ANKER

LATIN AMERICA
24-May-2023

SPECIAL REPORT
Is dollarization viable? Luis Caputo
lcaputo@ankerlatam.com

In this document we do not seek to take sides on whether dollarization is the Santiago Bausili optimal
sbausili@ankerlatam.com
monetary/exchange scheme for Argentina, but rather to contribute to the debate arguments
Federico Furiase
in favor of the need to contemplate an alternative monetary/exchange scheme, as ffuriase@ankerlatam.com well as
aspects related to the feasibility of its implementation. . Martin Vauthier
mvauthier@ankerlatam.com

Going forward to the conclusion, we believe that dollarization is an alternative that Felipe Berón is difficult to
fberon@ankerlatam.com
implement, requiring a complex legal and financial architecture, but not impossible to carry out
as some media or colleagues tend to simplify.

The origin of the problem

The backbone of the next economic program must be fiscal balance. It is important to understand that the economic
problems that the country has suffered for decades have their origin in the fact that the State consistently spends more
than it collects. Inflation, the dollar or debt crises are the consequences of the way the deficit is financed. Monetary
financing generates inflation and the rise of the dollar. Debt financing generates debt repayment crises. Politics typically
chooses to look for blame and populist solutions to these “consequences” instead of solving the root of the problem. So,
to stop inflation, businessmen are blamed and price controls are implemented, to stop the rise of the dollar, “traps” are
put in place, and the debt is restructured to produce some short-term savings. These measures, repeated for decades,
have eroded the country's credibility and with it the traditional policy-making tools available to the vast majority of
countries that have not committed these mistakes, which makes the resolution of our problems even more difficult.

How important is the monetary/exchange scheme in a future economic plan?

Although the consolidation of fiscal accounts should be the backbone of any stabilization program of a next government,
the abuse of financing the fiscal deficit via monetary emission that occurred during

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The current administration has resulted in the accumulation of a stock of remunerated liabilities on the balance sheet of
the Central Bank (Leliqs and Pases of the BCRA) that represents a threat to economic stability. The option of dumping
those pesos in the market could plunge the country into hyperinflation, but keeping them on the BCRA balance sheet
represents a quasi-fiscal cost of more than $1 trillion per month (20% of the April monetary base) with the stock and
current rates. Therefore, it is essential to implement a monetary scheme that is consistent with the required fiscal effort
and that helps mitigate the burning threat of the peso surplus. That is, reaching fiscal-financial balance in the short term
is a necessary condition, although no longer sufficient, to avoid a crisis that plunges the country even deeper into
poverty and destitution. Therefore, a monetary program that addresses the negative implications of this overabundance
of pesos becomes a fundamental piece to determine the success or failure of a future stabilization plan.

Free floating versus Dollarization. The role of money demand in reducing paid liabilities.

The high stock of paid liabilities can be reduced “by hook” or “by crook.” The hard way, through an inflationary
liquefaction or the breaking of contracts (e.g., Bonex Plan). For good measure, if society regained confidence in an
economic program that would translate into a significant increase in the demand for money capable of converting
remunerated liabilities into a monetary base. However, basing the success of a future economic program on the
accelerated recovery of a variable that depends on the behavior of society, such as the demand for money, can be risky.
Is it possible to anticipate how much confidence is needed to increase the demand for money? As an example, if the
proposal in a future economic plan were that the primary fiscal deficit be eliminated and that the BCRA would not
provide more financing to the Treasury, would that be enough to generate confidence in society so that enough money
would be demanded and Will it reduce exchange rate and inflationary pressure? Although some might think so, reality
shows that the demand for money in our country is very volatile, difficult to predict and control. As an example, the
program with the IMF between 2018 and 2019, despite shoring up the central problem of the fiscal deficit, ending
monetary financing to the Treasury, not having issued pesos since June 2018 and having kept currency in circulation
constant in public power until almost the end of the mandate, had to endure the two years of highest inflation in the

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administration of President Macri, 48% and 54% respectively. This was due to a sharp drop in the demand for money,
which behaved exactly opposite to what the IMF expected.

Consequently, we believe that a program that aims at fiscal balance, free exchange rate float with liberalization of the
stocks and inflation targets is an extremely risky alternative to which we DO NOT subscribe. We are not saying that it
cannot work, but that it may NOT work; Paradoxically, a luxury that a next government cannot afford if the objective is to
convince the population that this is the correct path.

Therefore, the challenge is to find a monetary scheme that helps solve the problem of the over-issuance of pesos and

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the resulting stock of remunerated liabilities without running the risk of basing the general equilibrium model on an
accelerated recovery in the demand for money. , which may not materialize. This is where dollarization arises, as an
alternative monetary/exchange scheme that seeks to eliminate said dependence in the recomposition of the
demand for pesos. It is worth clarifying that it is not the only regime that obeys this objective, but it is the one that we
have to analyze in this report given the public nature that the debate on dollarization has taken.

What is the immediate benefit of dollarization?

By eliminating the currency, the imbalances between the supply and demand of pesos no longer have an impact on the
level of inflation. In economies where the dollar serves as a reserve of value and unit of account, shock schemes such
as dollarization or Convertibility have the advantage of lowering inflation more quickly than other monetary policy
alternatives.

Ecuador, starting from an inflation of 61% the year before dollarization and 91% the year of dollarization itself (2001),
managed to bring inflation to single digits in just 2 years and managed to keep it at less than double digits during the
years. next 20 years, even going through two defaults on its debt (2008 and 2020). In Argentina, Convertibility allowed
inflation to be lowered from three digits to one digit in just over 2 years.

Achieving a slowdown of this magnitude in inflation is very difficult with other monetary policy schemes, even when they
are part of a credible stabilization program.

We insist on something, dollarization is not a magical solution to the country's problems. It does not come to solve the
root of the problem, which is the fiscal deficit, but to annul one of its sources of financing and engine of inflation:
monetary financing. Even implementing dollarization today would eliminate the possibility of using the nominal exchange
rate as a buffer against external shocks.

Far from being a magical solution, giving up having our own currency is the consequence of having lost all credibility to
comply with serious economic programs due to the constant and degrading subordination of our economic policies to
political priorities.

How would dollarization be implemented?

In order to implement dollarization, the Central Bank is required to have in its assets the amount of dollars sufficient to
transform all its liabilities into pesos (the Monetary Base composed of the currency and unpaid reserves, the Leliqs and
the Passive Passes). to dollars, at an exchange rate similar to the free exchange rate.

If the ratio between liabilities in pesos and assets in dollars were very different from the free exchange rate,
dollarization would not make any sense, and no one who is proposing this monetary scheme ignores this
condition. That is to say, dollarization "at any price" is ruled out, since if an attempt were made to implement it at a
higher exchange rate than the one incorporated in the economy's prices because "that's how the accounts say it," strong
inflation would be recorded in dollars, which is contrary to the desired objective: the higher the exchange rate, the lower
the dollar price of goods in the country would be, and consequently the greater their demand, particularly in countries
with a high stock of dollarized savings such as Argentina.

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Expressed in this way, the challenge is to find the combination of necessary assets and the appropriate legal and
financial architecture that allows the country to carry out this conversion; As an example, today it would be at an
exchange rate of between $400 and $500.

How many dollars are needed to implement dollarization?

With data as of May 17, the sum of the monetary base and remunerated liabilities amounted to $20 trillion. This would
imply that, for example, at an exchange rate of $490 the BCRA would have to have assets in dollars (banknotes or
market value of assets) for USD40.8 billion.

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It is important to clarify that the implementation of dollarization is not immediate. As the experiences of Ecuador and El Salvador show,
the exchange of currency tends to be gradual over time. For the same reason, it is not necessary to have all the dollars on the first day
since, for example, a part of the deposits will remain in the banking system, contributing liquidity to the BCRA. Nor should we confuse
a dollarized contractual obligation with the instrument of its cancellation, which could be in another good (e.g., the payment of taxes
with pesos at the dollarization exchange rate, as a settlement instrument).

How many dollars can you get to support dollarization in Argentina?

Let us take as an initial assumption that the BCRA did not have liquid net reserves available for the implementation of dollarization
(current situation). This implies that it would need to be financed in some way.

For this, the BCRA has assets on its balance sheet for a nominal value greater than USD84,000 million: Non-transferable Treasury
Bills in dollars, Treasury Bonds in dollars and pesos, and Treasury Transitional Advances in pesos. Additionally, the FGS has an
estimated USD13 billion in Treasury bonds in dollars and pesos. It is important to clarify that these assets should NOT and cannot be
sold to the market. They should not be sold because it would imply transforming intra-public sector debt into debt with the private
sector at aberrant rates (above 20% in dollars); nor can they be sold because even if they tried, there would be no demand in the
market to absorb that amount of bonds, even in the presence of a new, more orthodox government.

Although these assets should not and cannot be sold on the market, they can constitute the raw material for a financial architecture
that allows access to new dollars. As an example, the assets of the BCRA and the FGS could be contributed to a trust in a foreign
jurisdiction that could use these assets as collateral to obtain new financing.

However, as long as the underlying risk, whatever the financial architecture chosen, is Argentine risk, this demand for financing will
encounter limited supply. That is, beyond the level of collateralization of the financial structure and the Argentine risk mitigants (trust
based on foreign legislation + foreign law bonds, etc.), the market has a limit to the volume of financing.

available for this type of instruments . The universe of investors interested in a structured product is only a fraction of the universe
that participates in standard international placements.

As an example, in 2016 and 2017, the BCRA and the Treasury executed financing through repos for USD5,000 million and USD6,750
million respectively. These transactions were difficult to execute even with an international context of lower rates and much greater
appetite for Emerging Market assets and particularly for Argentine risk. Furthermore, in that context, the spread between the repo rate
and the bond yield was much smaller than that observed today. It is to be expected that investors would prefer (a) to purchase a bond
with a 30% yield and a right to claim 3.5x the original investment (price of $28.5) and known liquidity, over (b) to participate in an
experimental structure with a yield of Libor + 300/400 basis points and a right to claim 9x the original investment.

For these reasons, and considering that the market value of bonds under foreign law issued by Argentina today totals USD17.5 billion,
our estimate is that even if we added the bonds held by the FGS to the assets of the BCRA, the Demand for an overcollateralized
financial structure with Argentine risk and under foreign jurisdiction hardly exceeds USD12 billion.

This amount could increase if some credit improvement guaranteed by an entity with an AAA credit rating could be added to this legal
and financial structure, something similar to what happened with Brady bonds in the past. The market structures that were used in the
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90s with guarantees from insurers such as MBIA or partial guarantees from multilaterals with preferred creditor status such as the
World Bank and the IDB, no longer work. For different reasons they have failed in their mission.

In our experience, this guarantee would be very difficult to obtain, as well as direct fresh funds from other countries bilaterally, outside
the IMF.

What other financial assets could support dollarization?

The market value today of the shares held by the FGS is approximately USD4 billion, with potential for appreciation in a more
favorable political and economic context.

Could the IMF provide new fresh funds in a new program? Yes, based on our experience in the public sector, we believe it is possible,

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and even feasible, in a new renegotiation and agreement with the IMF, the contribution of fresh funds for between USD10,000 and
USD15,000 million. The final amount will depend on the amount of dollars necessary to implement dollarization, the robustness of the
economic program as a whole, and the country's negotiating power.

If there were $12 billion from the market, $4 billion from FGS assets, and $15 billion from the IMF, there would be funding availability
totaling approximately $31 billion.

The remaining balance of USD10 billion could come from the incorporation of other financial or non-financial assets or, ideally, via a
financial fiscal surplus, which would also contribute to the credibility and robustness of the economic program. The financial surplus
consistent with this exercise should be around 2.5% of GDP , which would imply a fiscal adjustment of around 7% of GDP
compared to the fiscal inertia projected for 2023 (2.5% primary deficit plus 2 % interest).

What is the recent history of adjustments of this magnitude?

The adjustment experience observed in other countries shows that it is possible to cut the fiscal deficit by the necessary orders of
magnitude when the political will exists. The attached table reflects recent experiences in other countries where fiscal adjustments of
significant magnitude were made in a short period of time.

Financial Result (% GDP)

Setting in
Initial Final
pp

Ecuador (2016-2018) -10,1% -2,8% 7,3

Greece (2009-2013) -15,3% -3,9% 11,4

Portugal (2010-2012) -11,4% -6,2% 5,2

Lithuania (2011-2014) -8,9% -0,7% 8,2

Ireland (2011-2014) -13,6% -3,6% 10,0

Source: IMF
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