INDEC’s default: 4,600 million dollars

by Andy Neumeyer 

Click here for Spanish version published in La Nacion

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Since the national statistical institute (INDEC) was taken over by commerce secretary Moreno last January, Argentina has been tampering with the consumer price index (CPI). This note analyzes the fiscal impact of doing this.

As Argentine price data is gathered both at the national and provincial level, it is possible to use provincial data to measure inflation misreporting at the national level. For example, since the beginning of the year, inflation in Mendoza has been 17 percent, while the national figure is 5 percent.

Between January and August 2007, Argentina defaulted on us$4.6 billion of indexed debt. Indexing the adjustable debt using Mendoza’s CPI instead of the one reported by the national government would raise the present value (discounted with risk free rates) of the indexed-debt-coupons by us$4.6 billion. Approximately half of this, us$ 2.2billion, corresponds to payments due before 2011 that directly affect the budget of the Kirchner administrations. Each percentage point of sub-reported inflation amounts to a default of us$334 million.

Sub-reporting inflation has large fiscal consequences as 45 percent of total public debt is indexed to the CPI. Since January 2007, Argentina reduced its indexed debt by us$4.6 billion. That is, indexing the adjustable debt using Mendoza’s CPI instead of the one reported by the national government would raise the present value (discounted with risk free rates) of the indexed-debt-coupons by us$4.6 billion. Approximately half of this, us$ 2.2billion, corresponds to payment due before 2011 that directly affect the budge of the current administration and the one that will be elected later this month. Each percentage point of sub-reported inflation amounts to a default of us$334 million.

The cost of the increase in the country risk stemming from misreporting inflation is hard to calculate but seems to be trivial by comparison. One way of measuring it, is to assume that the government finances each coupon payment with a consol. The difficulty in estimating the costs of the higher country risk lies in the fact that it is hard to predict the persistence of these “punishments”. For example, a 100 basis point increase in country risk implies a cost of approximately us$ 19 billion if it is permanent. Employing the historical persistence of the changes in country risk (only a 50% of the change remains after a year, 25% after two years, …) the cost of a one percent increase in country risk reduces to us$360 million.

The persistence of the higher country risk depends on the government behavior. The return to orthodox fiscal policies, as those of the Kirchner administration until 2006, will probably reduce the last increase in country risk pretty fast. Maintaining the current trend of fiscal policy (increasing public expenditures and defaulting over the adjustable debt), will almost certainly result in a higher and more persistent increase in country risk.

The net benefit of tampering with the price index between January and august has been significant. Argentina reduced its indexed debt by 12%, us$ 4,604 million. Since January 2007, Argentina’s country risk has increased near 2 percent more than Latam average; using historical data for the persistence of country risk shocks, the cost of this default is us$ 720 million. Considering only the cash-flows affecting the Kirchner administrations through 2011, the fiscal net benefit so far is 1,500 million dollars.

Is it in the best interest of the country to reduce the quality of economic information, thwart labor and financial contracts, and increase the cost of capital for the private sector for this amount? Probably not.

The fiscal benefit to be achieved in the next four years under optimistic assumptions about country risk, us$ 1,500 million, is only around half percent of national income. This figure is macroeconomically insignificant, equal to approximately 40 dollars per person.

Nevertheless, even when this numbers may seem very small at an aggregate level, they are large for those directly involved. Government creditors (mainly pension fund contributors) lost about 12 percent of their assets and the government has the possibility of using the benefits from the default for specific purposes like education, health or infrastructure.

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2 Responses to "INDEC’s default: 4,600 million dollars"

  1. Vitoria Saddi   October 11, 2007 at 4:26 pm

    Pablo, Does Argentina need to have bonds indexed to the CPI? I mean, I thought that due to the taming inflation the decrease in the demand for these bonds was significant. However, from your estimates it seems that some part of the government has to bear the costs of these inflation linked bonds?

  2. Guest   October 11, 2007 at 4:27 pm

    Do you think that the new president will keep taming inflation data or not?