The Argentine peso (ARS) depreciated by approximately 20% in two days at the end of August, despite an IMF loan of US$ 50 billion. Poor signaling by the government and doubts over whether the treasury could finance government operations in 2019 caused this second peso crisis of the year.
To calm these fears, the IMF and the Argentine government came to a new agreement on September 27, which included a larger line of credit and frontloaded loan disbursements. On top of this, the Central Bank of Argentina (BCRA) introduced an iron-fisted monetary policy and a new exchange rate regime.
The combination of these two market events seem to have worked for now. The peso appreciated 9.6% between September 28 and October 9. Now, multinationals and foreign investors alike must ask themselves whether this stability will last.
I recently spent time in Buenos Aires speaking with clients about our view on Argentina and what to expect in the short-term. Watch the video below for key takeaways from my trip or continue reading below.
Details of the new IMF deal and Central Bank policies
The new deal between Argentina and the IMF increased the overall line of credit from US$ 50 billion to US$ 57.1 billion. The agreement will also increase the amount accessible between now and the end of 2019 by an extra US$ 19 billion. This will help assuage investor fears that Argentina did not have enough funds to finance operations in 2019. Most importantly for multinationals, this significantly decreases the probability of default and another peso crisis until the end of 2019.
The IMF and the Central Bank of Argentina (BCRA) also agreed to allow a new exchange rate regime. The BCRA also unveiled new elements of its monetary policy:
- The BCRA now effectively uses a crawling band exchange rate regime: Even though the IMF and BCRA use the term “non-intervention zone”, this means that the BCRA will intervene in the exchange rate market if the value of the peso goes outside of the range ARS/US$ 34-44. The BCRA will raise this band by 3% monthly until the end of the year (e.g. November’s range would be ARS/US$ 35-45.3)
- Short-term ARS-denominated commercial paper – known as Lebac – will be phased out by December: The monthly auctions of Lebac were a major source of peso volatility. Portfolio investors can now only invest in treasury issued notes known as Letes, which have longer durations
- Zero growth in monetary aggregates until mid-2019:The BCRA will reduce the growth of money in circulation to zero until June 2019 which will greatly reduce inflationary pressures. However, this comes at the detriment of extremely low money supply which will negatively impact economic growth
The business implications from the IMF deal and new monetary policy are threefold:
- The volatility of the peso will become less extreme: MNCs should still expect a certain degree of peso volatility until the 2019 presidential elections, but not the kind of extreme peso depreciations that we saw this year
- Inflation will finally begin to decelerate: Once the pass-through effect from September’s peso depreciation to consumer prices has ended, inflation will finally begin to decelerate. FSG believes that the BCRA’s iron fisted monetary policy will result in significantly lower inflation by the end of 2019
- Customer demand will fall: A combination of asphyxiatingly high interest rates, contracting real wage growth, and low availability of credit will result in low customer demand across most industry verticals. FSG now expects an economic recession in 2018 and near-zero growth in 2019. This includes contractions in public and private consumption both this year and next
Actions to take
Multinationals operating in Argentina should consider the following actions:
- Companies should focus on protecting their margins: FX-related costs – such as translation and import costs – have increased significantly this year because of the peso’s depreciation
- Find resilient pockets of opportunity: Argentina’s economic recovery will vary significantly by province, industry, and consumer segment. In the meantime, MNCs should consider refocusing on provinces and industries which will benefit from a weaker Argentine peso.
For a more detailed analysis of FSG’s view on Argentina’s economic scenarios and business outlook, clients can schedule an analyst conversation via your Client Services Director.
Not a client? Please contact us to learn more.