For a major consulting firm, lifting the restrictions without reservations will “unleash chaos”

What else does Oxford Economics say about Milei’s economic policy?

• Since taking office, President Milei has implemented a gradual devaluation of the peso and a restrictive fiscal policy to address macroeconomic imbalances. However, Milei’s easing of his so-called shock therapy for Argentina’s economy and the central bank’s (BCRA) recent intervention in parallel markets pose risks to the removal of capital controls by eroding investor confidence: Sovereign spreads have widened since April and remain significantly higher than in 2016, when former President Mauricio Macri lifted foreign exchange restrictions.
• The main reason Argentina is unable to lift capital controls without an economic disaster is negative real interest rates. Multiple defaults and high inflation have led to negative interest rates, making Argentine peso assets unattractive. As a result, Argentines have preferred to keep liquid savings in dollars, either in accounts abroad or “under the mattress.”
• Capital account liberalization requires positive real interest rates, but Argentina is far from being able to manage positive real interest rates and sustainable debt. This will require years of fiscal surpluses to sufficiently reduce public debt and reduce investment risk.
• Economic theory suggests that the domestic interest rate should be equal to the international interest rate plus the expected depreciation of the exchange rate plus the country risk premium. If capital controls were lifted in 2025, the sovereign real interest rate would rise to 0%, compared with the IMF’s forecast of -31% for 2025, putting debt on an explosive trajectory.
• Removing capital restrictions is costly: In the absence of sustainable and credible fiscal consolidation to face positive real interest rates, Argentina needs to increase its reserves to cover the cost of lifting capital controls. Argentina will face titanic and ever-increasing debt payments over the coming years. To successfully lift capital controls, the government must pay $14 billion by 2025, or 2.3% of GDP. Otherwise, it will default on its sovereign debt.

How much should the currency be devalued, according to OE analysts?

• The government must also address the gap in the financial account. During Macri’s government, capital flight reached $11 billion and FDI inflows fell by 72%, resulting in a decline in Argentina’s financial account of $16 billion. We estimate that the drop could reach $8 billion for two reasons: FDI inflows could fall less than under Macri’s government, since Companies have announced investment projects in mining and hydrocarbon sectors that could reach US$6 billion annually, and a new capital repatriation plan could generate up to US$2 billion in revenues..
• Assuming that domestic debt is renewed in dollars, the total cost of removing exchange restrictions to pay bondholders, addressing multinational profit-making and some capital flight would be around $28 billion in the high-end scenario.
• Bringing the current account to levels of 2-4% of GDP requires another devaluation of the real exchange rate to have sufficient foreign exchange reserves. According to OE models, the real devaluation rate necessary to estimate the reserves required to cover the cost of eliminating exchange controls ranges from 11.5% to reach an annualized inflation rate of 2% of GDP, 18.5% to reach an inflation rate of 3% and 24.4% for an inflation rate of 4%.
• But another devaluation would put Milei’s strong support at risk. It is doubtful that Milei’s government would risk implementing it before the midterm elections, given the high political cost. Milei knows that his support from more than 50% of voters has limits, and his focus on slowing inflation appears to be an attempt to maintain this strong support in the run-up to the 2025 midterm elections. We believe the government will postpone lifting capital controls until after the midterm elections in 2025 to avoid losing its high level of support and depleting all its reserves.