Exchange rate remains stable despite monetary loosening

Exchange rate remains stable despite monetary loosening

On January 16th the Banco Central de la República Argentina (BCRA, the central bank) lowered the floor of the benchmark Leliq rate, from 52% to 50%. The policy rate has now been cut by a cumulative 1,300 basis points since December 10th 2019. However, this has not translated into significant peso weakening.

Such a rapid expansion of monetary policy—in conjunction with nominal exchange-rate stability—has been made possible by a confluence of factors. Firstly, real money supply had reached its lowest level in over a decade in the fourth quarter of 2019. Secondly, capital controls have served to artificially inflate the demand for pesos (by restricting access to foreign currency). Finally, there tends to be a seasonal increase in the demand for money in Argentina in the summer months (December-February), which allowed for the absorption of some of this increased liquidity.

As things stand, the peso remains significantly undervalued relative to its long-term average. Therefore, the black-market premium for US dollars (which stood at 26% on January 20th) largely reflects the pricing in of a 30% tax on purchases of dollars imposed by the government in late December 2019. However, with inflation showing strong inertia, monetary expansion will translate into further upward pressures on the blackmarket premium.

In the near term, we expect the monetary authorities to display a preference for continued nominal peso stability, as sharper currency movements would be damaging to an already uncertain economic situation. Indeed, exchange houses estimate that the BCRA sold reserves to support the currency in the week beginning January 13th for the first time since October 2019 (the BCRA stopped publishing data on its currency interventions since February 2019).

Assuming uncertainty around sovereign debt restructuring subsides by the second quarter of 2020, we expect the BCRA to allow renewed nominal currency depreciation. This will be necessary to support export competitiveness, as well as to ensure that a continually widening black-market premium does not complicate the disinflation process (with the unofficial exchange rate acting as a reference for inflation expectations).

Impact on the forecast Our forecasts are unchanged. We expect the authorities to allow for gradual peso depreciation in the medium term, which will also help to contain the black-market premium. However, expansionary monetary and fiscal policy will not be conducive to the objective of reining in inflation, and real peso appreciation, nonetheless, will take place over the 2020-24 forecast period.