Argentina’s Uphill Battle for Reform : South America: President Carlos Saul Menem’s plan to set up a free-market economy has run into resistance on all sides.

With plenty of false starts, backpedaling and detours, Argentina is lurching into the brave new world of free-market economies. For most analysts, it is an open question whether the train to modernization will derail even before it builds up steam.

The final days of December and the first weeks of the 1990s saw a ruthless new spurt of inflation, chewing up workers’ buying power just as it began recovering from last year’s hyper-inflation. People canceled vacations and otherwise scrambled to stretch their paychecks, a demoralizing blow at a time when fledgling President Carlos Saul Menem’s reform program seemed to be taking hold.

Last week, Menem accepted the resignation of the government central bank president. The new bank chief is the fourth since Menem took office last July, symbolic of the government’s groping as it attempts to reverse a half-century of state domination of the economy.

The defense minister, Italo A. Luder, also quit after a squabble with the army chief. That left Menem with half of his original Cabinet just seven months into his term. Incessant rumors of dismissals and policy changes, always denied but often proved true, have compounded the sense of national uncertainty.

Menem is now battling on every front to carry through his attempt to turn around decades of welfare-state doctrine in Argentina. Much of the resistance is coming from his own labor-based Justicialist Party, as the Peronists are formally known. But other powerful sectors, including banks and big business, are proving equally reluctant to surrender their traditional privileges.

The victims in the turmoil, as usual, are the nation’s wage earners. So far they have not rebelled, as they did last May by sacking supermarkets, but concerns of renewed upheaval are growing.

“The social problem is dangerous,” a senior foreign banker said. “The interest groups don’t realize that if they keep fighting among themselves, then the general public, the only ones who have really suffered, will say, ‘This is the end.’ In any other country, I would have expected a couple of banks to have been burned down by now.”

Struggling to halt the sudden price surge and regain the market’s confidence, Menem shook up his economic team in December and took the bold step of ending price and exchange rate controls. That worked for a few days, but the government’s internal debt, the cost of financing its borrowing from banks to cover the budget deficit, was a ticking time bomb.

Facing chronic instability and inflation, Argentines had come to rely on seven-day time deposits that paid enormous interest rates--up to 600% per month--to protect the value of the depreciating currency, the austral. Banks were required in turn to loan up to 80% of those short-term deposits to the central bank, which used the funds to cover the deficit. To pay banks the sky-high interest on those loans, the government cranked up the mint’s printing presses, further aggravating inflation.

So Menem abruptly decided, in effect, to seize those deposits and give investors 10-year dollar bonds in their place. People who had planned to get their money back in a week suddenly were told they must wait 10 years, or trade their bonds at 40% or so of face value.

There is surprisingly widespread agreement that the decision was fundamentally sound because it sought to break the nation’s seven-day financial mentality and at the same time halt the terrible cost in interest payments resulting from the internal debt.

(The foreign debt of nearly $70 billion, once a source of polemics, is barely a talking point these days since Argentina has made virtually no payments for more than a year.)

But agreement is even greater that unless the government makes some very hard decisions on how to cut the budget deficit further, no amount of short-term financial tinkering will help. That would mean major public sector layoffs, higher prices for government services and closings of state-owned companies as well as a firm resolve not to print more unbacked money.

Menem was credited with substantial advances from July until early December, and he did make progress on cutting subsidies, reducing the budget deficit, raising hard-currency reserves and beginning a process of privatizing state businesses. Inflation fell from 196% per month in July to 6% in November. But he sought unsuccessfully to hold the exchange rate at 650 australs per dollar, and when the black-market rate climbed to more than 1,000 per dollar because of the internal debt problem, the plan started coming apart.

In response, Menem broke with Bunge & Born, the giant Argentine holding company that provided his first two economy ministers. The first died five days after assuming office. The second minister, Nestor Rapanelli, resigned in mid-December and was replaced by Menem confidant Antonio Erman Gonzalez, who has overseen the subsequent dramatic changes.

“Hyper-inflation has been put off now for a month, or 45 days. But the danger now is a run on the banks. And there are many doubts about the government’s firmness,” said Jorge Avila, a respected economic consultant. “The plan is technically and potentially very powerful. But it depends on the government’s resolve.”

Avila noted that conflicting announcements from the government, a problem since Menem took office, also have fueled uncertainty. Talk of switching to a dollar-based economy in late December helped set off the huge price increases, even though that plan was never adopted. Prices went up 200% in a few days of paroxysm as people expected a dollar worth up to 6,000 australs, and then when the value of the austral actually rose instead--to 1,200 to the dollar from 1,900--prices came down only 20% to 30%.

Arturo O’Connell, an Argentine consultant for the World Bank, warned that “if the fiscal deficit doesn’t decline, we will be back in the same situation. I’m waiting for a second crisis in a month’s time, which will be pretty close to a terminal crisis.”

“They made this ideological leap into the abyss. But there’s no stability, because the basic causes are still there. Having free exchange rates doesn’t cope with the problem. You still cannot avoid the harsh reality of needing to cut down the fiscal deficit.”

The economic problems, the zig-zagging in policy and the repeated resignations by government officials have led to a sharp drop in Menem’s popularity in opinion polls from 67% to 44%, even as the latest changes have restored at least temporary stability.

The dollar-austral rate, a measure of confidence in the government, has remained relatively steady in recent days at just over 1,700, and consumer price rises fell to 1% in the third week of January, although the overall increases last month are expected to surpass 60%. The more stable austral results in part from the government’s attack on the internal debt, which dried up the supply of australs in circulation.

But huge lines formed outside the trade union confederation last week as people waited for food coupons, and soup kitchens are multiplying in working-class areas because a deep recession has cut consumption and led to layoffs.

Leonardo Anidjar, another economic analyst, credits Menem with “making a fantastic turnaround in ideology. No political leader has had the ideological courage of Menem. . . . The idea of free markets, free exchange rates, is a revolutionary turnaround in the historic economic misconceptions of Argentina.”

But at the same time, he said, Menem is not addressing the immense problem of central government subsidies to the deficit-plagued provincial governments, a huge inflationary drain. Menem’s success in drawing non-Peronists into the government also has meant a lack of coherence, he added, and some of the best Peronist economists are declining government posts.

Anidjar said he feared a renewed crisis within three months, “without the credibility we had built up previously.”