Flash Report /

Argentina: Credibility hit for policy (and the IMF)

  • Argentina’s central bank announced earlier this week further changes to its FX regime.

  • The central bank has effectively abandoned its non-intervention zone.

  • This replaces a carefully constructed rules-based FX intervention policy with a largely discretionary one.

Argentina: Credibility hit for policy (and the IMF)
Stuart Culverhouse
Stuart Culverhouse

Head of Sovereign & Fixed Income Research

Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
30 April 2019
Published by

Another day, another change to FX policy. Argentina’s central bank announced yesterday further changes to its FX regime, the third set of changes to the currency regime since February on our count (and excluding other policy changes to the monetary base target and interest rates). 

In short, the central bank has effectively abandoned its non-intervention zone (NIZ), the cornerpiece of its FX policy since October, and is pretty free to intervene as it likes to stabilise the peso (within reason), replacing what it had set out as a carefully constructed rules-based FX intervention policy with a largely discretionary one. 

Here, we set out some thoughts on what this means for the macro situation and our views on top-down equity strategy.

What has the central bank announced? 

The central bank will now: 

  1. Intervene (sell US dollars) even if the peso is below the ARS/US$51.4 ceiling of the NIZ – that is, the central bank can intervene in the area in which intervention was previously not allowed; and 
  2. Intervene (sell US dollars) on a bigger scale if the peso is above the ARS/US$51.4 ceiling of the NIZ, increasing daily dollar sales to US$250mn from the previous limit of US$150mn, and can intervene by more if it deems it necessary – that is, the central bank can essentially spend as much as it likes (within reason) if the peso falls outside the upper band.

At the lower end of the NIZ, the central bank confirmed its previous position that it will not buy foreign currency until June 2019 if the peso strengthens below US$39.8 (although that is academic at the moment, given the peso’s performance). 

Chart: ARS/US$ exchange rate

Source: Tellimer Research, Bloomberg

Macro context

The market seemed to welcome the latest initiative. The measures allowed the authorities to stabilise the peso yesterday, although we do not yet have the central bank’s intervention data on how much it spent to do so. Presumably, the central bank’s objective is to manage the currency for as long as it can (or is deemed necessary) through the pre-election period, to reduce currency volatility, limit the inflation pass-through, anchor expectations and minimise the cost to growth of what otherwise might require even tighter monetary policy (higher interest rates), but at the expense of lower reserves. 

Given the main driver of the currency is politics (amid market concerns over a policy shift if Cristina Fernandez de Kirchner [CFK] is elected), we presume it might have to continue to manage the peso this way until the October elections (or June, if CFK announces she is not standing, or August, depending in the outcome of the primaries) – see our Trip Report following the IMF Spring Meetings published on 26 April for background.  

However, the central bank’s new intervention approach will only be effective for as long as it has the resources to undertake the necessary intervention. With gross reserves of US$72.1bn (as of 25 April), the central bank would appear to have enough ammunition to keep the peso stable for a while. Assuming it spent US$100mn a day until the elections in October (26 weeks away), that is cUS$13bn in FX sales. And the IMF should have two more disbursements of US$5.4bn each before the election, to offset this draw down. 

However, that is gross reserves, and the true amount of ammunition is much lower and is given by non-borrowed net international reserves (NIR) – that is, gross official reserves minus gross official liabilities (which includes IMF money and other FX borrowings, as per the IMF programme’s technical memorandum). NIR in September 2018 were only US$15.7bn and the target in the IMF programme for end-19 is US$19.2bn (against gross reserves projected at US$62.2bn) – ie the implied amount of gross official liabilities is cUS$40bn (which, not coincidentally, is largely the sum of IMF disbursements by then; although we have not accounted here for how much IMF money goes to reserves and how much for budget support). We would expect, however, the IMF to recalibrate the NIR floor if necessary in the next couple of reviews (before the election). 

If the election outcome is one that ensures policy continuity (and ongoing IMF compliance), then confidence could return quickly, and the peso could be allowed to move more freely over time (as FX reserves are replenished). As such, the new FX measures essentially seek to buy six months of stability, after which things can then return to “normal”. 

However, if the election produces on outcome that fails to provide continuity, all that managing the peso does now is build up problems for the future, leaving the country with less reserves, with an overvalued exchange rate and, potentially, more likely to default – this might be a useful discipline device for any new president, but it could also make policy choices (and IMF engagement) even harder. 

Thus, in many ways, we think the most potent monetary policy lever would be persuading CFK not to stand! Inevitably, she and her political strategists are more likely to see the current currency crisis as a failure of Macri's economic policies and a siren call for her to take over, rather than a response to the perceived threat she poses to macroeconomic discipline.

Besides the technical issues, the other issue here for us concerns policy credibility. This is in two regards. First, the central bank is firefighting, and with so many and frequent policy changes – which, frankly, are hard to keep up with – risks damaging credibility even more. FX and monetary policy are hardly providing a predictable backdrop to entice foreign investors and may even be contributing to currency volatility. Second, IMF credibility risks being pulled down by Argentina too. The IMF came out in support of the new changes (see its statement here). But if this new policy is now “well calibrated to the challenges facing Argentina”, what were previous policies? 

The top-down risks facing Argentina equities are serious, but well understood

The risks are as follows: 

  1. The election may derail fiscal austerity policies and the IMF loan; 
  2. Popular opposition may, in any event, inhibit the implementation of austerity measures (protests, wage demands, strikes); and
  3. US$ and US rates outlook may deteriorate (which, in turn, exacerbates the FX rate devaluation, FX reserves erosion, imported inflation and the challenge to refinance external debt). 

The performance and valuation of the equities suggest these risks are well understood. 

  1. Argentina equities, measured by MSCI Argentina, are down 12% in total US$ return terms YTD, underperforming MSCI FM (up 6%), LatAm (up 9%) and EM (up 13%). 
  2. They are valued on trailing PB of 1.4x (trailing ROE of 26%), which represents a discount of 25% to the five-year median. 
  3. If this PB multiple is “inflated” by 35% (which is the FX rate devaluation implied by the difference between the spot FX rate and the 12-month non-deliverable forward), then the resulting 1.9x is approximately equal to the five-year median. 

We do not dispute the severity of the top-down risks at play. But we reiterate our list of conditions under which Argentina equities nevertheless perform well for a frontier and small emerging portfolio this year:

  1. US yields and US$ (ie broad risk appetite) remain benign; 
  2. Austerity and pro-market policies persist after the election (in turn, this requires the Peronist vote bank to splinter, which is likely either if CFK contests the presidential election without the support of the moderate Peronists, most of whom supported the post-IMF deal austerity policies, or if she does not contest at all); 
  3. IMF acts as if its own credibility is at stake in Argentina, given the unprecedented scale and speed of its assistance, and remains supportive of policy actions by the Macri-led government;
  4. MSCI EM index upgrade-driven index inflows occur;
  5. Soybean harvest is much better than last year;
  6. Brazil (largest trading partner) growth accelerates (albeit not as fast as some may have forecast prior to the strains within the Bolsanaro government becoming apparent);
  7. Banks' non-performing loans remain manageable; and
  8. LatAm equity assets under management remain at least stable and alternative destination markets (eg Mexico) have their own material top-down risks.

This is a long and uncomfortable list of conditions. But we also believe that the ADR nature of the largest Argentina stocks means that the hurdle for investment is far lower than for other distressed investment cases in further-flung parts of the FM and small EM universe (eg Nigeria, Oman, Pakistan, Sri Lanka). A small change in global risk appetite can trigger a large swing in the LatAm portion of mainstream EM equity funds back to Argentina.