Tuesday, June 12, 2018

Argentina maintains rate, tight policy until inflation falls

       Argentina's central bank left its monetary policy rate at 40.0% and confirmed its guidance from last week's agreement with the IMF that it is "committed to maintaining the current contractionary bias of monetary policy until it observes tangible signs that both inflation and inflation expectations begin to fall."
       But as part of a normalization of monetary policy, the Central Bank of the Argentina Republic (BCRA) said it was reducing the width of its corridor for 7-day passes to 600 basis points from 1,400 points, and the 1-day pass width to 1,000 points from 2,900 points.
       This means that rate for 7-day active passes is 43.0 percent and 37.0 percent for passive passes, and 45 percent for active 1-day passes and 35 percent for passive passes, BCRA added.
       In today's policy statement, the Argentine central bank reiterated key points of the June 7 agreement with the International Monetary Fund (IMF) that included a US$50 billion standby loan.
       The agreement  deepens the central bank's operational and financial autonomy, ratifies the inflation targeting regime with a floating exchange rate regime and sets new inflation targets.
       The central bank said "changes in the international scenario" - a reference to higher U.S. rates and a U.S. dollar - along with the process of fiscal transition led to a depreciation of the peso, which prevented compliance with the inflation targets.
       This necessitated a "redefinition" of inflation targets for coming years, the central bank said, adding it considers these new targets to be appropriate, given the starting point and a new context, "but at the same time they have to be very strict in terms of monetary policy."
       The reference to "strict" monetary policy implies that it won't repeat January's mistake of cutting interest rates in the face of rising inflation, only weeks after the government eased inflation targets.
      On Dec. 28, 2017 Macri's government pushed back the 2018 target of 8-12 percent inflation and set 15 percent as a target after inflation averaged almost 25 percent in 2017, well above the target of 12-17 percent target.
      But instead of treating the new targets as an acknowledgment of its failure to reach earlier targets, the central bank acted as if its credit card limit had been raised and went on a shopping spree.
      Within the next two weeks the policy rate was cut in two steps by a total of 150 basis points, unnerving many investors and accelerating the drop in the peso's exchange rate.
      This kickstarted the chain of events that led to this week's agreement with the IMF.
      For 2018 the central bank has eliminated its previous inflation target of 15 percent and replaced it with a target that aims for inflation below 22 percent for the second quarter of 2019, the first 12-month period that will be judged under the new policy framework.
       For 2019 the central bank will now target inflation of 17 percent, up from the 10 percent that was set last December.
       For 2020 inflation of 13 percent will be targeted, up from 5 percent, and for 2021 inflation of 9 percent will be targeted. By 2022 the central bank is targeting inflation of 5 percent, its estimate of price stability.
       In April Argentina's headline inflation rate was steady at 25.6 percent and the central bank said May inflation may show a lower-than-expected number, mainly due to lower regulated prices.
       However, high frequency indicators show an acceleration of inflation in June and inflation expectations for 2018 have risen to 27.1 percent from 22 percent for overall inflation.
       Meeting these new goals will be easier under the new monetary policy regime, the central bank said, adding it will be guided by how compatible the path of inflation is at the end of each quarter in relation to its new targets.
       As part of the agreement with the IMF, Argentina's government will prepare a reform of the central bank's charter from 2012 that aims to strengthen its financial and institutional independence while also requiring it to become more transparent in the way it presents its balance sheet.
       "In order to achieve the objectives of the BCRA, it is essential that the credibility of the monetary authority allows institutions and the population in general to trust that their decisions are credible and stable in the medium and long term," the agreement said.
       In order to strengthen its independence, the proposed bill will set strict limits on the reasons why the president, the vice president and directors of BCRA can be removed.
       To give the BCRA more financial independence, the reform will eliminate any financial assistance from BCRA to the Argentine treasury and the treasury will cancel its debt with the central bank of around US$25 billion.
       "This scheme, in which the Central Bank does not transfer peso to the Treasury and in which it cancels its debts with the BCRA constitutes a radical change in the monetary history of Argentina," the central bank said last week.
      As far as the central bank's overall operational framework, the BCRA said it would ratify a regime of inflation targeting with a floating exchange rate, a regime widely used by central banks in both developed and emerging economies since the 1990s.
      "This regime has proved effective internationally to anchor inflation expectations, thus maintaining low inflation and reducing the transfer to prices of exchange rate movements, allowing the real exchange rate to change to stabilize growth," BCRA said.
      Emerging countries that adopted a system of floating exchange rates instead of fixed or flexible exchange rates, or even monetary aggregates, "had greater decreases in inflation will less volatility," the central bank added.
       The Argentine peso was trading at 25.7 to the U.S. dollar today, down 27.6 percent this year and down 38 percent since the start of 2017.




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