Argentina: Making Sense of the Three Stages Plan
The Central Bank of Argentina's plan for macroeconomic stabilization includes three stages: an orthodox fiscal exit, establishing an orthodox monetary framework, and prudently lifting FX controls. The fiscal deficit reduction has helped end the monetization of the deficit, while transitioning to a controlled monetary supply aims to reduce inflation. The final stage's success depends on increasing reserves and managing capital flows to avoid depleting reserves. Discussions with the IMF and private banks are ongoing to support these measures.
Recently, the Central Bank of Argentina presented its plan for a macroeconomic stabilization agenda containing three stages. The first stage is an orthodox fiscal exit. The second stage is establishing an orthodox monetary framework. Finally, the third stage involves transitioning to currency competition and the prudent lifting of FX controls.
The Orthodox Fiscal Exit
From the beginning, it was clear that one of the main sources of Argentina's inflation was related to the fiscal deficit, which was ultimately financed by monetary emissions from the BCRA. This created additional measures to try to sterilize the excessive money. Those instruments were then offered to the financial system, demanding higher interest rates from the BCRA to be attractive. As most of those instruments were short-term, controlling the money supply was difficult, resulting in high inflation.
In this regard, the government was successful as the strong fiscal adjustment reduced the fiscal deficit to zero, allowing the BCRA to end the monetization of the fiscal deficit. Additionally, high-interest rates, when the BCRA holds a high level of debt, could increase the money supply, generating endogenous money creation. As the central bank pays high interest over its liabilities, once those interests are paid, the money supply increases. Additionally, the BCRA offered options to the financial system by which it is obliged to buy domestic bonds (puts), which could be triggered at any moment, increasing the money supply.
To tackle these problems, the BCRA lowered the policy rate to transfer its liabilities into Treasury bonds and is negotiating with private banks to find a way out of the puts, with an eye to ending money creation. In terms of FX, the BCRA is trying to maintain a 2% pegging crawl since the mega-devaluation and has successfully renegotiated the swap line with Chinese authorities.
Establishing an Orthodox Monetary Framework
This phase, which the BCRA claims to be in, relates to transitioning towards an orthodox monetary framework. Rather than allowing the growth of money supply to be endogenous—conditioned by the BCRA liabilities—the BCRA is now able to fully control the system's liquidity by determining the money supply. There is still some negotiation regarding the put option held by private banks, which can still be triggered at any time. With most liabilities passing to Treasury notes, all debt roll-over or debt emissions will be made by the Treasury, linked to the monetary policy rate. With control of monetary emissions, the government expects inflation to slow down, reducing the pressure on the appreciation of the real exchange rate as the inflation differential component diminishes.
Rather than applying a conventional inflation-targeting approach, where they specifically pursue an inflation target and use the policy rate to achieve it, the BCRA will seek to directly control the monetary base and rely on their crawling peg as an FX anchor and the "super" fiscal anchor as the main source of credibility for their monetary framework.
Prudent Lifting of FX Controls
This stage is somewhat unclear regarding how the BCRA will achieve it. The BCRA wants to lift all capital controls, allowing a free flow of USD. They state this will be done prudently. As the money supply is now controlled, they assume this will make the ARS a scarce currency, which, through the laws of demand and supply, will allow its price to stabilize. We still don’t know how this will be applied, but the current level of reserves does not allow this process to occur now. Additionally, there will always be a risk of Argentinians converting ARS to USD and taking this money out of the country. It seems the government wants to see whether the local market chooses to dollarize or not. One option would be bi-monetarism, as in Peru, or full dollarization, as in Ecuador.
Most countries need some sort of fiscal anchor to emerge from significant inflationary episodes. Argentina still needs to increase its reserves to lift major capital controls without risking most of its reserves being wiped out. Their deal with the IMF contemplates this happening around February 2024, but we believe this is likely too soon. Another possibility is another round of negotiations with the IMF, allowing FX reserves to increase to a level where lifting capital controls would be acceptable. All of these seem too soon to be implemented, but the discussion for that is ongoing.