Economy

The future of the “clamp” on currency trade

7th May 2020

By Martín Trombetta

The future of the “clamp” on currency trade

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As it happened several times throughout its history, Argentina’s foreign sector has gotten more complex than foreign watchers might be used to, with the return to a multiple exchange rate regime that is a rarity elsewhere in the world. With the “clamp” reinstated in September and the 30 percent “solidarity tax” on currency purchases created in December, the economy is back in a situation where a dollar is bought at 67 pesos for import purposes but the price is much higher if the buyer simply intends to save.

</p> <p>With currency trading at the official price significantly restricted, the <a href="https://gettheessential.com/economy/2020/04/09/argentinas-bankruptcy-becomes-more-clear-by-the-day-default-payroll-delays-firings-money-printing">renewed pressure against the peso</a> during the coronavirus pandemic was channeled through those alternative dollar rates, which soared to a peak of 120 pesos per dollar last week. The resulting <a href="https://gettheessential.com/economy/2020/04/30/graphic-pandemic-curbed-while-economic-threats-soar">gap</a> between official and parallel exchange rates, now above 70 percent, is a cause for growing concern, as the economic distortions it brings grow bigger by the day.</p> <h2><strong>Some history</strong></h2> <p>Multiple exchange rates are far from a novelty in our country. They always arise as a natural consequence of capital controls, a tool Argentine governments have resorted to time and time again. The aim is usually to guarantee low prices for imports, which may benefit companies and consumers alike in the short term, as it makes many key products cheaper, including capital goods and energy. When the “commercial” exchange rate becomes fixed and restricted, a somewhat-illegal “financial” exchange rate inevitably appears—a history of high inflation has created a permanent demand for dollars which will always find its supply.</p> <p>Though capital controls are usually deemed a kind of “last resort”, to be applied only in times of financial distress, this has not always been the case. In fact, the Kirchnerite clamp was established by the end of 2011, with the economy growing and the financial sector still in decent shape. The reasoning at the time was that what then came to be known as the “clamp” would hurt consumers less than allowing a devaluation.</p> <p>Lifting those controls was one of Macri’s 2015 campaign promises, and he did so in expedient fashion immediately after taking office. But by the end of his mandate, he had to reinstate them, putting even harder limits in place, this time clearly as a response to a critical situation — the government had tried everything, including defaulting on peso-denominated debt, before it was forced to come back to the tactic it had once campaigned against.</p> <h2><strong>Fails for outflows, works for inflows</strong></h2> <p>The goal of making imports cheaper for productive purposes is usually achieved, though at a sizable cost. The fact that exporters only receive a fraction of the financial value of their dollars is a strong disincentive on exports—or even worse, an incentive for smuggling and under-billing. High imports and low exports mean current account deficits, so the cocktail usually involves <a href="https://gettheessential.com/economy/2020/01/23/will-this-time-be-different-for-argentinas-import-restrictions">restrictions on imports</a>, leading to a more closed economy.</p> <p>But that is not the end of it. Foreign direct investment virtually disappears, as nobody is interested in putting their money in an economy if taking it out of which implies a 70% capital loss. At the same time, underground currency exchanges flourish and become one of the most profitable businesses around (you would not think all those people yelling “<em>cambio</em>” in pre-pandemic downtown Buenos Aires were doing it for free, would you?), making inefficiencies in Central Bank reserve management inevitable. Big companies frequently find ways to overbill their imports, <a href="https://gettheessential.com/economy/2019/10/03/service-exports-argentina-crisis-resistant-room-to-grow-devaluation">professionals</a> try to benefit from Fintech to keep a part of their income where no solidarity tax can reach it and other tricks to dodge the official exchange rate appear at the heart of the economy.</p> <p>Preventing <strong>capital outflows</strong> essentially does not work. Legally or illegally, savings find their way out, while the financial system shrinks and the real economy suffers. Economy Minister Martín Guzmán seems to support this view, but at the same time, he deems the current situation too fragile to risk transitioning to a free-floating exchange rate. The fact that large exchange rate movements always translate into macroeconomic instability has accounted for our traditional “<a href="https://www.jstor.org/stable/2696430">fear to float</a>”.</p> <p>On the other hand, it is true that milder alternatives to clamps exist. In fact, many developed countries feature capital <strong>inflow restrictions</strong>, such as minimum stay requirements. This is even the case of Chile, the country usually seen as the <a href="https://gettheessential.com/economy/2020/02/06/will-protests-mark-the-end-of-the-chilean-model-economic-hegemony">market-friendly landmark in Latin America</a>. Many specialists agree inflow restrictions have proven successful in reducing exchange rate volatility while causing little or no harm to investment. If “hot money” is considered a source of instability, it might be best not to let it in in the first place, rather than vainly trying to make it stay when things go south.</p> <h2><strong>Pandemic crossroads</strong></h2> <p>If something is different this time, it is the fact that controls and restrictions were conceived as a medium-term economic policy rather than an emergency measure. Fernández’s economic authorities believed since the start of their term that controls were here to stay, at least until Argentina reached a sustained growth path. But the economic crisis has grown over the last few months, so the problems of those controls could also get bigger.</p> <p>The overvaluation of the official exchange rate is one of these problems — sooner or later inflation will make the commercial rate too cheap and current account deficits will be a problem. The pandemic however has slowed down demand for dollars in sectors such as foreign tourism, which will bring some current account relief, but with commercial partners such as Brazil devaluating strongly, it’s not clear how long that could last.</p> <p>The fear of a floating exchange rate should not be dismissed as merely irrational. Nominal stability can be a valuable asset in these times of uncertainty. The transition to a free floating system will come with costs, so it might be a good idea to wait until the right moment to make that choice.</p> <p>So far, authorities have gone in the opposite direction, hardening some of the restrictions last week. The risk is that, with capital controls, it is the financial exchange rate that usually sets the pace that the official rates then follow. The government will have to be clever and bold to decide what to do with the pressure that is building up below the surface.</p> <p>

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Martín Trombetta

Martin Trombetta holds a PhD in Economics from Universidad Nacional de La Plata, a research grant at the CONICET institute, and teaches at the Universidad Argentina de la Empresa (UADE). His publications have focused on labor markets, income mobility, gender gaps and other topics.