Between the last week of April and the first week of May, the Argentine peso devalued over 11% despite the intervention of the Central Bank (BCRA, in Spanish) in the foreign exchange markets. Indeed, the BCRA had previously signaled that it would intervene more aggressively in the exchange rate market to reduce the depreciating pressure, and effectively put a ceiling to the exchange rate at ARS21/USD1. Nonetheless, the peso hit its lowest level on May 3, at ARS23:USD1, despite the hike in the monetary policy rate by 300 basis points on April 27; the policy rate was raised by another 300 basis points on May 3 and by an additional 675 basis points effective May 7 (that is, from 27.25% on April 26, 2018, to 40% on May 7, 2018, which in turn is higher than the 38% policy rate at the start of the Macri administration in December 2015).
In addition, Macri's economic team announced the reduction of the foreign exchange reserve requirement for banks, from 30% to 10%, and a significant reduction to the fiscal deficit target for 2017, from an initial 3.2% of GDP to a 2.5% of GDP, which will imply scaling down the ambitious public sector infrastructure spending plan at least in the short term. The Macri government also started the process to secure a credit facility with the IMF to ensure investors that liquidity will not be a problem in the short term.
The previous depreciating pressure episode came after the BCRA relaxed its inflation targets for 2018-20 in December 2017. This came after missing its inflation target in 2017 (set to a 17% annual average, while the actual annual average was 25.4%). The BCRA changed the target from a 10% +/- 2% annual average in 2018 to an annual inflation target of 15% for December 2018, 10% for December 2019, and 5% for December 2020; pushing back a year the timeline to reach its single-digit annual inflation goal. The BCRA had reduced the rate 150 basis points to 27.25% (in two steps from the 28.75% at end 2017) in January 2018.
Outlook and implications
Is the worst over? The series of measures taken by the economic team brought some relative calm back to the foreign exchange market. However, volatility is expected to continue as external factors, driven by geopolitical events, will continue having an impact on emerging markets' currencies, and the international market has signaled that despite supporting the policy direction of the Macri government, much work remains to be done to be on a solid footing. Indeed, the market sensed some weakness in terms of the possibility of scaling back utility and transportation tariff adjustments initially programmed for 2018 in order to appease the population. In addition, the country's inflation rate is not yet in the target path, but keeping a 40% monetary policy rate for an extended period of time would hinder economic activity and goes against the central bank's earlier aim to reduce the incentives to park capital in the public bond sector and rather reallocate it to the wider economy; in addition, it's not sustainable, as it would drain fiscal resources.
On the other hand, massive cuts to the policy rate in the very short term could bring more currency speculative episodes. Moreover, this could be a moment of make it or break it for the Macri administration, given that the sudden loss of confidence on the peso has increased the country's overall risk. Bringing back confidence on the policy direction and the economic team's ability to tackle challenges is a must to solidify the changes made so far and keep the current positive economic outlook; the key items continue to be the country's inflation rate and fiscal deficit.