Faced with rapidly dwindling foreign reserves, Argentine officials in January purposely sent their currency tumbling the most it has in one day since the 2002 financial crisis. While the sharp devaluation hurt Argentines’ purchasing power — the peso is now down 20 percent against the dollar since the beginning of the year — it also had the desired effect. The reserves’ pace of decline has slowed, the peso has stabilized and rising interest rates have helped mop up excess liquidity.
But Credit Suisse analysts think the reprieve is likely to be short-lived. President Cristina Kirchner’s government is merely alleviating the symptoms of the country’s economic malaise, rather than addressing the root causes, according to a report by analysts Casey Reckman and Daniel Chodos entitled, “Argentina: An Unsteady State.” Put simply, the government isn’t tightening fiscal policy enough to tame the out-of-control inflation that is the country’s primary problem. And the heavy public spending and subsidies fueling the rise in consumer prices will soon put Argentina right back where it started. By year-end, say the analysts, the country will likely have to go through a second, larger devaluation. “Argentina’s current economic situation is unsustainable,” the analysts say. “The government’s approach…still seems improvised and uncoordinated, which undermines its attempts to anchor expectations and restore confidence. Moreover, it has targeted the decline in reserves and other distortions that are symptoms of Argentina’s economic issues rather than addressing the underlying causes.”
That’s because government policy is what triggered the decline in foreign reserves – and not the other way around. The expropriation of private company assets — such as the 2012 seizure of Spanish oil company Repsol’s operations in the country — has dampened foreign investment. Making matters worse, the country has been locked out of international debt markets since its 2001 default, forcing it to use foreign reserves to fund imports and repay debt issued before it lost market access. Reserves dropped more than $12 billion to $30.6 billion in 2013 after sitting at more than $52 billion as recently as 2010. And Credit Suisse thinks they will continue to plummet, to $22.1 billion this year and $15.7 billion in 2015.
That said, the government’s January 22 and 23 devaluation was a move in the right direction. Combined with efforts to tighten monetary conditions through higher interest rates, the markdown of the peso is likely to “provide temporary relief for the peso and international reserves” until exports from the grains and oilseeds harvest starts bringing more dollars into the economy in March or April, according to another Credit Suisse report entitled “Argentina: Bandaged, But Not Cured.” The South American nation also relaxed restrictions on individuals purchasing dollars for savings purposes. Because Argentina tightly controls currency exchange as a way of supporting the peso and reducing capital flight, a black market for dollars has arisen in which the peso is 35 percent weaker than the official rate. Anecdotal evidence suggests that dollar outflows are even more restricted since the devaluation, which should increase pressure on the parallel exchange rate and further help slow the evaporation of reserves. The government will also seek to tamp down inflation by keeping wage increases to a minimum when it begins negotiations with labor unions in March.
Still, these are Band-Aids and not the necessary surgery. Dollar inflows will begin to slow as the harvest subsides around August, at which point inflation “could erode the benefits of January’s devaluation in no more than six months’ time,” Reckman and Chodos said. Indeed, the government reported consumer prices rose 3.7 percent in January compared with the previous month. Credit Suisse thinks inflation could reach 40 percent this year, up from 28.4 percent last year.
And that’s why Credit Suisse is currently expecting reserves to dip below $25 billion by year-end, which could necessitate a fourth quarter devaluation of 30 percent. “[That] second adjustment could be an even riskier and more disruptive undertaking than the most recent one,” Reckman and Chodos said. “It would produce another inflationary shock and…could quickly lead to heightened social and political tensions.”
How so? Just consider what the effect of another devaluation is likely to be on the real economy. It would prompt continued inflation, which would spur policymakers to raise interest rates again. Naturally, both of those things would tend to make consumers a little queasier about spending and further spook domestic investors. As a result, the economy may contract 0.5 percent next year, according to Credit Suisse. Economic indicators already look sickly, too. Credit Suisse projects a contraction in GDP of 0.3 percent for this year. Consumer confidence fell to 33.5 in February from 43.7 in January—the fourth consecutive monthly decline—according to a survey by Di Tella University in Buenos Aires. The indicator is currently at its lowest level since September 2002.
But it is in 2015 that the true nightmare scenario could take shape, as falling reserves increase the risk that Argentina won’t be able to pay its creditors – again. While Argentina’s debt is manageable this year, bonds maturing next year will increase the country’s foreign-currency 2015 debt service costs to $12.5 billion. That figure, which includes both interest payments and repayment of maturing bonds, amounts to 56.4 percent of Credit Suisse’s end-2014 forecast for foreign reserves. “This makes the outlook for dollar debt service look more worrisome,” Reckman and Chodos said.
Amid the turbulence, officials are reassuring the population that they have the situation under control. “The government is the one that can best defend the Argentine people’s moral integrity, their pocketbooks, their past and their future,” Kirchner’s cabinet chief Jorge Capitanich said several days after the devaluation, according to Argentine newspaper La Nacion. They’ve got their work cut out for them if they want to prove it.
Above: Argentina’s President Cristina Fernandez waves in front of an Argentine flag during an event on Dec. 10, 2013. Photo by AP Images/Victor R. Caivano