Why currency markets are so worried about Argentina
Robin Wigglesworth and Colby Smith in New York and Benedict Mander in Buenos Aires
The Argentine peso crashed to a new record low on Thursday despite the central bank in Buenos Aires ramping up interest rates to a world-topping 60 per cent.
The crisis has thrown Argentina’s reforming government into turmoil, unnerved investors and cast doubts over the International Monetary Fund’s record-breaking $50bn bailout.
What are investors most worried about?
The biggest worry is if Argentina can meet its financing needs in the coming years, while navigating a looming recession and runaway inflation ahead of a presidential election next year.
Oxford Economics estimates the overall funding needs for the rest of 2018 and 2019 at $77bn — a challenging number even with a more favourable backdrop.
Because almost 80 per cent of Argentina’s total sovereign debt is dollar-denominated, when the peso weakens it makes dollar-debt repayment far more difficult.
The peso’s double-digit plunge on Thursday, which built off Wednesday’s 7 per cent drop, significantly increased the size of Argentina’s debt burden.
At current levels, government debt could reach 90 per cent of gross domestic product this year.
As a result the cost of insuring against an Argentine debt default shot up sharply, and now indicates that investors consider the country the second-riskiest sovereign borrower in the world after Venezuela — which has already defaulted.
Will interest rates at 60 per cent be enough to stop the peso from sliding further?
The peso still tumbled on Thursday despite the central bank rate increase, but tighter monetary policy will certainly help support the Argentine currency.
Keeping rates this high until December at the earliest, as the central bank said it would do, indicates its commitment to shoring up the peso.
Investors worry that while the central bank has done its part, halting the peso’s slide depends on the government explaining in more detail how it will reduce the fiscal deficit and meet the IMF’s target of 1.3 per cent of GDP by 2019.
So far, the government has indicated it will slash energy subsidies and reduce wages for public sector workers among other measures, but it is uncertain how drastically Buenos Aires will cut spending and navigate the political pushback that such moves are all but guaranteed to spark.
What do Argentines feel about this?
Ever since the peso rout began in late May, Argentines have been increasingly on edge — and now more than ever. As a country that traditionally saves in dollars, thanks to a long history of economic instability, the value of the US currency is perhaps the single most important economic variable for most Argentines. Indeed, it is a useful proxy for the level of confidence in Argentina’s government and the economy in general.
So the peso’s dreadful performance this week would suggest that there is little optimism about the IMF-backed aid package, especially given dark memories of the last time the much-maligned institution was involved in Argentina. That ended with the country’s economic collapse of 2001.
Battle lines are now being drawn between government loyalists and their opponents, with the former backing campaigns on Twitter in support of President Mauricio Macri, while the latter are seizing the opportunity to attack the government’s much-questioned handling of the crisis.
What does this mean for Mr Macri’s re-election prospects?
A year is a long time in politics — especially in Argentina. With the presidential election not due until October 27 next year, few dare to make any predictions before various matters have been cleared up. Most importantly, whether former president Cristina Fernández de Kirchner — who pollsters assume Mr Macri would easily beat — will throw her hat into the ring, with a recent corruption scandal possibly hitting her chances of running.
Nevertheless, it is clear that the latest bout of exchange rate volatility is bad news for the economy’s chances of exiting a recession in good time before the election, and also the authorities’ attempts to bring stubbornly high inflation under control. No incumbent seeking to remain in power wants to enter an election campaign during a period of stagflation.
What will the IMF demand in return for an acceleration of its disbursement programme?
Christine Lagarde, the IMF’s managing director, said on Wednesday that the fund’s staff was working with the government to “revise” its economic plan through “stronger monetary and fiscal policies and a deepening of efforts to support the most vulnerable in society”. However, what this means in practice is ambiguous.
On one hand, the mention of stronger monetary and fiscal policies indicates the IMF wants to see higher interest rates to tame inflation and more aggressive government budget cuts to restore confidence in the government’s finances and trim its borrowing needs — fairly orthodox IMF prescriptions.
Economy minister Nicolás Dujovne on Wednesday said the government “ceiling” for this year’s budget deficit was 1.3 per cent of GDP, but some analysts say the IMF might require a bigger effort to eliminate the deficit quicker than planned.
However, the IMF has under Ms Lagarde sought to soften its image as a remorseless implementer of austerity, and the nod to “efforts to support the most vulnerable in society” underscores how the organisation is desperate to ensure that its programme does not wreck political support for Mr Macri’s government by hurting poorer Argentines. So although the fund is likely to require some more budgetary rectitude, it is unlikely to demand immediate, draconian spending cuts.
Will what happens in Argentina stay in Argentina?
Although Argentina fell into an IMF programme earlier this year, its woes were more recently exacerbated by the turbulence caused by Turkey’s financial crisis.
The Turkish lira collapse rippled through emerging markets earlier this month, and renewed pressure on Argentina. The lira and the peso are almost daily swapping positions as the worst-performing major currency in the world this year (Argentina once again pipped Turkey on Thursday).
While Turkey and Argentina may well be the most vulnerable countries, they are not the only ones that could be hurt by the tectonic shift in global monetary policy.
The Federal Reserve plans to raise rates two more times this year and continue to trim its balance sheet, while the European Central Bank will end its quantitative easing programme by the end of 2018.
The woes of Turkey and Argentina could indicate that the process of weaning the global economy off the post-crisis monetary tonic will be more challenging than many expected.