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New Year Brings Favorable Wind to Argentina as Peso Rallies, Country Risk Goes Down

For the first time in a year and a half, the BCRA bought dollars yesterday.

By | [email protected] | January 11, 2019 8:19pm

A man walks past Argentina's Central Bank in Buenos AiresA man walks past Argentina's Central Bank in Buenos Aires' financial district. May 11, 2018. (REUTERS/Martín Acosta)

It looks like international investors included the need to be more optimistic about emerging markets in their new year’s resolutions. Ever since the Earth began a new lap around the sun, the financial landscape has been extremely favorable for all emerging markets, and Argentina in particular.

Two key variables for the Argentine economy, the so-called country risk gauge and the peso-US dollar exchange rate, have been rallying during the past days.

Let’s take a look at what this means for the Argentine economy.

The peso appreciated to an extent that pierced the floor of the so-called “no intervention zone,” established in the reviewed stand-by agreement between the government and the IMF, for the first time on Thursday.

Let’s remember what this is about: this clause of the agreement established that the Central Bank (BCRA) would establish a “floor” and  “ceiling” to the levels of foreign exchange rate.

As long as it moved between those boundaries – which first increased by a three percent monthly rate and now by a two percent rate, in accordance with inflation expectations – the rate would float freely. If the peso depreciated and broke the ceiling, the BCRA would be able to auction a certain amount of US dollars – initially US $150 million a day, now US $50 – to keep it within the zone. On the contrary, if it pierced the floor, the entity would buy dollars from the market, also through an auction.

BCRA Governor Guido Sandleris

This scenario, unlikely for many since the policy was implemented, materialized yesterday for the first time, with the BCRA buying US $20 million. This allowed it to expand the monetary base and, at the same time, continue reducing the extremely high interest rates, which at this levels contribute to prolonging the recession by harming the private sector’s ability to take on financial credit.

However, the monetary base – the amount of pesos in the market, a factor that contributes to determining the inflation rate – cannot expand above a low established ceiling. This is also a result of the reviewed SBA, and determines that the BCRA cannot expand the monetary base by more than AR $27 billion per month – roughly US $730 million – to not lose control over this variable.

In sum, despite the favorable scenario, the BCRA is showing signals of continued caution, in order to minimize the possibility of a new financial crisis.

Moreover, the Treasury and Finance Ministry, led by Nicolás Dujovne, announced on Friday that, starting April, will auction in the market approximately US $10 billion, which needs to turn into pesos to face regular expenses, rather than selling them to the BCRA, like it did in the past.

This means that, if investors begin to buy dollars as a result of renewed uncertainty over the political and economic future of Argentina – naturally exacerbated by this year’s presidential elections – there will probably be enough foreign currency to satisfy this ensuing demand, and thus avoid a new run on the peso at a crucial time for the economy, and the government.

As for the “country risk,” after reaching a peak of almost 840 basis points in late December, the gauge, a variable that shows the level of perceived risk that Argentina will not be able to fulfill its financial obligations, decreased to almost 700 basis points. The figure is still extremely high and means that the spread between Argentine bonds and US Treasury bonds of comparable maturity is higher than seven percent (hence the 700 points), but the trend is decidedly favorable.

Federal Reserve Building, Washington DC, USA

According to Bloomberg, Argentine bond returns so far this year are 5.6 percent, when compared to last year, and comfortably beat their emerging counterparts, whose average is 1.4 percent.

Many analysts explained that a factor that influenced the good news was an announcement by the US Federal Reserve, whose leading officials indicated that they would be cautious regarding new increases in their interest rates, due to the need to learn more about the potential risks they entail for the American economy.

Since the risk-free US Treasury bonds are not shaping up to not be as enticing, investors shift to more risky (emerging) markets. And considering that the Argentine bonds are comparatively cheap, following the adverse end of 2018, they have become a palatable option.

Another factor is the trickle-down effect brought about by the newly-inaugurated Brazilian president, Jair Bolsonaro, as the projected economics of his orthodox economy minister, Paulo Guedes, are definitely favorable to the markets.

However, analysts also advised caution, pointing out that the structural reasons that caused the Argentine crisis in the first place are still very much present, and that a change of wind in the international landscape could very well wipe out the gained profit. In the meantime, however, those following the Argentine economy celebrate seeing green numbers on the screen after a decidedly long time.