Growth Would Address Fiscal and Monetary Imbalances

ARGENTINA - Report 04 Oct 2016 by Esteban Fernández Medrano

This report covers three interlinked macroeconomic issues: a) the deterioration of the fiscal balance; b) the monetary impact of that deficit on Central Bank inflation targets, and the Bank’s modification of the reference rate; and c) whether high-frequency activity data sends hopeful signals for those imbalances.

The Treasury in August received AR$37.5 billion in profit transfers from the Central Bank, and AR$5.8 billion from ANSES. These transfers reduced the headline financial fiscal deficit to only AR$-1.3 billion.

But after netting out those transfers, the monthly deficit closed at almost AR$-45 billion. Accumulating those fiscal results over the last 12 months generates a yearly deficit of AR$-462 billion, or -6.20% in terms of GDP, reversing the improvements of early this year, almost to the low point of December 2015. If additionally considering the LEBAC interest rates as a quasi-fiscal cost, the extended annual fiscal balance reaches AR$-613 billion, or -8.5% of GDP.

The Central Bank announced the operational framework of its inflation targeting for 2017-2019. Starting next year, the Bank will stop using the LEBAC interest rate as its reference market rate. It will shift to the 7-day interbank lending rate. In turn, the BCRA will start issuing the LEBACs monthly.

Yet the 17% inflation cap for 2017 faces some significant challenges. Adding to the stock of base money, the monetary financing to the Treasury and the projected LEBAC interest, while subtracting the implicit growth of the stock of LEBAC, gives exogenous annual growth on money supply of 43% y/y. This value exceeds the projected 34% growth of money demand expected by the BCRA, suggesting either higher sterilization needs or higher inflation than the 17% target. Put differently, assuming that real money demand increases 15% y/y, the expected increase in M0 suggests inflationary pressure of around 24%.

Higher GDP growth would clearly help resolve the fiscal and monetary imbalances. While aggregated low-frequency activity indicators for Q2 continue to reflect an economy in sharp recession, some preliminary, higher-frequency data have started to suggest gradual improvement, or at least a halt in contraction.

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