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Argentina | Trapped

| October 2, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The liquidity position at Argentina’s central bank is quickly morphing into a balance-of-payment crisis. The last few days have seen an acceleration of US dollar bank deposit outflows as well as central bank dollar sales. The central bank has again announced more to defend diminishing liquid foreign exchange reserves, including a reduction in export taxes, faster foreign exchange depreciation and indirect foreign exchange intervention by selling US Treasury bills and dollar-denominated sovereign bonds. The measures may become increasingly ineffective. The private sector may hesitate to supply dollars into unsustainable policies while policymakers remain reluctant to adopt orthodox measures that would weigh on near-term growth. There is no easy path, especially for policymakers that are more ideological than pragmatic.

The Eurobond price action on October 1 confirmed the pessimism. Investors could sell into strength and drive prices lower by 1 point to 1.5 points, but that came after a 3-point bounce earlier in the week. The crux of the problem is almost zero stock of dollar reserve assets, an external deficit in dollar cash flows and a huge $150 billion or more stock of future dollar debt liabilities.  The external deficit has to quickly reverse to surplus for Argentina to accumulate sufficient reserves over the next few years to repay bondholders.  It may have to get worse before it gets better, with a failure of heterodox polices that eventually forces orthodox policy management.  This suggests that bond prices are vulnerable and trapped at still low levels, and bondholders remain motivated to sell into strength.

The foreign exchange measures have not provided any breathing room and have only accelerated dollar demand.  The central bank sold $539 million since announcing the measures on September 15, the dollar bank deposit withdrawals have escalated to $200 million a day and the Blue Chip foreign exchange rate remains at its widest divergence ever from the official foreign exchange rate.

The new round of measures announced October 1 includes a 3% temporary reduction on soy export taxes, tax breaks for other industrial exports, higher foreign exchange volatility (faster pace of daily depreciation of 1%), higher repo rates and a calendar for US dollar Treasury issuance and resale of central bank holdings of sovereign US dollar bonds. The central bank also confirmed that there were no plans to activate the China swap line.

This latest round of measures appear less draconian, with a more cooperative approach to encourage dollar inflows as opposed to discourage dollar outflows.  However, a worsening crisis of confidence typically requires bolder counter orthodox measures as opposed to ad hoc measures.

China is not typically a lender of last resort while difficult International Monetary Fund negotiations may continue into next year with low prospects for new funding or conditional on an orthodox economic program.  Argentina’s inward isolationist strategy and heterodox policy management has deterred dollar capital inflows, and access to external credit has decreased. Although the latest measures are somewhat more coherent, it will be difficult to encourage exporters to relinquish their supply. There is increasing threat of a maxi-foreign exchange devaluation. And indirect foreign exchange intervention through US dollar Treasury bill auctions or even secondary sale of sovereign USD bonds may also meet limited demand if viewed as an ineffective hedge on higher USD debt repayment risks. The hike in the repo rate from 19% to 24% seems pragmatic; however, the subsequent regulation for banks to reduce their LELIQ positions seems contradictory.

The slow economic recovery from a deep economic recession probably further delays any shift to more orthodox policy management, such as the standard approach to balance-of-payments stress through a larger foreign exchange devaluation and tighter monetary and fiscal policies.  If this latest round of foreign exchange measures prove ineffective, then the central bank faces a decreasing margin of policy flexibility to counter the balance of payment stress.  It is important to monitor the daily stress indicators of the Blue Chip FX rate, daily central bank dollar purchases and other signs of whether the central bank can shift the balance-of-payment deficit to surplus.  The path is clear.  The balance of payments needs to quickly revert to surplus to capture export dollars for future debt repayment. Meanwhile, Eurobonds remain vulnerable to underperformance with zero carry and a still uncertain future debt repayment capacity that restricts price appreciation.

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