Wednesday, December 16, 2015

Gov’t lays groundwork for devaluation by raising interest rates

The new Central Bank authorities led by Federico Sturzenegger (centre) are pictured after taking office.

Banks ready to lend around US$7 billion in effort to boost country’s currency reserves

The ground is almost set for a big devaluation of the peso over the next few days.

The Central Bank increased interest rates significantly yesterday for its Lebac notes auction, which soared from below 30 percent to 38 percent for short-term notes and 35 percent for the longer term paper.

Most private banks are also on board for a loan worth billions of dollars that would boost the Central Bank’s foreign currency reserves, giving the monetary authority enough firepower to contain a run against the peso when the government tries to unify the country’s multiple exchange rates.

With the dollars from those loans close to being available, higher interest rates to encourage investment in pesos over dollar purchases and a deal with grain exporters to ensure a constant flow of greenbacks after the devaluation, Mauricio Macri’s Economic Cabinet is confident that the exchange rate will not spiral out of control even if restrictions on the dollar trade are also lifted.

Central Bank authorities are considering letting the peso-to-the-dollar exchange rate start floating this week, although they are determined not to allow the peso to devalue below the 15 pesos per dollar mark.

More banks on board

The new Central Bank board thinks the peso’s balance rate is below the 15 pesos per dollar mark, but some in Macri’s Cabinet still acknowledge the risk of initial instability when the currency starts to float.

That is where loans form banks, which could reach US$7 billion, become indispensable to have cash readily available in case dollar sales are needed to stabilize prices.

“We decided to join in yesterday. We will put US$1 billion,” Banco Santander-Argentina’s president Enrique Cristofani told TN cable news channel yesterday.

Santander was one of the few big banks that had not yet agreed to lend dollars to the new government following Finance Secretary Luis Caputo’s trip to New York to negotiate with their parent companies abroad. HSBC, Citibank, JP Morgan, Goldman Sachs and others are seen as already on board for the deal.

Market sources told the Herald yesterday that both the banks and the government are willing to go ahead — fine tuning some details and finishing the paperwork are the only steps missing before the deal is done.

The country will reportedly pay interest rates of between six and eight percent for the loans.

Interest rate hikes

Bank loans, however, will likely not be enough to ensure that the exchange rate doesn’t go up dramatically if the so-called clamp is lifted entirely.

With reserves plunging daily and hitting an even deeper nine-year low (closing at US$24.3 billion yesterday after losing almost US$200 million for the fourth consecutive day in Macri’s four working days in government), the initial target of an additional US$20 to US$30 billion needed to fully lift the clamp becomes harder to hit.

A high budget deficit and the recent conflict over dollar futures contracts (see below) means that the need for money printing might also go up next year.

That combination of factors has forced the new authorities led by Federico Sturzenegger to jack up interest rates to 38 percent in its first weekly Lebac auction.

More rate hikes could come in the future, according to analysts.

Di Tella University’s Germán Fermo said yesterday that the risk of the exchange rate overshooting could now be overtaken by the risk of overshooting interest rates.

If rates continue to rise, inflation and the peso-to-the-dollar exchange rate could stay relatively under control but economic activity could be hurt, making a recession in 2016 much likelier.

Timeline

Speaking to businessmen on Monday, Macri ambiguously hinted at putting an end to the “clamp” on the dollar this week, but it was not clear if it would be totally eliminated or only partly.

The latter would be harder to do, as completely freeing the cunrrecy exchange market without the capacity to absorb circulating pesos could push the price of the dollar further up. But a quick devaluation is still seen as indispensable by Macri’s team.

“We are working hard, we want to bring about change as soon as possible but without committing errors, and that is why the implementation (of this policy change) should come this week,” an official told Reuters. He added that the exchange rate would still be administrated by the Central Bank, with an upper limit of around 15 pesos per dollar.

Gap falling

Markets, meanwhile, seem to believe that devaluation is indeed coming soon.

Both the black-market dollar rate and the blue-chip swap rate fell yesterday. The former ended the day at 14.54 pesos per dollar after losing 15 cents, while the latter was last traded at almost the exact same figure, 14.53 pesos, after plunging 35 cents.

The official dollar rate, meanwhile, continued to rise at a higher pace than during former Central Bank chief Alejandro Vanoli’s administration, gaining two and a half cents to end the day at 9.82 pesos per dollar.

That meant that the gap between the official rate and the two most widely used parallel exchange rates fell to 48 percent.

That spread could dissappear almost fully this week if the devaluation of the official dollar rate finally takes place.

Herald staff