Some Thoughts on the Argentine Peso

Argentina’s new Finance Minister Alfonso Prat-Gay has called a press conference for 9 PM EST to announce an end to capital controls and to allow the peso to float. Of course, this begs the obvious question of where the exchange rate will end up. Officials have said that intervention to prevent a disorderly move would be seen.

We would expect a floating peso to trade somewhat weaker than the so-called “Blue Chip” parallel rate. As dollar shortages grew under the previous administration, the official exchange rate diverged more and more from the “Blue Chip” rate. Indeed, the wedge between the two rates was at its biggest on record in early December (at a 57.5% discount) before narrowing in recent days to around 45.5% today.

Not only will capital controls be axed, but it looks like export taxes on wheat and corn will be eliminated; for soy, export taxes will be reduced significantly. Argentine grain exporters are forecasting a large increase in shipments as a result, and this has pushed grain prices down sharply today. Wheat is down over 2%, corn is down nearly 2%, and soy is down nearly 1%. This has the perverse effect of worsening Argentina’s terms of trade, which should put further downward pressure on the peso.

The new administration really had no choice but to follow through on campaign promises to free up the exchange rate. As the previous government acted to keep the official rate artificially strong, foreign reserves fell steadily through much of 2014 before stabilizing in 2015, but then plunging -$6.3 bln in October and another -$1.3 bln in November. This was simply unsustainable, as reserves fell to only 2.75 months of imports. Short-term debt now equals 100% of foreign reserves, with both metrics in troublesome territory.

Even using the artificial official rate, the peso is one of the underperformers in EM, -14% YTD against the dollar. Using the “Blue Chip” rate, the peso is down -17% YTD currently after it traded at record lows near 15.55 last week before rallying nearly 10% this week. While today’s FX developments are positive for the country, we do not think the peso should be strengthening in light of the weak fundamental backdrop. In the short-term, a float probably means a plunging peso, spiking inflation, and potential recession as the central bank acts to limit the second round impact on inflation. Wherever the peso settles, however, the moves by the new government are very positive medium-term developments. We expect these measures, as well as the likely settlement of the debt holdout problem, will get foreign investors interested in Argentina again.