Post-pandemic recovery will need less FX restrictions

17th June 2020

By Matías Rajnerman

Post-pandemic recovery will need less FX restrictions

The COVID-19 pandemic aggravated all the problems that Argentina’s struggling economy was already dealing with. As a response, the Executive Branch implemented a series of expansive policies to attenuate the impact of the lockdown. Given that tax collection plummeted due to the decline in economic activity, and that Argentina has no access to credit since 2018, the increased deficit was financed through money printing, creating an oversupply of Argentine pesos.

</p> <h2><strong>Flight from the peso</strong></h2> <p>Despite the recession, the demand for pesos fell, helped by lower interest rates for peso deposits (as an example, the benchmark Badlar peso-denominated rate fell below 20 percent at the start of the lockdown, while inflation stood at more than double) and by a rise in uncertainty caused by the pandemic. With investors opting to buy US dollars instead, the <a href="">blue-chip swap rate jumped</a> from 90 pesos per dollar in mid-March to more than 120 per dollar in May, a 35 percent increase. Given that the official exchange rate barely moved during that same period, the <a href="">gap between the official and parallel exchange rate</a> reached 80% by mid-May, almost twice as much as before the lockdown.</p> <p>This dynamic helped heat up <a href="">devaluation expectations</a>, which are more closely tied to the value of the parallel exchange rate than the official rate or other macroeconomic fundamentals. This is why importers started anticipating inventory purchases and exporters tried to reduce their dollar sales as much as possible, adding pressure to the official exchange rate. To avoid a devaluation of the peso, the Central Bank sold more than USD 1.6 billion between mid-April and late-May, causing net Central Bank reserves to drop below the USD 10 billion threshold.</p> <p>By the end of May, the Central Bank decided to add new <a href="">restrictions to importers</a>. Among them were suspending access to the official exchange rate to companies that have USD-denominated assets outside of Argentina totaling more than USD 100,000, in a bid to try to conserve its dollar reserves. Although some caveats were added to this restriction over the last few days, securing access to dollars for agro-exporting and medical firms as well as for some SMEs, many companies are still excluded from making commercial transactions at the official exchange rate for the moment.</p> <h2><strong>Permanent or temporary restrictions?</strong></h2> <p>So will these new restrictions be seen as short-term or permanent? Its effects on economic activity and inflation depend on that answer.</p> <p>If they are temporary, then we will see a short-term plunge in imports, which companies could survive thanks to the inventories they have been accumulating, and which won’t be in high demand given the recession that is likely to continue in the coming weeks of continued lockdown. So firms could postpone some of their commercial operations until the situation is normalized.</p> <p>But if economic agents perceive that these new restrictions will be permanent, they will probably raise their prices, given that they won’t be able to access Central Bank’s cheap dollars to replenish their inventories.</p> <p>There is no clear private sector consensus on the answer to this question, so for the moment a combination of both scenarios could be expected. Inflation could go back near 2 percent monthly levels after three months of slowdown (April, May and, according to <a href="">Ecolatina&#8217;s forecasts</a>, also June), in which the CPI posted increases around 1.5 percent.</p> <h2><strong>Anti-exporting bias</strong></h2> <p>Sadly, the negative impact of these new restrictions does not end there. The restrictions have a strong anti-exporter bias, and will also generate unfair competition between companies.</p> <p>The anti-exporting bias is clear when looking at the fact that firms could be forced to import their necessary inputs at the blue-chip swap rate while exporting at the official rate. Given that it is impossible to push these additional costs to the international price of the products they sell, exporters will inevitably become less competitive.</p> <p>The unfair competition, meanwhile, will take place when some companies manage to comply with the new regulations, and thus access cheap US dollars, while others do not.</p> <h2>Unsustainable</h2> <p>If we leave all these negative effects aside, the Central Bank managed to <a href="">re-build its net reserves</a> in the first two weeks of June past the USD 10 billion threshold thanks to the restrictions. This has attenuated exchange rate pressures and devaluation expectations for the moment, but at a high economic cost. But what&#8217;s more important is that, <strong>if these restrictions persist, the chances of a post-pandemic bounce-back will be smaller</strong>.</p> <p>So there are two potential roads ahead in terms of exchange rate policy. In the first scenario, the Central Bank maintains the current regulations, which should help contain devaluation and loss of reserves, but accelerate the role that parallel exchange rates have on the economy. In this scenario, the official exchange rate could end the year at 85 pesos per dollar, barely a 40 percent depreciation throughout 2020.</p> <p>The Central Bank and the Economy Ministry say this will not be the case, as they argue restrictions are only transitory, saying they could be relaxed in a less adverse context, such as following the restructuring of the country’s debt and the end of the lockdown. In this scenario, although the “<a href="">clamp</a>” on foreign currency purchases would continue, it would not affect dollar purchases for commercial reasons, reducing the influence of parallel dollar transactions in the market. Such a flexibilization, however, would renew pressure on the official exchange rate, as many companies would regain access to it. As a result, one could expect a peso depreciation of 60 percent in the year, with the official exchange rate closer to 95 pesos per USD, but less restrictions to access it, which would create a higher chance for a post-pandemic recovery.</p> <p>To sum up, exchange rate tension in April and May led the Central Bank to tighten the restrictions for peso owners to access US dollars, taking it to a <strong>level of difficulty that makes the normal functioning of the country’s productive apparatus very high</strong>. After a debt renegotiation and lockdown easing, we will now see whether the money-printing shock has led the country to adjust its foreign sector through price hikes or quantity restrictions. What is sure is that, one way or another, this will in the end translate into inflation.</p> <p>

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Matías Rajnerman

Matías Rajnerman is the chief economist of the Ecolatina consultancy agency. With Lorenzo Sigaut Gravina they run Ecolatina's economic research team.