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October 15, 2020

The Week at a Glance

Argentina: Urgent Need for a Stabilization Plan

BY Andrés Borenstein, Miguel A. Kiguel, Lorena Giorgio, Mariela Díaz Romero, Rafael Aguilar, Isaías Marini

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( 17 mins)

Editorial: Urgent Need for a Stabilization Plan

The parallel dollar hitting 167 pesos set off all the alarms once again. The rumor mill prior to a long weekend anticipated new measures. They have not happened so far. The more it takes to find a consistent economic plan, the worse the damage will be. Net and liquid reserves barely amount to USD 1 billion. At this pace, they will be gone by the end of this month.

The economy cannot coexist with such a great exchange rate spread (over 100%) for long without turning net reserves negative or increasing the cepo for imports, which would abort any chance of activity recovery. The logic is that the spread creates demand for dollarized goods, which in turn generates more imports, while the incentives to export languish, adding more pressure on the exchange market.

And we believe that there can be no recovery until we get a minimum degree of credibility. Confidence will not be recovered overnight. What can be done quickly is raising rates more vehemently than how the Central Bank has done so far, almost with a hint of fear, given that every time the repo rate increased, it came coupled with a covert Leliqs reduction. In 2002, one of the factors that helped turn the page of the crisis was when Mario Blejer, head of the CB at the time, took the Lebac rate to 140%. We are not suggesting that exact rate, but rates should be unequivocally positive in real terms in the short run. Stating that time deposits have beaten inflation so far is simply not enough.

At this stage, a nominal devaluation also seems inevitable. The sooner it is done, the smaller the amount that will be needed. Rate hikes and faster or jumping depreciation will not be harmless. They will have short-term political and economic costs. But, at this point, it seems hard to avoid them. This crisis is going to leave us with a country that is poorer in dollars and with lower wages.

But it is important to mention that depreciating without a plan is not enough. It is time to speed up the agreement with the IMF and convey to the market and business community that Argentina is working on a program to lower the fiscal deficit faster, and that we are not ruling out asking for some more financial aid, the key to printing fewer pesos in 2021. The plan with the IMF could have caps on what the Central Bank hands over to the Treasury, which would create incentives to seek credibility with the market by the authorities.

Finally, in the combo of a consistent macroeconomic plan, there must be signs of improving institutions aimed at maintaining the sanctity of property rights, especially if entrepreneurs are expected to invest again, once this crisis is over. The IDEA colloquium begins this week, where several members of the Government, including the President of the Nation and the Governor of the Province of Buenos Aires will lecture to the most prominent members of the local establishment. It is crucial not to miss this chance. The business community is receptive and needs the exchange rate spread and the political rift to be reduced. In any case, it takes two to tango.

Considering the recent WEO-IMF forecasts, Argentina and Peru are the countries whose activity will be most affected in the region, considering data for 2020 and 2021 together. Argentina would fall 7.5% in both years combined, while Latin America and the Caribbean would fall 4.5%. Brazil would contract 3.2%, Uruguay 0.4%, Chile 1.8%, and Mexico 5.8%, just to mention some of the most relevant countries. In other words, we already are at the bottom of the list and there is no margin to keep on falling.

Coming up

  • On Wednesday 14, INDEC will release September’s inflation records. The market is expecting a little less than 3% monthly.
  • On Thursday 15, the Ministry of Economy will release its monthly report on public debt.
  • Also, on Thursday 15, INDEC will release their income creation account for the second quarter of 2020, which will tell us how the cake was divided in the midst of the lockdown between labor, capital, and mixed income.
  • Finally, on Thursday 15, the Central Bank will release its quarterly survey on credit conditions.


Record FX Spread, Sunk Reserves, and Inadequate Measures

Despite the announcement regarding a greater volatility of the FX rate, the official rate increased scarcely 20 cents last week

– The blue chip swap and MEP rates are operating at ARS 157.65 and ARS 145.66 respectively, and the FX spread has escalated to over 100%, a record figure since 1989’s hyper-inflation

– Despite the CB being able to purchase reserves on Wednesday, last week it lost USD 218 million and liquid reserves are coming close to zero

– The Central Bank increased the 1-day repo rate to 27%, lowered the 28-day Leliq rate to 37%, and kept the rate for retail time deposits

The Treasury and the CB are still adding reinforcements aiming at containing the FX spread and stopping the reserves drainage. In addition to attacking demand with the “XXL cepo” and encouraging supply with a temporary lowering of export taxes, over the last few days the CB has given signs regarding the interest rate and announced more volatility in the official exchange rate, while the Treasury has launched a dollar-linked bond. However, the week closed with alarming figures once again: with the official exchange rate rising scarcely 20 cents, the FX spread widened considerably and reached levels above 100%, unseen since the 1989 hyperinflation, while reserves lost USD 218 million.

The higher volatility announced by the CB at the beginning of the month was conspicuous by its absence last week. The daily depreciation rhythm under the new set of rules only differed from the previous one on the Friday after the announcement, when the CB set a sell position of ARS 76.95 per dollar at the beginning of the trading session, 70 cents over the closing rate of the previous day, meaning a 0.9% daily depreciation, way over the 0.1% average from the previous month. Throughout last week, and despite that, unlike the previous policy, in which the monetary authority placed a USD 50 million position at the beginning of every trading session, the CB is now starting the sessions with USD 1 million and USD 2 million positions, and the market’s volatility stayed low. In fact, last Monday’s daily depreciation (0.14%) was lower than the one that we usually saw on Mondays under the previous set of rules, while it was below 0.04% on Tuesday and Wednesday and was practically null on Thursday and Friday. Today, the wholesale official exchange rate (Communication A3500) closed at ARS 77.40 and the daily depreciation accelerated back to 0.38%.

This is a scenario in which low volumes are being traded (the amounts on Monday and Thursday were the lowest ones since September 7), and Central Bank’s activity was more intense in the futures market than in the spot market and the open interest in dollar futures has already surpassed USD 5.3 billion, with the CB as the main seller of contracts to manage depreciation expectations. December’s contract is today at ARS 85.40 with a 10 billion supply from the CB.

Despite that last Wednesday the Central Bank managed to purchase reserves little by little after 11 trading sessions (USD 20 million). During the other 4 days, it had to sell in order to avoid the official FX rate from getting out of control. On Friday, it intervened and sold UDS 30 million in the market and gross reserves closed the week at USD 41.0 billion (USD 41.2 billion the previous Friday), falling at an average USD 44 million daily rate. According to private sources from the market, the CB has allegedly purchased USD 10 million today. With liquid reserves at scarcely USD 1.0 billion, the CB will have to implement new measures to finally turn around the trend from the last few weeks. Should it fail to change the course, it can ultimately use part of the reserve requirements temporarily (as in 2015) or turn liquid part of its remaining gross reserves by, for example, disassembling the USD 3.2 billion swap with Basel or selling gold.

In this scenario, the various financial dollars have risen and are already operating with a spread over 100% with the official rate. The blue chip swap increased 1% today, reaching ARS 157.65 (ask), while the MEP dollar closed at ARS 145.66, 1.6% over last week’s closure. Compared to last week, they have accumulated 4.1% and 3.6% rises, respectively.

It is clear that the CB must urgently absorb part of the extra pesos in the economy to reduce the pressure on the dollar, and it is essential to lower the sterilization cost to stop compromising the quasi-fiscal balance. In this sense, the CB has decided to increase the reverse repos rate by 3 percentage points, reaching 27% and complementing the five-point rise from the previous week, while it took the Leliqs rate to 37%. Thus, the Treasury rates continue to gradually align with the rates of the CB’s sterilization instruments. The Treasury’s discount bonds, which operated in last Thursday’s auction, yielded 35.81% and 38.04% annually for maturities in October 2020 and January 2021, respectively.

In turn, these signs about the reference rates increase the CB’s effectiveness to affect the short-term rates of the economy. As for time deposits, the coefficients have been modified to keep a 33.06% 30-day nominal annual rate yield for individuals under 1 million pesos and a 30.02% nominal annual rate for the rest. In addition, the interbank call rate rose to 20.3%, while it increased to 19.8% between private banks according to data collected until October 8. That means that while the financing cost among banks went up, the average yield of interest-bearing liabilities went down, and the rates of time deposits that they offer their clients remained invariant.

Although the auction of the Treasury’s dollar-linked bond managed to get over ARS 136 billion, a great part came from the public sector and from disassembling Leliq positions, which implied a ARS 79 billion monetary expansion last Tuesday. Let us remember that the CB had forced banks to reduce their Leliq holdings by 20 percentage points, while it also increased the limit of Treasury bonds positions from 50% to 75% of net worth and increased the net global position for dollar-linked bonds. This way, the Government increased the debt’s duration, assuming the risk of a potential devaluation. By issuing bonds linked to the evolution of the exchange rate and auctioning discount bonds last Thursday, the Treasury now has most of the funding for the ARS 166 billion that will mature in October held by the private sector. The flip side of the coin is that the CB had to issue almost ARS 80 billion to pay for Leliqs, with a non-genuine sterilization afterward, one that ended up being a mere change of portfolio.

The measures implemented thus far have not yet managed to rebuild confidence in the peso, and the market is still expecting a correction of the official exchange rate in the short run. Currency settlements for exporters, for instance, have not responded to the lowering of export taxes in the way the Government had anticipated, as they are waiting for a sooner-than-later adjustment of the FX rate. The market is waiting for answers on how the current monetary and fiscal imbalance will be corrected, and expectations are now centered on a new program with the IMF that would anchor expectations and create foreseeability regarding the economic policy


Industry Ran Out of Gas in August

In August, the Manufacturing Industrial Production Index contracted 0.9% m/m ─seasonally adjusted series

– The official indicator slightly increased its year-on-year fall to 7.1%.

– Behavior among the main sectors was heterogeneous: the ones that fell the most were the producer of equipment, devices and instruments (-29.3% y/y) and the textile sector (-26.7% y/y); meanwhile, the furniture production (+10.2 y/y) and the petrochemical sector (+3.3% y/y) managed to grow

– Industrial Production accumulated a 12.5% drop in the first eight months of the year compared to the same period in 2019

The recovery process that had been taking place since May halted in August, according to the Manufacturing Industrial Production Index (IPI), just as we had anticipated in our last report. Although a higher number of productive facilities were able to operate normally due to the greater lockdown flexibility, the drop in demand is the main obstacle to the recovery process.

The manufacturing IPI ─seasonally adjusted series─ contracted 0.9%, after having grown 1.4% in July (reviewed downwards from 2.1% by INDEC). As a result, industrial activity was 7.4% below its February level, before the impact of the pandemic and the lockdown. In year-on-year terms, the official indicator increased its fall 7.1% (compared to -6.6% in July, reviewed from -6.3% by INDEC).

Among the main sectors, only two out of nine showed growth in year-on-year terms. The sector that registered the steepest fall was the producer of equipment, devices, and instruments, which contracted 29.3%, affected by the temporary closure of cellphone and television production plants due to the pandemic. The textile sector followed behind (-26.7%), with its demand still compressed due to the closure of commercial premises ─shopping centers were closed in the Metropolitan Area of Buenos Aires (AMBA) and will only open this week. As a result, 13.1% of the productive establishments in the textile sector recorded no activity at all, while this proportion was scarcely 2.6% for the manufacturing industry as a whole.

As for the automotive sector, it contracted 19.5% y/y. Although automobile production fell in seasonally adjusted terms (7.4% m/m) in August, September data is more than encouraging. According to ADEFA, 32,149 units were manufactured in September, which represents a 40.1% seasonally adjusted monthly increase and a 16.1% year-on-year growth ─not seasonally adjusted─, the first positive record since January. We expect that the next INDEC report will show a considerably better performance for this sector.

Meanwhile, the production sector of non-metallic minerals and basic metals fell 17.7% y/y. The greatest negative impact was recorded by the steel industry, affected by lower demand from construction activity and the oil sector, which recorded 15 active wells in August compared to 74 a year ago. Food, beverage, and tobacco production followed (-4.8%), whose decline was largely explained by the reduction in oilseed milling. Meanwhile, the metal products, machinery and equipment sector contracted 3.5%, although its intra-sector performance was heterogeneous: metal products fell, but agricultural machinery production recorded a substantial improvement (56.1% y/y).

In contrast, the furniture and other manufacturing industries sector grew 10.2% y/y, while the petrochemical sector grew 3.3%, favored by a low comparison base of the chemical sub-sector that more than made up for the drop in the oil sub-sector.

With these results, Industry accumulated a 12.5% fall in the first eight months of the year compared to the same period in 2019.

In August, industrial activity slowed down its recovery, but it is not all bad news: preliminary data for September allow us to be somewhat optimistic. Automobile production showed a significant rebound, while industrial electricity consumption ─which had fallen in August─ recorded a modest 1.4% increase ─seasonally adjusted. Cement production also improved significantly, and demand for other construction materials has risen sharply.

Setback in Construction After Three Months of Recovery

Its monthly fall was 1.0% in August according to ISAC-INDEC ─seasonally adjusted series─, ending the positive streak recorded between May and July

– The official indicator is 17.7% below its August 2019 level and its y/y fall worsened for the first time since April

– The demand for building supplies was uneven in August; some of the main items, such as hollow bricks (3.6%) and cement (7.2%), kept growing, but some others contracted

– Eight months into 2020, construction accumulated a 31.8% fall compared to the same period one year ago

Construction took a step back. In July, construction had spent three consecutive months on the rise, reaching its levels from the summer, before the pandemic struck. But the sector was unable to keep the momentum going and activity dropped 1.0% in August compared to July, according to the Synthetic Indicator of Construction Activity (ISAC) by INDEC. In addition, the institute revised July’s 6.8% rise and lowered it to 4.5%. Compared to August 2019, construction contracted 17.7%. Although it is still far from April’s slump (-76.2%), it worsened compared to the previous month (-12.9%).

This downer can be partly explained by the stocks of building materials stabilizing, as their supply was affected during the months of strict lockdown. The private index by the Construya Group anticipates a 12.6% recovery in September (a variation that comes from our own seasonal adjustment of that index), attributing August’s fall to the re-stocking effect of vendors. The wide spread between the official dollar and its parallel rates has also encouraged the speculative purchase of building supplies, valued at the official rate.

INDEC also observed how the consumption of materials decelerated. Although the use of key supplies for private works, such as hollow bricks, which grew 3.6% and surpassed August 2019’s record by 17.4%, and cement, which grew 7.2% between August and July, the rest of building supplies recorded lower variations compared to previous months, and even falls. Out of 13 categories of building supplies surveyed by INDEC, only 7 grew in August, while 10 did so in July.

What is going on with supplies is barely linked to employment. In July (INDEC provides labor data for the sector with a delay of one more month), registered construction jobs did not rise: between February and July, 55,793 formal jobs were lost in the sector. Since part of the demand responds to speculation, its impact on activity is not total. In addition, the sector’s high degree of informality and the acquisition of building materials for home repairs can help to explain this divergence.

The Government is placing its bets on public works for the post-pandemic recovery. Asphalt consumption kept rising in August. This building material, closely linked to state initiative, improved 8.0% monthly, although it still recorded a 60.9% slump in y/y terms. Anyhow, fiscal restrictions limit the boost the State can provide for construction.

The accumulated fall during the first eight months of 2020 is 31.8% compared to the same period in 2019. As a comparison, in 2002 construction sank 28.3%. Assuming the recovery manages to consolidate in the last quarter, this year’s contraction should be lower, although it will remain among the worst ones in historical terms. In addition, we have to consider that the sector had already fallen almost 8% in 2019.

Looking forward, preliminary data back the idea that we got over the setback in September: cement shipments grew 16.2% monthly according to the Portland Cement Manufacturers Association, while they had fallen 2.0% in August (revised from -3.5%). The high FX spread will keep influencing the demand of construction materials, although supply problems act against some of them. But the medium-run fate of the sector is tied to the economic stabilization and the level of reopening allowed by the pandemic.

More by Andrés Borenstein, Miguel A. Kiguel, Lorena Giorgio, Mariela Díaz Romero, Rafael Aguilar, Isaías Marini