Universal por Hijo, a monthly transfer for parents that are unemployed or working in the informal sector. The government has responded with double-digit hikes of the subsidy.
Likewise, provincial statistics departments and private economists have said inflation is roughly three times the official number – but not without retribution. The Fernández administration has slapped hefty fines on those private consultants that release independent numbers, causing many to cease their publication. Bevacqua, for example, started her own consultancy and was fined $500,000 on two occasions by the government; both times the cases were dismissed as “speculative” in the courts.
For economists, the impact of the INDEC imbroglio isn’t just symbolic. Government officials have confessed to wanting to keep payments down on bonds that are linked to inflation, but it has come with direct negative corollaries in the real economy.
In the second quarter of 2002, Argentina’s economy cratered and began a quick turnaround. A newly devalued currency slashed labour costs and jump-started industry. The nationalisation of some private debts in dollars got businesses hiring again. And Argentines with dollars took advantage of rock-bottom prices at home to drive a construction boom. Combined, it was what Anne Krueger of the IMF called the “dead cat bounce”.
From 2003, the politically astute Néstor Kirchner focused on protecting jobs and ensuring growth at all costs. The restructuring of most of Argentina’s US$100bn plus in defaulted sovereign debt freed up money for government programmes. High prices – and high taxes – for commodities exports generated an ample trade surplus and filled government coffers with cash, allowing Kirchner to pursue social policies, like the extension of pensions to millions of retirees. He also prioritised the repayment of debts to the IMF in order to steer clear of their policy prescriptions, which included reducing fiscal spending.
Money was flowing in, and largely staying in, the economy. Argentines, despite a historical tendency to save in dollars, began saving in pesos. The “dollarisation” of the economy was reduced significantly between 2003 and 2006, spurred by limits on access to loans in dollars and the development of a market of financial instruments (in pesos) indexed to inflation.
But this dynamic changed in 2007. Individual and institutional investors interpreted the manipulation of statistics at INDEC as a default on obligations that were indexed to inflation, according to Lucio Castro, an economist at CIPPEC, a Buenos Aires-based think tank.
“The most important impact of the INDEC intervention was on capital flows,” says Castro.
From 2003 to 2006, the purchase of assets in a foreign currency (capital flight) averaged US$2bn per year. From 2007 to 2011, the annual average jumped to US$16bn, according to statistics from the Argentine Central Bank compiled by the economists Eduardo Levy Yeyati and Federico Bragagnolo.
In other words, just as the economy was maxing out, and needed new investments to increase production, capital started flowing out of the country. The financing constraints and a worsening business climate would aggravate the natural limits to how quickly Argentina’s productive capacity could expand, and add to inflation.
In addition, the INDEC intervention had a drastic effect on inflation expectations. “When economic agents had no anchor for their inflation expectations, they made projections based on the previous year, without knowing exactly what those were,” says Castro. This led to inflation inertia after 2007, he says, when prices rise throughout the economy based on expectations.
“This was the second most important impact of the INDEC intervention,” says Castro.
Demand, In Demand
The survey of inflation expectations by the Universidad Torcuato Di Tella often shows Argentines expect inflation to be higher than it is. Inflation itself becomes a reason to consume, economists say: higher prices tomorrow mean it is better to buy today.
Other incentives for Argentines to consume rather than save have remained high, keeping upward pressure on prices. Subsidies for the energy and transportation sectors have soared, keeping prices low for industry and consumers (meaning they can consume elsewhere in the economy). Credit for consumption has expanded significantly, often at negative interest rates when inflation is factored in. And as this was happening, the government nationalised private pension funds and re-wrote the by-laws of the Central Bank to access fresh capital and continue spending prolifically.
Over time, inflated prices eroded Argentina’s competitive real exchange rate and diminished its trade surplus as imports became more attractive. (Also, Argentina’s energy deficit prompted sizeable imports of expensive gas.) The high inflation was not met with a corresponding devaluation of the peso that would rebalance the terms of trade, supporting exporters. This led to what economists call exchange rate lag: a depreciation of the peso was expected, and holding pesos was a losing bet. This lag, combined with the lack of investment options with returns matching inflation, led Argentines to once again seek refuge in the dollar, with capital flight nearing record highs in 2011.
In response, President Fernández ratcheted up controls on both foreign currency purchases and imports to stem capital flight and safeguard the trade surplus. Officials have also stated the measures aim to tackle widespread tax evasion and protect local industry. By most accounts, they have worked: capital flight is down, and the government met its trade surplus target for 2012 in the first eight months of the year.
Still, they have not been without negative consequences. First, most imports to Argentina are intermediate goods, meaning they are used as inputs. The import restrictions have choked off their entrance, slowing industrial output. Second, a parallel exchange rate has materialised, which has confused transactions and caused some businesses to index to the new rate, meaning higher prices in pesos. Lower industrial output and the marking up of prices indicates a third by-product: more inflation, but this time in the context of slow or no growth, or what economists call stagflation.
Overall, the government response has been counterproductive at best. Officials are still reluctant to publicly recognise the inflation problem, though they have approved annual salary hikes of 25-30% for union workers, almost triple the official inflation rate. The wages of informal and non-union workers, meanwhile, remain unprotected. And journalists and organisations that contradict government information are still subject to intimidation. Recently, Adelco, a consumer defence group, gave in to pressure from Guillermo Moreno to stop publishing its price index, which it had been doing for 20 years. Perhaps more importantly, government policies have created an uncertain business environment and discouraged the private investment needed for continued growth.
The causes and consequences of inflation, then, are at the heart of Argentina’s macroeconomic drama. In order to contain it, economists say a coordinated economy-wide effort must be implemented over a period of several years.
But it all comes back to INDEC, according to the economist Eduardo Levy Yeyati. As he wrote in a recent column for El Cronista: “It’s not possible to contain expectations without setting a realistic guideline for future inflation; fiscal and monetary policy must be consistent with that guideline; and there must be a credible price index that allows that guideline to be monitored.”