[Markets] Market sentiment remains pessimistic after the latest tightening of capital controls and FX premium widened to new record highs and, despite increased efforts, the central bank is still losing international reserves. With a reserves position reaching critical lows and no expectations of a major economic policy shift, we maintain our view that further financial repression to avoid an – unavoidable – adjustment of the official FX rate is coming down the road.
[Fiscal] On the positive side, fiscal data surprised positively for the second month in a row with real income falling -5.9% in August (up from -13.6%) and primary expenditure stable at 18% YoY, but 0.4% excluding Covid-19 related items (down from 2.5%). the primary and overall deficit totaled ARS 89bn and ARS 145bn respectively and accumulates 4.2%/5.6% of GDP in so far 2020.
We adjust our primary deficit forecast to 7.4% GDP (from 7.8%) for 2020 this year but maintain 5.0% GDP for 2021. It seems unlikely that the government will be able to cut COVID assistance as planned in the budget, as the social situation is worse than expected (estimated poverty is 43% for Q2). Furthermore, deceleration of spending is driven by Non-COVID Item and, looking forward, subsidies to repress inflation and Capex to gain political favors in an election year will be hard to contain and will probably be higher than current levels (12-month sum of 1.9% and 0.9% GDP, respectively).
[Activity] Few surprises on the activity front. Nosediving in Q2 (-16.2% QoQ) explained by April contraction and May and June fast recovery, and slower sequential recovery since then (avg. 1.5% per month). We estimate a +11% QoQ recovery in Q3, mostly explained by statistical carry, and September SA EMAE 9% below February.
The overall macro consistency depends on the strength of activity recovery that will most likely never show up. We believe that the recent combo of measures was the final blow of any recovery prospects beyond some growth related to the lifting of COVID related supply constraints. We maintain -11.5% for 2020 and 4.1% for 2021, explained exclusively by statistical carry.
A robust growth rate would improve the fiscal situation through higher tax collection and lower fiscal expenditure (fewer needs for cash transfers to households). This would also address the monetary imbalance, with lower Treasury financial needs and increased money demand. However, such a scenario looks unlikely, as measures aimed at containing FX pressures have an anti-growth bias and pulled economic expectations down even more. Our view of an inconsistent economic policy that is headed for a crisis seems warranted by recent events.
[Fiscal]
Fiscal data surprised positively for the second month in a row. Real income growth improved in August, moving up from -13.6% to -5.9% YoY. Meanwhile, primary expenditure growth remained stable at 18% YoY, though, excluding Covid-19 related items, it showed some deceleration (down from 0.4% to 2.5% YoY). As a result, the primary deficit totaled ARS 89.5bn (overall deficit of ARS 145bn) and accumulates 4.2% GDP in so far 2020 (5.6%).
Better than expected fiscal dynamics should be considered with caution. On the one hand, because August’s income improvement can be explained by higher receipts from Wealth Tax (+487% YoY in August vs +209% YoY in July) and Income Tax (3.4% vs -25% YoY). If collection from both of these taxes had been similar to 2020’s average, total income would have registered a real variation of -10.8% YoY. On the other hand, the deceleration of primary spending real growth is mostly driven by items not related to the “Covid-19 response package” (as seen in the graph above).
Cumulative Primary Deficit (% of GDP)
The fiscal outlook for 2020 improves, though not much. Considering the latest information, we adjust our primary deficit forecast to 7.4% GDP for this year but maintain the forecast of 5% GDP for 2021. It seems unlikely that the government will be able to reduce financial assistance to households, as the social situation is worse than official figures state (private estimates of poverty rate are in the range of 40% of the population for Q2). Furthermore, spending on economic subsidies (to repress inflation) and infrastructure (to push aggregate demand and gain political favor in an election year) will likely be higher than their current level (12-month sum of 1.9% and 0.9% GDP, respectively).
The overall macro outlook depends on the strength of activity recovery. A robust growth rate would improve the fiscal situation through higher tax collection and lower fiscal expenditure (fewer needs for cash transfers to households). This would also address the monetary imbalance, with lower Treasury financial needs and increased money demand. However, such a scenario looks unlikely, as measures aimed at containing FX pressures have an anti-growth bias and pulled economic expectations down even more. Our view of an inconsistent economic policy that is headed for a crisis seems warranted by recent events.
[Activity]
No surprises on the activity front. Official data confirmed that GDP nosedived in Q2, falling -16.2% QoQ (seasonally adjusted, s.a.) and -19.1% YoY. These figures are consistent with those anticipated by the EMAE (-16.6% QoQ s.a. and -19.6% YoY). With activity now back at late 2006 levels, the speed and strength of economic recovery remains under debate. Questions are less about the damage caused by the lockdown (less temporary and more profound than expected, as the possibly underestimated 13.1% unemployment rate tells) and more about the impact on activity of tighter controls over forex markets.
Gross Domestic Product (QoQ and YoY)
Economic recovery continues but at a slow pace. July’s data shows marginal improvement (see table below), with the latest official information related to consumption (supermarket sales up just 1% YoY and shopping center sales down -83% YoY). Commercial activity is still falling, while Industrial production disappointed and Construction recovered to pre-pandemic levels. We estimate that activity increased 1.5% MoM s.a. in July (down from the official 7.4% of June), but dropped -11.5% YoY (vs -12.3% the previous month).
Monthly GDP
Recent data shows activity dynamics in line with our -11.5% scenario. According to FIEL, manufacturing production increased for fifth consecutive months (2.5% MoM in August, -4.3% YoY) and sectoral activity has now returned to early-2020 levels. Something similar to what private estimates of Construction is reporting: both the Construya index and Cement sale are above February’s level (19% and 5%, respectively). Meanwhile, foreign trade data show both weak external and domestic demand: export volume decreased -8.1% YoY in August, while import volume dropped -18.3% YoY. With most activity restrictions lifted, there is little room for substantial improvements, especially considering the overall macro outlook.
Industrial electricity demand and Manufacturing Production (YoY)
Precisely, September’s early data is not encouraging. Mobility data shows some improvement in CABA and PBA (+3.5pp and +1.0pp during the last month, respectively) but the rest of the country is moving in the opposite direction (-7.0pp), as the Covid-19 contagion is starting to affect them relatively more. Overall data still shows a low level of mobility (compared to pre-pandemic levels), though this information should be considered with caution. On the other hand, as of September 16th, industrial electricity demand remains down -10.5% YoY, which points to a still weak sectoral activity.
The latest measures hurt growth prospects for the remainder of 2020 and also for 2021. The government is doing whatever they can to avoid a discrete adjustment of the official FX rate (see here), but measures are negatively received, as reflected by financial market indicators (see Markets section for details). We consider the government will continue down this road, trying to control or regulate foreign currency demand (imports) and supply (exports). They might gain some time, at the cost of distorting incentives, even more, increasing the anti-growth bias of economic policy and the chances of a (future) disorderly adjustment.
Selected Economic Indicators (YoY)
[Markets]
Market sentiment remains pessimistic after the latest tightening of capital controls. The stock market dropped -3.1% WoW and accumulates a fall of -12.5% since September 15th, a downward dynamic not completely explained by global factors (see graph). Meanwhile, the sovereign risk premium increased to 1,356bps (+119bps WoW, +237bps since September 15th) and the restructured bonds are now pricing in exit yields between 13-15%.
Stock market indexes (adjusted for FX) – August 17th = 100
Contrary to what the government expected, the FX premium widened even more. The BCS FX rate increased to ARS 145.3 (+13% since September 15th), widening the premium against the official rate to 92.4% (vs 71.2%). Meanwhile, the black-market rate moved up to ARS 141 (+7.6%) and the premium increased to 86% (vs. 74.2% on September 15th). The FX premium has gone above levels observed in the previous episode of capital controls (average of 40.2% during 2011-15, with a maximum of 81.7%) and we have to go back to the 1970s or 80s to see comparable data. These are uncharted waters for another reason as well: without an “expectations anchor” (change of government in the later phase of CFK’s second term), such a high FX premium might have more effects (on activity and prices, for instance) than thought.
Despite increased efforts, the central bank is still losing international reserves. As of September 23rd, the stock of net reserves had dropped to USD 6.2bn (down USD 371mn since the 15th) and net sales in the forex market totaled USD 133mn (unofficial information estimates that sales continued during the last couple of days). Coupled with intervention in the spot market, the BCRA has increased its sales of USD future contracts (open interest of USD 5.1bn in August, + USD 731mn MoM), and we estimate that this trend has continued recently in both Rofex and MAE markets.
With a reserves position reaching critical lows and no expectations of a major economic policy shift, we maintain our view that the government will continue tightening controls and restrictions to avoid an adjustment of the (official) FX rate. The problem is that, with such a FX premium, depreciation expectations will remain high, as the unification of a dual forex market usually took place through sharp depreciations of the official (lower) exchange rate.