Argentina: Interview with Ecolatina

Pre-election Scenario

  • Do you think Argentina will experience FX volatility in the run-up to the election? Or is the current monetary and FX framework strong enough to prevent this?

Exchange rate volatility is a characteristic of the monetary scheme designed by the IMF and Argentina’s Central Bank. With the main objective of controlling monetary aggregates, fluctuations in the demand for money are reflected in the monetary policy rate but also in the exchange rate. This characteristic was present from the moment of implementation of the scheme.

In this context, the political uncertainty around presidential elections exacerbates this dynamic. Every news that strengthens (reduces) the position of the opposition has a negative (positive) correlation with the exchange dynamics and Argentina’s country risk profile (EMBI Arg). Currently the sum of “good” news on the external and internal fronts, added to the IMF authorization to Argentina’s Central Bank to sell international reserves within the non-intervention zone, stabilized the FX market, even nominally appreciating the exchange rate. Over the next few months, the primary election will be key. Particularly, although it is clear that the ruling party will get fewer votes than the coalition headed by Alberto Fernández and Cristina Fernández de Kirchner, the impact on the foreign exchange market will depend on how narrow that difference is.

  • When do you see inflation peaking?

In terms of inflation, the worst has passed. After accelerating, on average, 3.5% month-on-month in the first quarter and decelerating slightly over the second quarter (although remaining at very high levels nonetheless), we expect that inflation will average 2.5% on a monthly basis in the third quarter and around 2% month-on-month by the end of the year. Our inflation projection is a response to changes in the main prices of the economy: wages, the exchange rate and the public service tariff. To the extent that the foreign exchange market does not show sizable jumps as observed in 2014, 2016 and 2018, it is expected that inflation will fall slowly because nominal wage increments will be around 40% this year, the highest in the last decade.

While the slowdown expected for the coming months is good news, it leaves a complex scenario for the next government. If wage growth does not moderate, contractionary monetary policy will do little to reduce inflation.

Election Scenario

  • What is your prediction for the election outcome?

The electoral result will depend on political and social variables, but also on how the economy fares. In this sense, whether the economy will help the government will depend on the memory of the undecided voter. If voters compare the situation of October with previous months, we believe that Macri has a slight advantage; however, if the comparison is made with 2017, or even 2015, the government will be at a disadvantage. In October, wages and consumption will improve, but at significantly lower levels than observed years ago. The bonanza in 2017 has passed and, with it, the certainty regarding the electoral outcome. Latest polls showed a virtual tie between the Macri-Pichetto ticket and the Fernández-Fernández opposition.

  • Do you think the vote will impact the pace or scope of the economic reform plan agreed upon with the IMF? Could the IMF assistance program be renegotiated? If so, which aspects of the program would most likely be subject to negotiation?

The vote will determine the new government and therefore will influence the direction of reforms. The next president will have to restructure the payment schedule with the IMF. To do so, it will be necessary to change the current arrangement (Stand-by) for one that satisfies both parts for a longer period of time (Extended Fund Facility), which would require structural reforms such as labor or social security.

Although this would necessitate Congressional approval, if re-elected, the current government will try to implement this type of reform. This would not be certain, however, if Alberto Fernández were to claim the presidency.

Post-election Scenario

  • If the Fernández-Fernández ticket wins the election, do you see any risk of reform reversal? If so, which economic measures approved by the Macri cabinet are most likely to be reversed?

We don’t see much risk of reform reversal in the event of Fernández-Fernández winning the 2019 presidential election, because Alberto Fernández’s economic proposals are relatively moderate, especially in comparison with Cristina Fernández de Kirchner’s second presidency (2012–2015).

That said, we would expect more state intervention in the economy in comparison with Macri’s administration (i.e. restrictions on short-term capital inflows) and a different approach in order to tackle inflation (i.e. prices-wage agreement policies).

In term of structural reforms, a Fernández government might not be willing to pass pension and labor reforms requested by the IMF (in order to change the Stand-by Agreement into an Extended Fund Facility) and financial investors.

  • Is the independence of the Central Bank at risk if the Fernández-Fernández ticket won the election? Would the monetary financing of the fiscal deficit be resumed?

We think the plan “A” of an Alberto Fernández administration would be to regain access to international markets. In order to restore confidence of international investors, the independence of the Central Bank cannot be jeopardized.

But if financial access was not regained, the Fernández government would have to resort to plan “B”. In this hypothetical scenario, the Central’s Bank independence would be jeopardized and monetary financing of the fiscal deficit would return.

  • If the opposition were to win, what is the impact on your forecasts?

After the 2018 balance of payment crisis, Argentina needs external financing just to repay the public debt services, which are mainly denominated in hard currency. In comparison with the opposition, we think that Macri has an advantage in terms of re-opening financial markets. That’s why, in the short-term, the Argentinean economic outlook would be a bit brighter if Macri were to be reelected. Nonetheless, if the opposition triumphs and implements a reasonable economic policy, financial markets might restore confidence too.

  • Do you think the new government will try to restructure its debt? Is there a risk of default?

There is risk of default because Argentina’s faces significant public debt services in hard currency (especially in 2022–2023 when the Stand-by agreement with the IMF has to be repaid) and access to financial markets is currently closed (the country risk of Argentina is around 800 b.p.). Moreover, Argentina already asked the IMF for assistance (financing of last resort) and net international reserves of the Central Bank are low.

Irrespective of who wins the presidency in Argentina, the next government should: i) regain access to financial markets; and ii) renegotiate the payment of the Stand-by agreement with the IMF.

In order to extend the repayment of the IMF debt, the current Stand-by agreement should be replaced with an Extended Fund Facility program, which would require structural reforms. Again, we think Macri has a better relationship with the IMF and has tried to pass pension and labor reforms in the past. That is an advantage in comparison with the opposition, but the key question regarding Macri serving a second term as president would be whether he would have enough political strength to pass those laws in Congress.

  • What are the biggest risks to the Argentine economy? Is there a risk of extreme scenarios such as capital controls?

The biggest risk for the Argentine economy is a default of the public debt. Although both candidates for the presidency want to avoid that negative scenario, if confidence was not restored and nobody was willing to finance the Argentinean Treasury (financial markets are still closed and there’s no new aid from international financial institutions), the worst case scenario could materialize.

As demonstrated by the huge economic, political and social crisis in 2001–2002, a default would result in the implementation of extreme measures and policies.

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