According to a study published by the Fed, Argentina is the emerging economy with the most fragile reserves in the face of the new rate hike cycle in the US

The shortage of reserves is one of the main reasons for Minister Batakis

A study published by the Dallas Federal Reserve, which is part of the Fed system, warned that Argentina and Turkey are the emerging economies with the least “adequate” or most fragile reserves to withstand the rise in interest rates that started the US Central Bank.

The general tone of the study is optimistic, since it indicates that In general, the emerging markets are prepared to resist the new cycle of rising interest rates, the strongest in the last three decades. In this regard, the report states that in the last 3 meetings the Fed increased the federal funds rate by 1.5 percentage points and that the increase is expected to total 3.25 percentage points throughout 2022.

Such an increase, they say J. Scott DavisDallas Fed Senior Economist, Michael Devereuxprofessor at the University of British Columbia, and changhua yuprofessor at Peking University (China), would be a quarter of a point higher than the increase of 3 percentage points that the Fed made between February 1994 and February 1995 and that caused the so-called “Tequila effect”, first in Mexico and then in Argentina.

In the last 3 meetings, the Fed increased the federal funds rate by 1.5 percentage points and the increase is expected to total 3.25 percentage points throughout 2022

The last increase in that cycle was 75 basis points (0.75 percentage points) in November 1994 and triggered the crisis in Mexico, which in the previous stage had accumulated excessive debt, suffered from political instability and maintained a “untenable”. That is why, say the authors, those 75 basis points of increase were the “final jolt” that led to the tequila shot. The Mexican peso, which had depreciated barely 8% throughout 1994, lost more than 40% of its value between December of that year and March 1995, and interest rates on Mexican bonds increased from 10 to 14 % to about 70 percent.

From gradualism to shock

Why, if during the rate hike cycle the Mexican currency had barely devalued, did it collapse with the new increase, asks the report, and resorts to a couple of models about possible “equilibria” when countries get into debt. In such cases, they say, “even a modest increase in the interest rate” can produce a sudden stop in external credit, forcing the economy into a “new equilibrium” of less credit, devaluation and falling consumption.

The account of "adaptation" of reserves shows negative results only in the cases of Argentina and Turkey
The reserve “adequacy” account shows negative results only in the cases of Argentina and Turkey

Not all emerging economies, the authors explain, went into crisis in 1994 and 1995. The Mexican collapse (and the Argentine crisis) at that time was due to two factors: excess debt and insufficient reserves for the Central Bank, selling part of them, stabilize the local currency. According to pablo guidottiFormer Argentine Treasury Secretary, in order to do so, the reserves must cover at least one year of maturities, a rule adopted in a speech by the then head of the Fed, Alan Greenspan, and that the authors call “the Guidotti-Greenspan rule”.

Based on that criterion, the paper studied how adequate the international reserves of a series of emerging markets were, at the end of 2021. As seen in the graph above, the countries analyzed have “adequate” reserves to face the current rate hike cycle, except for Argentina and Turkey, countries that, says the report, have a high debt stock and a low level of reserves. Hence, the “adequacy” of reserves is negative: the sum of reserves and the current account balance does not cover short-term foreign currency maturities (up to one year). The balance is close to -4% of GDP in the Argentine case and –1% in the Turkish case.

The balance is instead positive for Latin American countries such as Chile, Colombia, Brazil and Mexico, it is also positive for China, India, Indonesia and the Philippines, and it is very high for Russia and Thailand. It should be noted, however, that the data is from the end of 2021, so the degree of “adequacy” of Russian reserves does not account for the sanctions following the invasion and military aggression against Ukraine.

In the Argentine case, moreover, the agreement with the IMF was signed in March of this year and, if maintained, implies the advance of funds for the payment of maturities before the institution itself. In any case, the study -not attributable to the Fed as such, as clarified at the bottom of the document- is another evidence of the scarcity and fragility of Argentina’s reserves, despite the very favorable international terms of trade and several years consecutive consecutive years of trade surplus, the main component of the “current account”.


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