Appreciating pressure in January 2019 for the Argentine peso emerged, dropping below the Central Bank’s no-intervention range, encouraging the bank to repurchase hard currency and relax the monetary policy.

Meanwhile, their manufacturing sector posted a double-digit annual decrease in January. Also, in the following month, the monthly inflation rate re-accelerated leading to an annual rate above 51%.

The tight credit conditions, the high cost of inputs, and the reduced demand are taking a toll on economic activity.

Faster monetary policy easing

At the end of 2017, monetary authorities admitted their inability to reduce inflation to the target and increased the target range; at the same time, the Central Bank reduced the monetary policy rate. The sudden decline in value of the Argentine peso in May 2018 led to a series of measures including raising the monetary policy rate to 40%.

The peso continued to depreciate further in August and September 2018 and led the Central Bank to raise the monetary policy rate to 60%. In addition to, the country head into peso-denominated liquidity letters (LELIQs); rollover of the said instruments and their high interest rate have led to an accumulation in amount of LELIQs in the past five months.

Urgency to reignite economic activity led to a rapid decrease in the LELIQs rate from 52.4% to 43.9%, mid-February 2019. In turn, the peso weakened quickly. Despite the exchange rate being within the no intervention range, the Central Bank intervened and sold hard currency.

Moreover, failure to lower the monetary policy rate, monetary authorities continued to tighten the monetary policy and at the moment, the LELIQ rate is at 66.65%. These extreme interest rates are keeping credit in local currency down leading to an increase in dollarisation of credit in the banking system.

Finding the right mix of policies is a challenge

Authorities would like to reduce the incentive to park capital in the Central Bank’s instruments but the expectation of a remaining high inflation rate requires a tight monetary policy approach despite the deep recession.

The inevitable is that, should utility tariffs and other regulatory items increase in price and annual wages are adjusted, inflationary pressure will remain.

Furthermore, although the annual inflation rate is expected to gradually decelerate, it will remain above 40% until the third quarter of 2019. Parting ways from the vicious cycle of high devaluation and high inflation has proven quite difficult.

Bleak outlook

Macri’s administration is under pressure to restore economic growth especially before the upcoming October election.

The risk of loosening the monetary policy too fast, before the inflation rate is on a more sustainable path, has temporarily diminished since the February currency volatility; however, it is still significant, and it will expose the country's vulnerabilities that have not been broadly dealt with since the 2018 confidence crisis.

In March 2019, the IMF and Argentine authorities reached an agreement after the third review that requires a faster fiscal spending adjustment aimed at reinforcing the Stand-by agreement. However, social spending and subsidies to the private sectors are major sources of budget pressure, and are not expected to be fully tackled in the short term given the upcoming elections.

If Macri is re-elected, some tweaks and recalibrating of the current policies are expected, but not necessarily a full reform in terms of social spending. The outlook beyond 2019 is bleak.

Disclaimer: This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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