The currency crisis in Argentina and the dawning of the IMF

The Ministry of Finance, Buenos Aires. Wikimedia Commons.

A few months back, in an
article published in
democraciaAbierta, we gave an account of the current Argentine crisis,
highlighting the excessive vulnerability the economy was being exposed to as a
result of the impact of the financial opening carried out by President Macri.

Three aspects in particular threatened the country's future prospects: a strong
exchange deregulation policy that failed to stop the flight of capital, a boom
in foreign debt (at record level among emerging countries) and the promotion of
speculative capital inflows to carry trade (buying a title issued by the
Central Bank called LEBAC).

When international conditions worsened and the
carry trade circuit came to an end, the LEBAC bubble exploded and produced a
tremendous foreign exchange crisis that shook the Argentine economy, causing a
sharp rise in inflation and a severe recession from which the country has not
managed to escape.

To curb the flight of currency, the Argentine government ended up
requesting financial assistance to the IMF through a stand-by agreement, thus putting
an end to the fairy tale of Argentine financial integration emphatically
defined by Macri's as a "return to the world".

Worse still, in the
last few days, the pressures on the Argentine foreign exchange market seem to be
back. In this context, doubts about the country's future are re-emerging and
have led many observers to feel that the agreement with the IMF should be
re-negotiated.

We intend to analyze here in more detail what the Argentine agreement
with the IMF consists of and to suggest, in the context of current financial strife
in many emerging countries, a more structural rather than conjunctural vision
of a possible new dawning for the IMF as a regulatory agency of the difficult
Latin American transition.

The role of the IMF

In order to decipher the current situation, it is essential to take a
step back, and analyze briefly the role of the IMF in the recent past.

In
general terms, from the beginning of the 2000s until quite recently, the Fund
had been pushed into the background of the international and regional political
game board. This was due to several causes.

First, the Fund had to pay a
certain cost in terms of its own reputation for the Argentine default in 2001
and, later, for repeatedly criticizing the subsequent debt restructuring
process, which turned out to be very successful.

Second, there was the loss of the IMF’s centrality as a financial
institution in Latin America. It is worth remembering that in December 2005,
Brazil and Argentina canceled all of their debt with the Fund, making it clear
that they were unwilling to submit to any sort of restriction on their economic
policies.

Finally, after the outbreak of the crisis in 2008, the global expansion
of liquidity and low interest rates generated a very favorable scenario for external
debt of emerging countries.

This is the context where the opportunity for a new dawning of the IMF appears, after a long decade of marginalization: the Fund could fulfill the role of guaranteeing an orderly exit of global capital from the emerging countries and restoring market discipline.

And even though the emergence of the G20 in the
definition of the international agenda restored some of the IMF’s lost prestige,
the Fund never recovered its old role as the privileged lender.

So much so that
the IMF’s technical offices began to look for a new role for their bureaucrats,
trying to redirect them from technical review tasks (the so-called
"ex-article IV" missions) towards developing technical assistance
agreements with central banks and "comprehensive global models" for
global forecasting.

At the present stage, the situation seems to be changing. First, there
has been a sharp increase in financial volatility (caused by a long series of
disastrous events such as the crisis of European banks, Brexit, the Catalan
crisis, and the Trump-China trade war, among other things).

Second, the
tightening of the FED’s monetary policy and the end of the so-called tapering has led to a reversal of the
global capital flows towards the central countries. These capital movements
have severely affected emerging countries, causing crises and strong foreign exchange
rate tensions.

This is the context where the opportunity for a new dawning of the IMF appears,
after a long decade of marginalization: the Fund could fulfill the role of
guaranteeing an orderly exit of global capital from the emerging countries and
restoring market discipline.

And this issue seems to be centered once again in Argentina, expanding from
there to other countries. Proof of this are the market pressures on Turkey to
get it to accept a deal with the IMF, which finally did not happen. In the
Turkish case, the exit of the crisis was the regulation of operations in the
Lira derivatives markets and a dollar deposit agreement with Qatar.

In this
sense, the kind and apparently open to discussion attitude of the Fund’s director
Christine Lagarde during her several meetings with the Argentine government
should come as no surprise.

However, the fact that the IMF has had to change
some of its traditional key points should not lead us to think that "this
time it’s going to be different". A short review of the terms of the
agreement with Argentina should be enough to prove it.

Stand-by me, Argentina

Argentina’s current deal with the IMF is a stand-by agreement for a
period of three years for a total amount of 50,000 million dollars to be disbursed
in pre-scheduled instalments.

There was a first major foreign exchange deposit of
15,000 million dollars in June (equivalent to 30% of the Argentine Central Bank
reserves). Quarterly deposits of 3,000 million dollars are expected thereafter,
after compliance with the agreement is certified by the Fund's technicians.

On a closer look, the agreement with the IMF consists of three large
areas of quantitative monitoring on Argentina: fiscal policy, inflation and the
Central Bank’s reserves. To this a series of complementary measures are added, which
were called "structural agenda" in the past.

Regarding the areas of
quantitative monitoring for 2018, Argentina must meet a fiscal adjustment objective
equivalent to a reduction of primary deficit by 1.5 GDP percentage points;
second, a maximum annual inflation rate of 32%; finally, a minimum Central Bank
reserve floor of 53.600 million dollars.

By 2019, if the first part of the
agreement has been successfully fulfilled, the requirements would be a lower
fiscal adjustment, an inflation ceiling of 28%, and a minimum Central Bank reserve
floor of 55.600 million dollars.

As far as the structural agenda is concerned, the complementary measures
include a commitment to change the Central Bank’s balance sheet by eliminating
the LEBAC titles (which drove the foreign exchange run in May), a new organic
charter for the Central Bank reinforcing its independence, the limitation of Treasury
financing and the passing of a fiscal responsibility law at sub-national level
to prevent debt issuance by the provinces.

As in all stand-by agreements, non-compliance of any of the quantitative
monitoring measures in any revision of the agreement entails the immediate
freezing of future disbursements, the raising of a formal apology – known as waiver – before the IMF board, and
re-negotiation of the agreement.

In any case, it should be said that before the latter were to happen, the
consequences for the Argentine economy would be catastrophic, given the strong
increase in the country-risk rate, the ten-year bond yields and, above all, the
intensity of the capital flight that a negative IMF review would trigger.

Considering that currently both the country risk rate and the interest
rate on bonds are at dangerously high levels (almost 700 basic points and 10.1%
respectively), if we are to speculate on possible future scenarios we need to
see, first of all, if a breach of the agreement with the Fund is likely.

On the part of the Argentine government, what prevails is a strongly optimistic mood and a rhetorical celebration of the agreement, which is presented as a clear sign of recovered international confidence.

On the part of the Argentine government, what prevails is a strongly
optimistic mood and a rhetorical celebration of the agreement, which is
presented as a clear sign of recovered international confidence.

However, a substantial part of the story is lost through the fiscal
approach to the problems of the Argentine economy which characterizes the Macri
administration. From the government's perspective, the agreement with the IMF guarantees
the availability of the funds necessary for the refinancing of debt maturities
until 2021. The rest of the funding is expected to come from budgetary re-balancing.

But the current difficulties encountered in reducing the deficit of the balance
of payments indicate that we should be concerned with at least three aspects. First,
it is very unlikely that the country will be able to comply with the inflation ceiling
of 32% given that currently projected inflation is 31.8% and the foreign exchange
market continues to show a strong devaluation of the peso, which in Argentina
has traditionally had a direct effect on prices.

Second, by dismantling the perverse mechanism of LEBAC, the government
could be generating a new risk, since it is encouraging the private sector to
compete in dollars – worse still, short-term dollars from the Treasury.

This
implies a substitution of debt in local currency for debt in foreign currency
and, if the climate of strong uncertainty were to remain, a greater pressure on
the dollar through the flight of small investors, on top of the flight of
institutional investors.

As a result, the Central Bank reserves have fallen sharply over the last
weeks at a rate averaging 500 million dollars per day as a consequence of a
massive shift of savers from LEBAC to dollars.

This decrease in reserves leads
us to the third aspect to monitor: the minimum level of reserves established by
the agreement with the Fund. Currently, Argentina is very close to
non-compliance.

As can be estimated by adding debt maturities and capital, and being
optimistic about the current account deficit and capital flight, an additional
4800 million dollars would be needed for 2018 and at least 14,200 million for
2019, especially between the months of March and June, just as the campaign to
renew executive posts begins, which makes it difficult to think about strong
adjustment policies.

So, what the Argentine government needs is not only for financial
support to be sustained, but also for it to be strengthened, which seems highly
unlikely given the persistence of the currency crisis, capital flight and the
current account deficit.

In such a context, the fragile stability of the Argentine market is only
guaranteed in the short term and only by the injection of dollars corresponding
to the first stage of the agreement with the IMF.

In the near future, even if
we were to assume that Argentina will meet all the agreement’s requirements,
IMF dollars will simply not be enough to meet the financing needs of the
economy.

Vice versa, if this flow were to be interrupted, it is very likely
that the country will enter the terminal stage in the crisis process which started
a few months back.