January … a fast or a slow negotiation?
Changes in the Central Bank reaffirm our FX scenario
The economic costs of foreign currency shortages lead to negotiating in January
2015 Scenarios
The world will continue to help
From Presbisch’s external constraint to the Keynesian liquidity trap
Just two months away from the expiration of the RUFO clause and with it the end of the risks of a negotiation of Judge Grisea’s ruling in favor of the Vulture funds, the costs of foreign currency shortages remain in force and are reflected in the fall in economic activity. This reduction is mainly concentrated in the areas which are directly affected by the shortage of foreign currency, but also affects the rest of the economy through the difficulties to reduce inflation and sustain real wages. “Normative and verbal” progress which has been made to stabilize the gap, including changes in the Central Bank, have had immediate effect but will not function as a medium-term strategy to reverse the business cycle, if the currency shortage is not solved ,
Faced with this dilemma, the chosen policy has been to limit the adjustment through prices; as it is still paying the costs of the December-January devaluation and with a twelve-month horizon ahead, the decision has been to not validate a sharp devaluation again. In fact, this has been one of the first signs of the change in the Central Bank’s authorities, via an increased supply in the futures market (the dollar rate as of December traded at AR $ 8.86), to management of the spot market Consistent with limiting dollar sales to the daily availability of commercial foreign currency seeking to smooth decrease in Reserves and tackling with the exchange rate gap by appealing to demand restrictions and expanding supply via the “suggestion” to insurers to settle dollarized bond positions against pesos. Simultaneously, The liquidity achieved by this operation provides leeway to cushion the fiscal dominance which is implicit in the Government’s gap of remaining pesos of AR $ 70/80 billion for the remaining months. In a world where liquidity is still abundant and Argentina’s cost of funding is three times that of any country in the region even if their external and fiscal imbalances are significantly lower, the sustainability of the prices of dollar assets
(stocks and bonds) contributes to this indirect mechanism of public sector funding.
However, the aim of boosting the macroeconomy through exchange rate appreciation is relegated by the supply restrictions implicit in the inherent import rationing and fundamentally by the FX uncertainty proper of a scheme of increasing fiscal gap and a central bank which for now looms as the sole lender. Managing the access to the availability of dollars allows the consistency of this “strategy” but obviously adapting the size of the economy to foreign currency availability. In this context, and as we have stated since September 2013, the scenarios are directly dependent on the ability of the policy to achieve financial dollars in order to finance the required increase in imports, facing the implied fall in imports in a scenario where reserves cannot be lost abruptly, no external financing is achieved, strong debt maturities are faced (especially in the second half of 2015) and with exports far from increasing but rather showing a significant drop in a context where their prices adjusted downwards and the management of exportable surpluses will hardly help in a context of increasing exchange rate appreciation. These financial dollars would also help to reduce FX pressure and inflation by means of expectations of devaluation and gap reductions, which would help sustain and improve real wages in 2015 “echoing” the deterioration of 4/5 points verified in 2014, similar to the solution applied by countries like Uruguay or Brazil with current account deficit of 6.5% and 3.5% of GDP respectively, and contrary to what happened in the last few months, as well as to stabilize the demand for pesos without an overreaction of the interest rate.
In other words, the ability of the policy to appreciate the exchange rate and have real effects, which was the pursued objective when the government began turning to credit late last year (ICSID, Repsol and Paris Club) but was delayed by the non-resolution of the dispute in New York, will directly depend on the achieved amount of financial dollars. Resuming the agenda of external credit in a world where our neighbors borrow at rates around 4%, even with fiscal and external gaps greater than ours, looks like the best option for policy. This stands especially when, as we have been stating in our reports, the ruling which has been extended to all the vulture funds and other creditors is equivalent to 4% of GDP, compared to a debt floating in the market which represents 11.8% of GDP (12.5% if the GDP coupon valued at today’s prices is considered), and its sole resolution would reduce Argentina´s cost of credit by half (from the current 12.5%, according to the Bonar 24, to a rate of around 6/7%). Although in the meantime the government seems to be looking for other sources (China, now Russia, Bank of France, and even issuing a dollar bond in the market validating higher rates), none of them seem a priori deep enough to ensure the foreign currency the economy needs to be able to grow in 2015.
In this context of rising costs of scarcity, the most likely scenario of the ruling as of January, eleven the sword of Damocles implied by the RUFO clause disappears, with probable involvement of private groups that would mitigate the necessary change in discourse . However, since our last report and the battle is over, scenario 1 (a rapid negotiation in January) is giving way to scenario 2 (negotiations with obstacles) as the most likely one, assuming that although the change will start in January, the conditions will not be given in order to achieve a quick and “successful” negotiation without validating at the cost of the ruling higher than the government seems currently willing to pay.
