Beyond the exchange and monetary point of no return?

When there is a technical problem in an airplane before takeoff, a signal indicating that something is wrong begins to be heard. From there It is essential, first, that the pilots listen and do not ignore the issue and, then, that they make the appropriate decisions to avoid reaching a dreaded “point of no return”. Today the Government finds itself in a situation analogous to that of an emergency on an aircraft, with respect to the dynamics of international reserves and Leliq, the notes that the Central Bank (BCRA) uses to withdraw pesos from the market, pesos that it issues through another window to finance the Government. It is close to, if not already past, the point of no return. Either the government makes a brutal fiscal adjustment that allows it to completely eliminate financing from the Central Bank, or the dynamics of the Leliq will become unsustainable.

Let’s see the magnitude of the problem. The number of Leliq increased substantially during the mandate of Alberto Fernández. It went from 1.1 billion pesos on December 10, 2019 to 7.2 billion now. Measures in today’s pesos, that is, adjusted for inflation, doubled. Measured in dollars, Leliqs have risen from around $20 billion to more than $50 billion now. Measured as a percentage of GDP, they reached close to 10%, compared to 4.2% at the end of Mauricio Macri’s presidential term.

The cost of the interest of the Leliq became more and more onerous. It went from 2.7% of GDP in 2021 to an estimated 4.4% this year. The increase of the Leliq is the counterpart of the disorderly monetary financing of the Central Bank to the Government, which reached 7.4% of GDP in 2020 and 4.7% in 2021. The agreement with the International Monetary Fund (IMF) was supposed to restrict it to 1% of GDP in 2022. However, by July it already accumulated the 2.6% of GDP, if we add the issue of money used to buy government bonds in the market.

A feature of the monetary policy has allowed the Leliq to not become explosive so far: the interest rate paid by these instruments is lower than the rate of inflation. That is, inflation is liquidating them. But this policy of negative (inflation-adjusted) real interest rates, typical of populist governments, is coming to an end, at the behest of the agreement with the IMF. so far this year, The Central Bank raised the Leliq rate sharply: from 48.2% to 96.5%.

When the Indec publishes the inflation for August, which will exceed 6% per month (almost 77% year-on-year), it is likely that the Central Bank will have to readjust the Leliq rate to further cool down the economy. If the government wants to prevent inflation from continuing to rise and reaching triple digits at the end of 2022 or in 2023, rates will have to go above inflation at some point.

and that’s when the magic of the Leliq’s liquefaction will end. At that point, either monetary financing to the public sector is stopped and, thus, new Leliq is avoided to remove those pesos from the economy, or the dynamics of the Leliq will become unsustainable. Sooner or later, the Central Bank would have to restructure them, or it would have to liquidate them with an inflationary and exchange rate jump, as Luis “Toto” Caputo did in 2018. When he assumed the presidency of the Central Bank, on June 14, 2018, the market he did not want to renew the Lebac, the predecessor letters of the Leliq. What Caputo did was let a large portion of them expire. Lebac’s total fell by $406 billion to $775 billion on September 25, 2018, when he left office. The cost was tremendous. The monetary issue jumped, as well as inflation, which went from less than 3% per month before June to 6.5% in September. The peso depreciated 55% against the dollar, to $38.4, in just over two months.

The fiscal/monetary alarm sounds, but at least someone is pushing some buttons. The fiscal result for July, with a much lower deficit than in previous months, plus the savage adjustment that Economy Minister Sergio Massa is implementing in areas such as education and housing, generate some expectation that the Government would be taking the initiative to reduce the fiscal deficit, although the result of the maneuver is still uncertain. Instead, where all the alarms sound, but the Government still does nothing, is in foreign exchange and reserves. Although the Central Bank has been buying dollars in the market since August 10, what it has accumulated is very little, and it has lost US$533 million in the foreign exchange market in August. And reserves fell US$1.23 billion in the month.

This recent accumulation also has a lot of fictitious: importers are receiving very few dollars. Its situation at this point is desperate: in the first semester its commercial debts with foreign creditors increased by US$6 billion. That is, real imports were US$6 billion higher than imports paid abroad in the first six months of 2022.

With this fiction of earning reserves kicking import payments, Massa is going to have a very difficult job convincing the IMF that the deal is on track. Net international reserves (of Central Bank liabilities) were supposed to increase by US$650 million in the third quarter, but They have been falling by more than US$4.3 billion. The Central Bank today has very few dollars, which makes the maturities coming with the IMF itself even more dramatic: US$2,855 million in September and US$2,799 million in October. If the IMF does not disburse the 3,000 million Special Drawing Rights (SDR), equivalent to about US$3,900 million, corresponding to the revision of the goals of the program for the second quarter, there will be no dollars to pay you when due in October.

The IMF knows that Argentina has already passed the point of no return with its reserves, and very likely put pressure on the government to devalue the peso. Or, at least, to formally double the exchange rate in a commercial and a financial market, although also with some depreciation of the commercial one, in order to gain international reserves.

However, in the renegotiation of the program, the IMF technicians should already be clear that Massa’s objective is not to resolve the imbalances of the Argentine macro, but only to avoid a mega-crisis before December 2023 and throw the problems to the next government. He said it himself, in a Freudian slip. In his first meeting with leaders of the Liaison Table of the agricultural sector, He told them that he will not be a candidate in 2023 and that he could be in 2027. His unconscious must have reasoned thus: “I imitate Axel Kicillof and leave a bomb that is difficult to disarm the next non-Peronist government, causing it to fail, and I will return, as president, in 2027.”

In any case, Massa’s biggest problem is not the IMF, but local economic and political dynamics. If it were partially successful in its management and managed to stabilize the reserves and the monetary dynamics, it would generate a recession. His problem is that this is the best scenario he faces for the next few months. It is that, to comply with the fiscal program, primary spending (without interest) has to contract 6.7% in real year-on-year terms in the second half, compared to expansions of 9% and 10.8% in the second half of 2021 and the first of 2022, respectively.

Added to the parate of fiscal spending is a prohibitive interest rate, tax advances for companies and restrictions on imports. The recession is just around the corner. In July, industrial production contracted 2.9% compared to June, according to FIEL. As I mentioned in previous columns, the international environment is unlikely to help the Argentine economy in the coming months. With the dollar so strong against the euro and other currencies, commodity prices are going to come under pressure. And, after we were few, the drought brought by La Niña for the third consecutive year threatens the 2022/2023 harvest.

The recession is going to increase the pressure from his political partners for Massa to expand public spending, which would jeopardize his partial success in stabilizing reserves and the dynamics of the Leliq.

The IMF and these imbalances will make it very difficult for him to repeat Kicillof’s trick in 2015, when he delayed the exchange rate and greatly expanded public spending. That would be today, in terms of our analogy, like speeding up the plane with the alarm going.

The Argentines today have a pilot and a co-pilot who accelerate to the crash, worried about their personal problems, and who do not allow the flight engineer – who in any case seems only concerned about being promoted to pilot – to touch all the buttons to that the Argentine economy avoids a colossal accident.

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