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Flows of “hot money” into Argentina are worrying policymakers in a clear sign of the dramatic turnround in sentiment since a new centre-right government took power in December.
Although dollar shortages were one of Argentina’s most urgent problems just six months ago, foreign investors emboldened by recent market-friendly reforms were this week banned by the central bank from buying its local currency notes amid fears that the peso’s strength is harming competitiveness.
Faced with the challenge of extinguishing inflation running at more than 30 per cent, the central bank jacked up local interest rates to 38 per cent earlier this year. That stimulated a sharp surge of dollar inflows that have helped to strengthen the peso at a time when most other emerging market currencies are weakening.
“How times have changed,” says Siobhan Morden, head of Latin America fixed income strategy at Nomura Securities, referring to the previous populist administration’s desperate need for dollars as central bank reserves reached precariously low levels. “Argentina still needs dollars but now they can afford to be selective,” she adds.
Ms Morden pointed out that the new government of President Mauricio Macri has benefited from renewed access to the international capital markets after it put an end to an epic legal dispute with its “holdout” creditors in April. That allowed major debt issues by the national and regional governments which, together with the soya harvest that causes a seasonal rise in exports, have encouraged inflows that have strengthened the peso.
In addition, investors taking advantage of the “carry trade”, where investors borrow at lower interest rates in one currency to invest at higher rates in another currency, have been piling into Argentine local currency bonds for the first time in many years after capital controls were removed in December. These inflows have also bolstered the peso, which has appreciated from almost 16 pesos to the dollar in March, to 14 pesos this week.
“We can’t allow a couple of Wall Street boys to bring their money and put the cart before the horse,” Federico Sturzenegger, the central bank president, told a senate commission last week. “We’d like these boys to leave and remain with the exchange rate we want, and to see it strengthen at the same pace as production, the real economy, and not at the pace of the finance world, even if this is complicated in a world of open capital.”
Despite the new restrictions put in place by the central bank this week, which were accompanied by a fresh cut in interest rates to 35.25 per cent, Martin Castellano, an economist at the Institute of International Finance, argues that the inflows of speculative capital are a “transitory development”.
“The central bank’s priority now is fighting inflation, which requires high interest rates,” says Mr Castellano. He explained that inflation has risen in recent months after a devaluation in December and increases in utility tariffs by as much as 500 per cent.
But most expect the central bank’s aggressive monetary policy to lead to a sharp slowdown in inflation in the second half of the year, which would remove pressure from the exchange rate. Lower inflation would allow lower interest rates, making the carry trade less attractive.
“The challenge could become more serious if inflation fails to decline as expected, which could mean high interest rates for longer,” says Mr Castellano.
Ms Morden points out that most of the region has had to battle against capital inflows during an era of quantitative easing, when low interest rates in developed markets have triggered a search for higher yielding debt.
Officials have plenty of options, she says, and can choose between continuing to deter dollar inflows, buying dollars or allowing the exchange rate to appreciate. “They’ll muddle through,” she says.