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Over the past few months the Argentine government has introduced a number of formal and informal controls on foreign-exchange purchases aimed at preserving the trade surplus and international reserves. Importers are required to obtain government authorization before purchasing U.S. dollars. The central bank must approve dividend and profit remittances overseas. Foreign-exchange purchases for tourism purposes require an extensive list of documents. And, while in the early stage of these controls the government assigned quotas (albeit non-transparent) for Argentines seeking to purchase U.S. dollars for savings, this transaction is now virtually impossible.
The controls, together with the uncertainty related to the YPF nationalization and the strains in the euro zone, have triggered a run to the USD in parallel markets: the so-called “blue” and “blue-chip swap.” Through the “blue,” Argentines are able to purchase USD bank notes on shore. Using the “blue-chip swap,” residents can receive USD in an off-shore account. The exchange rates in both markets have weakened significantly over the past two months. Furthermore, many have started to withdraw their USD deposits, fearing a forced "pesification."
The government now faces a dilemma. Because the exchange-rate is the economy’s nominal anchor, devaluation would bring inflation to even higher levels. On the other hand, maintaining the current slow pace of exchange-rate depreciation and resorting to controls is significantly hurting the economy: the overvaluation is hitting exporters, while controls are causing supply-chain disruptions and lowering confidence. Furthermore, the depreciation in the parallel markets could raise inflation expectations further, undermining the government’s goal of keeping inflation in check.
We explore five possible scenarios for the exchange-rate market in Argentina:
1) The most efficient solution would be exchange-rate devaluation, interest-rate increase and fiscal tightening. We see this as the only long-term solution to the competitiveness issue and to keeping inflation from rising at the same time. However, this solution seems to be the least appealing to the government. The “orthodox” nature of these policies will likely make them unacceptable from a political standpoint.
2) The government opts for leaving the current policies (controls, slow exchange-rate depreciation and expansionary fiscal and monetary policies) unchanged. In this scenario, inflation will increase further as the official exchange rate loses its role of price anchor and spreads in the “blue” markets rise. The reserves will fall (through the withdrawal of USD deposits) and growth will continue very sluggish: supply-chain disruptions will continue, real exchange-rate will get even more over-valued and USD export pre-financing will disappear together with the USD deposits. In our baseline scenario the government insists in the current set of policies, but a run to the parallel markets triggers more moderate policies (government looses controls and increases the pace of exchange-rate depreciation, interest rates rise and the fiscal deficit is reduced) at some point in this year. However the government may try to postpone adjustments by exploring some other “unorthodox” policies, described in the scenarios below.
3) The government could sell USD in the “blue” market. Although the drop in the “blue” spread could help keep inflation expectations in check, we believe that the government is unlikely to move in this direction. First, the “blue” market is not legal. Moreover, the central bank would lose reserves in order to supply USD in the parallel market.
4) The government could deepen the “blue-chip swap” market. This scenario is similar to the previous one (#3). Purchasing USD for savings would remain virtually impossible at the official exchange rate. The central bank or the treasury would intervene in the “blue-chip swap” market by selling USD-denominated bonds in the domestic market. Argentines seeking to save in USD would go to this market. However, Argentina’s commodity wealth is much lower than that of Venezuela, so the ability of the Argentinean government to increase its USD-denominated debt is limited, particularly considering the current market conditions. We therefore also see this scenario as unlikely.
5) Finally, the government could implement an official dual exchange-rate market. This would include a “financial exchange-rate” designed for savings and other USD transactions. This exchange rate would be set at a weaker level than the exchange rate for trade purposes. This arrangement would allow a number of transactions that cannot be carried out under the current controls. The gap between the two exchange rates would have to be managed carefully in order to prevent arbitrage opportunities. Some government officials back this idea and we see it as much more likely than alternatives #3 and #4.
João Pedro Bumachar Resende
Juan Carlos Barboza