Late last month, Argentina voted to throw out the Peronists. In what amounted to a sharp rebuke of Cristina Fernandez de Kirchner's handling of the economy (among other things) Mauricio Macri defeated Daniel Scioli, Kirchner’s hand-picked successor, ushering in what the market hopes will be a new era for a country plagued by persistently high inflation and slumping growth.
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First on Macri’s to-do list (and trust us, it’s a very long list), is reforming the exchange rate regime. As we recounted three weeks ago, The President-elect wants to unify the official and parallel exchange rates (~9.60 and 15.50 ARS/USD, respectively) and that will of course entail a substantial devaluation. Just how overvalued is the peso, you ask? "Grossly" so, Citi opined, following Macri’s election.
As we went on to detail, selling dollars to support the peso really isn't an option anymore because, well, because there are no more dollars. Although Argentina’s official reserves sit at some $25 billion, net reserves (which factor in swaps with China, among other factors) are likely somewhere between $400 million and $2 billion, which for all intents and purposes means the country is out of dollars.
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This rather precarious situation led central bank head Alejandro Vanoli to do two things last month, i) force banks to sell half their dollar assets, and ii) sell $17 billion of dollar futures. Earlier in November, police raided the central bank after Macri's allies lodged a criminal complaint against Vanoli for violating the bank's charter by basically turning it into a giant derivatives trading hedge fund.
Last week, Macri succeeded in forcing Vanoli’s resignation.
“Although certain sectors are trying to spread the idea that reserves are ‘at zero’, the reality indicates otherwise,” Vanoli wrote, in a letter to Kirchner. “If the president-elect decides to impose a violent devaluation it will be exclusively as a result of a political decision.”
“However, many economists warn that liquid reserves are dangerously low since they have been used to prop up the peso’s value against the dollar, which is valued at 9.7 pesos at the official exchange rate but commands about 15 pesos on the black market,” FT writes [6], adding that “Macri called for Mr Vanoli’s resignation at a press conference the day after his election victory, amid outrage at the bank governor’s attempt to prop up the official exchange rate by selling about $17bn of future dollar contracts at an artificially low rate that will cause serious losses for the central bank if the peso is devalued.”
With Vanoli gone, the path is clear for the deval. A key figure in the execution of Macri's currency plan is former JP Morgan global head of FX research Alfonso Prat-Gay who will be Argentina's finance minister under the new Presdent. Prat-Gay was president of the country's central bank beginning in 2002. Over the course of Macri's campaign, Prat-Gay voiced support for the idea of unifying the official and black market peso rates. "There are no reserves left, and the capital controls don't make sense," the new FinMin said in November.
"The program to unify the currency market is the first signal for the economy to start to normalize," Prat-Gay told La Nacion last week. "We're going to fulfill that promise as fast and as exhaustively as possible. If we can do it the 14th, we'll do it the 14th, and if not, we'll do it once we see the right conditions," he added.
Well, the new FinMin might have missed that deadline, but not by much because Prat-Gay just made it official.
- ARGENTINA ENDS FX CONTROLS: FINANCE MINISTER PRAT-GAY
- ARGENTINA LIFTS CURRENCY CONTROLS AS VALUE OF PESO SEEN FALLING
The groundwork was set for the move earlier this week. As Bloomberg noted on Monday [7], Macri ordered financial institutions to "unwind their foreign-currency positions as part of an agreement with the futures exchanges under which they will rewrite the terms of some derivatives that would have handed holders a windfall profit." In other words, the new President is looking to ensure that when the deval comes, the central bank won't get hit too hard as a result of Vanoli's adventures in dollar futures. Here's more:
Federico Sturzenegger, the new central bank president, had to resolve the futures impasse before proceeding with lifting controls in order to reduce the bank’s liability stemming from the contracts, according to Rafael Di Giorno, a director at Proficio Investment in Buenos Aires.
“The government has to devalue as soon as possible since they need an inflow of dollars to rebuild reserves, especially from exporters,” Di Giorno said. “If they had devalued without fixing these contracts they would have faced a huge loss.”
And so, the stage is thus set for a new era in Argentina. For those interested in a case study of what happens after a dramatic devaluation, you now have front row seats for what is likely to be a 25-30% peso plunge. “It’s not a process devoid of risk but there’s also significant risk in doing this in several installments," Goldman's Alberto Ramos says.
Grab the popcorn.
