Commentary 3: International Economics

Title of article: Argentina Central Bank Seen Seeking Weak Peso Under Fernandez

Source of article: Bloomberg

Date article published: 15/11/2019

Date commentary written: 10/12/2019

Word Count: 732

Article

https://www.bloomberg.com/news/articles/2019-11-15/argentina-central-bank-seen-seeking-

weak-peso-under-fernandez

Argentine President-elect Alberto Fernandez is preparing to task the country’s central bank

with trying to boost the crisis-torn economy through a weak exchange rate, according to two

people with direct knowledge of the strategy.

Fernandez takes office on Dec. 10 having promised voters he will revive the economy from its

slump. He now intends to make the central bank a centerpiece for that strategy, taking

advantage of the fact that it’s not legally independent from the government.

Under the plan, Fernandez will ask the central bank to actively intervene to curb the peso’s

value to avoid appreciation cycles such as the ones that helped generate large trade deficits in

the past, the people said.

A weaker currency will spur exports, the theory goes, helping to close a current account gap

that many economists consider the root cause of Argentina’s repeated episodes of financial

turmoil. The deficit is estimated to be 1.8% of gross domestic product this year after reaching

more than 6% in the third quarter of 2018. 

“The central bank must control the currency market,” Matias Kulfas, one of Fernandez’s

economic advisers, said in a recent speech.

Argentina’s real exchange rate, the value of the peso measured against a basket of

international currencies, is above the average of the past eight years, signaling the country’s

improved competitiveness with its main trade partners. That’s a level that the incoming

administration would like to sustain with this policy, the people said.

Although the peso-dollar exchange rate wouldn’t be fixed, it would be what’s called a “dirty”

float, with the central bank gradually buying dollars to put more pesos in circulation, thereby

weakening the currency, according to the people. These dollar purchases would coexist with

some form of capital controls similar to the measures currently in place, which don’t allow

Argentines to buy more than $200 in greenback per month.

The incoming administration believes that a weak exchange rate would help eventually boost

exports by about $20 billion per year and create foundations for sustained growth, according to

the two people consulted.

A spokesman for the president-elect didn’t provide a comment for this story.

New Head 
Other elements of Fernandez’s plan for the central bank include replacing President Guido

Sandleris and a yet-to-be defined pact involving salaries and pensions with labor unions and

businesses to contain inflation and offset the risks of a weaker exchange rate. Another aim

would be to cut the benchmark interest rate from 63%, the highest in the world.

Miguel Pesce would be the new head of the central bank under Fernandez, according to the

Buenos Aires-based newspaper Clarin.

The plan nevertheless risks further repelling investors already worried that Fernandez’s team

will undo the pro-market stance of incumbent Mauricio Macri. The economy faces a third year

of contraction in 2020. Argentine dollar bonds due in 2028 now fetch as little as to 36 cents on

the dollar and an International Monetary Fund aid package is in jeopardy.

Fernandez’s team will also seek to ensure the central bank improves the access of households

to credit and imposes tougher financial regulation, the people said.

A New Monetary Goal

The incoming administration is considering a new monetary policy target in which the central

bank would focus on the monetary aggregates known as M1 or M2. The first tracks the amount

of money in circulation and in public and private checking accounts. The latter follows

everything in M1, plus public and private savings accounts. Right now, the central bank focuses

on the monetary base, which is the amount of money in circulation. Monetary expansion could

be around 35% annually, one of the persons said.

Rates, Leliqs
If inflation starts to recede, the central bank could reduce the policy rate and the stock of local,

short-term notes called Leliqs, currently used to set the main rate. The advisers say that the key

rate won’t be negative in real terms, meaning it would stay above the rate of inflation, currently

at 53% in annual terms. The central bank will prefer to absorb pesos by forcing commercial

banks to hold more cash in reserve requirements instead of issuing Leliq notes, two people said.

Expanding Credit

The proposal among people close to Fernandez is to expand credit in the economy by lowering

interest rates. While they may increase banks’ reserve requirements, Fernandez’s central bank

leaders could also maintain current levels for banks that offer loans to businesses at low rates.

Those loans would likely be at real negative interest rates, of around 45% to 55% annually in

pesos.

Banks Under the Spotlight

The central bank will seek to boost its control over the financial system, one person said.

Fernandez’s team is studying changes to banking regulation so that they can continue financing

companies with poor credit profiles. Fernandez’s policies will likely be similar to those

implemented under from 2003 to 2011 during the Kirchner governments. These included a

rule mandating that a 30% cash deposit be applied to dollar inflows, and an obligation that

agricultural exporters sell the dollar proceeds of their grain sales in the FX market within 120

days.
Analysis

According to the article, the Fernandez government wishes to solve its current account deficit

by devaluing the peso exchange rate with the US dollar. When there is a current account deficit,

a financial account surplus must exist to pay for the deficit. The financial account surplus is

currently being funded by the IMF. This essay will explore the likely consequences that

Argentina will face by devaluing its currency and the effectiveness of this policy to restore the

current account deficit.

 Exchange Rate of ARS to US$ 

Self-constructed in draw.io 

When the central bank devalues its currency, it sets a target represented on the graph above as

US$1. As stated in the article, the Argentinian central bank will buy US$ and this will increase

the quantity of ARS supplied to the exchange market from Q to Q 1. This increase will cause the

supply to shift from S to S 1 and the exchange rate to decrease from US$ to US$ 1. A devaluation

in the exchange rate will cause Argentinian goods to become cheaper to foreigners as they can

exchange dollars for more ARS. The price of Argentine goods and services remains the same in

ARS but decreases in US$.

The revenue of Argentinian exporters increases as the demand for exports increases, with

foreigners more willing and able to buy Argentinian goods and services. This increase is

represented by the rise in the quantity demanded of ARS from Q to Q 1. The devaluation of the

ARS will also make imports seem more expensive because Argentinian individuals and firms will

need more ARS to exchange into the same amount of US$, As a result, US goods and services

will seem more expensive and therefore, the demand for these goods and services will

decrease. The combined effect of increasing exports and decreasing imports will resolve the

current account deficit because the net export value will increase and therefore, more money is

coming into Argentina.

Argentinian Economy 

Self-constructed in draw.io

The Argentinian government expects to increase exports by US$20 billion; this will increase

RGDP, because RGDP is composed of C+I+G+(X-M), where X is exports. As AD represents RGDP,

AD will increase; on the graph this is represented by a shift of AD from AD to AD 1. The shift in

AD causes an increase in the general price level from PL 1 to PL2. This increase, in turn, creates

an inflationary gap as the price level exceeds PLfe or full employment. An inflationary gap can be

problematic because it could cause goods and services to become more expensive for

consumers, just as Fernandez worried. However, the increase in RGDP can lead to an increase
in employment. As firms receive more profits, they can expand their operation and hire more

workers to increase their production capacity. 

Argentinian Economy 

Self-constructed in draw.io

A decrease in the value of the ARS as compared to the US$ will make it more expensive for

Argentinian firms to exchange ARS for US$. This causes imported goods and services to seem

more expensive as they will now cost more ARS. If the majority of Argentinian firms import
commodities, such as iron and crude oil, to carry out production, this could cause a supply

shock. This is because the cost of production would increase and therefore output would

decrease. On the graph this is represented by a leftward shift in the AS from AS to AS 1. This shift

will cause RGDP to decrease from RGDP e to RGDP1 and the general price level to increase from

PL to PL1. As the costs of production increase, firms will have to cut other costs, such as labor

costs by, for example, making workers redundant and/or increase prices. This will cause a surge

in unemployment and inflation; this phenomenon is called stagflation. Stagflation is

devastating; the unemployed, with no income, face rising prices, compounding the decrease in

standard of living.

The government is particularly worried that credit agencies will downgrade their credit rating. If

they do, Argentina will have to offer higher interest rates to investors. If the Fernandez

government does not resolve the current account deficit, the economy will be heavily affected

by high interest rates due to Argentina’s high level of debt. By correcting the current account

deficit firms will feel less pressure to seek investment. Therefore, the newly elected

government feels that the consequences of a devalued Argentine peso will be less significant

than correcting the current account deficit.