Argentina Heading For Recession, Peso Hits New Low

Argentina Heading For Recession, Peso Hits New Low
September 17, 2018

 

Despite the efforts of Argentinian President Mauricio Macri to encourage possible investors, Argentina’s struggling currency reached a threshold of over 40 to the dollar amid a decline in investor confidence. The Latin America’s no.3 economy is fighting desperately to prevent an economic collapse, with inflation anticipated to exceed 40% for 2018. Dollar demand rose on Friday due to excessive liquidity sparked by an auction of Treasury bills. The peso has surrendered 53% of its value to the dollar so far this year, more than 7% in September alone, as demonstrations against revived government efforts to reduce costs to regain market faith increased.

 

What caused the contraction of the Argentine economy?

After Argentina’s economy recovered in 2017 and pro-business President Mauricio Macri’s coalition government won at legislative elections last October, mainstream economists had high expectations for the South American nation at the beginning of 2018.

Surprisingly, the economy began to collapse due to the following reasons: Economists had long maintained that Argentina’s peso currency was overpriced, and the government admitted that it would devalue gradually and slowly without causing panic in the market. However, the peso unexpectedly fell in April on renewed investor fears about the government’s ability to manage inflation and interest rate hikes by the U.S. Federal Reserve, which strengthened the dollar. The depreciation made Argentina’s dollar debts more unaffordable for the government, forcing it to request the International Monetary Fund (IMF) for a $50 billion loan.

Argentina’s soaring inflation rate is one of the main attributes that make it more susceptible than the rest of the emerging markets to portfolio churning by international investors. The rapid decline in the exchange rate has led to an acceleration in inflation in recent months. The central bank reacted to the rapid devaluation and rise in inflation by raising interest rates to 60% and diluting billions of dollars in Forex reserves to defend the peso, which has led to a sharp drop in reserves, which had gradually increased since Macri took over in December 2015. While the IMF loan gave the reserves a boost, the ongoing pressure on the peso encouraged renewed intervention by the central bank in recent weeks. A debilitating drought destroyed the harvests of soybeans and corn, the pillar of Argentina’s economy. The economy has now contracted with the agricultural sector for three consecutive months, paving the way for what economists believe will be a recession.

The economy declined 6.7% in June, the worst monthly decline since the 2008 financial crisis. Last Thursday, thousands of public school teachers and university professors protested against Macri ’s fiscal prudence plans in capital Buenos Aires, saying that the government was sponsoring the military and police while letting education and welfare programs suffer. Bleak inflation news also affected the currency, with official figures showing that retail price rose 3.9% in August, bringing the 12-month rate to 34.4%.

Commenting on the situation, Sergio Stape, a 46-year-old teacher, said: “The government is reducing opportunity, not only for education but for healthcare as well, while steering a big part of the budget toward security. We say this is a step backward.”

Targets mentioned in the original IMF agreement are being finalized to better reflect market fears that the government was not working fast enough to bring down its primary fiscal deficit.

Macri’s government now promises to eliminate the funding gap next year. His earlier 2019 deficit target was 1.3% of the gross domestic product. History has shown that countries which had seen their currency plummet by more than 40% in a year have generally suffered GDP contractions of over 6% the year after. Peso has lost roughly 53% in the past year. Moody’s is estimating a 2% decline in each of the succeeding two years, while Fitch Ratings forecasts a 2.5% recession in 2018, with additional contractions possible.

Todd Martinez, an analyst at Fitch in New York, said: “The currency selloff has already had a big negative impact on confidence. It means higher inflation going forward, which erodes real wages and pensions and will weigh on consumption.”

Edward Glossop, Latin America economist at Capital Economics, said: “Our . . . view is that the IMF will ultimately agree to disburse more funding to Argentina, but whether the government will be able to stick to the conditions attached to the new deal will be another matter.”

How quickly the country recovers depends largely on Macri’s long-term strategy, yet with an election looming at the end of next year, steep fiscal reforms may not be acceptable to the public. Students campaigning university budget cuts forced the closure of the main boulevard in Buenos Aires, while boycotting truckers shuttered off access to a major grain port in northern Argentina.

Over half-a-century of currency devaluations from Chile to Indonesia indicate gloomy prospects for Argentina and President Mauricio Macri – a deep financial crisis followed by political uprisings.

ARS - technical analysis - 17th September 2018

The USDARS pair remains on a firm uptrend in the historical price chart. Unless the inflation issue is sorted out, the Argentine peso will continue to remain bearish.

Disclaimer: Any financial trading analysis offered here is our opinion and is not intended as advice or direction for investors. We cannot guarantee the success of any trades made as a consequence of this article, and we encourage traders to incorporate a strong money management strategy to limit losses when they enter the markets. Please use this article as part of your own research before formulating strategies prior to trading.

Ian Maguire

Ian Maguire

Ian is our resident contributor to the latest going ons in the cryptomarket, keeping up to date with the latest icos and coins


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