Next quarters, certain stagflation; afterwards, uncertain recovery
In retrospect, immediately after the release of our last quarterly forecast on April 20, the Argentine economy suffered a severe sudden stop in the flow of foreign capital, particularly from the beginning of May. As a consequence, the foreign exchange rate jumped from about 20 to approximately 28 pesos per dollar in spite of the strong measures taken by the Central Bank to dampen the depreciation of the peso. Very high interest rates paid on LEBACs and strong intervention in the FX market, plus the negotiation of an unusually large Stand-By Agreement with the IMF, have not yet been fully effective in restoring confidence in the FX and the capital markets.
The large stock of very short-term LEBACs has been threatening FX and local capital market stability. Even though the Central Bank seems to have designed a strategy to remove this “Sword of Damocles”, foreign and domestic investors are still concerned the government may not secure enough support to implement the fiscal adjustment committed to in the program negotiated with the IMF. They are also concerned about the risk that, even if the government succeeds in implementing the agreed-upon fiscal adjustment, the political costs to be paid by Macri’s government might bring the populist opposition back to power after the presidential election of 2019.
It is already clear that the sudden stop is producing a stagflationary scenario that may last for several quarters. As a consequence of the large devaluation, monthly inflation jumped from 2.3% in May to approximately 4% in June and very likely will fluctuate around 3% over the next few months, as it did in the first semester of 2016 after a similar devaluation of the peso following the removal of exchange controls in December 2015. The level of economic activity has already declined rapidly in May and June and very likely will continue declining over the course of the second semester. The government recognizes that stagflation is now a realistic forecast for the second semester of 2018, but expects that once it becomes clear that this administration is succeeding in implementing the fiscal adjustment, growth will be renewed and inflation will decline rapidly throughout 2019.
The recovery and disinflation in 2019 is not guaranteed. It will depend on the ability of the government to neutralize the strong opposition that will try to capitalize on social unrest and promote strikes, street blockades and other manifestations of popular dissatisfaction.
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