Emerging

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EcoEmerging// 1 quarter 2019  
economic-research.bnpparibas.com  
Argentina  
A high-risk election year  
Calm has returned to Argentina’s financial markets since the end of September 2018. The peso has levelled off after depreciating  
0% against the dollar in the first 9 months of the year. The central bank finally managed to loosen its grip after raising its key  
5
policy rate by 70%. Restored calm can largely be attributed to IMF support, but it comes at a high cost: a strictly quantitative  
monetary policy and the balancing of the primary deficit as of 2019. The economy slid into recession in Q2 2018 and is likely to  
remain there through mid-2019. So far, the recession has not eroded the country’s fiscal performance, the trade balance has swung  
back into positive territory and inflation has peaked. Yet will that be enough to restore confidence before October’s elections?  
Financial tensions ease...  
1-Forecasts  
Since the end of September 2018, financial tensions have eased in  
Argentina. After depreciating by nearly 50% against the dollar in the  
first 9 months of the year, the peso has levelled off and is now  
fluctuating at between ARS36 and ARS38 to the dollar. The 7-day  
liquidity bill rate (Leliq), the central bank’s new benchmark interest  
rate , eased from 73.5% to 61%. Yet investors are still wary, and the  
risk premium on 5-year CDS rose to 750bp in mid-January, a 150bp  
increase since October.  
2
017 2018e 2019e 2020e  
Real GDP growth (%)  
2.9  
-2.5  
-1.5  
2.5  
Inflation (official, annual average, %)  
Fiscal balance/ GDP (%)  
25.2  
-6.0  
33.8  
-5.2  
37.0  
-3.7  
18.0  
-3.0  
1
Public debt/ GDP (%)  
57.1  
78.0  
-5.2  
83.0  
-3.0  
87.0  
-2.5  
Current account balance / GDP (%)  
External debt / GDP (%)  
-4.9  
37.2  
55  
54.7  
66  
56.9  
60  
51.5  
65  
Forex reserves (USD bn)  
The first signs of financial stability can be attributed to the 26  
October announcement of the revision of the IMF’s standby credit  
facility, which was extended from USD 50 bn to USD 56 bn in  
October, and the 19 December conclusion of the second review of  
the standby agreement and the disbursement of USD 7.6 bn, which  
helped shore up the central bank’s foreign reserves (to USD 66 bn  
at end December, from USD 51 bn at end November). Financial  
stability can also be attributed to a very restrictive monetary policy,  
the cost of which was a severe recession.  
Forex reserves, in months of imports  
Exchange rate USDARS (year end)  
6.2  
7.0  
7.3  
6.5  
18.6  
38.5  
55.6  
57.5  
e: BNP Paribas Group Economic Research estimates and forecasts  
2- Hard time  
Real GDP (yoy %)  Construction activity (yoy %)  
Industrial production (yoy %)  
2
2
1
1
5
0
5
0
5
0
5
…thanks to very tight monetary policy  
Faced with a self-feeding dynamics between the peso’s depreciation  
and inflation, the monetary authorities have pursued a very strict  
quantitative monetary policy since September. The central bank  
(
BCRA) temporarily abandoned its inflation target and will target  
zero nominal growth of the monetary base through June 2019 (with  
the exception of seasonal increases in December and June).  
Thereafter, the increase in the monetary base will be limited to 1% a  
month in H2 2019. At the same time, BCRA is not authorised to  
intervene to support (or weaken) the peso as long as the currency  
fluctuate within a rather broad band (20%). In contrast, the upper  
and lower limits are following a growth rate of 2% a month. This is  
much lower than observed inflation, which averaged 4.3% over the  
past 6 months, and is even lower than inflation expectations, which  
averaged 2.5% in Q1 2019 according to the BCRA’s December  
survey. The BCRA is allowed to intervene when the peso trades  
outside of these fluctuation bands, although it cannot sterilise its  
interventions.  
-
-
10  
-15  
-20  
2008  
2010  
2012  
2014  
2016  
2018  
Source: INDEC, FIEL  
This framework brings to mind a currency board, albeit a more  
restrictive variant as far as the monetary rule is concerned . The  
strategy consists of anchoring inflation expectations thanks to a real  
appreciation of the exchange rate, which is justified ex post by the  
improvement in the ratio between foreign reserves and the  
monetary base.  
2
1
Since mid-2018, the Leliq has massively replaced the Lebac, the BCRA’s  
2
sterilisation instrument, the cost of which had placed too much of a burden on  
public finances (see “Argentina: a touchy transition” Conjoncture, BNP Paribas -  
September 2018). The Leliq became the benchmark policy rate on 8 August  
A currency board arrangement does not impose absolute stability but rather  
relative stability of the monetary base through a constant ratio between the  
monetary base and foreign reserves. Ordinarily, however, the forex fluctuation  
band is much narrower.  
2018.  
EcoEmerging// 1st quarter 2019  
21  
economic-research.bnpparibas.com  
Although it is too early to evaluate the effectiveness of this monetary  
and forex policy, inflation has slowed sharply, with headline inflation  
down from a peak of 6.5% (per month) in September to 3.2% in  
November, and core inflation easing from 7.6% to 3.3%. The BCRA  
lowered its intervention rate to 60%, a minimum it intended to  
maintain as long as survey results did not show a decline in 12-  
month inflation expectations for two consecutive months (as was the  
case in November). Thanks to the peso’s stability and the downturn  
in metal and then oil prices, producer prices even declined 0.6% in  
the month to November, compared to +16.2% in September.  
Although inflation expectations showed greater rigidity, they also  
declined.  
The only positive point is that the contribution of net exports turned  
positive in Q3, thanks not only to the contraction of imports but also  
to a rebound in exports. Yet industrial output and survey results  
suggest that GDP declined again in Q4. Household consumption is  
unlikely to rebound given the contraction in real wages (-11.3% in  
the year to Q3 2018 vs. +4% in Q4 2017) and the decline in  
employment (-1.5% year-on-year for the period September-  
November 2018, vs 2% at year-end 2017). Moreover, the rebound  
in exports will not prevent investment from declining. Lastly, fiscal  
policy will continue to be very restrictive given the target of  
balancing the primary deficit (excluding net interest charge) as of  
2019.  
This monetary and exchange rate strategy is not risk-free. Firstly,  
prohibition of sterilizing capital flows outside the fluctuation bands  
may trigger interest rates volatility. Even if monetary policy is  
credible and thus allows a decline in real interest rates, potentially  
high volatility of short term rates - when they get close to the limits  
of the corridor - can deter investment decisions that usually require  
good predictability of the cost of borrowing. Secondly, the fact that  
there exist limits on how far the exchange rate can depreciate may  
result in an overvaluation of the real exchange rate which may harm  
competiveness. In both case, there is a potentially negative impact  
on growth.  
For the moment, the recession has not had a perceptible impact on  
fiscal performances. To the contrary, tight control over spending has  
reduced the primary deficit to 2.4% in 2018 from 3.8% in 2017.  
Primary spending was reduced from 23.2% of GDP to 21.2%. The  
net interest charge, in contrast, rose from 2.2% of GDP to 2.4%.  
Although the net interest charge has not increased much yet, its  
relative weight will swell due not only to the revaluation of interest  
on foreign currency debt, but also to real domestic interest rates,  
which are much higher than before the 2018 financial shock.  
Moreover, the balance of payments equilibrium is still fragile. The  
current account deficit may have been slashed in half, from  
USD 31.3 bn in 2017 to USD 15 bn in 2019. But the wait-and-see  
attitude of investors in the run up to October’s elections is likely to  
reduce the capital account surplus. Net foreign direct investments  
and non-resident portfolio investment are bound to dry up  
(USD 8.8 bn and USD 13.3 bn, respectively, in Q1-Q3 2018). The  
balance of payments equilibrium will depend on resident capital  
outflows, which have been massive over the past two years  
(USD 20 bn in 2017 and USD 26 bn in Jan-Nov 2018). Capital  
outflows could slow if the exchange rate stabilises. Yet nothing is  
less certain with the approach of the elections. For the moment,  
thanks to the extension of maturities following the clearance of  
arrears in 2016, debt servicing on Argentina’s international  
government bond holdings (USD 190 bn) is largely bearable  
In the case of Argentina, the aforementioned two risks are not major  
risks. Corporates are used to live under considerable financial  
stress and, in a through-the-cycle view, investments decisions are  
more constrained by macroeconomic policy instability or the  
business environment than interest rate volatility. On the contrary,  
the solvency of economic agents indebted in foreign currency  
(
foremost of which is the state) requires the real exchange rate to  
remain as stable as possible. Indeed, a depreciation of the currency  
has a mechanical and strong impact on the debt dynamics whereas  
the impact of the real exchange rate on the current account balance  
3
is small . More generally, the priority for supporting growth is to curb  
inflation in order to give more room of manoeuvre to monetary policy.  
The price: a severe recession  
(
USD 8.1 bn in 2019). In contrast, debt servicing on the state’s total  
external debt and dollar-denominated domestic debt is massive  
USD 37.5 bn), which explains the size of the IMF’s credit facility.  
Argentina’s economy sank into recession in Q2 2018 with real GDP  
contracting at an annualised quarterly rate of 15.6%. Nothing  
suggests that the country recovered in Q4, and the recession could  
extend at least through the first part of 2019.  
(
In Q2 and Q3 2018, the cumulative decline in real GDP is estimated  
at nearly 5% (-3.9% compared to the same period in 2017). The  
farm sector (8% of GDP in volume in 2017) largely contributed to  
the overall decline (-2.8% over 12 months) due to a very poor Q2  
performance, which more or less levelled off in Q3. In contrast, in  
other economic sectors (construction, industry and services), the  
economy continued to contract, although at a slower pace than in  
Q2.  
3
According to the IMF, the elasticity of the current account with respect to the  
real exchange rate is only -0.06 compared with -0.23 for China (which is  
assessed as small). The very low elasticity reflects the large weight of primary  
products in total exports.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
Ce site présente leurs analyses.
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