Three contradictions of the scheme
Since our last monthly report, the Central Bank of Argentina (BCRA) has lowered the policy interest rate three times from 7% to 4.2% monthly, with inflation decreasing from 11% in March to 8.8% in April (according to our Retail Price Survey), while staunchly maintaining the crawling peg at 2% monthly. The aim is to have inflation in May between 4% and 5%, for which it halted the planned increases in gas, electricity, transportation, and fuel taxes, and pushed Prepaid Health Plans (deregulated in January via an executive order (DNU)) to lower fees by 20%, rolling back the inflationary increase since December without considering the costs they had transferred. Together, these measures reduce our inflation projection for May by 2.1 percentage points to 4.2%.
Delaying the exchange rate (the multilateral exchange rate is currently 8% below the levels at the end of the Cepo with Macri and only 10% above the 1997 levels before the change in the global financial cycle and the devaluation of Brazil seriously damaged the Convertibility scheme in a country with systemic productivity and a relative price structure much worse than it had back then) while sending 20% of exports (80% of the trade balance) to supply the blue-chip swap dollar market, does not seem consistent. At the end of the day, to stabilize peso demand without restrictions, the interest rate that remunerates pesos needs to be equal to the dollar rate plus the devaluation expectation. Today, the world’s risk-free rate approaches 5%, the country risk fell to 1,200 basis points, and the devaluation expectation is contained with the capital controls (crawling peg at 2% in the official rate and cross controls plus 20% of exports in the blue-chip swap dollar market).
The rush to remuneratied liabilities and “destroy” the quasi-fiscal deficit by lowering rates, appreciation of the FX (via a 2% crawling), and encouraging banks to move from the BCRA debt (Argentina’s Central Bank) to financing the Treasury with indexed instruments and PUTs, increases dependence on capital controls. In numbers, interest-bearing liabilities decreased from $57 trillion in December to $34 trillion at today’s prices, although at the same time, the sold PUTs amount to $19 trillion (almost half of the Treasury’s peso debt, which is also indexed). Remember that PUTs are the option banks have to sell the BCRA bonds in pesos in their portfolio at the previous day’s exchange rate.
The economic team is very “meticulous in issuing zero-coupon debt” in order to not impact interest costs and to avoid complicating fiscal numbers. For now, while it pays dollar maturities with cash flow (something that in 2025 does not seem sustainable without a greater recession, affecting both fiscal matters and polls), Guzman’s “grotesque” restructuring allows him to pay low coupons on dollar debt, and the Cepo allows him to take advantage of negative interest rates. The interest burden on the debt stock (average coupon) is only 3.8%. This explains why the interest account is at 1.7% of GDP compared to the 3.4% of GDP they represented in 2017 when the Treasury’s debt stock in the market (including agencies) is 15% higher than it was then and continues to grow as the dismantling of remunerated liabilities that are not diluted is done with Treasury debt and not with a surplus.
Three contradictions/risks posed by the scheme:
1) As long as the Blend is maintained, the recession needed to sustain the purchase of dollars once imports payments normalize (in May, 100% would be paid, compared to 17% in December) complicates fiscal accounts. But if the economy recovers quickly, the external surplus is lost in a context of delayed exchange rate adjustment. With the economy closed (country tax, plus installment payments for imports, plus duties, plus public service rates), the import parity “protects” the local market in a context of a very strong economic contraction. Removing this protection (something that is beginning to happen selectively in some sectors) helps to reduce inflation but dangerously destroys employment unless there is a change in systemic productivity that is not yet in sight.
2) The lower the interest rate and the delayed exchange rate, the greater the dependence on currency controls, unless they are considering a new jump in the dollar assuming that without pesos, the pass-through to prices will be lower. However, with the change in the composition of debt (more indexed Treasury debt and less fixed-rate BCRA debt), this strategy does not seem like the best option.
3) Even assuming the market story and a change in rating that increases USD15/20 bond prices, it is difficult to imagine that Argentina can finance itself in dollars below 10% without a sharp drop in the risk-free rate; and as we saw in the 2019 primaries, the country risk is “volatile”. Dollar debt maturities with the market escalate next year to USD7.1 billion and it is difficult to think that they can continue to be paid with cash flow as they have been so far. Peso-denominated debt maturities measured in dollars amount to USD19 billion for the rest of the year (and USD25 billion in 2025) and their roll-over currently depends on the capital controls, validating negative rates and incentives (PUT and price differential).
Regarding Governance, for now, there is a great tolerance for adjustment reflected in the polls. And it is precisely the polls, along with the decrease in inflation, the purchase of dollars by the BCRA, and the fiscal numbers, the four variables that the market monitors to continue supporting the trend that local financial assets have been experiencing. For now, it’s a trade; for it to become a different process, a response to points 1, 2, and 3 is required, greater than the abuse of the army of trolls in a game that should be more like chess than the Game of the Goose.
