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Latin American Economy & Business - January 2014 (ISSN 1741-7430)

ARGENTINA: On the road to ruin – or stumbling to the finish line in 2015

UPDATE [24 January 2014]: Argentina – a tense weekend ahead

The recent fall in foreign exchange reserves, and the rise in the black market ‘Dólar Blue’ exchange rate, has prompted many commentators to suggest that Argentina is headed imminently towards an inevitable – and major – currency and monetary crisis. On 24 January the government announced that it would loosen some of its tight foreign exchange controls, a day after the peso suffered its steepest daily decline in 12 years to close the day at ARS8.4/US$ officially, and ARS13.1/US on the black market.

In a terse five-minute announcement, Cabinet Chief Jorge Capitanich said that as of Monday (27 January), the tax rate on dollar purchases would be reduced to 20% from the current 35%, while the purchase of dollars for savings accounts will also be permitted.

“This decision reflects the government's belief that in the context of a floating exchange rate, the price of the currency, i.e. the dollar, has reached an acceptable level for the objectives of economic policy", Capitanich stated. This is in effect, an official devaluation, which in the medium term should boost exports and stem the drain on central bank reserves (now US$29bn). The question in the immediate term is whether the government led by President Cristina Fernández can retain some degree of control in coming days. The government will also quickly need to do something to anchor inflation expectations, somehow.

In our view, there are numerous policy options still available to the government to keep the situation under control.

In the event of a full-blown crisis in the coming week, the government will have to achieve three outcomes simultaneously. It will need to boost the foreign currency reserves at its disposal. It will need to stabilise the Dólar Blue rate. And it will need to engineer a profound change in sentiment of investors and other market protagonists as these situations inevitably turn on perceptions.

This could be difficult, but not impossible. We suggest that the government has the following options:

  • It could tap unorthodox sources (such as Chinese loans or the foreign currency assets of entities under its control).
  • The central bank could increase the Badlar rate (paid by banks on wholesale deposits in pesos) from the current level of around 20%. The Badlar rate has not provided wholesale depositors with a real return for a long time: if it were perceived to be doing so, the flow of money from dollars to pesos could be substantial.
  • The government could issue new tranches of US dollar certificates of deposit (Cedins) and economic development bonds (Bodes) on attractive terms, with the aim of attracting ‘blue’ dollars circulating within Argentina.
  • The government could intervene aggressively in the Dólar Blue market, in order to suppress the premium to the official rate (which, presumably, would continue to weaken as a result of the ‘sliding peg’ policy). This intervention would probably be accompanied by ferocious rhetoric from the President and her economy team: they would argue that the move was essential to counter currency speculators seeking to undermine the government and the economy. Anyone that had been foolish enough to borrow ‘blue’ dollars to speculate would be hurt badly.

We recognise that pursuing the third and fourth of these options (or both together) would result in a substantial dollarisation of the financial system. More crucially, it would likely produce a massive currency mismatch within Argentina’s banks. In the short term, US dollar deposits would be boosted enormously. However, loans and securities would be denominated mainly in pesos. The mismatch would greatly increase the risks within the system.

* For the next update on this topic see our LatinNews Daily Briefing on Monday 27 January.

Full original article:

The recent fall in foreign exchange reserves, and the rise in the black market ‘Dólar Blue’, exchange rate has prompted many commentators to suggest that Argentina is headed imminently towards an inevitable – and major – currency and monetary crisis. In our view, this is incorrect. A full blown crisis of that scale would require an exogenous shock. In the event of such a shock, be it the result of problems with the soybean harvest or something else, there are numerous policy options still available to the government led by President Cristina Fernández to bring the situation under control.

Various recent developments have highlighted the fragility - and long-term unsustainability - of the economic model that continues to be pursued by the Fernández administration (notwithstanding the recent and important changes to her economics team). The central bank’s foreign reserves hit US$29.8bn in mid-January, their lowest level since 2006, having slipped from US$30.7bn in early December 2013 and US$33.2bn in late October 2013. Thanks to the continued monetisation of the budget deficit, inflation is generally reckoned to be running at around 25%-30%.

Prompting particular commentary is the fairly sharp depreciation in the Dólar Blue rate in central Buenos Aires. As of 20 January, the rate stood at ARS11.95/US$. This compares with the official rate of ARS6.81/US$. Another widely followed unofficial exchange rate, the Dólar Bolsa, stands at ARS10.35/US$. The Dólar Bolsa is the rate at which institutional investors may gain access to foreign currency, by buying debt securities in pesos and then selling the securities for US dollars.

Overall, though, it is premature to suggest that a financial crisis is imminent. In terms of the numbers of pesos that may be bought with one US dollar, the Dólar Blue rate stands at a premium of about 75% to the official exchange rate. Although that is quite high by the standards of the second half of 2013, when the premium was typically in the 50%-65% range, it is less than the 100% premium reached when the Dólar Blue spiked to above 10 (the so-called 'Messi Rate', for the jersey worn by the Argentine football star) for the first time in May this year.

Moreover, as is indicated by the figures above, the rate at which foreign reserves have been falling appears to have slowed. Reports indicated that in early January, the Administración Nacional de la Seguridad Social (ANSES - the state pension fund agency) raised around US$2.3bn in US dollars by selling Argentine government treasury notes maturing in 2018. ANSES had purchased these securities from the government in 2011.

The unresolved disputes in US courts between the Argentine government, on one hand, and the 'vulture funds' that hold its debt on the other; mean that the government continues to be denied access to global capital markets. The government simply cannot raise money the orthodox way - through a large-scale issue of US dollar denominated bonds.

However, unorthodox sources remain available to the government. As we pointed out in Latin American Economy & Business (July 2013), two Chinese state-owned policy banks, China Development Bank (CDB) and China Ex-Im Bank, have been active lenders in Latin America over the last five years or so. Some funds have also been forthcoming from Industrial & Commercial Bank of China (ICBC - one of the four large state-owned commercial banks). Sometimes, the Chinese institutions lend at higher interest rates than those demanded by multilateral lenders such as the World Bank; on other occasions, at lower rates. On occasions, the Chinese banks advance the money on a loan-for-oil basis: the Latin American borrowers gain US dollar cash immediately, while Chinese parties have access to a reliable supply of oil over the medium term. If the borrower is not providing oil, it may be required to make commitments for the award of contracts to Chinese companies for infrastructure construction or supply of capital goods.

Data compiled by the Inter-American Development Bank (IDB) and the World Bank indicates that, from 2005 to 2011, Chinese institutions lent US$10.0bn to Argentina. Over the same period, the World Bank and the IDB advanced US$7.2bn and US$9.6bn respectively. Over the same period, the total amount lent by these three sources to Mexico was, at US$27.4bn, very similar to the US$26.8bn advanced to Argentina. However, the Chinese institutions only lent US$1.0bn to Mexico: the remainder came from the two multilateral lenders.

In March last year, we suggested that the government would likely face problems on at least one of two fronts. One was the possibility that Argentine households and businesses shun peso deposits in order to avoid the impact of structurally (very) high inflation. In this situation, the money would likely be spent on goods and services and/or invested in real assets within Argentina, given the capital controls that have been imposed by the government. Alternatively, we saw the possibility that rampant inflation (including demands by workers for wage increases) or a disruption to the flow of tax revenues from soybean farmers to the government, would result in a budgetary crisis.

Notwithstanding that the premium of the Dólar Blue rate to the official rate has surged in recent weeks, it appears that we were overly pessimistic. The government appears to be generating the revenues that it needs to maintain its regular operations (albeit critics accuse it of ‘robbing Peter to pay Paul’). There have not been the shortages of consumer goods or a bubble in real asset prices that would take place in the event that households and businesses refused to support the peso.

In short, the Argentine government has proven itself able to ‘muddle through’ a challenging financial and economic environment – much as it has for most of the time since the 2001-02 crisis. Since May 2013, foreign reserves have fallen dramatically, from around US$39bn. In the meantime though, the global economic environment has improved. It is not obvious that there have been any other fundamental changes. Argentina posted estimated real GDP growth of 4.5% year-on-year in 2013, on (December 2013) estimates by the UN’s Economic Commission for Latin America and the Caribbean, which however projects slower growth of about 2.6% in 2014.

Mainstream media reports indicate that Argentina is headed towards a bumper soybean crop this (southern) summer. This would boost foreign exchange earnings and the government’s tax revenues. We concede that any development over the next 13 weeks or so which results in a weaker-than-expected harvest (be it anti-government action by farmers and other workers, dislocation in global soybean markets, or weather-related problems), would likely have a sharply negative impact on investor sentiment and would substantially increase the challenges facing the government.

In the event of a true crisis in the coming weeks, the government would have to achieve three outcomes simultaneously. It would need to boost the foreign currency reserves at its disposal. It would need to stabilise the Dólar Blue rate. And it would need to engineer a profound change in sentiment of investors and other market protagonists.

This would be difficult, but not impossible. We suggest that the government has the following policy options to deal with a crisis, whatever the exogenous shock may be:

  • The government could tap unorthodox sources (such as Chinese loans or the foreign currency assets of entities under its control).
  • The central bank could increase the Badlar rate (paid by banks on wholesale deposits in pesos) from the current level of around 20%. The Badlar rate has not provided wholesale depositors with a real return for a long time: if it were perceived to be doing so, the flow of money from dollars to pesos could be substantial.
  • The government could issue new tranches of US dollar certificates of deposit (Cedins) and economic development bonds (Bodes) on attractive terms, with the aim of attracting ‘blue’ dollars circulating within Argentina.
  • The government could intervene aggressively in the Dólar Blue market, in order to suppress the premium to the official rate (which, presumably, would continue to weaken as a result of the ‘sliding peg’ policy). This intervention would probably be accompanied by ferocious rhetoric from the President and her economy team: they would argue that the move was essential to counter currency speculators seeking to undermine the government and the economy. Anyone that had been foolish enough to borrow ‘blue’ dollars to speculate would be hurt badly.

We recognise that pursuing the third and fourth of these options (or both together) would result in a substantial dollarisation of the financial system. More crucially, it would likely produce a massive currency mismatch within Argentina’s banks. In the short term, US dollar deposits would be boosted enormously. However, loans and securities would be denominated mainly in pesos. The mismatch would greatly increase the risks within the system.

Paris Club

As the government continues tightening currency controls, on 22 January Economy Minister Axel Kicillof said that Argentina was ‘optimistic’ about rescheduling its Paris Club foreign debt and was expecting an initial response from the creditors.

Argentina faces a potentially very serious dollar shortage in the last two years of President Fernández’s term (running to end-2015). A successful renegotiation of Paris Club debts, which have been in default since late 2001, might help ease some of that pressure. At issue is whether next year’s democratic transition will have to be carried out against the backdrop of a deepening financial crisis - or whether it will be a calmer affair.

The Paris Club groups creditor governments and multilateral financial institutions. Argentina stopped servicing its Paris Club debts at the end of 2001. By end-2012, outstanding debt stood at US$6.5bn, mostly owed to Germany and Japan. If overdue interest and penalties are included, the total could be US$9.5-US$10bn, on some estimates. Kicillof and Hernán Lorenzino (the former economy minister who now heads the government’s debt restructuring team) were in Paris in mid-January to meet Club officials and present their proposals. Details were scant, but the Argentine press speculated that Buenos Aires might be offering a down payment (perhaps US$2bn) and might accept the Club’s demand that it ‘normalise’ its relationship with the International Monetary Fund (IMF), which would mean allowing its economic policies to be reviewed through the mechanism known as Article IV consultations.

Speaking on his return to Buenos Aires, Kicillof said he was “optimistic” about the outcome, but warned that negotiations could take time and insisted that Argentina would not change its economic policies. “The worst agreement with a creditor is one that can’t be delivered” he noted. Separately, the former finance secretary Guillermo Nielsen, said that one point in favour of an agreement was that the Paris Club was being lobbied by big companies and capital equipment suppliers, “who don’t want the Argentine market to be left entirely to the Chinese, who continue lending to the country”.

  • The Damocles Sword

Of the many court cases involving Argentine foreign debt still working their way through the US legal system, two stand out. The ‘big’ case involves the demand by a group of ‘hold-out’ creditors, including many hedge funds, that demand that they be paid in full for money owed when Argentina defaulted on its foreign debt of around US$100bn in late 2001/early 2002. While about 93% of the country’s creditors by value accepted a write down of around 70% in rescheduling agreements reached in 2005 and 2010, the remaining 7% of hold-out creditors have been arguing that they have a right to payment in full. The reason this issue is being dealt with in the US legal system is that most of Argentina’s debt contracts were written under US law. The US courts have tended to agree with the holdouts. In October 2013, Judge Thomas Griesa of the New York-based 2nd Court of Appeals ruled that Argentina cannot service its restructured debt if it does not at the same time pay off US$1.33bn to the holdouts, something the Buenos Aires government has consistently refused to do. There is a stay on execution of this ruling to allow Argentina to appeal to the Supreme Court. While dates may change, Argentina is expected to submit its appeal by mid-February. There is no firm date for a final judgement. The outcome is critically important to the Argentine economy because if the ruling is upheld and Argentina still refuses to pay, a technical default will be triggered.

  • The Supreme Court separately has agreed to hear the ‘little case', but one which also has important repercussions. On 10 January, the court agreed to hear an appeal by Argentina against a lower court ruling allowing one of the holdouts, NML Capital (a unit of Elliott Management Corp), to subpoena records of Argentine assets from the US offices of Bank of America and Banco de La Nación. NML says it has obtained over US$1.6bn in legal judgements against Argentina, and has the right to subpoena the bank records to identify assets and locations where it may recover its debts. NML and other creditors have already taken some actions in this regard. They were behind the temporary seizure of ARA Libertad, the Argentine navy’s training ship, in Ghana in late 2012. “Federal law does not give Argentina the right to conceal its assets from its lawful creditors” an NML lawyer said. Argentina made no official comment, but has in the past said such a subpoena would violate its sovereign immunity. On this point, the US authorities seem to be inclined to support Argentina. US Solicitor General Donald Verrilli said that without condoning Argentina’s refusal to pay debts as ordered by US courts, the lower court ruling would impose “worrisome burdens on a foreign State”.
  • In another move to preserve scarce dollars, the Argentine tax collection agency (AFIP) has introduced new regulations forcing Argentines purchasing goods from international websites to make a sworn declaration and produce it at a customs office, where packages have to be collected. Items purchased from websites like Amazon and eBay are no longer delivered to home addresses. Argentines are allowed to buy up to US$25 worth of goods from abroad tax-free; above that level a 50% tax is levied. These new restrictions on online shopping come on top of a pre-existing 35% tax on credit card transactions outside the country.

End of preview - This article contains approximately 3014 words.

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