Economist Alonso Perez-Kakabadse is very well placed to assess the promise to dollarise the Argentine economy made by Javier Milei, one of the main candidates for the presidential election on 22 October. Mr Perez-Kakabadse currently works as Senior Portfolio Advisor and Strategist at UBP, but was part of the team that led Ecuador’s dollarisation process between 1999 and 2002. He took time out to speak to Allnews.
Does dollarisation mean the death of the central bank?
It would mean the end of printing money, but the central bank would keep its banking supervision role. The people needed to fulfil that task would have to remain in place, along with those working for the statistical office and those in charge of making cyclical adjustments to the amount of cash that commercial banks are required to hold with the central bank.
In the absence of a central bank, international payments are cleared by the banking system itself. As a result, a dollarisation regime must be accompanied by a banking system that is well integrated into the international financial system.
What were the main difficulties in implementing dollarisation in Ecuador?
Ecuador went through a serious financial crisis in 1998 and 1999. The problems were both internal and external. Emerging-market countries were suffering major turbulence because of the Russian and Asian crises. At home, Ecuador had to deal with El Niño: as the world’s leading exporter of bananas and second-largest exporter of shrimp, its production of both were seriously affected. To make matters worse, Ecuador is an exporter of oil, and its tax revenues were hit by the slump in the oil price to $8 per barrel.
“My experience of dollarisation was very positive as a way of boosting Ecuador’s credibility and increasing its stability.”
The IMF had no intention of getting involved with a country experiencing those kinds of difficulties. It did not understand the consequences of dollarisation which, it is true, was a unique experiment. Panama had already undergone dollarisation, but no country had done it in order to boost credibility. Even before Argentina, the Ecuadorian government had introduced “Corralito” emergency measures, i.e. temporarily freezing deposits in order to save the 25% of the financial system that became insolvent as a result of bank runs in 1998. Ecuador was genuinely a situation of extreme urgency. President Jamil Mahuad took the right decision by starting the dollarisation process, on which his economic team had been working for several months.
How is Argentina’s situation different? It is also facing urgent issues, with inflation of over 120% in August.
Indeed. Dollarisation should be introduced as part of a comprehensive package of measures, which requires precise and detailed preparation. Presidential candidate Javier Milei, who is promising dollarisation, and his team seem to understand this.
The central bank’s role changes completely if the dollar becomes a country’s legal tender. The central bank would no longer be the lender of last resort, but it would have to provide the financial system with a credible system of banking supervision to prevent any panic spreading among banks. In Ecuador, we thought about setting up a fund capable of providing liquidity to certain banks depending on the circumstances. In the end, we rejected this idea, because merely accessing this fund might have sent a worrying message to the public, causing panic by itself. Banks preferred to adopt an internal system of recycling liquidity between themselves. This point should be carefully considered in Argentina.
Argentina’s economic competitiveness should also be assessed, because dollarisation means that it is impossible to make economic adjustments by devaluing the currency. Competitiveness can only be increased by improving productivity.
In Ecuador’s case, export industries welcomed dollarisation and became very competitive: exporters of flowers, shrimp and bananas are good examples. Rather than using exchange-rate differentials, companies exponentially increased their R&D spending in order to become more competitive. Faced with an economy that will remain cyclical, they must also make their structures more flexible than before.
How can all these challenges be addressed?
It is vital to put in place new legislation and convince both the people and a majority in Congress to vote for a highly detailed and exhaustive set of measures.
In Ecuador, from the time dollarisation was announced in January 2000, it took barely six months to validate the legal framework that made it possible, but that was because the situation was extreme. Shortly after the announcement, a military coup took place in Ecuador, although fortunately it only lasted a week. Public-sector workers, including teachers and even police officers, had not received any wages for months. Many people expressed their despair and demonstrated before Congress, which they regarded as riddled with corruption. Congress took fright and approved the new legislation without any major discussion. However, dollarisation not only places major constraints on monetary policy – which includes determining bank reserves but with no ability to print money – but also makes it impossible to run unsustainable budget deficits. The question is how Argentina would be able to adjust to the demands of that new model.
What are the main differences between Argentina’s dollarisation in the 1990s and today’s plans?
Dollarisation can be total, where the dollar becomes a country’s legal tender, or partial, where two currencies – the local one and the dollar – co-exist. In the latter situation, it is always possible to go back to the initial situation, which reduces the credibility of the new regime. If the dollar is the only possible currency, citizens adjust their spending and saving habits and realise that devaluation is not possible.
“Argentina’s people are tired of high inflation and poor management of the public finances.”
In addition, under dollarisation, the central bank only needs a small amount of reserves to convert the money supply into dollars. Not many economists understand this. During discussions about dollarisation in Ecuador, the central bank significantly overestimated the reserves necessary. It believed that the amount of international reserves needed to convert the local currency (the sucre) into dollars was equal to the monetary base. That was far from the case. Only a fraction of that amount, enough to exchange notes and coins, is sufficient. In Argentina, the total amount is likely to equal only 3% of GDP, i.e. between $10 billion and $15 billion. The main constraints lie elsewhere. The aim is to establish a viable, credible and sustainable regime, and to achieve that, the co-operation of Congress is necessary.
Are you confident that Argentina can make dollarisation a success?
Dollarisation could work very well for Argentina, but it must be able to carry out institutional, monetary and labour-market reforms for it to be successful. My experience of dollarisation was very positive as a way of boosting Ecuador’s credibility and increasing its stability. In Ecuador, we achieved it without any external support. The Washington institutions were not involved in the adoption process. The United States would probably have preferred a more stable country to be the first to explore this model.
However, Argentina is too big to be ignored. In my view, Washington would welcome an economic programme that puts an end to a difficult situation that has lasted for two decades now. Argentina has huge natural resources and abundant human capital. It has everything it needs to be a prosperous country. I cannot rule out Washington co-operating with a dollarisation process. Even the IMF’s directors would probably be in favour. Today, the IMF understands the advantages and drawbacks of the dollarisation model much better.
How can Argentina become more competitive?
Argentina has some highly productive industries, such as agriculture, which is very innovative and a big exporter. The problem lies in the country’s high level of macroeconomic volatility.
What would Argentina’s macroeconomic prospects be after dollarisation, aside from lower inflation?
In Ecuador, inflation fell and remained below 10% for a decade. 87% of the Ecuadorian people support dollarisation. If implemented properly, it could give a major boost to Argentina. It could lead to greater transparency, flexibility, productivity and fiscal discipline.
You are an asset manager. Is Argentina an investment opportunity?
I am watching closely to see how these plans develop. The devil is in the detail of course. Argentina’s people are tired of high inflation and poor management of the public finances. They clearly want change, and they are prepared to adopt a new model. The challenge will be to achieve consensus in Congress. Dollarisation could be positive if all conditions are met, not just the monetary ones.
Alonso Perez-Kakabadse