As expected, the new Macri government in Argentina wasted no time in lifting the currency controls only a few days after its inauguration on December 10. Widely considered a necessary, but deeply risky measure to begin normalizing the economy, the move did not provoke alarm in markets and among consumers, and the subsequent fall of the peso value is under control.
MACRI’S ECONOMIC TEAM MAKES BOLD EARLY MOVES
1) The new administration eliminated or reduced export taxes on grains and oilseeds to facilitate the export of USD 6 billion worth of product in the next three weeks.
2) They were able to attract emergency dollars to strengthen the Central Bank reserves (repurchase agreement with foreign banks for at least USD 5 billion at an “elevated” interest rate of 7%; converting a part of the swap with China to dollars, and other foreign currencies to be attracted in the upcoming weeks in order to achieve a pool of USD 15 to 20 billion). The Interamerican Development Bank also offered a USD 5 billion credit. Whether the backup figures announced are accurate is subject to discussion, as the Government never confirmed exactly how much and how the loans are going to be repaid. But so far the effect on the economy is positive and the market believes the money is there.
3) Staying within the law and without violating any contracts, the government reached a solution for the problem of the future exchange contracts. They limited their losses originated by the exchange rate difference that the Central Bank must respond to with monetary emission.
4) Simultaneously, they increased the interest rate to make the domestic currency more attractive and to moderate exchange rate pressures associated with lifting the currency controls. Indeed, after lifting controls, the value of the peso is now 15% above the exchange rate in the informal market during the last days of the restrictions.
Perhaps the weakest link of the plan to lift currency controls is that there has not yet been an announcement for a concrete fiscal program to reduce the hefty fiscal deficit inherited from the previous government. There was only a promise from Finance Minister Alfonso Prat Gay that measures will be outlined in the coming weeks and the statement by the Minister of Energy that tariffs on electricity and natural gas will start to be adjusted (meaning: a decrease in subsidies) in the beginning in January
The one surprise is that the government has lifted the controls in a much less gradual manner than was expected. Specifically, they completely liberated the flows of capital and only applied a gradual approach to stocks (commercial debt of importers and different payment timelines for profit remittances, bonds, etc.)
With respect to the flows, the government returned to the same scheme that was in place at the end of 2011, prior to the start of the currency controls. There will only be one exchange rate (no longer a dollar exchange rate for tourism and a different one for saving). There will no longer be barriers to exports or on purchases of foreign goods (although some kind of import administration will remain in place via automatic and non-automatic licenses). Agents will be able to purchase dollars for savings freely (up to USD 2 Million per month) in banks and exchange entities without previous authorization from AFIP and agents will be able to remit dollars to foreign countries. Additionally, and very important, the government also announced the elimination of the 30% tax on capital entering the economy.
WHAT ARE THE RISKS OF AN ALMOST COMPLETE LIFTING OF CURRENCY CONTROLS?
The primary risk is a very steep rise of the exchange rate and the interest rates, with very negative consequences in terms of inflation, economic activity and employment.
For the moment, the government is counting on the risk being limited and the first few days suggest that this is the case. In contrast to what occurred in the past, in this case the devaluation will likely lead to a dollar exchange rate of between $14-16. In the past, when it was necessary to devalue because the Central Bank ran out of reserves, there was more uncertainty, which led to episodes of high volatility that spilled over to strong price accelerations and lower economic.
However, the government is aware of the risks, as several comments by Minister Prat Gay suggest. The market will give the government a “window of opportunity” (considering that their beginnings have been auspicious and the government has been fulfilling electoral promises). But the market will also measure and focus on what’s missing: a meaningful fiscal program, which will be a significant challenge for the new government.
The reduction of the deficit of public finances is key in lowering the inflation tax (monetary expansion) and to enable a prudent monetary policy directed toward lowering the inflation rate. In other words, it is necessary that the fiscal and monetary policy function as a nominal anchor in order to give consistency to the macroeconomic policy, now that the exchange rate will no longer play that role,.
An important component which the new government counts on to lessen the impact of the devaluation on prices and minimize the wealth-distribution struggle, is the January 2016 negotiation of a comprehensive economic-social agreement with unions and employers.
For the moment, the future looks promising. The principle suppliers (the agricultural sector), will be put into action with less taxes and a more competitive exchange rate. There are also important expectations for the influx of dollars from investment by foreign companies. In any case, the challenge will be large in a country where buying dollars has always been a national sport.
In conclusion, the currency controls are now a thing of the past. Amongst the options that were available, the government finally opted for the most risky. There is no turning back. The government played on the limit. If the wager goes well, it will be a success. For this to occur, it will be crucial to advance on the most difficult points: to organize the fiscal madness that the Kirchner’s government left behind and to reduce the tax burden.
WHAT ARE THE VARIABLES TO BE MONITORED IN THE SHORT TERM?
It will be necessary to follow closely:
- How many dollars the Central Bank sells daily and at what exchange rate they do so;
- How the grain and oilseeds exports evolve;
- The Central Bank interest rate;
- The monetary expansion at the end of the month of December;
- the impact of the new exchange rate on prices;
- If the fiscal announcements that are truly put into action (especially how the subsidy reduction scheme is implemented in January) ;
- The reaction of social and political stakeholders to new measures and corrections (for example, it is not easy to negotiate salaries in the context of price acceleration and a rising exchange rate).
With all of this in mind and despite the risks and challenges, most of economists continue optimistic. We believe that after a first semester of contraction in activity and consumption as a consequence of the corrections and higher inflation, there is a chance that the economy will begin to recuperate, driven in large part by investment and with decreasing inflation. The government hopes that negative impacts on consumption will largely be compensated by an improvement in investment and exports.
Additionally, large law firms and consultancies are already studying direct foreign investment projects. They expect those projects to kick off in the second half of 2016, while delayed infrastructure projects from companies in Argentina will start moving by March. In our point of view, the success of the first measures adopted by the government will anticipate the calendar. As such, 2016 will see a slight recovery of the economy and we can have a 2017 with a 5/6 percent growth rate.