On October 30, 2017, the executive branch presented a comprehensive package of reforms, in various areas such as judicial, tax and labor, which have given rise to a large number of political interpretations, due to the immediacy of their presentation, after the official victory in the midterm elections this year.
The purpose of this note is to move away from that place and present an analysis of the measures included in the reform package, in the macroeconomic situation in which they are presented. That is, in their context.
This entry is accompanied by a report detailed in detail on the state of the country's situation, in both monetary and fiscal aspects.
The report addresses the role of the Central Bank in combating inflation, its influence on exchange rate policy, the tensions with the Treasury, the problem of the fiscal and trade deficit, the need to buy time by issuing debt, and the vulnerabilities that this entails.
The measures (a summary)
Taxes for companies:
- The income tax rate will be lowered, with the aim of encouraging companies to reinvest their profits.
- For those companies that reinvest their profits, there will be an early refund of VAT. This is intended to reduce the financial cost of investment projects.
- Employer contributions will also be modified, with the aim of reducing informal employment.
Other taxes:
• The check tax may be used as payment on account of profits.
• It was proposed to reduce, in each province, the taxes corresponding to gross income and stamps.
• As for the self-employed, it is proposed to double the amount of special deduction in Income Tax, going from $50.000 to $100.000.
• New tax scheme for financial income, which will be taxed in certain sections.
Consumer Taxes:
- Cell phones, televisions, monitors and other similar products go from paying 17% of internal taxes to 0%
- Mid-range cars and motorcycles will have their taxes reduced from 10% to 0.
- Cigarettes will have their tax rate reduced by 5 percentage points, reaching 70%
- The VAT tax base is expanded to include digital services.
- Soft drinks in general and other non-alcoholic beverages gradually increase from 4 to 8% for those with added sugar to 17%. It should be noted that light or sugar-free beverages maintain 0%.
Main labour reform measures:
The draft labour reform involves important changes to the employment contract regime, the main ones of which are detailed below:
- The employer is authorized to introduce all changes relating to the form and modality of the provision of work.
- Part-time contract.
- Changes in worker's licenses
- Collective bargaining agreements may establish compensatory systems of time credits known as “Hour Banks”.
- Modification to the calculation of Compensation.
As can be seen, most of the broad-based tax measures tend to reduce pressure or alleviate problems of mismatch with respect to payment terms.
On the other hand, rates are created or increased for specific goods, whether they are considered luxury goods or consumer goods that can be considered related to health expenditure of the population (such as the case of sugary drinks).
From the tax authorities' point of view, the direct effect and immediately, it is estimated that there will be a decrease in revenue; but with a partial relief of out-of-pocket expenses in favor of consumers, due to the lowering of prices of the affected goods, which, conditional on the generalized structure of imperfectly competitive markets in which the Argentine economy operates, may not be captured in a significant proportion by family units.
In turn, the indirect effect -it is estimated- that this will be a greater dynamism of the economy, due to the margin left in favor of companies, as a result of lower tax pressure; together with the expectations of lower costs on that front.
All of which results in the use of the debt mechanism to tolerate the cost of the readjustment that the measures imply if they are approved.
In terms of the general strategies available to the government to alleviate the problem of fiscal deficit, the bet from the tax point of view, consists of the following dilemma: reduce tax pressure (and, therefore, tax revenue) to increase business activity (to increase revenue).
Since companies operate in imperfect market structures, it is likely that a majority of the margin remaining after the tax cut will be absorbed by them.
In this sense, the question of policy implementation is whether this surplus will be reinvested to generate greater activity. And more importantly, whether the sacrifice in revenue will ultimately be compensated.
On the other hand, it is worth noting that, in the proposals presented, there are no additional measures to reduce spending, beyond those that are being exercised in matters of withdrawal of subsidies.
One of the limitations in this regard is that it is estimated that approximately 60% of expenditure is indexed, creating rigidities that end up directing the bulk of the fiscal effort towards areas that do not have this characteristic. Again, subsidies.
Finally, the most delicate point is that it refers to the Labour Reform. In general, it is observed that after the past decade of high prices in commodities, Latin American economies are converging towards reforms of their labor markets, aimed at achieving other conditions of formality and mobility.
This includes expanding the types of contracts that can be contracted, adjusting them to the changing requirements of the productive sector, while seeking to guarantee the security of workers in terms of labour formality.
On the other hand, there is a tendency to promote adaptations towards more specialized profiles, in the context of a process of technological change tending to the elimination of certain jobs that currently exist, and their replacement by the emergence of new positions and tasks in the labor market.
In addition, there is a tendency to analyze and reorganize issues related to pension system, mainly by postponing and equalizing the retirement age between men and women.
At this point, the country and the region are not immune to a global context where concerns abound about how to sustain and finance pension systems in the medium and long term.
The flip side of this process, which generates skepticism, especially in the union sector, is the possible loss of rights against workers, or the lack of a proper institutional framework to enforce the modifications, given the existing asymmetry between the bargaining power of companies and their employees.
However, these types of questions are in contrast to the fact that around 30% of workers work in the informal economy, where union representation has no influence.
The context
How can we reconcile the consolidated state of the Argentine economy with the package of reform measures that are being promoted by the executive branch?
From the Central Bank, a plan has been designed anti-inflationary plan with four pillars, one of which is to end fiscal dominance, and which is the one that causes the highest level of inconvenience to the highest monetary authority.
For its part, the Ministry of Finance has promoted a plan of targets for reducing the fiscal deficit, which is consistent in concept with the solution to the aforementioned problem.
Thus, the problem between both policies lies mainly in their coordination, especially with regard to the implementation times of the objectives of each plan.
In this sense, while the Central Bank seeks to combat the inflationary process, the Treasury seeks to increase - or at least maintain - the level of economic activity.
From the analysis it follows that the process of reduction of public deficit, for the moment, turns out to have a slower pace than that required by the monetary authority.
Since both types of policies influence each other, in order to gain time in the simultaneous implementation of both plans, the Argentine economy has entered into a process of taking on debt, both domestically and in dollars.
However, like virtually every measure in the economy, this strategy ends up conditioning the previous ones, by modifying the path of increase in the consolidated deficit.
Thus, as far as the BCRA is concerned, since the new government came to power, the organization has doubled its liabilities, with significant increases in the monetary base, and in the level of debt by LEBACsThe latter being the component with the largest share: 36,15% of the BCRA's liabilities, at the end of June 2017.
On the other hand, within the entity's assets, international reserves also doubled, driven mainly by a higher level of debt, the liquidation of exports for the year, and the result of the money laundering process.
Under this strategy, the Central Bank seeks to control the core inflation, offering a LEBAC rate that has remained –practically- above 25% annually throughout 2017, as a tool to gradually dry up the market for pesos, and extend the possible impact on the general price level, staggering maturities and subsequent renewals.
The cost of this strategy is therefore the increase in interest payments, which in 2017 came to represent a positive real payment. Thus, the problem facing the monetary authority continues to be that of fiscal dominance.
In this regard, it is worth noting that both temporary advances to the Treasury and the holding of non-transferable bills have decreased dramatically in favor of the Central Bank's anti-inflation plan.
However, the relatively high level of overall deficit projected – for the moment – undermines this objective: after the removal of subsidies in 2016, inflation is falling, although not to the expected level, especially as regards core inflation.
Thus, in the month of September, the inflation recorded by the INDEC was 1,9%. This level exceeded the 17% target set as the maximum for 2017 by the BCRA in its inflation target plan.
As a result, the overall cumulative level for the period January-September 2017 is 17,6%, although annual estimates remain in the range of 20% to 23%.
The following table shows the accumulated annual evolution of the different categories of goods in the current year. The table shows that, as a result of the tariff adjustment, regulated goods and services have maintained a greater increase in relation to other goods, similar to what occurred in the first half of the year.
For its part, from the perspective of the TesoroThe dilemma is how long to maintain the deficit level and, consequently, how to finance it. In other words, the general strategies available are: increase resources or decrease spending.
As for the first option, 2017 is showing a slight improvement in tax collection compared to 2016, and this is precisely where the reform package has a strong impact.
However, the decline in economic activity has affected the main sources of tax revenue (VAT and income tax), while the decrease in income from tradable goods has been even more pronounced in the first half of 2017, also due to the modification of the withholding tax regime.
In turn, the social security system It faces increasing challenges, which are making it increasingly deficit-ridden; while the profits of the FGS have not been allocated to financing current expenditure, but - mainly - to provincial housing plans.
As regards expenditure control, whether capital or current, the information presented shows marked stability in real terms, with the exception of two items that abruptly changed their composition: social security expenditure, showing an 89,01% growth between the second quarter of 2015 and the second quarter of 2017; and subsidies, with a 41,42% drop for the same reference period.
Although the primary deficit is expected to narrow, this is partly due to increased debt, which leads to a financial deficit (including interest payments) that decreases more slowly and has much more rigid components in its structure: in 2016, interest accounted for 33% of the financial deficit, but in 2019 it is expected to account for 63%.
In this way, the red numbers of the public sector are being financed with higher levels of debt, leaving the country exposed to sudden corrections in the international interest rate.
Furthermore, the increase in debt generates greater pressure on supply in the foreign exchange market, which impacts the dollar exchange rate, generating the risk of falling into an exchange rate lag.
However, as can be seen in the table above, the goals set by the national government have been comfortably met up to the third quarter of this year.
In other words, gradualism in the fiscal sphere, and more shock policy in the monetary sphere, tend to generate the real appreciation of the weight and, therefore, limit the possibilities of expansion of the economy through international trade.
On the other hand, if the economy were to grow due to other factors, the current productive structure would inevitably lead to an increase in imports, with greater pressure on the trade balance.
Botton line
Each of the points mentioned in this note are fully justified in the report "Gaining time: State of the situation and dilemmas of the Argentine economy", which we leave at your disposal. In it, a disaggregated reading of the performance of the BCRA and the national public sector, in fiscal terms.
For the moment, nothing has been decided. It is expected that these measures will be the focus of debate in the National Congress. However, the fiscal impact of these measures is still unclear, given the dilemma of promoting greater dynamism in exchange for lower tax collection.