Markets on wait-and-see mode as key fiscal turning point nears

As of October 2017, according to market consensus, President Macri’s government had managed to improve the Argentine economy by applying a “gradualist” approach to curb the fiscal deficit and raise the possibility of balancing public finances with an inflow of external capital.

The scheme functioned like clockwork: Minister of Finance Luis Caputo successfully completed a series of international bond issues that secured the dollars required to ramp up the Central Bank’s reserves, as well as the pesos to cover the Treasury’s excess spending.

This was not the only result, however. The inflow of dollars to cover the fiscal deficit (the treasury managed to sell a total of $33.32 billion of bonds to foreign investors between June 2016 and June 2017), in combination with the measures adopted by provincial governments and the private sector, provided the currency stability that the economy needed. The price of the dollar remained under control, only breaking the ARS 18 mark just before the primary elections.  And even then, the forex market stayed on track.

The central bank, by contracting money supply, keeping interest rates high, and making sporadic interventions, managed to keep the dollar in check and offer the reassurance required to build confidence in the economy. The results of the primary elections provided a real measure of the government's chances of winning the October 22 legislative elections, helped boost confidence even further.

Central Bank Chairman Federico Sturzenegger played his hand well in this scenario. He bought dollars to shore up Argentina´s foreign reserves, which in August 2007 stood at $48.5 billion, after growing over 51% in a year.

From the outset, this effort by the central bank to buy dollars from the treasury was accompanied by printing of more money. Closing the loop, Sturzenegger decided to intensify the central bank’s policy of absorbing funds in the market, by offering high-yield central bank notes (later known as the “famous Lebacs”) that attracted a hefty share of the pesos that were available.

Key anti-inflation tripod

The following figures are clearly indicative of the central bank’s policy: the Lebac notes paid a 27% annual interest rate, compared to an annual inflation rate of 21-23%, while money supply (currency in circulation plus demand deposits) increased by only 3% between January and September.

For monetary authorities, this three-pronged policy was key to trigger the decline of the inflation rate. In third quarter 2017, with a monthly inflation rate of about 1.5%, the prospect of achieving a 1% rate by year-end seems more feasible.

Throughout 2017, the tight money policy coexisted with the increased lending activity. This resulted in part from the banks’ decisions, on the one hand, to not renew all the central bank notes and, on the other, reducing their surplus liquidity levels to increase their lending capacity.

The outcome was a leap in loan origination across the whole lending spectrum: personal, secured, etc. As a novelty, mortgage loans bounced back for the first time in years, thanks to the indexing clause, which came at a time when inflation is expected to continue declining.

In the weeks leading up to the October 22 elections, it looked like the planets had aligned to favor the government’s economic policy. Meanwhile, the background music kept playing: the steady inflow of funds that brought the dollars to guarantee the official “gradualist” approach to lower the fiscal deficit.

Up to that point, it seemed that this approach would not come at a cost. But recent foreign sector data seem to indicate that the “turning point” for key fiscal decisions may be drawing near.

Basic common sense dictates that nobody can go on living on credit forever and that, at some point, one has to start repaying debt.

In a presentation during the annual Convention of the Foundation for Latin American Economic Research, economist Ricardo Arrizu pointed out that the Argentine problem is not only the level of fiscal deficit, but that “this year (referring to 2017) we are going to end up with, at least, a $21 billion current account deficit.”

The positive impact of the inflow of dollars is just as evident as the negative impact when they depart.

Argentina faces yet another turning point in fiscal matters, something for which it has never been able to find lasting solutions. Everything suggests that in 2018, the country will have a new chance to ratify a short-term reactivation, or lay the foundation for more sustainable growth. Ladies and gentlemen, place your bets!