The Argentine peso (ARS) has depreciated by approximately 20% since August 30. This is an even sharper short-term depreciation than May and June’s peso crash and raises further concerns about Argentina’s economic outlook and the probability of policy continuity after 2019’s presidential elections.
Summary of latest events (as of September 6)
While the Argentine government has been explicit in its commitment to the conditions laid out by the IMF, markets casted doubts on whether Macri’s administration would be able to carry on with the necessary economic adjustments, and honor debt commitments in 2018 and 2019. Investor fears were confirmed on August 29 when Mauricio Macri announced on live television that he would ask the IMF for access to the entire USD 50 billion line of credit up front. This all happened in a worsening external environment characterized by a risk-off attitude towards financially vulnerable emerging markets (e.g. Turkey), which raised the level of scrutiny and attention to Argentina.
What sparked the peso’s depreciation the week of August 26th was the fact that Macri’s announcement essentially confirmed investors’ fears that 2019’s financing gap was larger than anticipated. The peso’s depreciation then became a cascading effect as domestic investors began selling pesos for dollars in haste, fearing another peso crisis. Foreign investors, sensing this fear, also began to accelerate selling pesos and peso-denominated assets.
However, MNCs should understand that so long as the IMF continues to back the Macri administration – which FSG views as highly likely – then the Argentine government will have enough financial support to finance government operations until 2020. In an attempt to satisfy investors and to show the IMF their commitment to hitting the targets outlined by the original agreement, Macri announced several measures on September 3:
- More aggressive primary fiscal targets: The Macri administration will strive to reduce the primary fiscal deficit to zero by 2019 (from a previous goal of 1.3% of GDP) and achieve a 1.0% surplus in 2020 (from a previous goal of a 1.2% deficit). Reducing the fiscal deficit will help reduce the need for external financing in the medium term, which is a positive because investors were becoming more and more concerned about Argentina’s external debt levels
- Greater government spending cuts: The government will slash next year’s capital spending by 27% in 2019. They also eliminated or merged nine of the 19 government ministries, thereby lowering public administration costs. However, the government has guaranteed that they would increase social spending in real terms. This will help to act as a social safety net to the most vulnerable parts of the population
- Introducing or reinstating export taxes: Agricultural exports – including soy, corn, and wheat exports – will now be taxed four pesos for every dollars of exports (which equates to about 10 cents on the dollar, or a 10% effective tax rate). Industrials and services will be subject to a tax of 3 pesos on the dollar (which equates to about 8 cents on the dollar, or an 8% effective tax rate). The government plans to collect extra revenues of about USD 1.5 billion by December 2018 and approximately USD 11.4 billion in 2019, about 2.3% of GDP
Multinationals should expect a sharper reduction of economic activity as a result of these measures. The government is making it clear that they are willing to sacrifice economic growth in 2018 and 2019 if it means financial sustainability in the medium- to long-term. This means that government demand will be contractionary this year and next. Furthermore, the taxes implemented on export sectors will negatively impact the gains that the sector will see because of the peso’s depreciation and the recovery of Argentina’s 2018/2019 agricultural harvest. While exports revenues will likely allow Argentina’s economy to recover in 2019, multinationals should expect slightly reduced customer demand from provinces that rely on exports (e.g. La Pampa, Córdoba, and the Province of Buenos Aires).
Multinationals should continue to anticipate peso depreciation and currency volatility until the 2019 presidential elections. Whether the peso is subject to more episodes of sharp depreciation over the short term depends on how financial markets view Argentina’s debt sustainability. The Argentine government and the IMF will have to signal that they will do whatever it takes to protect the interests of creditors and investors, as Mario Draghi did in the midst of the Eurozone’s crisis. This will likely mean sacrificing economic growth in the short term, which is something that Macri signaled that he was willing to do in this Monday’s announcements. However, this will also require political support from the pragmatic opposition and the Argentine public. Without this, political uncertainty will increase ahead of 2019’s presidential elections, increasing peso volatility.
Finally, the peso’s latest depreciation will mean that inflation will end the year higher than previously forecast. FSG now forecasts 2018 year-end inflation of between 35.0-40.0%.
FSG outlined its 2019 pre-electoral scenarios in a recently published report. This report accounts for the key economic variables that will influence a positive or negative electoral outcome for Macri’s coalition Cambiemos. FSG plans on updating the GDP, inflation, and FX numbers of each scenario as soon as possible.
FSG expects that the events of the past week (September 3) and subsequent measures announced by Macri will have a negative political impact. As such, FSG now considers that it is more likely that a pragmatic opposition candidate emerges before the 2019 elections (“Alternative Downside” = 40% versus 30% prior). The probability of re-election of a Cambiemos candidate is now less (50% versus 40% prior). The likelihood of a return to populism remains at 10%.
Signposts to watch
FSG clients to continue to monitor the following signposts which will determine Argentina’s economic outlook and pre-electoral scenarios:
- Inflation/FX dynamics: Failing to contain inflation by the end of 2018 (i.e. inflation of excess of 40% EOY) will likely reduce the probability of Cambiemos re-election in 2019. Bringing down inflation will be tightly correlated to the central bank stabilizing the value of the Argentine peso in the coming months
- Consistent economic policy: The key thing that investors are demanding from Argentina is policy continuity. The Argentine government and central bank have made numerous unforced errors over the past year, which have increased economic uncertainty and reduced investor appetite toward the country. Consistent economic policy will also increase IMF support, which will be crucial is tempering investors’ anxiety
- Hitting fiscal targets: Investor sentiment toward Argentina will increase so long as the Argentine government hits ambitious fiscal targets in 2018 and 2019
- 2019 budget negotiations: Cambiemos will need the support of elements of the opposition to approve the 2019 budget in September. Tracking the rhetoric and support of opposition politicians toward the government’s efforts to end this economic crisis will be key in budget negotiations. It was also be an important sign to markets that the government will hit 2019’s fiscal targets
- New or revised IMF agreement: FSG believes it is highly likely that the IMF will continue to support the Macri government. Because markets are demanding that the Argentine government can guarantee its financing through the end of 2019, the Argentine government and the IMF will more than likely reach a new or revised agreement that guarantees this financing
- Politician approval ratings: This will be the most direct measure of not only Macri’s re-election chances in 2019, but also if the opposition can rally around one candidate. Whether that opposition candidate is more populist or pragmatist would determine FSG’s “Downside” and “Alternative Downside”, respectively
FSG will be making changes to its forecasts the week of September 10th, which will be live on FrontierView (click here to log in to Dashboards). Clients should expect an economic contraction in 2018 (around -2.0%) and a smaller economic recovery in 2019 (1.0-1.5%). FSG will also revise inflation upwards in 2018 and 2019, and a higher average ARS/USD exchange rate for the entire forecasting period.
Given the high levels of uncertainty regarding global and domestic events impacting the peso, FSG will proactively inform clients of any forecast revisions in the coming months.
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