Mon | Jul 13, 2020

Walter Molano | Argentina: The Three Zeros

Published:Wednesday | October 24, 2018 | 12:00 AM
The Central Bank of Argentina

Signs of an early summer are registering in Buenos Aires. Balmy nights, sunny days and warm breezes are indications that the winter has finally come to a close.

Despite the negative industrial production numbers, there was not much evidence of a severe recession. Traffic was still relatively chaotic. Restaurants were full and the airports were busy. Nevertheless, retailers are reporting a sharp decline in sales.

Some of the restaurant patrons were tourists, mainly Brazilians, and the people in the airports could have been visitors from the neighbouring country. Indeed, the flight to New York was pretty empty.

One thing is for sure: Argentina is cheap. This is the cheapest I have seen it since the collapse of the Convertibility Plan in 2001. The drastic change in relative prices is a recent phenomenon.

Expected tidal wave

Earlier this year, we calculated the Argentine peso, the ARS, almost 50 per cent overvalued. Now, we estimate it at slightly undervalued. This will soon lead to a tidal wave of tourists. It will just take time for tour companies and airline companies to get the word out. Likewise, the number of Argentines travelling abroad will collapse, leading to a big improvement in the balance of payments.

Other things will also boost the external accounts. A bumper crop will raise exports. Similarly, the surging output of oil in Vaca Muerta will eliminate the country's need to import natural gas. Gas exports are already moving into Chile, and Argentina will eventually become an important oil exporter.

All of these developments point to a sunny disposition for the Argentine economy. Still, the economy will have to endure some pain to fully enjoy the fruits of its merits.

Several local economists are labelling the new IMF programme as the 'Three Zeros'. It means zero fiscal deficit, zero monetary expansion and zero intervention in the exchange rate markets. This is an incredibly draconian adjustment. However, it should stabilise the economy very quickly, and move it on to a sustainable glide path.

A combination of higher taxes and reductions in public-sector investment is allowing the government to make its fiscal adjustment. The problem is that it has to cut 2.7 per cent of GDP in government spending, and still try to win the elections next year. This is a feat that has never been done before.

Polical landscape

The good news is that the opposition remains divided. A recent poll showed that the popular support for former President Cristina Kirchner remains very low. It is similarly low for some of the other so-called presentable Peronists, such as Juan Manuel Urtubey, and even much lower for Sergio Massa, the former presidential candidate.

At the same time, the poll numbers for Buenos Aires Governor Maria Eugenia Vidal, a member of the president's Cambiemos coalition, are higher than those of the president. It is possible that she could run in his stead in order to secure a victory for the coalition. Either way, the country continues to enjoy unconditional support from Washington.

There are some members of the United States government, particularly in the Trump administration, who believe that Argentina is the front line against the return of leftist populists to the region. The last thing that Washington wants is a repeat of the Venezuelan debacle in one of the larger Latin American countries that only results in opening the region to further meddling by the Chinese, Russians, Cubans and leftist Spaniards.

Dominant position

Therefore, it will deploy its dominant position in the multilateral lending agencies, such as the International Monetary Fund, World Bank and the Inter-American Development Bank to express its interests.

The other two zeros - zero monetary expansion and zero currency intervention - go hand in hand. With inflation running at almost 50 per cent, zero monetary expansion will be painful. Desperate for pesos, households and businesses will run to the currency markets to sell their dollars.

Under normal conditions, it would have just led to an appreciation of the peso. However, given that the government introduced a currency band, with a lower limit of 34 and upper limit of 44, this will be the only allowable venue for the central bank to expand the money supply.

In other words, when the ARS hits 34, the central bank will have to sell pesos and buy dollars. In the process, it will expand the money supply and accumulate international reserves. This will convert the ARS into one of the most interesting carry trades in the market.

Three things will make the trade more attractive: interest rates that are north of 60 per cent; an exchange rate band that adjusts by only three per cent per month, even though the last inflation rate was 6.5 per cent; and no limit on how many dollars the central bank can buy.

The US$150-million-per-day limit that the central bank can sell is only for the upper band, not for the lower band. This may result in an unexpected expansion of the money supply and downward pressure on interest rates, leading to an appreciation of the ARS instruments. Argentina may become the sunniest, cheapest and most lucrative destination for emerging market investors.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.