Why not just let the Argentine peso fall?

I wrote this almost a week ago, but forgot to hit “post.” With today’s further fall in the peso to 25 per dollar, it sadly remains relevant. So ...

Why is Argentina going to the IMF at all? Why not just let the peso fall?

Answer: currency mismatch. Argentina seems to be shot through with foreign borrowings. Some of these borrowings are hard to understand.

Other foreign borrowings are not as hard to understand. Consider the gross data on Argentine financing through international capital markets. When President Macri took office, the country regained access to foreign lending. It then proceeded to take full advantage of that new access to raise needed capital. Together the federal government, provinces, and the state-owned oil company (YPF) have borrowed about $48 billion (gross) under the Macri administration through the end of 2017. (There are credible reports that these figures may be understated by a factor of two.)

Now, I’m not saying that borrowing caused the run on the peso. Nor am I saying that it’s a huge amount for a ~$545 billion economy. But it would be rough if the capital suddenly stopped flowing, which is what would happen if the authorities just threw up their hands and let the peso plummet. Budget deficits would still need to be plugged and expiring debts would still need to be rolled over, only at much greater cost in peso terms. 

But wait it gets worse! Argentina’s financial system is heavily dollarized. That means people and businesses denominate their debts in dollars, not pesos. Why they do this is not clear: there are plenty of other countries with as checkered a monetary history, yet debts and contracts are made in the local currency. Nonetheless, many Argentine businesses write their debt contracts in dollars, even though most of them make sales in pesos. 

How serious is this problem? Well, I once again turn to the Argentine central bank. In 2016, 39% of manufacturing industry debts were in dollars, along with 37% of farm debts and 32% of service businesses. Only commerce (17%) and construction (12%) had less dollar debt … but even those numbers are pretty high. Twelve percent of construction business liabilities, the nontradable par excellence, are in foreign currencies?

Should the peso crash, those debts would become overwhelming. In fact, according to the Institute for International Finance, the situation has become a lot worse in the last two years: they report that a whopping 64% of Argentina’s combined government and corporate debt is denominated in dollars. Imagine if the value of 64% of your debts doubled over the course of a few days.

It follows that Argentine banks are exposed to depreciation. As of September 2017, 9% of bank loans were denominated in dollars, against 15% of their liabilities. The weight of those liabilities could soar if the peso crashed. Moreover, considering as most of those loans are probably to Argentine entities who earn in pesos, those dollars loans would start looking shakier as well.

In short, jacking up interest rates and going to the IMF is bad. But letting the peso just fall as far and as fast as the market will take it is also bad. It might even be worse. In other words, cry for Macri, Argentina: it is a terrible and unavoidable choice. 

Comments

[J.H.]

Hmmmm....well a possible reason for the persistence of the Blue Market was discussed before (http://noelmaurer.typepad.com/aab/2017/04/observatorio-argentino-34-what-is-the-opposite-of-blue.html) but I don't think it explains the deep dollarization of Argentina's financial system. Perhaps as a result of the crisis in 2001, financial institutions have preferred debt contracts written in dollars rather than pesos? Could it be that debts issued in dollars are more likely to be approved and/or come with more favourable terms?

Maybe Argentina should just dollarize fully now like Ecuador?

[Douglas Muir]

oh man systemic currency risk is a bitch.

as you know Bob my thinking on this issue was permanently warped by being in Indonesia in 1997. banks had borrowed heavily in foreign currencies because why not? the economy was growing, the rupiah was stable. until it wasn't -- 60% drop in two weeks. whoops.

dollarizing loans just pushes it downstream. the banks aren't on the hook directly but watch their NPL rate head for the moon because nobody can afford to repay their debts.

the IMF solution in Indonesia was, I shit you not, "austerity!" yeah guys great job converting what should have been a two year recession into a lost-decade depression. around 2010 they publicly admitted they'd screwed that one up. nobody ever suffered any consequences, of course, but hey the "my bad" was nice.

okay so Argentina. jacking up IRs to keep the currency afloat is a painful solution that at a minimum is growth-killing and at worst will shut down bank lending because why loan money when T-bills are paying 23% or whatever. it's also a bit late in the day given that the systemic exposure is large and the peso has already fallen far -- even if rate hikes stabilize it, borrowers are still going to feel pain. some of which will be transferred to the banks through NPLs. weaker banks may go to the wall. are there weak Argentine banks that are 'too big to fail'? whoops now you have the fun choice bailout / or don't.

there are some solutions floating around that AFAIK have never been tried. one that caught my eye was a mandatory cramdown: by law, all dollarized bank loans made before date X get fixed at a particular exchange rate. no idea if it would work but the current menu of policy options is not very heartening.

Doug M.

[Noel Maurer]

The mandatory cram-down as described sounds like the Argentine corralón. The corralón pesified all debts at an exchange rate of 1:1, while pesifying deposits at 1.4:1. So if you owed $1 and had $1 in deposits, you now owed one peso and enjoyed 1.4 pesos in deposits; this at a time when the market exchange rate had crashed from parity to about 3 pesos per dollar.

The corralón didn't work well, as you know, but the Argentine government waited until the alternative was to altogether abandon the credit economy before trying it.

Is the cram-down proposal significantly different?