Argentine Investors Tested as Disjointed Policies Sap Confidence

(Bloomberg) -- Argentine policy makers are learning just how hard it is to restore investor confidence after two extraordinary interest-rate hikes in the past week failed to assuage currency traders.

After the second increase Thursday, investors indicated it still wasn’t enough, sending the peso down to a fresh record low of 22.45 per dollar after a 3.1 percent wipeout Wednesday. Officials need to take coordinated steps to demonstrate a commitment to tackling inflation and shoring up finances, according to strategists, economists and traders.

The peso’s downward drift of the past years is accelerating to an all-out selloff amid growing concern that disjointed policy is allowing for runaway inflation and excess government spending. It’s a disappointment to investors who saw President Mauricio Macri’s election in 2015 and his promises to bring predictability and lure foreign capital as a turning point. For years, Argentina had suffered from state interference in the economy and lawsuits with disgruntled creditors that locked it out of international capital markets.

“External conditions will not accommodate the government’s strategy of gradually removing the country from its medicine -- it’s time to rip the Band-Aid off,” said Sean Newman, a money manager who helps oversee $3.8 billion in assets at Invesco Advisers. “The pace at which the fiscal deficit is closed needs to be accelerated.”

The central bank raised benchmark borrowing costs 3 percentage points Friday and another 3 percentage points on Thursday, bringing the rate to 33.25 percent, the highest in the world. The peso fell as much as 5.9 percent Thursday.

Alberto Ramos, the head of Latin America research at Goldman Sachs Group Inc., said monetary policy needs to be accompanied by strong signals officials will shore up the budget. Jim Barrineau, the co-head of emerging-market debt at Schroders in New York, says there needs to be a coordinated plan across the government that demonstrates the country’s commitment to getting things back on track.

It couldn’t come soon enough for currency traders, who have made the peso the worst performer in emerging markets this year as it sank 16 percent. The country’s overseas bonds -- including a 100-year note it sold last year -- are also among the world’s worst performers, and Telecom Argentina and Petroquimica Comodoro Rivadavia SA have had to postpone debt sales amid the carnage.

The selloff has its roots in an unconventional move in December. That’s when central bank President Federico Sturzenegger, after pumping up rates to the highest in the world in a bid to rein in price increases, loosened inflation targets after coming under pressure from the government. In January, the bank cut rates by 1.5 percentage points, even as annual inflation running at about 25 percent showed no signs of abating. It’s accelerated since then.

Macri, for his part, has stuck with a plan of only gradually tackling the government budget deficit, something he predicted would be made easier by quicker economic growth. But with analysts expecting the combined current-account and budget balance to exceed 10 percent of gross domestic product this year, investors are growing skeptical of the strategy.

“We’re in the emergency room now and we need bold moves to anchor the system,” Ramos said. “The policy mistake was cutting rates when inflation expectations were deteriorating rapidly. They’re now doing the right thing in order to bring order to the foreign exchange rate market and to regain some of the lost credibility, but it’s going to be tough.”

The government will need to begin by showing a coordinated response that lays out a step-by-step policy toward stabilizing currency markets, according to Schroders’s Barrineau.

“In emerging markets, when a central bank loses credibility, it’s never one policy or one rate hike that does the job to regain it,” he said. “It takes time, it takes explaining to the market exactly what the plan is. Here, it looks like there is no plan.”

New Strategy

Before the two recent surprise interest-rate increases -- which both came at previously unscheduled out-of-cycle meetings -- the central bank had been relying on selling dollars in the currency market to try to buoy the peso. This year, they spent $6.9 billion on the efforts, or about 10 percent of the country’s international reserves.

On Wednesday night, policy makers seemed to be rethinking that strategy and planning to reduce the amount of dollars they sell in the foreign-exchange market, according to people with direct knowledge of the matter. They say officials attribute peso’s decline mostly to external shocks.

And no doubt there have been global factors at play in the peso’s drop. Global pessimism toward riskier assets and renewed dollar strength were factors last week. But also at play was an exodus of overseas investors from Argentina after a new income tax for foreigners took effect.

"When there’s a global or regional shock and all currencies fall, the peso should fall too,” said Marcos Buscaglia, a founder of consulting firm Alberdi Partners and a former Latin America chief economist at Bank of America. “To intervene under every circumstance was a mistake.”

On the fiscal side, Macri is facing pressure from labor unions to boost salaries to keep up with inflation at the same he’s running into resistance against efforts to curtail energy subsidies and pass the higher costs on the consumers. Opposition lawmakers have put forward bills looking to partially roll back the price increases, a move that shook utility stocks. After talks with coalition members, Macri will allow consumers to pay increases in installments.

“Congress is already trying to back off tariff hikes, but if the government backslides on the fiscal area to ease people’s pain, the market will keep the pressure on,” said Greg Lesko, a money manager at Deltec Asset Management.

The most important thing policy makers can do is restore their credibility by taking bold steps and communicating a clear strategy to the market, according to Barrineau.

“We’re waiting for an appropriate policy response that signals that they understand what the issues are and can lower volatility,” he said.

©2018 Bloomberg L.P.

Bloomberg
Follow The Latest On The Global Economy On BloombergQuint