Argentina’s lower rates helping central bank shore up balance sheet at savers’ expense – economist

SAO PAULO (ICIS)–Argentina’s latest cut to interest rates had more to do with shoring up the central bank’s balance sheet, possible thanks to currency controls implemented by the prior Administration, than the actual control of price rises, according to the director at Buenos Aires-based Fundacion Capital.

Carlos Perez said the so-called Cepo currency controls limiting the ability to buy or sell any foreign currency may be causing losses for savers getting returns on their deposits below the rate of inflation, but they are helping the central bank to kick off a much needed shoring up of its balance sheet.

Effectively, savers who have their pesos in the Argentinian banking system are paying with their losses certain stabilization for the central bank’s balance sheet. Stability is something the Banco Central de la Republica Argentina (BCRA) could do much with.

First introduced by Cristina Fernandez de Kirchner’s cabinet in 2011, the restrictions became informally known as Cepo cambiario (Spanish for ‘exchange clamp’). They were lifted by the center-right cabinet of Mauricio Macri in 2015 but implemented again by his successor Alberto Fernandez in 2020.

Argentina’s new President Javier Milei blasted the Cepo controls during the electoral campaign and has promised to lift them in due course but, for now, some old regime tools are coming in handy to shore up the new regime.

Last week, the BCRA lowered the main interest rate benchmark from 80% to 70%. One day after that, the country’s statistics body Indec said the annual rate of inflation had jumped to nearly 290% in March, although it noted a fourth consecutive slowdown in monthly price increases.

See bottom graphs for monthly and annual inflation rates.

Lowering rates amid rocketing inflation: just the opposite of what is meant to be done, as the global inflation crisis has just showed us.

MAKING SENSE OF IRRATIONAL
So, while trying to get Argentina back into the realm of “normal economic policy”, according to Perez, some irrational measures are still being used.

But, at least, the central bank is quickly consolidating its position and starting to resemble a normal central bank, the economist went on, and not just the printer of money, or lender of last resort, it had become under the prior Administration, who used it to finance its recurrent spending, fueling inflation along the way.

Milei’s two more controversial proposals – dismantle the central bank and dollarize the economy – are now forgotten: Argentina was far from having the necessary dollars to dollarize, and the central bank, like in any economy, has in these four months proved a useful tool to start stabilizing runaway inflation.

Perez said the current interest rates – nominally, monthly at around 5% – are well detached from the monthly rate of inflation, now at around 11%. Effectively, savers’ deposits are losing 6% of their value. But this sacrifice, added the economist, had to be seen considering the wider stabilization of the system.

“In Argentina right now we have economic variables which are running at speed, like inflation; others which are walking, such as the interest rates; and others which are crawling, such as the peso’s official exchange rate,” said Perez.

“In this situation, Cepo controls take center stage. By law, most deposit holders have almost no way to dollarize their savings, for instance. Their money is imprisoned, so to speak. Thus, the central bank is effectively cleaning up its balance sheet by liquidizing little by little the liabilities it holds.”

Financial institutions and banks will place their deposit holders’ savings within the central bank, like in any other economy; the Argentinian specific feature lies in that the bank itself is charging savers by keeping their returns well below inflation.

Milei has hinted at lifting the Cepo controls by mid-2024 – but it remains to be seen whether more sacrifices from suffering savers will be required.

It is worth noting that a lot of Argentinian money left Argentina years ago. Some estimates say Argentinians hold around $250 billion in assets abroad.

“Therefore, the logic behind a real negative interest rates can only be found in the Cepo system. If the economy was free of those restrictions, we would be probably facing a massive capital flight, now contained by the law,” said Perez.

“Will the government lift the Cepo system? It will be facing a dilemma. While Cepo is in place, a progressive clean-up of the central bank’s balance sheet can take place. Without restrictions, returns on deposits will have to match or surpass the inflation rate, if a large-scale capital flight is to be avoided.”

INFLATION DOWN
So, asking savers to make sacrifices is one leg of the plan to stabilize the central bank’s balance sheet and, with it, the economy.

To stabilize runaway inflation, a second leg has been stopping all issuance of bonds by the central bank to finance recurrent public spending, a vice the prior Administration became too addicted to.

Printing money became virtually the sole financing method for the Administration as finding investors abroad willing to buy Argentinian debt became a rarity and the IMF’s bailout would only partly cover the spending needed in what was at the time one of the most subsidized economies.

A third leg has come from the fiscal adjustment implemented by the government. Milei’s “chainsaw” which propelled him to fame when he was just a libertarian, media-prone economist, has started making its early rounds: subsidies have been severely curtailed and recurrent spending is on the cards with a plan to implement large-scale redundancies among civil servants.

ECONOMIC RULEBOOK, AT LAST
The recession is hitting hard the real economy, said Perez, but voters who overwhelmingly backed Milei seem, at least for the moment, be putting up with the pain. This time, Argentinian world-famous, violent-at-times, media-grabbing street protests have so far been absent.

Global investors and the IMF alike also like the tune of what is being done.

But no-one hides that the recession is hitting consumers hard, and poverty levels have jumped over 50%, according to official figures.

With the hit to consumers’ purchasing power comes the hit to the petrochemicals-intensive manufacturing sectors, which official figures confirm are registering hefty falls in output.

Petrochemicals sources in Argentina have said to ICIS this week they are registering falls in demand between 30% and 50%; for now, stocks are still catering for depressed demand.

Perez, ordinary voters struggling to make ends, and global investors alike are for now giving a vote of confidence to a cabinet which is playing by the book set out in the electoral campaign. Milei never shied away from the fact it had to be a “brutal” adjustment if past errors were to be mended.

Perez said that, at least, the measures being implemented are all within the realm of ordinary economic policy, a terrain Argentina had left years ago, he added.

“The first four months have been quite positive. From one day to the other, Argentina went from an irrational economic policy to a reasonable one,” he said.

“The fiscal adjustment has been severe, relative prices are starting to adjust positively, the central bank is shoring up its reserves – albeit they are still in the red; the relationship with the IMF is good; and the cabinet is working hard to shore up its economic policy with political support in Parliament, where Milei’s party is in a minority.”

Argentina’s fertilizers- and export-intensive agricultural sector should also register a positive harvest in the second quarter, which will continue propping up much-needed dollars reserves within the central bank.

“Right now, the positive financial feelings contrast with how hard the recession is hitting the real economy. At Fundacion Capital we expect GDP to contract by around 6% in Q1, year on year. In Q2, output will also fall, but the hit will be lessened by agriculture,” said Perez.

“The first half of 2024 will be very hard for ordinary Argentinians. And let’s not forget, the challenges for the government remain daunting: the fiscal adjustment still lacks sustainability, i.e. political support. And despite the improvements, the central bank’s reserves are still negative: a genuine, sustainable flow of dollars into Argentina is yet to take place.”

ARGENTINA MONTHLY INFLATION RATE
In % change

Source: Indec

ARGENTINA ANNUAL INFLATION RATE
In % change

Source: Indec

Front page picture source: Shutterstock

Interview article by Jonathan Lopez