Emerging markets currency crisis: how contagious is the situation in Argentina?

Emerging markets currency crisis: how contagious is the situation in Argentina?

For an Argentine, turning to the International Monetary Fund (IMF) in a moment of crisis is unthinkable. When the lender of last resort refused to release a $1.3bn (£1bn) tranche of its loan to Argentina in late 2001, the country was brought to its knees.

The government’s policy of Corralito – which stopped Argentines withdrawing from their bank accounts – led to uproar. Argentines took to the streets banging pots and pans, cities were paralysed by a general strike, neighbourhoods were overrun by looting, dozens were killed and two presidents resigned in nine days.

Mauricio Macri, Argentina’s current, more market-friendly president, was tasked with bringing an end to what has been described as the largest populist experiment in the world. But, knowing the severe political cost, Macri retreated back to the feared IMF in June to secure a $50bn loan.

Thousands marched and posters and graffiti urging “Fuera el FMI” –get out IMF –adorned Buenos Aires’s European-style facades. The peso plunged to a record low last week when Macri took to You-Tube to ask for IMF payments to be brought forward. His reach for relief triggered a crisis of confidence in a country already lumbered with a chequered credit history.

After hiking interest rates to an eye-watering 60pc, ramping up export taxes to raise revenue, pledging to balance the books, and scrapping entire government ministries, Macri is running out of policy levers to pull.

“They have tightened fiscal policy probably to the best of their ability. They’ve hiked interest rates probably as high as they can go. Now it’s in the hands of the IMF,” warns Gustavo Rangel, the chief economist for Latin America at ING. More draconian measures, such as capital controls, are possible if Macri’s rescue package fails, he adds. Currencies and stocks in developing economies have tanked in recent weeks on fears that the dual effect of higher borrowing costs at the US Federal Reserve and the resurgent dollar will expose cracks in countries with a large pile of --dollar-denominated debt, such as Argentina. The current emerging-markets sell-off is now the longest since the financial crisis, overtaking the Fed “taper tantrum” in 2013 and the Chinese yuan devaluation shock two years later. This year’s slump is starting to look less like a reactionary wobble and more like a full-blown retreat of capital.

The dollar’s stranglehold on emerging markets has grown tighter in 2018. Growth in some emerging-market economies has been fuelled by dollar debt. It allows countries to access a greater pool of investors compared with issuing debt in the local currency. But it comes at a cost.

Emerging markets are held to ransom by the whims of the US president and the Fed. Every rate rise, healthy economic indicator and explosive tweet in the States can inflict pain on developing economies.

“Turkey and Argentina are not the cause of this stress but the symptom,” explains Paul Greer, portfolio manager at Fidelity Emerging Markets Debt Fund. The US central bank is expected to lift borrowing costs twice more in 2018 to stop the buoyant American economy from overheating. Every rate rise makes servicing that pile of debt in Argentina more expensive.

“If we had a global environment that was very pro-risk, emerging markets were doing well, and there was ample global liquidity, then investors may be able to forgive Argentina and allow it time to make the required fiscal adjustment,” says Jon Harrison, managing director, macro strategy, at TS Lombard. “That was the case over the past few years but this year that has changed.

”The collapse of the Turkish lira still threatens to develop into a full-blown crisis, while the South African rand’s downward spiral accelerated this week when markets were shocked by its economy slipping into a recession. Argentina’s crisis of confidence is unique, however. Its economy is geared towards riding high in boom years but buckling in turmoil. Mending the roof while the sun shines rarely wins votes in a country steeped in populist tendencies. Dr Néstor Castañeda, a Latin American specialist at University College London, explains that its “government increases public spending in good times and does not build surpluses for the bad times”.

This makes its economy “vulnerable to external shocks” and constrains its “capacity to navigate monetary crises”. Argentina’s long history of economic woe has fostered a culture of distrust in the local currency among investors. Under Macri’s predecessor, Cristina Fernández de Kirchner, investor trust faded after her Peronismo administration cooked the books, claiming inflation was much lower than it was.

Capital Economics predicts the turmoil will lead to a 4c contraction this year and a 2pc slump in growth in 2019. A debt default is a “real possibility” if the currency plunges further, bond yields rise, or Macri’s government strays from its fiscal plan. “Everyone should be concerned about the social impact of these measures and to what extent that may affect Macri’s governability,” argues Rangel. “The risk of social unrest has been rising.”

Populist pressures ahead of elections in October 2019 could force Macri to cede ground and threaten his pro-reform agenda, rattling markets once again. Greer said: “Investors had a very awkward relationship with the Kirchner dynasty. If Macri is kicked out, the return of Peronismo is going to potentially create big issues with the IMF.”

Troubles in Argentina’s relatively small economy could pale in significance if elections in Brazil trigger a markets wobble next door. Investment bank UBS found Brazil is considered most at risk of contagion from Argentina as it nears a crunch vote next month. Brazil also holds the highest exposure to Argentina in terms of exports. Just over 8pc of Brazil’s exports make the journey west over the 761-mile border to its third-largest overseas market afterthe US and China. Harrison warns the likelihood of a market-friendly outcome in the first round of voting in Brazil’s election is receding. Opinion polls have raised the possibility of far-Right and far-Left candidates reaching the second-round run-off. Brazilians have shunned the established elite in the wake of the huge corruption scandal that has engulfed the country in recent years. The stabbing of Jair Bolsonaro –the far-Right front-runner who has made anti-gay and racist comments and been labelled the Tropical Trump –at a rally on Thursday highlights how the political discourse has deteriorated. Harrison says: “Brazil is an important market for emerging market investors. If crisis conditions do indeed develop, there will be significant contagion to wider emerging markets.”

An economic crisis in Argentina is all too familiar for investors but the capitulation of Brazil’s $2 trillion economy would be something else entirely.

www.prensa.cancilleria.gob.ar es un sitio web oficial del Gobierno Argentino