View Change August 22, 2018 / 08:20 pm UTC

Argentina Forced to Apply Shock Therapy

By Priscila Robledo

View change: We now have a more adverse outlook on Argentina in the rest of 2018 and 2019. Our new forecasts are for lower GDP, weaker ARS and higher inflation. Our forecast changes are because Argentina has had to front-load the elimination of some sources of vulnerability due to a less supportive external scenario (and to assure compliance with IMF conditions). The new adjustments include a rapid fiscal consolidation and efforts to lengthen the maturity of the country’s liabilities. Notably, front-loading adjustment implies that there is potential for a faster recovery beyond 2019, although this potential could be spoiled by politics

Figure 1: Forecast Changes

Headings; 'Up' Style2018 GDP2019 GDP
2018
Inflation (Avg.)
2019
Inflation
(Avg.)
USDARS
(end-2018)
USDARS
(end-2019)
Previous Forecast0.6%1.4%30%19%2933
New Forecast-0.3%1.4%31%24%3133

Source: Continuum Economics

Argentina Has Had to Front-Load Adjustments

The persistent turmoil in emerging markets, triggered by the Turkish crisis, has hit Argentina. More turbulence ahead cannot be ruled out given Argentina precarious situation. Since the government knows this—and still needs to fulfill the conditions imposed by the IMF in its standby loan—it has front-loaded the elimination of several sources of vulnerabilities. The new measures include a faster elimination of public services subsidies, a pause in the reduction of tax rates to exports, and the elimination of the stock of LEBACs by this December. 

Outlook Is for Weaker Activity, Peso Depreciation, and Higher Inflation

The faster elimination of public services subsidies comes at the cost of pressuring inflation, which is already very high. For example, a 20% to 28% increase in energy prices (depending on the level of consumption) in August will impact September and October inflation. Also, an increase in gas prices (the magnitude of which is not known yet) is scheduled for October, and its impact will extend to November. This, together with the constant rise in gasoline prices, will push inflation even higher than we expected. 

Notably, higher-than-expected energy prices in Q4 do not significantly change our estimate for 2018 average yearly inflation, but they change our inflation forecasts for 2019 more significantly. 

The worse-than-expected external scenario has also caused us to cut our GDP growth estimate. In particular, due to an activity slowdown in Brazil—Argentina’s main trading partner—we now expect GDP to fall in 2018. This slowdown will be exacerbated by a pause in the reduction of tax rates on soybean meal and soybean oil exports and a reduction in tax refunds on exports that harm agro-industry production. 

As for LEBACs, the BCRA announced the elimination of the stock on August 13, which resulted in a peso injection. Authorities were hoping to absorb this liquidity with treasury papers of longer maturities, but as the market is reluctant to accept longer maturities, this measure has increased ARS pressures. We expect that, by extending the maturity of Argentina’s liabilities, this measure will reduce ARS volatility once the program ends (the BCRA plans to eliminate the stock of LEBACs completely by this December, provided that market conditions permit). 

Other reasons behind are weaker ARS forecast for 2018 are overall EM FX weakness, late BRL weakness from elections, and effects of “the notebooks” corruption scandal.

Main Risks to Our View Come From Outside

Our new estimates are subject to several risks. The main downside risks (for lower economic activity, weaker ARS and higher inflation) are a harder landing in Brazil and an escalation of trade wars. The main risk for higher inflation in 2019 would be a return to backward-looking wage claims (a consequence of a loss of confidence in the government’s ability to reduce inflation). This would also likely imply higher growth in 2019 by increasing workers’ purchasing power. 

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Analyst Certification
I, Priscila Robledo, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.