The overvaluation of the peso complicates economic recovery, making the country’s exchange rate excessively expensive in dollars. The official exchange rate is currently set by the government, which also imposes capital controls. Almost the entire December devaluation has been erased (see chart 2). This involved an initial devaluation of the peso by more than 50%, then by 2% each month. But monthly inflation has been higher than moving parity. The result is that the real effective exchange rate is rising.
The effects are evident from the peaks of the Andes. In a single long weekend in April, some 40,000 Argentines crossed the mountains to Chile to buy everything from sneakers to car tires as, surreally, Chile became cheaper than Argentina. Mr. Milei castigates those who say the peso is overvalued, calling them “intellectually dishonest.” However, when the Argentine president says that there will be no devaluation, taxi drivers know that there is a good chance that there will be one, quips Nicolás Gadano of Empiria Consulting in Buenos Aires.
A high peso scares away tourists, makes exports expensive and discourages investors. An overvalued currency often ends up collapsing. “If you see Argentina appreciate, it’s always a sign of worse things to come,” says Eduardo Levy Yeyati of the Torcuato Di Tella University in Buenos Aires. Falling exports make it harder for the central bank to accumulate dollars, which it needs to repay its foreign debts and build up its safety reserves.
The government could allow the peso to float or accelerate the gradual 2% peg. But either would likely increase inflation, endangering Mr. Milei’s popularity and undermining some of the benefits of devaluation. For now, Mr. Milei is able to keep tight control over the exchange rate through capital controls.
What next? Mr Milei has promised to remove capital controls as part of his plan to restore investor confidence. He says inflation will soon reach 2% a month, the same rate as the devaluation. That would allow him, he says, to gradually ease restrictions and keep the peso afloat without its value collapsing.
Here is more from The Economist. To be classified under the heading “difficult balance, and market prices do not work their magic”.
