Argentina’s central bank announced an increase in the repo rate from 24% to 27%.
This is the second increase in a month: on October 1, the Argentine Central Bank raised the rate by as much as 5 percentage points, from 19% to 24%.
The increase in the repo rate is primarily aimed at limiting borrowing by banks. Yes, this is a restraining monetary policy, but the Bank of Argentina is forced to resort to this measure due to the fact that all possible economic agents are actively converting the domestic currency into dollars.
Moreover, this is happening despite the restrictions introduced by the Central Bank of Argentina. The country has introduced taxes on currency exchange: individuals cannot buy more than $ 200 per month. Moreover, despite these measures, the volume of purchases of foreign currency per month has been steadily growing since March.
After the first increase in the repo rate at the beginning of the month, the peso fell by 1.2% and so far, there are no signs of its recovery. The population does not trust national currency at all and tries to invest in dollars whenever possible. The reason is that the Argentine government finances the budget deficit with money emission. This is not surprising, because borrowing when the annual yield on 10-year bonds is 15% is not possible for a country with a government debt-to-GDP ratio exceeding 100% by the end of the year.
What does all this mean?
The second rate increase in such a short period of time suggests that the Central Bank of Argentina is not able to control the situation. Mistrust in the peso is only growing, especially if you keep in mind the huge national debt in the country and the fact that inflation is already over 40%. Moreover, for many years already, the GDP in this country has been falling: in 2018, the fall was 2.5%, in 2019 – 2.2%, and by the end of this year, a decline in GDP is projected at 5.7%.
There are really big risks today: the depreciation of the peso will result in even larger problems for the economy. Within a week, the IMF is likely to offer Argentina another support program, but it is far from the fact that this will be enough.
Two things are clear to us about the Argentine economy:
- The government will definitely continue to print money to cover the budget deficit.
- The population will continue to get rid of the peso.
Treat the disease itself, not the symptoms.
Measures such as limiting capital flows and raising rates have short-term effects. Dollarization is a symptom of an unstable fiscal system and distrust of the currency. The central bank is failing to bring the situation under control.
One conclusion can be drawn: no IMF will help until the country does really hard work reforming fiscal policy. Without fiscal discipline, nothing will help and the peso, alas, will continue to fall, despite the restrictions from the Central Bank.
So the trouble spots: Turkey, Argentina, … who else is ahead? The accumulation of such points increases systemic risk and can lead to a shift from quantity to quality. Another 2-3 cases of similar problems with debt and currency in emerging countries and everything may well end in massive capital flight from developing countries.
The most serious attention should be paid to the currencies of emerging markets since it is the exchange rate that is an indicator of the stability of the country’s debt and the confidence of agents in the currency.
