Are Argentina's Multiple Exchange Rates An Arbitrage Opportunity?

by: Jaime Campo

Summary

Argentina is a frontier market that has suffered from poor economic policy making and economic instability for more than a decade.

Although GDP growth has been strong for much of the last decade, imbalances are choking the economy as inflation rises, fiscal deficit widens, and international currency reserves fall.

In 2011, the government imposed a limit on currency exchanges in order to prevent international reserves from falling further.

In response, demand has developed creative ways to convert Argentinean pesos into U.S. dollars in different markets at multiple exchange rates.

For the adventurous investor, this may create arbitrage opportunities.

A policy of limits on international currency exchanges has been in place in Argentina since 2011. Individuals and companies have to go through lengthy bureaucratic processes in order to obtain permission to buy U.S. dollars and other currencies, many times with negative results.

This limited supply, in a country with high inflation where individuals have a long-lasting habit of saving in U.S. dollars and most companies, both foreign and local, have a policy of putting cash reserves in international banks, has created an excess demand for international currencies (we will use the U.S. dollar as it is the most traded currency).

This has resulted in the appearance of several markets for the U.S. dollar, which trades at different prices in each. We will analyze each of these markets and then focus on the one that may interest international investors the most. As always, when the same good trades at different prices in different markets, arbitrage opportunities arise.

First is the market established by Argentina's Central Bank that sells very limitedly to companies that need to pay imports and wire dividends. As of last Friday's closing, the bid and ask for the U.S. dollar in this market were 8.79 and 8.89 Argentinean pesos per U.S. dollar. However, this market cannot be taken into account by investors as supply is extremely limited and only selected entities can buy. Price is managed by the Central Bank, and the trend has been towards a slow but continuous depreciation of the peso. For individuals who want to buy U.S. dollars for savings reasons, a very small amount is available each month at a 20% premium over the official asking price. As of last Friday, the price of this retail dollar was 10.67 pesos per U.S. dollar. Average daily volume last week for this official market was USD 192 million.

Second is the market that arose as an immediate response to exchange restrictions: the black market. This is a small market in comparison, and it is operated mainly by individuals. As of last Friday, bid and ask for this market were 12.59 and 12.79 pesos per U.S. dollar for a 44% spread from the official exchange rate. The analysis of this market is useful only in the sense that it reflects the general public's expectations of what the U.S. dollar should be worth if a free market existed.

The third market is the most interesting of all, as it was developed as a legal alternative for buying U.S. dollars in unlimited amounts. Operators in this market are generally sophisticated investors and companies. The mechanism exploits the availability of securities that trade both in Argentinean pesos and U.S. dollars. Investors who want to buy U.S. dollars buy a security (bond or share) with quotations in both currencies using pesos and simultaneously sell that security at its U.S. dollar quotation. Conversely, investors who want to sell U.S. dollars can buy a security with U.S. dollars and sell it at its quotation in pesos. The particularity of this market is that it is subdivided into many small markets, as each security with double quotation is a market in its own with an implied exchange rate. Most of the time, these quotations are arbitraged by local operators to deliver the same implied exchange rate. Sometimes, however, these opportunities appear for small patient and adventurous investors.

Security Name Ticker Category $ Peso Quotation (in AR$) U.S. Dollar Quotation (in USD) Implied Exchange Rate (AR$/USD)
Boden 15 RO15EXT Sovereign bond 1,168 98.75 11.82
Bonar 17 AA17EXT Sovereign bond 1,150 96.7 11.89
YPF S.A. (NYSE:YPF) Common stock/ADR 358.5 30.15 11.89
Tenaris S.A. (NYSE:TS) Common stock/ADR 188 31.40 11.97 (adjusted)

For an arbitrage opportunity to exist, a determined profit must be locked in at execution with zero risk. This trading strategy may, in certain cases, involve risks such as sudden price changes while positions are open and clearing delays. However, we believe these multiple exchange rates create an environment in which enterprising and patient investors, who are adventurous enough to consider this exotic investment destination, may find true arbitrage opportunities.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.