Domingo Cavallo Announces Proposals To Save Argentine Economy

by Mike Godfrey, Tax-News.com, New York

23 March 2001

Domingo Cavallo, Argentina's newly-appointed Finance Minister (but Prime Minister in all but name) who cured the country's rampant hyperinflation ten years ago, has announced scanty details of his plan to revive the moribund economy, calling for wide powers to give him freedom of action without the need for constant recourse to legislation.

Centrepiece of the proposals is a new transaction tax, similar to the one imposed last year by Brazil, which raised 1.7% of GNP in its first 12 months. Mr Cavallo's proposed tax of 0.6% on all financial transactions could raise as much as $5bn in a year, but will be offsettable against other tax liabilities. The idea is to bring transactions out of the black economy and reduce the scale of tax evasion - Argentina has nothing to learn from the mother of all tax evaders, Italy, in this respect. Cavallo will make cash transactions of more than $1,000 illegal - people will have to use cheques or credit cards instead.

Mr Cavallo's predecessor, Ricardo López Murphy, had proposed a fiscal adjustment package including major spending cuts, but some ministers resigned in protest, and he was replaced after just 15 days in the job. In announcing his plan Mr Cavallo said that spending cuts were desirable, but that this was not the moment for them. Instead, Mr Cavallo has proposed a reduction in tariff levels on imported capital equipment and an increase in tariffs on consumer goods to encourage import substitution. He said his measures were designed to cut costs of production for Argentine industry by about 20 per cent

Mr Cavallo's proposals run counter to current economic orthodoxy, which would probably call for devaluation and spending cuts - but the government has no control in the upper house of parliament and lacks the strength to implement such unpopular measures.

Argentina's stocks and bonds fell sharply on Thursday in the wake of Mr Cavallo's speech, although reaction from local commentators was positive overall. The MerVal stock index plunged by 6.6 per cent, partly because of global markets and partly due to nervousness over Argentina's situation. The market rout was aggravated by rumors, immediately denied, that Argentina's president, Fernando de la Rúa, would resign. The spreads on the country's bonds widened to 9.85 per cent, the highest levels in several months. Argentina's outstanding debt of $124bn accounts for 23 per cent of the emerging debt market, and the spread is now pricing in a real possibility of default.

Really, the details of the measures don't matter as much as Domingo Cavallo's superstar standing with Argentines - his reputation is almost God-like, and if it's confidence that is needed to cure Argentina's ills then he will succeed just by being in charge. "Soon, Argentines will see us in action," Mr. Cavallo said, "and the country will be different."

External reactions to Mr Cavallo's plans were mixed, with Brazil in particular concerned that Argentina was stepping out of line in the Mercosur South American trading bloc. On Tuesday Mr Cavallo said he had spoken to his Brazilian counterpart to say that he needed to change tariffs unilaterally, and yesterday after making his announcement Mr Cavallo and Argentina's foreign minister, Adalberto Giavarini, flew to Brazil to soothe their biggest trading partner in person.

Recommended