What multinationals should monitor in the aftermath of Argentina’s peso crash

The Argentine peso (ARS) has depreciated by approximately 16% in the month of May, causing fears of a new financial crisis.

In order to contain the peso’s free fall the Central Bank of Argentina (CBRA) sold approximately 10% (US$ 5 billion) of the foreign exchange reserves and increased interest rates by 12.75 percentage points (to 40%) last week, and the Ministry of Finance revised their primary fiscal deficit target to 2.7% from 3.2% of GDP to assure investors that the government was serious about achieving fiscal equilibrium.

However, these measures failed to contain speculative attacks on the Argentine peso. As such, the Macri administration began negotiations with the International Monetary Fund (IMF) with the aim of ending the peso’s slide and avoiding an economic and financial meltdown. The IMF loan will probably be a “stand-by arrangement” (SBA) of US$ 30 billion for an interest rate of around 4%.

The peso finally began to stabilize on May 15 after the CBRA managed to roll-over all maturing ARS-denominated commercial paper (known as the Lebac) at a 40% interest rate.

What caused the crash of the Argentine peso?

  • General EM currency flight: The strengthening of the US dollar and raising US treasury bill yields made investors decide to reallocate their portfolios from riskier EM assets to less risky US denominated assets. Investors analyzed economic fundamentals in EM economies to decide which ones were more vulnerable to external shocks. This made investors particularly averse to ARS-denominated assets
  • Delayed peso depreciation (atraso cambiario): the ARS/US$ spot rate was stable during March and most of April despite a highly inflationary environment
  • The introduction of the capital gains tax: the implementation of the 5% tax on foreign holders of the Lebac generated a massive capital outflow since April 25
  • Loss of confidence after December 28 split inflationary target press conference: At that time, the Ministry of Finance unilaterally established 15% as their year-end inflation target compared with the Central Bank of Argentina’s own goal of 12%. This resulted in an increase in inflation expectations because the market doubted the CBRA’s independence from the government. Inflation expectations dampened further when the CBRA cut interest rates 150 basis points at the beginning of 2018 despite high monthly inflation data
  • Lower supply of hard currency from exporters due to the drought: Argentina experienced its worse drought in almost 50 years which resulted in a soybean harvest of 37.6 million tons (a 31.6% YOY decline). Soy exports are Argentina’s primary source of hard currency
  • Macroeconomic imbalances: Namely, twin deficits (fiscal and current account) and high inflation, which make Argentina more vulnerable than other emerging markets to external volatility, such as potentially faster monetary tightening in the US.
  • Argentina’s psychological attachment to the US dollar: Argentina’s default in 2001 caused Argentines to view the US dollar as the ultimate safe-haven asset. Any time the peso depreciates, Argentines act quickly to exchange their pesos for dollars. When Argentines do this en masse – which happened as a result of the initial peso depreciation two weeks ago – the peso depreciates even more

FSG believes that the peso’s slide will end – and reverse, slightly – because the government and the Central Bank of Argentina (CBRA) have independently acted in a way that suggests avoiding an economic crisis is their prerogative, even if that means sacrificing economic growth in 2018. Raising interest rates to 40% will increase demand for ARS-denominated assets soon enough. In addition, the government cutting public spending further shows that structural adjustment needs to accelerate, no matter the political cost. Going to the IMF to ensure financial stability only confirms this.

What signposts should MNCs monitor in the near term?

  • The conditions of the IMF loan deal: The IMF will likely stipulate some degree of further fiscal consolidation. However, the degree of these demands will dictate not only economic growth but also Macri’s political power. Extreme austerity measures would steer conditions to the downside given the negative historical connotations of IMF support. The IMF will likely disclose details of the agreement in the coming weeks. They have, however, indicated that the deal will be “tailored to Argentina.” This means that it is unlikely that the agreement will be as stringent as a traditional SBA
  • Approval ratings of all politicians: Currently, no opposition politician has an approval rating of more than 32% according to D’Alessio IROL and Berensztein. This shows that the opposition is still weak with no clear leader. A gradual uptick in the opposition leaders’ approval ratings would suggest that the opposition has stronger chances to win the presidency in 2019
  • FX/inflation data: MNCs will clearly need to monitor inflation numbers over the next two to three months, since it is extremely likely that the depreciation of the peso will have pass-through effects to consumer prices
  • Major votes in Congress: So far, Cambiemos has been able to count on pragmatic elements of the Peronist opposition to pass legislation. Multinationals should monitor how the opposition votes in future congressional sessions. If all elements of Peronism begin voting in one bloc, that would indicate a unified opposition leading up to the 2019 elections
  • Street protests: Intense street protests against the Macri administration could cause them to roll back on their economic policies (e.g. the IMF loan), losing investor confidence and pointing to a major setback in next year’s presidential elections

FSG will continue the monitor the evolution of these events in Argentina and will update clients accordingly. If you have any questions or if you would like FSG to debrief you or your team on our updated Argentina view, please contact your contact your Client Relationship Director.

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