A battle won but not the war

Argentina never ceases to amaze the New England economist Dr Hale, who writes incredulously:

“Could peace be breaking out on your turbulent markets? All last week I was assuring people that the initials IMF now stand for “Is Macri Fried?’” and now suddenly I see his government start winning some battles although not yet the war. Just as soccer upsets are invariably followed by the question: “What went wrong with the team which looked so good?” in the after-the-match inquest, I would now ask: “What went right for the team which looked so bad?”

My reply:

“These crises of confidence are so often all about who blinks first and this week it was the turn of the markets. Instead of resisting the global trend to devaluation harder than anybody else and suffering it the most, the government retreated to its new Hindenburg (or Maginot?) line of a 25-peso dollar and 40 percent interest rates where it defended successfully. When the week began with the rampant dollar surging beyond 25.50 pesos, the Central Bank called the market’s bluff by offering US$5 billion (almost 10 percent of its remaining reserves) at 25 pesos and daring it to advance to this bridge too far — a challenge which ended up costing only US$408 million (a trifle by recent standards) of the exposed reserves. The IMF package of US$20-30 billion in the offing also beefed up Central Bank muscle against the markets. By midweek the dollar was below 24 pesos, halting the run on the currency.

“But the real battle loomed for Tuesday with 617 (originally 670) billion pesos worth of short-term Lebac Central Bank bonds up for renewal — equivalent to almost half of the foreign currency reserves potentially gravitating straight to the dollar. But last week the Central Bank had repurchased around half these Lebacs on secondary markets while Monday’s psychological victory reduced the greenback’s attraction for the other half. As a result renewal was more than total at almost 621 billion pesos, including such household names among major global asset management funds as BlackRock and Templeton. But renewed at interest rates of around 40 percent, of course — evidently foreign investors see a continued potential for lucrative “carry trade” far beyond the new five percent levy on their earnings. Yet whatever happens now, such a flood of money will not be entering the market in a single day for some time to come with all the dangers entailed during high volatility.

“A battle won but not the war, as you say. Interest rates at levels like 40 percent are supposed to fight inflation but they also feed it — something like a quarter billion pesos would need printing for the next renewal of these Lebacs. Such pressures come on top of a stubbornly high inflation. On Tuesday INDEC statistics bureau announced an April inflation figure of 2.7 percent — this was always going to be high because of the household gas bill increases of up to 40 percent as well as fuel prices but impossible to pin all the blame there since core inflation topped two percent. With little in the pipeline from regulated or seasonal prices, pre-crisis expectations of May inflation had been below two percent but Treasury Minister Nicolás Dujovne started this week by admitting to more inflation and less growth as a result of dollar volatility while others fear that this month could be worse than April. Dujovne is sticking to the official 2018 target of 15 percent but the government cannot even count on improving on last year’s 24.8 percent.

“Argentina remains highly vulnerable but at least a tottering confidence has been partially retrieved by some intelligent reactions showing some control of the situation and dispelling the sense of panic often sweeping markets in recent weeks. Calling the market’s bluff and anticipating the Lebac renewal were both smart moves but until then there was more or less a tragedy of errors. Squandering all those billions of reserves only pumped up a relatively tiny currency market, overrating its importance, while feeding speculators with plentiful supplies of rising dollars. Raising interest rates to a recessive and disruptive 40 percent only invited the direct comparisons to the 2001-2 meltdown despite nothing like the debt overhang of those default days. Yet the supreme overreaction was turning to the IMF (an abrupt move which seemed wholly improvised at the time but was probably decided some days beforehand when neither reserve sales nor higher interest rates were doing the trick) — a step more typical of countries on the brink of default. Some observers give IMF input the credit for the smarter reflexes shown this week but I think that Argentina’s vast experience of turbulence can make locals astute enough by themselves when handling crisis.

“Early days for predicting the outcome of IMF negotiations but there are signs that they could be concluded relatively fast without too much in the way of specific conditions (which would speed up agreement) although, having said this, it should be said that stand-by loans rarely come without a heavy dose of number-crunching. The IMF generally considers the peso to be overvalued (far less now, obviously), making the economy less competitive, but, rather than seek a specific percentage for devaluation, are more inclined to insist on the currency floating genuinely (which it manifestly ceased to do with the multi-billion interventions of recent weeks). Nor is the primary deficit target likely to be much of an issue — partly because it was already accelerated early this month (from 3.2 to 2.7 percent of gross domestic product) and partly because the IMF does not take the primary figure too seriously when servicing the debt doubles the overall deficit. The balance of payments is seen as the key number, especially trade (hence the insistence on a competitive exchange rate). The IMF also subscribes to that economic orthodoxy which insists on squaring the circle by lowering taxes and deficits at the same time.

Anyway Central Bank Governor Federico Sturzenegger might have redeemed himself somewhat by displaying skill this week but I have a slightly different candidate for the hero who brought the turbulence to a halt for now — on the same Monday the Central Bank faced down the markets and started to regain control, the national football team coach Jorge Sampaoli announced his official preliminary list of 35 players for next month’s World Cup in Russia, thus reminding the nation of the imminence of this supreme event and its real priorities.”