Why Argentina's past still haunts its future?

Decades of populism and recurrent sovereign debt defaults make it difficult for Argentina to regain credibility despite unprecedented fiscal austerity. There is a way out.

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After reaching a low of 559 basis points on January 9, 2025, Argentina’s country risk premium (CRP), as measured by the EMBI+, reversed course and began to climb, peaking near 1,000 basis points in early April during the "black week" triggered by Donald Trump’s tariff announcement. Although the CRP has fallen sharply from this peak, it remains at levels comparable to early November 2024, and before that, to those last seen in March 2019. Objectively, the economy is in better shape than in 2017. However, the CRP is 300 bp higher.

With the exchange rate, the CRP is the most telling indicator of how international capital markets assess the credibility of a government’s economic policy. More importantly, in the case of Argentina today, it also allows us to evaluate its financial sustainability. Why? Over the next five years, the country faces principal and interest amortization payments on its foreign currency debt totaling approximately $100 billion.

Sovereign borrowers typically refinance their debt at maturity rather than repaying it in full. But a debt roll-over can only happen if the bond market is receptive. In practical terms this means a CRP below 450 basis points, which ensures that the coupon rates will not exceed 9% (although Argentina did it in the late nineties, it is not advisable for sovereign issuers to “print” double-digit coupons on their long term bonds).

In other words, unless the CRP quickly resumes its downward trend, Argentina will face a serious problem. This is not the fault of the current administration, which has maintained an unprecedented strict fiscal discipline, but rather the result of decades of economic mismanagement and recurring sovereign defaults. In Argentina, when it comes to policy credibility, the past seems to condition the future.

To evaluate the credibility of current economic policy, I built a simple econometric model that explains CRP levels across Latin America as a function of expected GDP growth, public debt-to-GDP ratio, inflation, government spending, the primary fiscal balance, and the current account balance. I used the projections for 2025 included in the IMF’s latest World Economic Outlook for fifteen Latin American countries (excluding Argentina and Venezuela) that have sovereign bonds outstanding. I also added an historical variable: the 10-year average of CRP.

Despite the model’s limitations, it provides a key insight: when it comes to CRP, in Latin America, the past seems to matter more than the future. The ten-year average of CRP explains nearly 60% of current CRP levels. For the remaining 40%, the primary fiscal balance is the most significant explanatory variable. Combined, these two variables account for 95% of current CRP levels. The other macro variables are statistically insignificant.

Applying the estimated parameters to Argentina, the model predicts a CRP of 1,319 basis points—roughly 600 basis points above the current market level. This suggests that investors value the government’s fiscal efforts, despite Argentina’s long history of defaults and fiscal indiscipline. The second key insight is that if Argentina’s ten-year average CRP were equal to that of the average of the fifteen countries included in the sample (386 basis points), its estimated CRP would be 143 basis points. In other words, the country pays a 1,176 basis-point premium (or almost 12% a year) for being a serial defaulter. Remarkably, the current administration has managed to cut this cost in half.

In a June 2014, article titled "Lessons from Game of Thrones for Argentina," I warned that the Kirchner administration’s refusal to comply with Judge Thomas Griesa’s rulings would impose a heavy burden for the future. Eleven years later, Argentina is still paying a high cost for having tampered with official statistics to default on the GDP warrants, for being declared in contempt of the court by a judge in New York for refusing to comply with his rulings, for declaring another sovereign default in 2020 followed by a poorly executed restructuring, for imposing draconian capital controls, and for pursuing irresponsible fiscal policies.

As Nobel Laureate Finn Kydland once observed, once a country loses credibility, it is very difficult to restore it. It basically requires long-term fiscal and monetary discipline—a challenge for young democracies with deep rooted frustrations.

If the government cannot rewrite history, are we doomed by our past? Not necessarily. A decisive electoral victory would demonstrate that not only economic policy, but Argentine society itself, have changed. Another way of alleviating the burden of the past entails adopting a policy regime with a low probability of reversal. Which inevitably leads us back to the dollarization debate.

In normal countries, the exchange rate reflects macroeconomic fundamentals. In Argentina, given its long (and unique) history of alternating between populist and non-populist regimes, it also reflects politics. More specifically, to what degree a policy regime is politically sustainable. Under a non populist regime, the real equilibrium exchange rate is lower than under a populist regime. Therefore, in such scenario, the peso will likely appreciate. However, if at some point, the markets perceive the politically sustainability of a non-populist regime is in doubt, an overshooting of the exchange rate will likely occur. In the coming months, we will be able to verify this hypothesis.

Skepticism about the political sustainability of a non-populist regime explains why the CRP remains high despite Argentina having the best macro figures of any country in Latin America. Again, that skepticism may fade if electoral results indicate broad support for this government’s policies.

At the end of the day, the debate about dollarization is a debate between optimists and pessimists. Those in the first camp believe this time is different—that the government’s policies will finally break the vicious cycle of illusion and frustration that has characterized Argentina for the last eight decades. Those in the second camp, in which I include myself, acknowledge that this government’s policies are indeed different—and enthusiastically celebrate and support them, but believe Argentina has not changed. Peronism has not disappeared. The populist threat persists, despite enormous progress in the “cultural battlefront”. The key question then is: under which of these assumptions are the costs of being wrong greater for Argentine society?

The credibility of an economic policy regime depends on its perceived likelihood of reversal. In Argentina, where regime changes are abrupt and frequent, that likelihood tends to remain persistently high unless a policy regime with low risk of reversal is adopted. There is only one available: official dollarization. We tried with the Convertibility regime, and politicians found a way to revert it. This government won’t last forever. If populism returns, so will printing money to finance excess spending, as it has been the norm since 1945. We know what this entails: inflation and stagnation. Given the strong relationship with the Trump administration and the government’s hard-won fiscal credibility, Argentina now has a unique opportunity to implement official dollarization.