Argentina: Sandleris takes over the reins of Central Bank and steers a dramatic shift in monetary policy
September 27, 2018
In a press conference held on 26 September, Guido Sandleris, the newly appointed governor of the Central Bank of Argentina (Banco Central de la República Argentina, BCRA), announced a drastic shift in monetary policy, in an attempt to rein in runaway inflation and curb heightened FX volatility. Starting 1 October, the Bank will abandon its inflation targeting regime to adopt a rigid monetary rule which consists of keeping the monetary base unchanged from its current level through June 2019. The new monetary rule thus sets a 0% monthly growth for the monetary base, defined as currency in circulation plus reserve requirements. According to press reports, Luis Caputo, the previous governor of the Central Bank, resigned after advocating greater intervention in the FX market to curb the depreciation of the peso, which was opposed by the IMF.
Mounting inflationary pressures, which have gone hand in hand with a strong expansion of the monetary base and which saw inflation climbing above 30% in both July and August, prompted the radical shift in the monetary strategy of the BCRA. Spiraling inflation and a plummeting peso, compounded by a severe drought, drove the contraction of economic activity in the second quarter and the likely continued weakness in economic activity in the third quarter. The change of course is also a byproduct of the revision of the program of economic stabilization and reduction of macroeconomic imbalances agreed with the IMF on the same day. As a consequence of the new monetary base target, LELIQ interest rates will fluctuate daily, resulting from LELIQ auctions rather than being directly set by the BCRA.
The Central Bank also adopted an FX regime which combines a free-floating range for the peso with the prevention of excessive ARS/USD fluctuations. The Central Bank will refrain from intervening in the foreign exchange market when the peso trades between 34 to 44 per USD and the range will be adjusted daily at a rate of 3% per month until the end of the year. In the event that the peso moves outside the non-intervention band or in the event of episodes of considerable exchange rate volatility, the Central Bank will act to reduce FX volatility by making sales of up to USD 150 million per day or, conversely, by buying USD reserves.
The adoption of such hawkish monetary measures, if effectively followed, could well succeed in bringing inflation under control. Since June, the Central Bank has stopped financing the fiscal deficit, thus reducing potential political influence towards monetary expansion, and market actors will most likely see the new course as credible. It can thus be expected that, perhaps after a period of adaptation to the new monetary rule by market participants, inflation will stabilize and potentially fall. This would also likely contain the depreciation of the peso, although some short-term weakening in economic activity could also emerge.
Ultimately, restoring confidence is key to the success of the new monetary strategy. If, over the next few months, economic operators regain confidence in the peso, the currency will stabilize and Argentine bond yields will fall, leading to an improvement in the economic situation. If not, monetary tightening could translate into stubbornly high interest rates, choking liquidity and damaging economic activity.
Analyzing the combined effects of the new monetary policy rule and the revised IMF agreement on the FX market, Diego W. Pereira and Lucila Barceito, economists at JPM, note:
“This arrangement is deemed as adequate since it combines a completely free-floating range, while preventing excessive exchange rate fluctuations. But, in our view, volatility in that range is likely to remain elevated (as for the front end rates), given the nature of this economy with a shallow financial market and given the new monetary base growth rule. The fact that the IMF drawdowns will go entirely to budget support rather than reserves limits the ‘disposable’ ammunition power of the central bank, what is consistent with the wide range for the non-intervention zone. Yet, it also raises doubts on the firepower in case of extreme disruptions. Granted, the hawkish monetary rule is to help contain depreciation.”