Macri plays dangerous game with peso

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Analysts abroad largely agree removing restrictions too quickly could spark troubl

NEW YORK — If there’s one point president-elect Mauricio Macri has been crystal clear about, it’s that he hates all the rules and restrictions throttling the country’s currency market. On Tuesday, Macri reiterated his pledge to do away with the foreign-exchange controls immediately upon taking office next month.

It’s an audacious plan, one that could jump-start his efforts to lure much-needed investment to the country but it also comes with great risk. With the official and black-market exchange rates currently 58 percent apart, lifting the controls will almost certainly trigger a plunge in the value of the peso. That could cause a surge in consumer prices in a country where inflation is already running above 20 percent, deepen the economic slowdown and spark a public and political backlash against the new government.

The plan is so fraught with risk and so logistically difficult that many outside observers insist that he won’t really try to pull it off so quickly. They chalk it up to campaign rhetoric. But Macri isn’t toning down his language as president-elect. When asked Tuesday how fast he’d move, he replied December 11, one day after he’s sworn in.

“History is littered with the corpses of countries that have abandoned capital controls precipitously,” said Barry Eichengreen, an economics professor at the University of California at Berkeley and former senior policy adviser to the International Monetary Fund during the 1997-1998 Asian financial crisis.

Should Macri, two-term mayor of Buenos Aires and wealthy businessman, follow through on the rhetoric, the US$540 billion economy could suffer a big blow. “There will be a single exchange rate,” Macri said Tuesday. “The controls don’t make sense any more since there aren’t even any dollars left to defend in the Central Bank.”

Assuming he devalues the peso by 39 percent to 15.8 percent in three months to align the exchange rate with black-market prices and removes utility subsidies, the Central Bank will have to raise interest rates to 40 percent by September to control inflation, according to Oxford Economics, a UK research firm. Under such a “shock therapy,” the economy will shrink by about three percent annually in the next two years before picking up in 2018, economist Luiz Kessler wrote.

Venezuela, a Mercosur trade bloc partner and long-time ally, has been there before. In 1989, newly-elected President Carlos Andrés Pérez abruptly lifted foreign-exchange controls and let the currency plunge after finding that the Central Bank was running out of foreign reserves. Consumer prices soared 21 percent in one month alone, leading to the “Caracazo” riots that killed hundreds and spurred Hugo Chávez, then an Army officer, to accelerate plans to stage a coup attempt that launched his political career.

Instead of shock and awe, Macri should adopt a gradual transition to a free-floating exchange rate, said Paulo Vieira da Cunha, a former Brazilian deputy Central Bank governor. That would give the government time to pass measures that will soak up extra pesos, implement a credible fiscal plan and draw in cash from abroad, he said.

“There is a difference between doing something gradual with credibility and doing something haphazardly into a void,” said Cunha, now chief economist at Los Angeles-based money manager Ice Canyon.

Economic woes

No one is saying Macri shouldn’t start implementing changes quickly. The economy is reeling from the lowest foreign reserves in nine years at US$25.8 billion, the biggest budget deficit in three decades and a foreign currency controls. In the last four years, the peso has fallen just 55 percent, compared with annual price increases of more than 20 percent since 2011.

Excluding items such as dollars held for commercial lenders and a US$10 billion currency swap with the People’s Bank of China, the country has just US$2 billion in readily-available reserves, according to Barclays.

But for Macri, the margin for error is thin. As 49 percent of voters went for his opponent the Victory Front (FpV) candidate Daniel Scioli, unpopular measures of large devaluation, coupled with spending cuts and tax increases, would only alienate Argentines and erode his political support.

Mario Blejer, former Central Bank head who devalued the peso in 2002, said capital controls should only be phased out and lifted sector by sector, starting with importers. To mitigate the impact, Macri will have to increase interest rates on Central Bank notes and spur demand for pesos, said Blejer, who boosted those yields to 140 percent 14 years ago.

“We used to think about it as an equation in which the greed for higher interest rates will trump the panic of holding pesos,” Blejer, who was most recently advising Scioli, said. “They’ll see that it’s difficult. You can’t just change everything from one day to the next.”

Ultimately, Macri’s narrow victory over Scioli may be the loudest call for a gradual approach, said Vargas.

“What I’m seeing is that they’re becoming aware of the magnitude of the adjustments, maybe because of how close this race was, and that’s going to impact how aggressive they are,” he said.

@xieyebloomberg, @katiaporzo

Source: Buenos Aires Herald

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