Government tries to stabilize the exchange rate as expectations worsen
During the first quarter of 2019, the Argentine economy performed worse than expected by the government, by the IMF and by most private forecasters. Inflation was much higher than anticipated.
The exchange rate, in pesos per dollar, began depreciating rapidly in March towards the upper limit of the non-intervention zone. The government reacted by tightening monetary policy and fixing the upper limit of the non-intervention zone at 51.4 pesos per dollar to try to anchor expectations. Furthermore, this morning the Central Bank has announced that it will be able to intervene even if the exchange rate is below 51.4, a clear signal that it wants to reduce volatility and to approach that limit only gradually.
Since March there are clear signs that the sudden stop in the inflow of foreign capital is now being reinforced by residents who are rapidly dollarizing their financial assets. As a consequence, the economy is moving closer to the ¨sudden stop¨ scenario of our previous quarterly forecast.
In this report we present a new forecast for 2019, which is in between the previous quarterly report scenarios, with and without a sudden stop, respectively. The difference with the sudden stop scenario is that we believe that the government, with the support of the IMF, will be able to prevent the exchange rate from exceeding 51.4 pesos per dollar. This assumes that the IMF will allow the authorities to use unlimited reserves for intervention in the foreign exchange market.
If President Macri wins reelection in November, we foresee two alternative scenarios for 2020. One of them assumes continuity of the current program without significant changes. Whatever structural reforms Macri’s government is planning, in this scenario we consider that they will not begin in 2020.
The other scenario for 2020 assumes that in order to reactivate the economy and reignite growth, the government decides to change its monetary and exchange rate policies and, at the same time, introduces a significant change in fiscal policy from the very beginning of 2020. Namely, the government decides to eliminate all distortionary taxes and economic subsidies, and introduces a drastic de-indexation of the economy through a monetary reform that allows the dollar to play the role of the most important currency for every kind of domestic transaction.
Of course, it cannot be discounted that the government fails to stabilize the exchange rate, and a financial panic brings the economy to the verge of hyperinflation. In that scenario, President Macri would likely lose the election, and it is impossible to make quantitative predictions of what would happen in 2020 and thereafter.
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