The big question is whether this rise was simply due to a temporary liquidity problem in the financial system, which can be explained by the smaller supply of funds in the interbank market by public sector banks (which was later partly reversed), or if instead it reflects a change in the monetary and financial conditions which would indicate that this is the beginning of a process of rising interest rates, as has been predicted.
In our opinion, everything indicates that we are reaching the end of a cycle and that from now on the Central Bank will encounter monetary policy dilemmas in most decisions. These decisions will involve important tradeoffs between different policy objectives. For example, if they opt for high levels of liquidity to maintain low interest rates, the risk is losing international reserves and hence facing exchange rate pressures, or a rise in inflation. If instead they choose to tighten monetary policy to dissuade the purchase of dollars and to maintain the stock of international reserves, the cost will be accepting an increase in interest rates. Within these dilemmas we do not include the fulfillment of the monetary program, as we do not believe that the Central Bank has it as one of its priorities.
This type of tradeoff among monetary policy objectives tends to be the rule throughout the world rather than the exception, although this dilemma has only recently begun to emerge in Argentina. In this context, it is worth asking what the potential problems might be, why they have not appeared until now, and what the risks to monetary and exchange policies are.
The main trigger for the change in the monetary scenario has been the increase in the demand for dollars, which was in part driven by expectations of an increase in the rate of devaluation of the peso and that not by chance coincided with the end of a large sale of the bulk of the soybean harvest.
The exchange rate has been very stable since the 2009 elections. Between October 2009 and June of this year the dollar went from $ 3.83 AR to AR $ 4.10, implying an annualized depreciation rate of 4%. During this period people were willing to stay in pesos and maintain relatively high cash balances with stable interest rates.
However, significant increases in domestic prices and costs (especially wages) that well exceeded the depreciation of the currency have led to dollar inflation and have begun to raise concerns about the competitiveness of the peso. In other words, the current exchange rate is beginning to affect the ability to export for many sectors of the economy. This situation is compounded by the increase in the purchases of dollars that typically precedes an election and by the possibility of the adoption of a more interventionist economic policy after the elections.
The main change from now on seems to be a difficulty in maintaining the rate of devaluation at levels similar to past years. This to the extent that, if inflation remains at current rates (around 25% per year), the Central Bank will no longer be able to devaluate at a rate of around 4% per year and simultaneously maintain the competitiveness of the currency.
During these recent years the exchange rate was the nominal “anchor” that allowed the Central Bank to simultaneously maintain a relatively stable exchange rate, while also keeping interest rates well below the rate of inflation and high levels of liquidity in the banks. The end of this “equilibrium” is being determined by the level of the real exchange rate, which is now significantly starting to affect the competitiveness of some sectors, an indication that this equilibrium is not sustainable for much longer.
One problem facing the Central Bank is that individuals no longer want to keep so many pesos unless interest rates offset the risk of devaluation. This puts rising pressure on interest rates.
A second problem generated by this situation is that if the Central Bank prints money and increases the levels of liquidity to prevent a rise in interest rates, it generates a surplus of money that will eventually be used for the purchase of dollars (thus the Central Bank would lose reserves) or the purchase of goods (with which there would be a pressure on prices).
In recent weeks, this seems to have been the choice of the Central Bank. In recent auctions of Nobacs and Lebacs the maturities were only partially renewed, which injected pesos into the market to avoid pressures on interest rates. In the last three weeks, the base expanded by almost AR$ 3 billion this way.
The movement of interest rates also shifted the market preference towards Nobacs (which are at floating interest rates) over the fixed interest rate Lebacs, a move that indicates that banks are concerned about increases in the Badlar rate. Furthermore, the allocation of Lebacs and Nobacs in the Central Bank auctions in recent weeks is among the lowest in the past year, indicating that banks have smaller amounts of excess liquidity as loans are growing faster than deposits.
In our opinion, the economy is going to converge to a new equilibrium in the coming months in which the interest rate will be slightly higher than in the first months of this year (between 12.5 and 13.0%), as banks will not have significant excess liquidity (as was the case in recent years). This balance may change after the elections, when we anticipate two possible scenarios, though both include increases in interest rates.
The first option is that there is no change in economic and monetary policies, in which case increasing capital flight is possible, along with expectations of a further depreciation of the currency and hence a rise in interest rates. In this case, the increases in interest rates would be a result of market pressures.
The second option is one in which there is a change in monetary policy with the objective of reducing inflation. In this scenario, there would be a rise in interest rates driven by a change in monetary policy; however, the impact on the exchange rate is not clear; if it coincides with an increase in investor confidence in the Argentine economy and a sharp increase in capital inflows, it is possible that the country will experience a strengthening of the peso (à la Brazil).