Argentina’s smooth peso devaluation a rare bright spot in emerging markets

January 13, 2016
A man walks past a currency exchange rates board at a money exchange in Buenos Aires' financial district, Argentina, December 16, 2015. Argentina will announce a much anticipated relaxation of currency controls on Wednesday, the government said, setting the stage for a weakening of the local peso and an increase of soybean shipments from the world's No. 3 exporter.  REUTERS/Marcos Brindicci - RTX1YZQ2

A man walks past a currency exchange rates board at a money exchange in Buenos Aires’ financial district, Argentina, December 16, 2015. REUTERS/Marcos Brindicci – RTX1YZQ2

Argentina’s new government untied the first of many tight knots in a tangled economy with a surprisingly smooth transition to a floating currency regime.

The peso is now close to ‘fair value’ – one that truly reflects Argentina’s economic fundamentals — after President Mauricio Macri devalued the currency in December as part of his business-oriented approach to restore growth.

Argentina’s detachment from a long affair with currency pegs that impaired its economic flexibility gave Macri breathing room to fend off a recession and made the country’s outlook surely one of the brighter spots in what otherwise has been a rough start to the year for emerging markets.

Naysayers had warned that a quick unwinding of the stiff capital controls implemented under former President Cristina Fernández de Kirchner’s administration could open a Pandora’s box. But those fears have proved unfounded – at least so far.

In his latest report on Argentina, economist Edward Glossop at London-based consultancy Capital Economics calls Macri’s first days in office an “impressive start”:

… after just a month in office, Mr. Macri’s progress in tackling Argentina’s economic imbalances – particularly on the external front – has been highly encouraging. We’ve noted many times in the past that most reforms by new governments in emerging markets tend to come in the first 100 days in office. If Mr. Macri’s reform momentum is maintained, we think Argentina could return to growth of 3% next year, following a relatively shallow recession in 2016.

Following an initial 26.5 percent devaluation that was in line with market forecasts, the peso has been weakening calmly. The road ahead for the currency is looking more in line with the outlook for regional peers, such as the Brazilian real — i.e., more weakness, but not as bad as last year.

The Argentine currency’s stabilization was paved by renewed U.S. dollar inflows from a surge of agricultural exports by producers seeking to cash in on a more favorable exchange rate. Expectations were also anchored by improved prospects for the country’s grains output.

The peso was quoted at 13.48 per dollar on Tuesday, or a loss of about 1.3 percent compared with its close on December 17, the day of the devaluation. By contrast, Brazil’s real has fallen 3 percent in the same period and the Mexican peso by even more.

ARS chart

BNP Paribas saw the peso at a ‘fair value’ of 16.50 by year-end, implying a 22 percent drop in 2016. Although that estimate is three times the amount they expect the real to fall, it has little to do with capital flows and more to a long-standing problem in Argentina: runaway inflation with no reliable official measure.

Economists polled by Reuters, including analysts at BNP Paribas, project an inflation rate of 35 percent in Argentina this year, one of the highest in a world where most economies are generating very little of it.

That’s in part owing to rampant money printing by the government of Fernández de Kirchner to pay for popular programs before the election of 2015, but also partly a side effect from the recent devaluation.

The new authorities at the national statistics office INDEC appointed by Macri decided at the turn of the year to stop releasing economic figures that were compiled with methods allegedly devised during Fernández de Kirchner’s administration to massage data in order to show lower inflation readings.

With no credible official data for inflation at hand, the central bank’s new authorities used, among other sources, figures from a private anonymous blog in their monetary program for 2016, which was published last month.

Much will depend on how quickly Argentina can move back to reporting more trustworthy official economic data.

According to Pilar Tavella and Sebastian Vargas at Barclays Capital:

‘The publication of a new CPI is a prerequisite for the announcement of any inflation target … A new CPI index and a transparent communication strategy should increase the credibility of the central bank and help coordinate the wage/price-setting process.’

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