President Mauricio Macri’s government and the IMF reached a new agreement on 26 September which provides further financial support and will most likely shield the country from any credit distress this year and next. The revised standby agreement (SBA), however, comes with conditions, most importantly including: a primary budgetary balance by 2019—one year earlier than stipulated in June’s SBA—and a strict monetary base rule to curb inflation. The latest fiscal data shows that, although the primary deficit narrowed by almost a third in January–August, interest payments surged. The SBA came after national accounts data showed that GDP shrunk dramatically in Q2, reflecting contractions in both domestic and external demand, compounded by the effects of a severe drought. That said, data on economic activity in July, without changing the broad picture, suggests some improvement, given that the pace of year-on-year contraction softened considerably in the month. However, other indicators point to prolonged economic weakness as demonstrated by consumer confidence, which continued to plunge in September, and the trade deficit, which widened further in August. There is a great deal of uncertainty surrounding the performance of the Argentine economy in 2019. Not only will it depend on the success of the fiscal deficit and inflation reduction program agreed with the IMF; its fate also rests on the subsequent restoration of investor confidence and on achieving more solid macro fundamentals. That said, the contraction of the economy should ease significantly, thanks to growing agricultural output and increasing external demand, while domestic demand should remain weak due to high interest rates. LatinFocus Consensus Forecast analysts see the economy contracting 2.0% this year and a much softer 0.1% in 2019, down 0.8 percentage points from last month’s estimate. Inflation rose to 34.4% in August (July: 31.2%) amid adjustments to public service tariffs and a weak peso. Next year inflation is projected to decelerate notably thanks to the new monetary policy strategy and as the Central Bank has stopped financing the Treasury. Analysts expect inflation to end 2018 at 44.7% and 2019 at 27.1%. On 26 September, the Central Bank announced it would abandon its inflation targeting regime to adopt a rigid monetary rule which consists of keeping the monetary base unchanged from its current level through June 2019. LELIQ interest rates will consequently fluctuate daily, resulting from LELIQ auctions rather than being directly set by the Central Bank. Analysts see the LELIQ rate ending 2018 at 59.42% and 2019 at 35.62%. On 5 October, the ARS traded at 37.81 per USD, 2.1% higher than on the same day a month earlier. The peso is expected to lose ground next year weighed down by high, albeit decelerating, inflation and a weak economic performance. Analysts see the ARS at 42.89 per USD and 51.06 per USD in 2018 and 2019, respectively POLITICS | IMF boosts Argentina’s bailout, lending the government some breathing room On 26 September, the IMF announced a revamped and upgraded financing agreement to crisis-stricken Argentina, giving President Mauricio Macri’s government an economic lifeline until next year’s general election. The revision of the agreement between Argentina and the Fund—delivered after protracted negotiations and the resignation of Central Bank Governor Luis Caputo—ensures additional financial support to the Argentine government and considerably reduces the possibility of credit default this year and next. The revised standby agreement (SBA) grants the country quicker and more flexible access to funds for budgetary support, contrasting the previous agreement which could only be used in case of necessity. This is a crucial change as, in the absence of support from the Fund, the government could have been compelled to turn to the markets to finance itself, which would have exposed it to further confidence crises amid capital flight and exchange rate storms. Although the deal requires further fiscal consolidation measures and thus likely intensified near-term economic suffering, the agreement could be the key to restoring confidence, shoring up government finances and thus promoting a more sustainable future growth trajectory. Although the full details of the revised SBA are still pending and although the deal has yet to be approved by the IMF Executive Board, the revised agreement commits the government to stick to stricter fiscal goals than the ones included in the original agreement. A primary budget balance will have to be reached by 2019, one year earlier than in the previous agreement, improving to a primary surplus of 1.0% of GDP in 2020. (The 2019 budget, which includes necessary tax hikes and social spending cuts, is currently being examined by the Congress; however, with President Macri’s Cambiemos party lacking a majority in both chambers, it has so far failed to win its approval.) As a further point of the agreement, the Central Bank of Argentina (BCRA) had to abandon inflation targeting and committed to keeping the monetary base unchanged until June 2019 in order to curb inflation and limit exchange rate volatility. Additionally, the BCRA adopted an FX regime which combines a free-floating range for the peso alongside the prevention of excessive ARS/ USD fluctuations through exchange rate interventions. The revised SBA increased the original SBA amount of USD 50 billion by USD 7.1 billion to USD 57.1 billion. From this line of financing, USD 15 billion was already transferred to the Central Bank in June, following the approval of the original agreement. In what remains of the year, Argentina will receive USD 13.4 billion, well above the nearly USD 6 billion provided for in the original agreement, while the IMF will transfer the remaining USD 22.8 billion next year. The revision’s main goal is to dispel doubts about the country’s financing capability. With a total disbursement of USD 36 billion until the end of 2019— USD 19 billion more than stipulated in the June’s SDA—the Treasury will now be able to cover the primary deficit and repay debt interest on maturing debt. Stabilizing the foreign exchange market, strengthening macroeconomic fundamentals and putting the economy back on a growth path will depend on whether investors and market operators trust the government to pursue the fiscal reforms and the Central Bank to stick to such a stringent policy rule. The outlook is littered with risks, especially stemming from the possibility of a vocal social backlash against the fiscal measures as well as from the scenario that next year’s elections deliver an unfavorable result to President Macri.
LatinFocus Consensus Forecast analysts see the economy in recession this year, contracting 2.0%, down 0.8 percentage points from the previous month’s forecast. Analysts see the economy contracting again next year, albeit at the much softer pace of 0.1%, which also down 0.8 percentage points from last month’s estimate.
REAL SECTOR | Economy contracts sharply in Q2 According to the Statistical Institute (Instituto Nacional de Estadísticas y Censos, INDEC), economic activity in the second quarter swung from Q1’s 3.9% year-on-year expansion to a sharp 4.2% contraction. The print comes after five consecutive quarters of growth and represents the lowest reading since Q3 2014. On a quarter-on-quarter basis, the economy plunged 4.0% in the second quarter, contrasting the 0.7% increase in the first quarter and marking the worst contraction in nearly ten years. The downturn in Q2 reflected contractions in both domestic and external demand as well as the effects of severe drought. Domestic demand swung from a 6.4% expansion in Q1 to a 2.0% fall in Q2. Growth in private consumption decelerated notably from Q1’s 4.3% expansion to a slight 0.3% increase. Consumer spending was likely hit by a weaker currency and subsidy cuts in public utilities, which continued to fan inflation and eat into consumers’ pockets, as well as by falling confidence. Fixed investment rose 3.1% in the second quarter, far below the 15.7% figure recorded in the previous quarter. A sharp slowdown in construction activity growth and a downturn in the manufacturing sector were largely behind the weak quarterly expansion in fixed investment. Meanwhile, government consumption contracted 2.1% in the second quarter, a sharper fall than Q1’s 1.2% decrease. The decline again reflected the government’s efforts to rein in fiscal spending and reduce the fiscal deficit. The external sector, meanwhile, performed poorly in the second quarter, as imports continued to grow while exports fell significantly. Growth in imports moderated from 15.6% in Q1 to 2.7% in Q2, while exports swung from a 6.4% expansion in Q1 to a 7.5% plunge in Q2. Softer growth in imports largely reflected weaker private consumption and shrinking demand for intermediate goods from industry, while the sharp contraction in agricultural output and the drop in industrial production weighed heavily on foreign sales.
REAL SECTOR | Contraction in economic activity softens considerably in July The monthly indicator for economic activity (EMAE, Estimador Mensual de Actividad Económica) contracted 2.7% in annual terms in July, a much softer drop than the revised 6.8% fall recorded in June (previously reported: -6.7% year-on-year). Although the reading marked the fourth consecutive month of year-on-year contraction, it also represented the first improvement in five months. July’s contraction came on the back of significant annual declines in agricultural and industrial output, as well as severely restricted trade activity. However, the pace of contraction in the agricultural sector eased significantly, while less negative performances were also recorded in the industrial, trade, transport and communication sectors. Growth in activity in the construction and financial intermediation sectors, meanwhile, gained steam from June, while output in the fishing sector rebounded strongly A month-on-month comparison showed that economic activity jumped 1.4% in seasonally-adjusted terms in July, strongly contrasting a 1.3% contraction in June and marking the best result in over three years. Finally, average economic activity decreased to 1.3% in July from 1.9% in June. REAL SECTOR | Industrial sector continues to contract in August Industrial production contracted 5.6% in August over the same month of last year, according to data released by the National Statistical Institute (INDEC) on 4 October, which was marginally less than July’s 5.7% year-on-year decline. August’s reading reflected contractions in almost all components of the index. As in July, the tobacco industry recorded a significant decline in output, along with the textile industry and the oil refining sector. Continued plant shutdowns drove the drop in production of processed crude oil, while food output also contracted largely due to a double-digit decline in milling of cereals and oilseeds. On the other hand, the basic metal industries and automotive industry continued to record significant expansions in output. Panelists participating in the LatinFocus Consensus Forecast expect that industrial production will contract 2.3% in 2018, which is down 1 percentage points from last month’s forecast. For 2019, the panel expects industrial output to rise to 0.2%, down 0.9 percentage points from last month’s projection. OUTLOOK | Consumer sentiment sinks to over four-and-a-half-year low in September The Universidad Torcuato di Tella (UTDT) consumer confidence index fell to 33.7 points in September from 36.3 points in August, marking the worst reading since February 2014. As a result, the index moved further below the 50-point threshold that distinguishes pessimism from optimism among consumers, where it has been uninterruptedly for nearly a year. September’s print reflected a sharp decline in consumers’ willingness to purchase big-ticket household items, and a sizable drop in consumers’ assessments of their personal finances, only partially offset by an improvement in consumers’ assessments of the broader macroeconomic environment, especially the long-term perspectives on the general economic situation. Panelists surveyed for the LatinFocus Consensus Forecast see private consumption dropping 1.7% in 2018, which is down 0.6 percentage points from last month’s forecast. For 2019, panelists expect private consumption to increase 1.1%, which is down 1.2 percentage points from the previous month’s projection.
MONETARY SECTOR | Inflation climbs steeply in August According to the National Statistical Institute (INDEC), national consumer prices rose 3.9% over the previous month in August, coming in above July’s 3.1% month-on-month increase and marking the fastest increase in prices in over two years. August’s print reflected a broad-based increase in all 12 components of the index. The strongest price increases were recorded for: communication; housing, water, electricity, gas and other fuels, mainly due to adjustments to public service tariffs; and food and non-alcoholic beverages. Meanwhile, inflation increased from 31.2% in July to 34.4% in August, the highest print since March 2017.
Inflation is expected to be 44.7% at the end of the year 2018, which is up 4.1 percentage points from last month’s forecast. Inflation is projected to fall to 27.1% at the end of 2019, which is up 1.6 percentage points from the previous month’s estimate.
MONETARY SECTOR | Sandleris takes over the reins of Central Bank and steers a dramatic shift in monetary policy In a press conference held on 26 September, Guido Sandleris, the newly appointed governor of the Central Bank of Argentina (Banco Central de la República Argentina, BCRA), announced a drastic shift in monetary policy, in an attempt to rein in runaway inflation and curb heightened FX volatility. Starting 1 October, the Bank will abandon its inflation targeting regime to adopt a rigid monetary rule which consists of keeping the monetary base unchanged from its current level through June 2019. The new monetary rule thus sets a 0% monthly growth for the monetary base, defined as currency in circulation plus reserve requirements. According to press reports, Luis Caputo, the previous governor of the Central Bank, resigned after advocating greater intervention in the FX market to curb the depreciation of the peso, which was opposed by the IMF. Mounting inflationary pressures, which have gone hand in hand with a strong expansion of the monetary base and which saw inflation climbing above 30% in both July and August, prompted the radical shift in the monetary strategy of the BCRA. Spiraling inflation and a plummeting peso, compounded by a severe drought, drove the contraction of economic activity in the second quarter and the likely continued weakness in economic activity in the third quarter. The change of course is also a byproduct of the revision of the program of economic stabilization and reduction of macroeconomic imbalances agreed with the IMF on the same day. As a consequence of the new monetary base target, LELIQ interest rates will fluctuate daily, resulting from LELIQ auctions rather than being directly set by the BCRA. The Central Bank also adopted an FX regime which combines a free-floating range for the peso with the prevention of excessive ARS/USD fluctuations. The Central Bank will refrain from intervening in the foreign exchange market when the peso trades between 34 to 44 per USD and the range will be adjusted daily at a rate of 3% per month until the end of the year. In the event that the peso moves outside the non-intervention band or in the event of episodes of considerable exchange rate volatility, the Central Bank will act to reduce FX volatility by making sales of up to USD 150 million per day or, conversely, by buying USD reserves. The adoption of such hawkish monetary measures, if effectively followed, could well succeed in bringing inflation under control. Since June, the Central Bank has stopped financing the fiscal deficit, thus reducing potential political influence towards monetary expansion, and market actors will most likely see the new course as credible. It can thus be expected that, perhaps after a period of adaptation to the new monetary rule by market participants, inflation will stabilize and potentially fall. This would also likely contain the depreciation of the peso, although some short-term weakening in economic activity could also emerge. Ultimately, restoring confidence is key to the success of the new monetary strategy. If, over the next few months, economic operators regain confidence in the peso, the currency will stabilize and Argentine bond yields will fall, leading to an improvement in the economic situation. If not, monetary tightening could translate into stubbornly high interest rates, choking liquidity and damaging economic activity. Analyzing the combined effects of the new monetary policy rule and the revised IMF agreement on the FX market, Diego W. Pereira and Lucila Barceito, economists at JPMorgan, note: “This arrangement is deemed as adequate since it combines a completely free-floating range, while preventing excessive exchange rate fluctuations. But, in our view, volatility in that range is likely to remain elevated (as for the front end rates), given the nature of this economy with a shallow financial market and given the new monetary base growth rule. The fact that the IMF drawdowns will go entirely to budget support rather than reserves limits the ‘disposable’ ammunition power of the central bank, what is consistent with the wide range for the non-intervention zone. Yet, it also raises doubts on the firepower in case of extreme disruptions. Granted, the hawkish monetary rule is to help contain depreciation.” On average, panelists participating in the LatinFocus Consensus Forecast see the 7-day LELIQ rate ending 2018 at 59.42%. They see the 7-day LELIQ rate easing further in 2019, closing the year at 35.62%. EXTERNAL SECTOR | Trade deficit widens further in August Exports contracted 1.4% in year-on-year terms in August, contrasting July’s revised 1.8% expansion (previously reported: +1.7% year-on-year). August’s drop reflected an over 20% contraction in exports of primary commodities, only partially offset by strong increases in industrial, and fuels and energy exports, and by a slight expansion in exports of agricultural products. Imports dropped 0.3% annually in August, swinging from July’s 2.2% uptick. A sharp fall in capital goods and consumption goods imports, only partially compensated by heavier imports of intermediate goods and energy, explain August’s decline. The trade deficit widened from USD 0.8 billion in July to USD 1.1 billion in August (August 2017: USD 1.1 billion deficit). The 12-month rolling trade deficit came in at USD 11.0 billion (August 2017: USD 4.0 billion shortfall), in line with July’s result. Panelists participating in the LatinFocus Consensus Forecast expect exports to expand 4.4% in 2018 and imports to decrease 0.7%, pushing the trade balance to a USD 5.5 billion deficit. For 2019, the panel expects exports to increase 11.1% and imports to contract 2.6%, with a trade surplus of USD 3.0 billion.
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