Argentina's exchange rate band

A new monetary experiment begins

ON FRIDAY, the International Monetary Fund Board passed a new program for Argentina, the third in the past decade.

There will be much to say about this new program, hopefully later this week. But perhaps the most interesting aspect will play out in coming days, as the program introduces exchange rate flexibility alongside the relaxation of capital controls. ARS will therefore have to find its feet once more—or as the Staff Report puts it:

Under the new FX framework, the exchange rate will initially float within a sufficiently wide exchange rate band to permit price discovery, with FX purchases within the band consistent with reserve accumulation goals.

A killer chart?

If there is a “killer chart” in the new document, it is perhaps one contained close to the end of the bundle released by the Fund late on Friday (page 120).

It shows the evolution of program funds since 2018, illustrating that the new EFF implies up-front financing that takes the Fund’s total exposure to Argentina close to SDR45bn over the next two years—before amortisations (“repurchases”) under the previous EFF take hold, following which amortisations under the new EFF begin.

Fund exposure continues until 2039, meaning there will have been IMF exposed to Argentina for over two decade—so much for revolving credit!

In short: the new program means more money.

In fact, “peak Fund credit to Argentina, assuming disbursements are made as scheduled under the proposed arrangement, is projected to reach SDR 43.1 billion in 2026 (1,352 percent of quota.)”

SDR43.1bn is USD58bn.

That is, the new program takes Fund exposure to Argentina about SDR3bn above the amount penciled in at the augmentation of the SBA back in 2018 of SDR 40.71 billion or 1,277 percent of quota (at the time USD56.3 billion but at today’s SDR rate USD55bn).

A crawling band?

A crucial part of the program includes changes in Argentina’s exchange rate arrangement and capital controls.

Indeed:

Staff agrees with the authorities’ decisions to gradually lift FX restrictions and allow the exchange rate to float within a sufficiently wide exchange rate band, to permit price discovery, while also allowing FX purchases to meet reserve accumulation goals.

To this end, local press reports the crawling peg is replaced by an exchange rate band between ARS1,000 and ARS1,400 (with Friday’s close at ARS1,075 per dollar.)

Elsewhere it is reported that the banks will depreciate at 1% per month.

This set-up is illustrated in the chart below. The initial depreciated band is about 23% lower than the spot rate on Friday—while a 1% crawl from here implies as much as 29% depreciation by end-year.

Curiously, the IMF’s document implies ARS will end the year only 14.6% weaker—which is below their estimated real exchange rate misalignment.

The exchange rate band is accompanied by the gradual removal of capital controls.

That is:

initially focusing on lifting current account restrictions (notably the elimination of the export incentive scheme and reduction of delays on import payments) and on easing the ability of households to convert peso deposits into USD [limited to USD200 per month]. Importantly, this liberalization will be gradual, as the existing withholding taxes (30 percent) on outbound tourism and FX credit card purchases by households would remain in place to limit risks from capital outflows.

Conclusions

This program is much more “conventional” than any of the recent agreements with Argentina—tight fiscal policy alongside exchange rate adjustment to eliminate an initial overvaluation.

Yet the overall strategy to preserve IMF financing and accumulate FX reserves at the central bank may be tested quite quickly—indeed, within minutes as some of the capital controls are removed and the exchange rate allowed to float.

Given that the real exchange rate is thought, according to IMF Staff’s external balance assessment, to be overvalued by “15 and 25 percent” (see page 62) while the upper band is only 23% weaker, there is a possibility that the currency hugs the upper band quite quickly—and intervention is required again.

But the bigger picture would note that price liberalisation is an important step forward, as well as being very Hayekian—so President Milei will be pleased. That is, providing the upper band does not get in the way.

Let price discovery begin!

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