Argentina Is Struggling To Avoid A Deeper Recession

Mar. 26, 2019 7:49 AM ETARGT4 Comments
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Summary

  • The deepening of the recession calls for the loosening of the monetary policy; however, the inflation rate is still very high and not in a clear decelerating path, thus raising the risk of extreme volatility in the local currency.
  • The IMF and Argentine authorities reached an agreement in March 2019 after the third review that requires a severe/faster fiscal spending adjustment aimed at reinforcing the SBA approved in 2018.
  • The economy is in recession, and confidence in the government's ability to push through severe adjustments is still weak. Breaking away from the vicious cycle of high devaluation and high inflation has proven quite difficult.

The Argentine peso showed appreciating pressure in January 2019, dropping below the Central Bank's (Banco Central de la República Argentina: BCRA) no-intervention range and prompting the bank to purchase hard currency and to relax monetary policy. However, the monthly inflation rate re-accelerated in February, leading the annual rate to be above 51%. Meanwhile, the manufacturing sector posted a double-digit annual decrease in January. The tight credit conditions, the high cost of inputs, and the reduced demand are taking a toll on economic activity.

Faster monetary policy easing, déjà vu?

In December 2017, monetary authorities acknowledged their inability to reduce the inflation rate to the target and increased the target range; at the same time, the BCRA reduced the monetary policy rate. The sudden decline in the value of the Argentine peso in the first week of May 2018 prompted a series of measures that included raising the monetary policy rate to 40%. The government negotiated a Stand-by Arrangement with the International Monetary Fund (IMF) and secured funding. Nonetheless, the confidence crisis deepened, and the peso depreciated further in August-September 2018. The fast pass-through of the depreciation onto domestic prices quickly hiked up the consumer price index. The BCRA increased the policy rate to 60%. In addition, it changed its strategy to control liquidity by committing to freezing the monetary base (high-powered money) and by moving away from the USD-denominated instrument LEBAC to a peso-denominated LELIQ (which are short-term BCRA bills with rates currently determined by supply and demand for liquidity).The rollover of these instruments and the high interest rate have led to the significant increase in the amount of LELIQs in the past five months.

The urgency to reignite economic activity led to a rapid downwards adjustment in the LELIQs rate in mid-February 2019 (from 52.4% to 43.9%); in turn, like a knee-jerk reaction, the

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