The government enacted a new set of regulations tightening FX controls to new extreme levels. The combo includes an increase of the exchange rate through taxes for dollarization purposes, further rationing of foreign currency for savers and corporates, different “parking” periods for assets involved in BCS market operations, and finally pushing out non-residents of the BCS market.
The already low credibility has been strongly hit and any potential positive feedback from the debt agreement has been definitively aborted. The main signal is that the government has abandoned any idea of a coherent macro program and has decided to simply kick the can down the road, trying to muddle through an election year with a reloaded version of the 2011-15 economic policy.
A second “signal” released this week was 2021’s Budget Bill with a primary deficit of 4.2% next year. Even though the policy signal extracted from the budget should not be overstated, the message seems to be that fiscalconsolidation will be modest. This dynamic is in line with our estimates (cash basis primary deficit of 7.8% GDP in 2020 and 5.0% in 2021) and reveals that no significant fiscal effort is on the making, beyond some COVID expenditure reversal. On top of that, fiscal consolidations are easier said than done and policy so far has been proven to be decided on a short term reactive fashion.
The FX decisions taken this week may have been the tipping point of an endogenously explosive path, one that cannot be avoided unless an active policy reversal is implemented. However, the stabilization plan required to addresses both fiscal and monetary imbalances entails political costs and also has non-negligible implementation risks and, at this point, looks highly unlikely as the electoral date comes closer.
This broad macro scenario is in line with our “continuity scenario”, described in previous reports (see here and here): Dynamics are inconsistent with a persistent fiscal deficit financed by the Central Bank in the context of important and increasing monetary overhang, and measures that aim to preserve reserves and repress inflation tend to hurt growth and trade balance prospects and deteriorate market expectations. We believe FX tension will prevail in the absence of a policy shift. Official FX adjustment that agents expect may have been postponed but will be stronger.
Capital controls are tightening to new extreme levels. With international reserves falling at an unsustainable rate (an average of USD 43mn per day since end-August, with the net stock down to USD 6.7bn), the government enacted a new set of regulations. First, an increase of the exchange rate (through taxes) for dollarization purposes. Second, increased rationing of foreign currency for savers (credit card consumptions in USD reduce the available limit for FX purchases) and corporates (forced restructuring of external debt in order to gain limited access to foreign currency at the official rate). Third, different “parking” periods for assets involved in BCS market operations (MEP/CCL). Fourth, non-residents will be pushed out of the BCS market.
Our take is that these measures are but a short-term patch, at best. Those that affect residents aim to lower the pressure on international reserves, at the cost of increasing black-market and BCS premiums. Regulations that affect non-residents do not impact reserves but tend to reduce FX demand at the BCS market, thus relieving some tensions on the BCS premium. Put together, they neutralize whatever positive effect of solving the sovereign default might have had on expectations, as they signal that BCRA’s reserve position is weak and policy stance extremely defensive. Additionally, over the medium term, tighter capital controls reinforce Argentina’s “financial autarky” and further disincentivize investment (especially, IED).
The market reaction to the news was negative, as expected. The BCS FX rate increased to ARS 129.8 (+0.4% since September 15th), widening the premium against the official rate to 72.4% (vs 71.9%). Meanwhile, the black-market rate moved up to ARS 141 (+7.6%) and the premium widened to 87.2% (vs. 74.2% on Tuesday). The stock market index dropped -6.7% and, conversely, the country risk premium increased to 1,236 bps (+117 bps).
The other “signal” released this week was 2021’s Budget Bill. According to the Treasury, the primary deficit of the National Public Sector (accrued basis) will end 2020 at 8.3% GDP and decrease to 4.2% next year. This reduction will be the result of higher-income (+0.8 pp) and some cuts in fiscal expenditure (-3.3 pp), particularly of Covid-19 related items. This dynamic is in line with our estimates (cash basis primary deficit of 7.8% GDP in 2020 and 5% in 2021) and reveals that there will not be any significant fiscal effort. At least on the expenditure side, as the government is studying a tax reform that, most likely, will increase the tax burden and was not included in the Budget Bill.
he broad macro scenario is in line with our view. As explained in previous reports (see here and here), dynamics are inconsistent: there is a persistent fiscal deficit financed by the central bank in the context of important monetary overhang. The economy requires a stabilization plan that addresses both fiscal and monetary imbalances, but which entails political costs and also has non-negligible implementation risks.
Instead, the government puts its hopes on the “confidence fairy tale” and has decided to simply kick the can down the road. Economic objectives can be reduced to an improvement of expectations through a modest fiscal consolidation plan combined with lower monetary assistance and avoiding a disorderly FX adjustment through active management of the forex market. The problem is that the time-horizon of economic agents has reduced to weeks instead of months, credibility is very low, and most measures that aim to preserve reserves hurt growth prospects, repress inflation, and deteriorate market expectations. Muddling through an election year with a reloaded version of the 2011-15 economic policy means that the FX adjustment that agents expect will take place later but will be higher.
Inflation accelerated in August. Official data reports an increase of 2.7% in consumer prices last month (vs 2.2% MoM of July), exactly in line with market expectations (2.7% according to the latest REM). Our early estimate was above official data (3.5%), though we warned of downside risks to our figure (see here). Meanwhile, August’s interannual inflation moved down to 40.7% (from 42.4% of the previous month).
Headline inflation is affected by the government’s decisions and the lockdown. Last month, Seasonal items jumped 4% MoM (vs previous 0.9%), while Core inflation was of 3% MoM (vs 2.5%) and Regulated prices increased only 1% MoM (vs 0.5%). By freezing public services’ tariffs (which now include TV, Internet, and cellphones), the government keeps artificially repressing inflation. This can also be seen by comparing the inflation rates of goods (3.3% MoM) and services (1.5%), which are also affected by the lockdown (for example prices of Education and Tourism are clearly lagging behind). The misalignment of relative prices is increasing, another warning sign for the future.
We expect the monthly inflation rate to remain close to 2.5% in September. The inflation shock of mid-July is clearly fading off, with relatively low weekly printings (0.5% WoW in the past 2 weeks). Furthermore, August left a low statistical carry-over and regulated prices will remain frozen. It seems likely for the inflation rate to eventually converge, more or less, to the crawling-peg of the official FX rate (2.5% MoM in August). However, forex market tensions remain high and the possibility of a discrete FX adjustment that changes (which would spike inflation) is significant.