Lack of dollars… excess subsidies… The rest is “fib”
Regarding the transfer of a sharp devaluation onto prices
Regulatory factors affecting the transfer onto prices
About the fiscal impact of a devaluation
2016 scenarios, Draft version
With a meager difference (surveys again were “mistaken”), Mauricio Macri will be the president of the Argentines for the next four years as from December 10th. Meanwhile, in the 15 days remaining until such date, the country lives with an illiquid BCRA and a demand for dollar coverage which, without sales for new futures contracts, already begins to seep increasingly onto domestic prices. Partly as a counterpart to the decisions of private agents against the expectation of a faster exchange rate correction in a highly protected economy and partly as a counterpart to the political decision to postpone some of the increases until after the elections, such as occurred with fuel prices whose “indexation” to the dollar (at a price 50% above the international one) no longer operated as from last September and became operational again the day after the second round of elections. In fact, after a year when inflation was in the monthly average of 1.6%, November data points to 3%. Meanwhile, new Central Bank regulations to, once again, force banks to let go of their dollars are urgently operating to find alternative resources to finance the management to the end of the term.
However, beyond the attempts made by both parties (those arriving and those leaving) to distribute the costs of outstanding corrections (a story we have already seen at the end of the convertibility regime), the fact is that in a scheme with FX restrictions the BCRA is still the one which, almost in the absence of transactions, manages the official exchange rate parity, while foreign exchange shortages seeps into the FX gap (which is currently contained by expectations of unification) and into activity, given the obligated padlock on import payments. And although it is true that, in a world where liquidity is still available, a new government has margin to start narrowing that shortage (a scheme to provide liquidity to BCRA bills and to the swap with China, a scheme of “syndicated loans” from foreign banks and/or transitional mechanisms to accelerate the settlement of the retained harvest, while politically negotiating the agenda to settle with the vulture funds), the margin to lift the “FX restrictions” at least only through flows (and not debt stocks with importers and utilities) on the first day risks an overshooting of the exchange rate and/or of the interest rate. While taking this risk without having secured Reserves is the opposite of our recommendations, it seems to be the agenda of the new president, leaving the level of exchange rate and/or of the interest rate in the hands of how successfully they raise dollars quickly and of the decisions taken to maintain some quantitative restrictions for some flows, especially those associated with large volumes. A Dollar at AR$15 with quantitative restrictions and an interest rate at 50%, which after the overshooting returns to 13.5/14 and 40/45%? This numerical combination is difficult to ensure ex ante and it is even more difficult to predict correctly the economic costs of an overshooting that will directly depend on its duration and indirectly on the time taken to recover Reserves.
The thing is, as we have been pointing out, the absence of a nominal anchor (BCRA´s reputation) which coordinates the dynamics of domestic prices in the economy and a certain risk of accelerating inflation (which then does not return as deflation even if the exchange rate declines after overshooting) that does not generate the pursued gains in terms of competitiveness. As we have maintained, our neighbors´ recent experience of devaluation in real terms is not valid given the rate of indexation that is seen in the starting point as a result, mainly, of the funding “strategy” adopted in the last thirteen years and of the abuse of the inflationary tax. Of the three recent Argentine devaluations, 2002, 2009 and 2014, the last is the most similar to the current one, because the exchange rate gap was already in place, because of the dynamics of international prices, because of the rate of indexation seen in the starting point and fundamentally because of the fiscal dominance, although current deficit levels are almost twice those seen then.
But the FX issue is just one of the pending issues: the subsidies account (counterpart of the tariff imbalance in public service sectors and fuels) and the fiscal gap, in a context where indexing occurs at around 23%, are the other two issues. Although it is worth recalling that they do not work as separate compartments, but rather they are highly interrelated, as subsidies account for nearly 80% of primary fiscal deficit and, in turn, the subsidies account is indexed to the dollar with costs (gas oil, fuel oil and gas) which adjust in accordance with the exchange rate and the tariffs are fixed in pesos, and thus the required fiscal corrections are exponentially greater. It is true that an acceleration of inflation (product of the recovery of relative prices) would help to “liquefy” expenditures, however, that depends directly on the management of the distributive struggle (indexed pensions and social plans, and wages dependent on trade union negotiations – 50% of expenditure and 13% of GDP) and on governance (discretionary transfers to the provinces, current and capital – 7% of expenditure and 2% of GDP), but mainly on the management of tax policy, implying the aggressiveness in lowering the tax burden on incomes as promised to citizens (3.2% of GDP) and lowering export withholdings (1.5% of GDP). And this regardless of the fiscal gap generated by the decision of the Supreme Court to give back 15% of the Federal Tax Sharing to Santa Fe, San Luis and Córdoba with an immediate fiscal cost of 0.3% of GDP and not including that this ruling might extend to other provinces and excluding debt stocks. It is worth remembering that the fiscal imbalance before interest of 4.5% of GDP that is inherited coexists with an unprecedented tax burden in Argentina’s history.
With that said, it is not clear that an exchange rate changing faster can live together with a reduction of the fiscal gap. That is why, especially in the first months of the new management, it is expected that the need to overreact with the interest rate, to manage a larger surplus of pesos, will coexist with a higher exchange rate in order for the program to be consistent, particularly if the opening of the capital account is delayed. Although the a large account in pesos will depend on the fiscal gap seen at year end, on the immediate impact of corrections at the starting point (especially if the aim is to accelerate the FX agenda and delay the tariff agenda), and mainly on the strategy used –once the exchange rate correction began- in consolidating the outstanding debts of the BCRA due to retained earnings, unpaid imports and derivatives. After all, the latter might work in fact as the main mechanism of sterilization of the excess of pesos of the economy.
The problem of the attempts to make corrections is that the costs are immediate and the benefits are future. It is also true that if they are dilated in time, costs can also be high, because the leverage capacity of the economy is linked to the ability to finance it in the starting point. Obviously, the agenda of correction of relative prices to restore export competitiveness, a necessary condition to make the required financing sustainable at startup to strengthen the Central Bank and moderate the costs of fiscal dominance, requires coordination to manage the economic and political variables simultaneously.
In any case, and as we have already anticipated in our report last March “Growth in 2015… Development in 2016?”, it will be difficult to see next year the strong growth and moderating inflation that was forecasted by the market back then despite the change of expectations announced beforehand. As of today, the scenario looks clearer, but obviously will depend on the definitions taken by the next government to address the pending corrections of relative prices and, most importantly, on the success in coordinating the further dynamics of prices and wages in the economy, based on a scenario of absence of a nominal anchor. In any event, it appears that gradualism begins to have an increasing place in the agenda, although probably with a greater exchange rate jump –managed by the BCRA- and an agenda to reduce subsidies which will be, probably, less aggressive (given the impact of the exchange rate on the account of subsidies and the political cost).
Taking this into account, we built a first scenario for 2016, with a dollar at $13.8 at end December 2015 (with overshooting) and an average exchange rate of $14.8 for the entire 2016, trade union wage negotiations settling at around 28% (this requires a strong policy management) and an increase in electricity tariffs at around 350%. In this scenario, the primary deficit is stabilized in the area of 4.5% of GDP and the attempt to narrow the fiscal dominance generates a jump in the interest rate of Lebac to an average around 45% in the first months and 34% on average for the next year. If this happens, the economy in 2016 would fall by around 2%, with consumption dropping somewhat faster and an average inflation rate at around 40% (34% between ends), due to the incorporation of the change in relative prices, after a 2015 where the acceleration of inflation in the last two months would drive the index from a rate of increase of 22% yoy in October to a rate closer to 35% yoy in December.
113 The external constraint at the top of the agenda (part II)
