The government will likely need to speed up the fiscal deficit adjustment.
The central bank announced new measures to stabilize the peso, including a 1500-bp rate hike in another inter-meeting decision. The policy rate (the 7-day Leliq, a bill issued by the monetary authority) is now at 60%. In the press statement announcing the decision, the central bank pledged not to cut the policy rate until at least December. In addition, the monetary authority ordered a 5% increase in reserve requirements, to 36%. The extra compulsory deposits can be met through allocations on Leliqs or 1-year Nobacs (central bank bonds paying a coupon), as the central bank seeks to improve the transmission of the reference rate hikes to the deposit rate paid by commercial banks.
Argentina had already been taking the proper medicines to deal with the deterioration of financial conditions for emerging markets: it reached an agreement with the IMF; government is slashing public expenditures; the central bank is tightening monetary policy amid a weakening currency.
However, the government is having to intensify the medication. In this context, President Macri announced yesterday that he asked the IMF to frontload the disbursements of the USD 50 billion credit line, ensuring financing availability for 2019 (a year with potential turmoil given the presidential elections), which we read as positive given market participants were questioning from where funding would come from next year.
In fact, the key concern in Argentina is government financial needs and the current account deficit is only the side effect of the fiscal imbalance. The currency depreciated by more than 13% today, in spite of the rate hike, following an 8% depreciation yesterday. The new level of the real exchange rate is likely enough to bring the current account deficit to no more than 1.2% of GDP next year (which is the average of the past 10 years, when Argentina was frequently out of access to international financial and capital markets), from 4.8% in 2017. But the fact that approximately 90% of the net public debt is dollarized, when the market is concerned with debt service, means that the weaker currency doesn’t help much to improve the chances of market stabilization. In fact, at current real exchange rate levels, the net public debt will likely end this year at 55% of GDP, from 31.8% of GDP by the end of 2017.
In this context, the government will likely need to speed up the fiscal deficit adjustment, potentially bringing the primary balance to zero before 2020 (which is the current agreement with the IMF). Yet the strategy is not free of risks, given the negative interaction between adjustments and government’s popularity, in an election year. Although Cristina Kirchner’s image could be weakening amid recent investigations, she could capitalize with the deepening of the economic crisis, a possibility that contributes to leave investors away from Argentina, in spite of more attractive asset prices and the guarantees provided by the IMF package. The still turbulent external environment (including the political uncertainty in Brazil) is also a key obstacle for stabilization.