"There Are No More Dollars In The Central Bank": Argentina's New President Confronts Liquidity Crisis

On Monday, Mauricio Macri, the son of Italian-born construction tycoon Francesco Macri, beat out Cristina Kirchner’s handpicked successor Daniel Scioli for Argentina’s presidency in what amounted to a referendum on 12 years of Peronist rule. 

A legacy of defaults combined with exceptionally high inflation and slow growth finally tipped the scales on the Leftists and now, Macri will try to clean up the mess. 


As Citi noted in the wake of Macri's victory (which was accompanied by some very bad dancing), "the most urgent challenge on the economic front is FX policy." 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 says. Here's their take:

Regarding the real overvaluation of the ARS, we estimate that real effective exchange rate has dropped (appreciated) 44% since 2011. Thus, for Argentina to have the same REER than four years ago, the USDARS should stand at 17. A different approach would be to compare the evolution of the real exchange rate vis-à-vis the USD in Argentina and other countries in the region. While the LatAm currencies (BRL, CLP, COP, MXN, PEN and UYU) real exchange rates relative to the USD have increased on average 36% since 2011, the USDARS has dropped 19% in real terms. Thus, from this point of view, the USDARS should stand 68% higher at 16.1.


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 and, as Reuters reminds us, "won widespread acclaim for swiftly taming runaway inflation and championing central bank independence." If that sounds to you like characteristics that might rub a Peronist the wrong way, you'd be right, and Prat-Gay was ousted by the Kirchners.  

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 earlier this month. "They just destroyed local economies, exports and a good part of industry."

Here's a look at Argentina's reserves:

That chart would be bad enough as it is, but the unfortunate reality is that Argentina actually has no reserves. Consider the following from La Nacion (translated): 

While the Central Bank reported yesterday that its reserves amounted to US $ 25.918 million, that number includes loans, as having taken with China or with the Bank of France, which initially only serve to swell the accounts but which are not easy to translate into dollars; also includes, among other items, the foreign exchange part of reserve which by law must make banks increasingly taking a dollar deposit to the public, and those belonging to foreign bondholders who, by order of the judge in New Thomas Griesa York, have not yet been transferred.


"The dollars you have in reserve assets side are offset by liabilities of the Central Bank. The availability in terms of net cash reserves is zero," says the former head of Carlos Perez. "What happens is that, in terms of liabilities, there are some that are not payable immediately, as is the case of the dollars that were frozen by order of Griesa, which could eventually be used," says the economist.


According to private estimates, the $ 26,278,000 reported to the Central Bank last week, would be US $ 10.853 million of the loan (swap) with the Bank of China; US $ 1.2 billion of credit with the Bank of France; US $ 155 million would be committed to payments within ALADI (the Latin American Integration Association); US $ 50 million are due to Brazil by the system of local currencies for foreign trade); US $ 8.615 billion are funds of depositors that banks have deposited in the Central; US $ 199.2 million are debts to be paid off with international organizations to December 15; US $ 427.3 million are deposits in custody, and US $ 2,640.7 million are trusts with $ bondholders exchange, which conflict with vulture funds could not cash (US $ 539 million Bank of New York and US $ 2.1017 billion National Bank). In addition, there would be US $ 1.1 billion of Treasuries US Sedesa owned (society that guarantees the deposits of the financial system) and US $ 613 million Cedin titles, which can be cashed at any time.


So in reality, Argentina has about $424 million or, as La Nacion puts it, "less than you need for a week." Here's a look at World Bank data on import cover for selcted Latin American countries (note that Argentina was dead last going into 2015):

Argentina's reserves fell by more than $1 billion in November alone and as should be clear from the above, selling dollars to support the peso really isn't an option anymore because, well, because there are no more dollars. This rather precarious situation led central bank head Alejandro Vanoli to do two things this month, i) force banks to sell half their dollar assets, and ii) sell $17 billion of dollar futures. Earlier this month, 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.

Here's a bit of color from Barclays on central bank liquidity:

President-elect Macri will inherit low liquidity levels at the central bank. Reserves have been falling consistently in 2015, largely because of the political decision to prevent a nominal devaluation that would correct the current real exchange rate misalignment. The reserve drain has been substantial – averaging US$100mn – in the past two months, and reserves stood at just US$2bn as of November 16 (Figure 1). The ratio of reserves to the monetary base has fallen to a record low of 0.5 since the Boden payment in October. Since exchange rate controls introduced between end-2011 and the start of 2012, the ratio has halved. In addition, the central bank‘s net worth has fallen from US$12.7bn in December 2014 to US$4.6bn as of October 30 (Figure 2). The liquidity position is so low that, on Saturday November 21, the central bank published a regulation that puts three new limits on banks, effective on December 1. The first forces banks to reduce their foreign exchange positions – which include all assets in foreign currency including treasuries and gold – from 15% to 5% of adjusted net worth1 . The fact that the central bank is depending on this type of urgent measure would seem to confirm that the China swap is not liquid, and that liquidity is better measured by net reserves than by gross reserves. 



And here's Barclays on Macri's FX challenge:

Success in the liberalization of the exchange rate controls and unification of the market would be measured by the extent of the FX overshoot and inflation pass-through (and, hence, how much real wages fall). We think the central bank has room to limit the exchange rate overshoot, given the lack of financial dominance: it can increase local interest rates to very high levels, given that, due to low leverage in households, banks, and firms, it would not cause immediate financial risks. Furthermore, the more gradualist approach to the depreciation of the peso, the lower the risks. 


The size of any overshoot and FX pass-through to inflation once exchange rate controls are lifted is uncertain at this point. Given the central bank’s low liquidity position, we expect it to try to rebuild the liquidity position before fully lifting exchange rate controls, in line with president-elect comments. As a reference, in 2002, the monthly average overshoot was 22%2 . The value of the ARS depends on several hard-to-forecast variables. First, the currency will likely become stronger the more successful the new administration is in setting a credible monetary program and switching the nominal anchor of the economy from the exchange rate – as it is currently – to the interest rate. Second, it should become stronger the higher and faster the inflow of capitals, which in turn depends on the credibility of fiscal adjustment announcements and fluid external financing. Third, we expect it to be stronger if the FX passthrough to inflation is lower, as a lower nominal devaluation will be needed to achieve the same correction of the real exchange rate.



So good luck Mr. Macri. You'll first need to oust the central bank chief and sort through the implications of billions upon billions of USD futures he sold and then, once you've determined how much the government will likely lose on those trades, you'll need to figure out a way to rebuild the coffers. 

Only then can you attempt to reform the FX regime on the way to unifying the official rate with the black market. 

For now, we'll simply leave you with the following hilariously straightforward assessment from Macri which came across the wires late Tuesday evening: