Central Bank switches benchmark interest rate in December

At its 18 December meeting, the Central Bank of Argentina (BCRA) decided to switch the benchmark interest rate from the previous 28-day Leliq rate to the 1-day reverse repo rate. While the 28-day Leliq rate stood at 133%, the new rate has been set at 100%. Moreover, the Bank discontinued the issuance of 28-day Leliq notes.

The decision to adopt the new monetary policy tool was aimed at lowering borrowing costs while simplifying the monetary policy framework. The move is consistent with the new government’s goal of reducing monetary financing of the fiscal deficit and encouraging banks to invest in Treasury notes instead of lending money to the Central Bank. That said, the decision relies on the assumption that the ambitious deficit reduction plan and broader macroeconomic reforms adopted by the government will be successful. If the government’s wide-ranging reform program maintains investor confidence, the country’s public debt may attract investors. However, should the government fail to reduce the burdensome fiscal deficit, investors might turn their backs on debt securities and opt to buy dollars, fueling inflation in turn.

The Bank did not give explicit forward guidance in its press release, but stated that “all monetary policy tools will be geared towards achieving monetary stability and reducing inflation”. Most of our panelists expect the BCRA to cut the one-day reverse repo rate this year.

Commenting on the decision, economists at the EIU stated: “The authorities' main aim is to halt the growth of the monetary base in order to end the self-reinforcing cycle of monetary expansion, which, alongside a wide fiscal deficit, has been the source of inflationary pressure in Argentina. The BCRA's negative real interest rates on its notes will encourage banks to invest in government bonds to finance the fiscal deficit. The success of this strategy will depend on how quickly the government reduces its fiscal deficit. If it works, fiscal consolidation and disinflation will encourage lending to the private sector and boost economic growth.”

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