Peso appreciation is worrying the government but not the Central Bank

ARGENTINA - Report 07 Apr 2017 by Domingo Cavallo

Inflation seems stuck at monthly rates slightly above the target set by the Central Bank, and the economic recovery still appears fragile. Kirchnerist opposition to the government has taken advantage of the social discontent to promote riots, strikes and street blockades in Buenos Aires and other big cities. However, on Saturday, April 1, a largely spontaneous march of several hundred thousand people all across the country expressed their support for democracy and encouraged the government to persevere in solving the economic and social problems created by the populist and corrupt policies of the previous administration.

Macri’s government appears re-energized and is trying to find an adequate balance between the restrictive monetary policy that pursues price stabilization and the expansionary fiscal policy that is generating a large fiscal deficit. The greatest policy dilemma relates to the appreciation of the peso which, on one hand, helps to lower inflation but on the other, is starting to discourage exports and create unemployment in import-competing manufacturing sectors.

The solution is not simple. If the government wants to allow the nominal exchange rate to depreciate at the same rate as the increase in the domestic costs of production in the tradable sector, it would have to relax its monetary policy. The Central Bank would have to continue reducing the interest rate it pays on LEBACs, perhaps at a higher speed than it has been so far, and at the same time it would have to intervene in the exchange market, purchasing foreign reserves without sterilizing the resulting monetary expansion. We think this decision would not have a significant effect on the inflation rate, but that is not what the Central Banks thinks. Therefore it is very difficult to predict what will actually happen. The best strategy for financial investors is to follow closely the decisions the Central Bank will adopt over the coming weeks.

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