Peso recovery brings new problems for Argentina
Many have applauded the return of stability to Argentina’s peso, which was one of the world’s worst-performing currencies in 2018. But being one of the best performing currencies this year brings a whole new set of problems.
The central bank is striving to maintain currency stability while fighting record levels of inflation, which reached nearly 48 per cent last year, without also prolonging a recession that could endanger President Mauricio Macri’s chances of re-election in October.
“You can’t have rates at this level [around 57 per cent] — the economy is really suffering,” says Diego Ferro, portfolio manager at Greylock Capital. He notes that the central bank’s ultra-tight monetary policy is part of an austerity plan backed by the International Monetary Fund in return for a record-breaking $56bn bailout loan.
But Mr Ferro says the crisis of confidence triggered by the failure last year of the government’s “ gradualist” economic policy, leading to a 50 per cent devaluation of the peso, prevents interest rates from being lowered too quickly.
“They now have a serious credibility problem, so they have to overdo it [by keeping rates high],” he adds.
Since the implementation of the revamped IMF-backed plan nearly four months ago, the peso has appreciated about 10 per cent. This year it has repeatedly traded beyond the threshold of a so-called “no intervention zone”, prompting the central bank to buy dollars rather than sell them, as it did spasmodically during the currency rout in 2018.
That has led to speculation that the central bank could decide to boost its capacity to intervene in foreign exchange markets at its next monetary policy meeting at the end of January. The bank is currently limited to buying just $50m a day when the peso appreciates beyond a set range.
Guido Sandleris, the central bank governor, said at the World Economic Forum in Davos this week that the “guiding principle” when taking the decision is “to be very cautious”, warning against pumping too many pesos back into the economy if demand is weak.
Mauro Roca, managing director for emerging markets at TCW, a US asset manager, argues that caution must also be applied to interest-rate cuts, since the currency stability that has been achieved with high rates is a prerequisite for lowering inflation. Mr Sandleris said in Davos that quashing inflation was the central bank’s “biggest challenge”.
In the run-up to elections in Argentina, many investors tend to move to dollar-denominated assets to mitigate the risk of a “bad” outcome — in this case, the possibility that the former populist president Cristina Fernández de Kirchner could win. That could mean a renegotiation of the IMF deal; at worst, some fear another debt default.
This shift into dollars ahead of the elections could unleash renewed volatility in the peso, which Mr Roca sees as the main risk for the economy and therefore Mr Macri’s chances of re-election. Another risk: headwinds of the kind that Argentina suffered last year, when a strong dollar and US-China trade tensions undermined stability in the peso.
So far this year, Argentine bonds have rallied, benefiting from a broader bounce in riskier assets. Interest-rate spreads over US Treasury bills have narrowed by about 150 basis points as fears over the US-China trade spat have subsided and the US Federal Reserve has sounded less hawkish. But Argentine bond yields are still much higher than those of emerging market peers, such as Brazil or Mexico.
“It is unlikely that country risk will fall significantly until there is greater visibility over the result of the October elections,” says Matias Eliaschev, chief executive for Latin America, excluding Brazil and Mexico, at Lazard, the investment bank.
“When there is greater certainty or confidence that this government will be re-elected, only then will there be a price correction.”