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Argentina Economic Summary: October 29, 2018

Core Content Overview

This report provides an analysis of Argentina's economic situation, focusing on capital flight, foreign asset formation, the Leliqs (Local Exchange-Led Instruments) mechanism, and the foreign exchange (FX) market dynamics. It is authored by BNP Paribas and outlines the challenges and risks facing the country's monetary and financial system.

Main Points

Capital Flight and Foreign Asset Formation

• Capital flight remained high in September 2018, totaling USD 16.2bn on a 12-month rolling basis, up from USD 6.8bn a year ago.
• Foreign asset formation (from both financial and non-financial sectors) stabilized in September at USD 2.3bn, but the 12-month cumulative total reached a record high of USD 31.4bn or ~6.5% of GDP.
• Despite ARS depreciation and high domestic real interest rates, there are no signs of capital flight reversal.
• Non-resident portfolio flows remained negative in September, at USD -1.285bn, indicating continued outflows.

FX Market Dynamics

• USD demand from the private sector remained robust, with net demand for US dollar notes at USD 1.2bn in September.
• The average USD demand per client was USD 2,740, with ~47% of clients demanding up to USD 10,000 per month.
• The commercial FX flow stabilized, but positive trade balance is still required to offset financial outflows and support economic re-monetization.

International Reserves

• Gross international reserves (excluding IMF) totaled USD 48.2bn as of October 23, 2018.
• Net liquid reserves were estimated at ~USD 10bn, showing a continued decline.
• The Leliqs now account for ~78% of international reserves (excluding deposits and IMF), and 158.3% of net liquid reserves when swaps with China are netted.

Leliqs and Quasi-Fiscal Deficit

• Leliqs, which are high-yield instruments (71% annually), are contributing to a quasi-fiscal deficit.
• If money demand does not increase significantly, the BCRA may need to implement liability management to address liquidity issues.
• The Leliqs-to-time deposits ratio reached ~43% in October, raising concerns about the sustainability of the monetary system.
• The high yield of Leliqs is increasing the need for further issuance, which could worsen the quasi-fiscal deficit to 3.5-6% of GDP in H1 2019.

Target Zones and FX Regime

• The new monetary system is considered appropriate, but floating exchange rate conditions are not met in Argentina.
• The inflation target is primarily driven by ARS depreciation and expectations, not by interest rates.
• High real interest rates may negatively impact public debt sustainability.
• A stable FX rate is essential for forward-looking inflation expectations.

Key Risks and Concerns

• Uncertainty surrounding Presidential elections could trigger a wave of re-dollarization, forcing the BCRA to issue more pesos to meet liquidity needs.
• A sharp acceleration in inflation or ARS depreciation could result from unexpected external shocks or decline in ARS demand.
• The sustainability of the current stabilization program depends on a series of positive external and domestic events.
• The combination of capital flight, high foreign asset formation, and unsustainable Leliqs growth pose a systemic risk to the financial sector.

Data Highlights

• Monthly average of foreign asset purchases since 2015: USD 1.49bn
• Cumulative foreign asset formation (non-financial private sector) in 2018: USD 55.3bn
• Leliqs yield: 71% annually
• Leliqs-to-time deposits ratio: ~43%
• Quasi-fiscal deficit (H1 2019): 3.5-6% of GDP (depending on money demand scenario)

Conclusion

Argentina's economy continues to face significant challenges in managing capital flight, foreign asset formation, and the Leliqs mechanism. While foreign asset purchases have stabilized, non-resident portfolio inflows remain negative, and international reserves continue to decline. The BCRA may need to implement liability management if money demand does not improve. The FX market remains highly dependent on dollarization, and the target zone conditions are not met, raising concerns about the sustainability of the monetary policy and the overall economic stability.

Figures and Tables

• Fig. 1-6: Foreign asset formation and USD purchase by the private sector
• Fig. 7-15: Capital flight and foreign asset formation dynamics
• Fig. 17-19: Growing unease with Leliqs and their impact on reserves

Legal Disclaimer

This document is a marketing communication and not independent research. It is not investment research and is not intended to provide advice. The information is based on public sources and not independently verified. BNPP may have conflicts of interest and financial interests in the securities discussed. No liability is accepted for any losses arising from reliance on this document.