A Dirty Float

ARGENTINA - Report 01 Jun 2016 by Esteban Fernandez Medrano

In this report we review the trajectory of the peso, given BCRA polices vis-à-vis a floating exchange rate regime with FX interventions (i.e., a dirty float).
The Central Bank started to buy currency for its reserves in mid-January, when the peso dropped below 13.5. Yet, it inverted its net buying position when the peso drifted above 15, and sold it aggressively when the dollar approached 16. Then the peso rebounded, and the BCRA inverted its sell position to a buy. When the peso drifted close to 14.5, the BCRA started to buy more aggressively; it acquired close to $1 billion in May.
Furthermore, the Bank is expected to continue lowering Lebac interest rates. In May it decreased its reference rate three times (out of four issuance dates), from 38% to the current 35.25% (via cuts of 50 bps, 75 bps and 150 bps, in that order). The Bank also announced an increase in minimum reserve requirements for deposits, as an alternative tool for controlling inflation, as it continued to buy dollars.
One of the main reasons the market has been "ignoring" the BCRA’s recent signals is linked to the announcement of a new tax bill being prepared for presentation in Congress.
If that proposal is approved in July, the expected capital inflows could compensate (partly or entirely) for the seasonal decline of agricultural exports, therefore generating a more constant FX inflow during H2, and hence continuing peso appreciation pressures.
But from the point of view of the real economy, we continue to believe that an FX rate below 14AR$/US$ might be tough for the tradable sector to digest. The external equilibrium is far from being closed; headline inflation has not yet started falling; and the multilateral real exchange rate is appreciating quickly, while seasonally adjusted exports dropped in March and April.
Without a significant improvement in export performance, a rebound in economic activity would lead to a deepening of the trade deficit. We therefore believe that the BCRA is likely to continue buying for reserves, and that the market might eventually react to this.

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