A brave monetary bet

ARGENTINA - Report 29 Feb 2016 by Esteban Fernandez Medrano

Before the start of the new congressional session this Tuesday, for which Macri’s opening speech will probably include the announcement of a bill to be presented regarding the ongoing negotiations with the Holdouts, this report reviews some of the monetary policy modifications implemented so far by the BCRA in response to the current macro challenges.

The Central Bank developed a brave “monetary bet”, that is, to tighten monetary aggregates through the issuance of short-term LEBACs, in order to gain time for the government to obtain alternative financing sources that might lower the need to monetize the fiscal deficit. At the same time, in order to avoid locking in high interest rate costs, the monetary authority shortened the maturity of its bonds, betting on an interest rate reduction in the second half of the year.

The total stock of LEBACs went from an average AR$ 330bn in December to AR$ 476bn in February. That is a 43% rise in less than 60 days. Roughly speaking, one third of this new debt issuance offset the monetary injection the BCRA had to implement because of its exposure in the local dollar futures market, at a cost, so far, near AR$ 55bn.

Yet, when analyzing overall fiscally-driven monetary injections, the dynamic picture becomes somewhat worrisome. If we project for this year the same BCRA financing as last year (both in transitory advanced payments and profit transfers to the Treasury), the annualized impact on M0 would imply a 50% monetary injection after adding the current sterilization costs.

In light of these results, we expect the BCRA to maintain its strong sterilization efforts in the short term. However, to avoid facing debt sustainability concerns (i.e. rollover risk), with the implicit inflationary and FX pressures, the government must develop non-monetary fiscal financing. This reinforces the importance of an agreement with the Holdouts.

Luckily for the government, the Kirchnerists, opposed to such a restructuring, are losing some of their power in Congress.

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