Recent peso depreciation may boost recovery if the Central Bank does not overreact
The economy saw two areas of good news in June and July. On one side, several indicators showed that the economy is reviving faster and more broadly than most forecasters expected. On the other side, peso devaluation accelerated, and by the end of July the nominal exchange rate coincided with the purchasing power parity exchange rate, as estimated by PriceStats.
As we predicted in our previous Quarterly reports, inflation did not fall to Central Bank target levels, but has instead since July fluctuated at around half the average level of H1 2016. This is quite an achievement, since fiscal policy and structural reforms did not accompany monetary policy in the Central Bank’s stabilization commitment.
Since the end of April, the nominal exchange rate has been depreciating faster than the nominal interest rate paid on LEBACs (the instrument the Central Bank uses to conduct its inflation targeting policy). This is discouraging carry trade operations, and is the best indicator that monetary policy has reached its limits in terms of the disinflation that can be achieved without adequate non-monetary policies.
This phenomenon, which is disconcerting speculators, may have a positive effect on the real economy, particularly if the Central Bank does not overreact, and keeps the nominal interest rate paid on LEBACs unchanged, or even better, resumes the downward trend it abandoned in April 2017. Inflation will not fall for the rest of the year, but the reactivation, if accompanied by prospects of a more active action of the government after the election in the fiscal and pro-growth policy fields, may help stimulate the necessary investments and exports crucial for achieving sustainable growth. If this happens in 2018, the inflation-targeting monetary policy may recover its effectiveness that year. It will be better if the exchange rate stabilizes due to the inflow of export and FDI dollars rather than via short term carry trade dollars attracted by the high interest rates on LEBACs.
In our forecast, we introduce only two small changes from last quarter. We adjust upward our forecast for the nominal and real exchange rate, and raise our forecast for 2017 GDP growth, from 2.6% to 3%. Except for a few changes that are a consequence of these two adjustments, all other figures remain unchanged.
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