Just a few months after the IMF announced in June what was a record-setting $50 billion, 36-month bailout agreement with Argentina, the International Monetary Fund said it would expand the credit line to $57 billion in an attempt to halt the economic and financial crisis that has sent the country’s currency plunging over 50% this year, and pummeled the third-largest Latin American economy. In exchange, Argentina will set a “no intervention” zone for the peso from 34 to 44, meaning the exchange rate will be flexible but not floating.
The revised standby agreement is “aimed at bolstering confidence and stabilizing the economy,” IMF chief Christine Lagarde said Wednesday in a joint statement with Argentine Economy Minister Nicolas Dujovne.
The agreement, which is subject to IMF Executive Board approval, “front loads IMF financing, increasing available resources by US$19 billion through the end of 2019, and brings the total amount available under the program to US$57.1 billion through 2021,” according to statement.
Argentina had started renegotiating the terms of the bailout deal last month when it became obvious that the original funds would be insufficient, and when President Mauricio Macri asked to speed up payments in the original agreement. Meanwhile, as part of the deal, Argentina would be required to fulfill certain stipulations under the agreement, which would need congressional approval by way of the 2019 budget. In exchange, the IMF would cover a significant portion of Argentina’s financing through next year, according to Moody’s.
As part of the government’s efforts to cut its debt, which is projected to reach 70% of GDP next year. Macri and finance minister, Nicolas Dujovne unveiled economic reforms earlier this month, including highly unpopular spending cuts and export tax increases demanded by the IMF. However, balancing the budget as Buenos Aires has promised, will prove difficult for Macri as elections near and the program will be frowned upon by all local politicians. According to the local media, with an approval rating that tumbled below 40% this year, there’s a possibility the conservative, whose campaign focused on free-market reforms, may not be re-elected.
Meanwhile, Argentina is expected to slide into recession this years as a result of the currency collapse and the economic slowdown. GDP has already tumbled in the second quarter, marking the first economic contraction in more than a year, and is expected to continue to slide in coming quarters. With the economy sliding 2.7% Y/Y in July, Capital Economics predicted that the full year GDP drop would be 4% in 2018.
Meanwhile, Lagarde said that “a central element of the authorities’ plan will be to reach budgetary balance by 2019, one year earlier than previously intended, and to move to a 1 percent primary surplus in 2020.” She added that “to tackle inflation, the authorities will shift towards a stronger, simpler, and verifiable monetary policy regime, replacing the inflation targeting regime with a monetary base target.”
“This new framework will contain the supply of money, and keep short-term interest rates at their currently high levels, aiming to bring down inflation and inflation expectations decisively and rapidly” said the IMF head.
But while the IMF expects the economy will stabilize by the end of the year and begin a recovery as soon as 2019, analysts are skeptical: “The worsening of the situation in Argentina despite the rate hikes and government efforts to restore market confidence confirms our view that the situation is far from being solved,” Craig Chan of Nomura wrote in a research report.
Making matters worse, Argentina’s labor unions have already called for a nationwide strike to protest austerity measures and economic conditions, which will further slowdown the economy. Many citizens have spoken out against involvement with the IMF, which was criticized for its involvement in Argentina’s 2001 crisis which culminated in a sovereign default.
But what is the biggest question is how the market will respond: the $7 billion tack-on to the bailout fund may be seen as insufficient as the expectation had been for an increase in the range of $5-$20 billion, with some calling for as much as $30 billion, according to Bloomberg.
As part of the revised bailout agreement, the Central Bank of Argentina will adopt a floating exchange rate regime without intervention as long as the Argentine Peso is in the 34-44 range. In the event of extreme overshooting of the exchange rate, the BCRA may conduct limited intervention in foreign exchange markets to prevent disorderly market conditions.
It is unclear if the flexible exchange rate will be seen as a positive. While the central bank will be able to intervene under extreme conditions to control volatility, it would also be a drain on reserves, and the market will likely push the currency low enough on short notice.
Keep a close eye on the ARS tomorrow when it opens for the market reaction: if it is negative, the IMF may have to quickly expand its bailout yet again.