Argentina’s Currency Collapse
Last Wednesday (29th August) the Argentine peso lost over 7% against the US dollar. Thursday it lost another 12.5%. It’s been cut in half over the past year. In dollar terms, the MSCI Argentina index is down 57% since it’s January top. But it’s still not a bargain, given the high inflation rate and political uncertainties.
Back in June 2017 – partly due to investors being enamoured with the government but also as a symptom of the global bond bubble – Argentina even managed to issue a 100-year government bond (see here). Investors, for the privilege of taking such absurd risk, accepted a paltry yield of 7.9%. The bond price is now down about a quarter and the yield has jumped to 10.3% (when fixed-coupon bond prices fall, yields rise, and vice versa).
At the time of writing, after another two-day peso rout, one dollar now buys 38.20 pesos (according to Bloomberg). That means the peso lost 54% against the dollar over the past 12 months. This looks like an overshoot, but there’s no getting away from the fact that it’s a currency crisis.
Argentina’s president, Mauricio Macri, made a statement last week that was supposed to inspire confidence in markets. He said the government had asked the IMF to bring forward into 2019 credit promised for 2020, ensuring that the country could meet its obligations. Instead, this was interpreted as a sign of weakness and markets panicked.
The central bank hasn’t helped, as it’s sent out confusing signals. One minute it says that the peso is free to float, the next minute it’s intervening heavily to prop it up. Speculators have clearly scented blood.
Of course, the policy makers are between a rock and a hard place. The government has worked hard to bring down bloated government spending. It’s reduced the budget deficit from high single digits when Macri took office to somewhere around 1-2% expected this year.
A large part of that has been the progressive removal of massive, populist subsidies for utility bills and travel on buses and trains. For example, a couple of years ago my monthly electricity bill ran to the equivalent of US$3.50. (It’s now up over 10 times, but still very cheap by international standards.)
The problem is that both higher utility and travel costs feed into just about everything else. Inflation over the year to July was 31%, partly driven by the 47% increase in utilities and fuel costs and 41% increase in transport costs.
On top of that, the international oil price has rocketed to US$70 per barrel, up from US$48 per barrel a year ago. That’s an increase of +46% in dollar terms and (with the peso now at 38.20 per dollar) +220% priced in pesos.
Another big problem is the trade deficit, which was US$8.5 billion during 2017, or 1.4% of GDP. Years of penalising the export sector – with high corporate taxes that included (believe it or not) massive export tariffs on agricultural production (grains and meat) – have yet to be fully corrected. As imports (not least of oil and gas, after years of underinvestment) continue to exceed exports, it’s another drain of dollars from the country.
Now it’s all come to a head. Macri’s honeymoon period is clearly over, which also significantly increases the political risks once more. And then there are the massive corruption scandals to contend with as well.
Many of the senior kirchneristas – ministers and functionaries under Cristina Fernandez de Kirchner, the previous president – are either in jail already or under investigation for corruption. Recent developments have blown open a whole new web of bribes under the previous Kirchner governments (Cristina was preceded by her husband Nestor Kirchner). Cristina herself is under investigation in multiple cases.
How much money is involved is unknown. But evidence suggests that 5% of transport subsidies paid to bus and train companies were being kicked back to the people that doled them out. And public works projects were overpriced by around 20%, again with that margin kicked back to the government people that commissioned them. One forensic accounting firm has done a rough estimate, totting up the numbers over many years, and reckons the final tally could run to between US$20 billion and US$35 billion.
Another hit came from a major drought, which is a big deal in a country where the majority of exports still come from the agricultural sector. This is reckoned to have knocked as much as 1% off 2018’s GDP, and reduced the inflow of much needed export dollars. Compounding this, the dollar price of soybeans – the most important crop – is down 15% over the past year.
No one really knows the extent, or where the money is deposited or buried (according to witnesses, a lot was paid in bags full of crisp, 100 dollar bills). Macri’s government wants to recover the money, and has offered a 10% of sums found to anyone providing crucial evidence.
Despite all of this, Cristina still has a strong, hard-core support base (as does Brazil’s ex-president Lula – leading the Brazilian polls, although already in jail). Polls suggest 30% of voters would still pick her for president.
The rest of the Peronists are split, and Macri’s support is likely to fall further in the circumstances. Never mind that the alternative could have been far worse, with Argentina already well on the road to Venezuelan-style authoritarianism and hyperinflation.
(The last lot had the printing presses running at full tilt to pay for their populist policies and bloated public sector, and achieved an inflation rate in the high 30s / low 40s by 2014. By now, if they’d stayed power, I’m pretty sure the situation would have been far worse.)
Argentina has new elections in October 2019, and the outcome looks increasingly uncertain. Macri’s only hope is for things to settle down, but the latest currency collapse will keep inflation higher for longer. (I previously expected it to fall sharply, once the process of removing subsidies had been completed this year. But now that’s far less likely in the short run.)
Source: Zero Hedge