A Look at Argentina's Currency Woes

A Look at Argentina's Currency Woes

This month, just as Argentines were preparing for summer vacation, they received news that surely put a damper on the travel plans of more than a few of them. The government announced it was raising its tax on overseas tourist packages and the goods and services its citizens buy abroad. Faced with plummeting foreign reserves, the tax hike is the most recent effort by the South American nation to keep inflation-spooked Argentines from pulling money out of the country.

The government is right to be concerned. In 2013 alone, reserves have plunged more than $12 billion to $31 billion, down from around $50 billion two years ago. The pace of outflows has risen for a variety of reasons, Credit Suisse’s Argentina economic and political analyst Casey Reckman writes in a recent report called “Argentina: How Low Will Reserves Go?” Foremost among them: debt service, rising energy imports, a surge in credit card purchases abroad, lower gold prices, and an artificially high exchange rate that hurts exports.

It’s a problem more than a decade in the making. Argentina has yet to find its way back into the good graces of international financial markets since it defaulted on $132 billion in foreign debt in 2001. The resulting lack of external financing has forced the country to use existing foreign exchange reserves to repay creditors and fund imports. Tourism whittles down reserves, too, as plenty of Argentinians travel to purchase things more cheaply abroad than they can at home. “Argentina is an extraordinarily expensive place to live, and there are no dollars,” says Riordan Roett, director of the Latin American Studies Program at Johns Hopkins University. “I don’t see an easy way out for this government.”

The administration’s most pressing task is to stop the hemorrhaging or risk being unable to afford fuel imports or debt payments. As a result, officials are attempting to repair Argentina’s standing in international financial markets. In February, Argentina became the first country ever to come under International Monetary Fund sanction for providing inaccurate inflation and GDP data. The country plans to introduce a new national consumer price index which it has worked on with the IMF by early next year. Argentina also aims to negotiate a settlement with the Paris Club of creditor nations, to whom it still owes billions of dollars, and is working on compensating Repsol for the 2012 seizure of its stake in YPF. The second prong is an effort to get the official exchange rate to converge with the parallel rate. The central bank manages Argentina’s exchange rate, but they have been allowing it to depreciate recently.

Limiting foreign currency transactions remains an important part of the strategy for the time being. Argentines must apply to receive dollars at the official exchange rate. The government’s latest effort to dissuade Argentines from purchasing foreign currency or spending money overseas was an increase in the tax on those transactions from 20 percent to 35 percent. Lawmakers are also expected to approve tax hikes on luxury goods such as yachts and imported automobiles.

But those measures probably won’t be enough. Reckman thinks Argentina’s gross international reserves could fall to $26.1 billion by the end of next year and to a mere $15.1 billion by the time the next president takes office in December 2015. The peso’s depreciation means the inflation outlook isn’t likely to improve, which could encourage wealthier Argentines to continue seeking to pull even more money out of the country. Credit Suisse forecasts that privately estimated inflation will increase towards 30 percent in 2014, compared with just under 26 percent in November.

Reckman doesn’t see any short-term prospects for large new capital inflows that could help reverse the situation. Plans to compensate Spanish oil and gas giant Repsol for nationalizing its stake in Argentine energy company YPF may help attract more foreign direct investment, but “it could take months to sign deals with foreign companies and even longer for those investments to have an impact on Argentina’s trade balance,” she says in a note this month called “Argentina Trip Notes.”

Reckman believes Argentina should be able to keep making debt payments for the next two years, but there is little room for error given the low levels of reserves – particularly if capital outflows accelerate. In that event, the government would have little choice but to devalue the peso or hustle a little harder to smooth over relations with the Paris Club and holdout bondholders and hopefully regain access to international markets, which could help stave off a default “If reserves decline more quickly than expected, the government would sooner carry out a large devaluation than default ahead of presidential elections in October 2015,” Reckman says.

While she certainly wants exports to become more competitive, President Cristina Fernandez’s lame-duck government will likely hold off on a large, one-off currency devaluation for as long as possible, says Reckman, choosing instead to allow the exchange rate to fall. The nominal exchange rate is expected to fall around 30 percent by the end of this year and even more quickly in 2014, Credit Suisse says.

Some have suggested that Argentina create a separate exchange rate for tourism, luxury goods and possibly financial transactions that would be weaker than the current official rate, but talk of a multiple-rate regime has recently died down. Policymakers could also curtail subsidies of public services and utilities to bolster public finances, but any progress on that front is likely to be gradual given the political sensitivity of reducing social benefits. In the meantime, the government has instituted limits on the amount of pesos banks can lend to big exporters to encourage foreign companies to bring dollars into the country instead.

There’s also the possibility that an Argentinian default infects the whole region. In the 1980s, Mexico, Argentina and Brazil all defaulted on debt payments, and the International Monetary Fund was forced to eventually intervene with loan programs to many countries in the 1990s. And the Asian crisis of 1997 started when Thailand’s currency collapse spread to a handful of other countries.

The good news? That kind of domino effect is unlikely to occur today, says Johns Hopkins’ Roett. For starters, a number of countries, including Mexico, Chile and Colombia, have much healthier stocks of reserves that could withstand any initial fallout from the problems in Argentina. What’s more, the region has benefitted from a general shift away from a tendency to tighten fiscal and monetary policy during downturns – the austerity model that Europe has been following – and instead turning to expansionary policies. So Argentina’s neighbors don’t have to worry as much as they once might have about the country’s latest financial troubles. But that doesn’t mean Argentina and its creditors can worry any less.

source: CS 19-12-2013