Argentina’s economy is stuck in a twin crisis. On the one hand, there is the COVID related shock. April’s activity was -20% YoY, the deepest instant contraction in recorded history. The economy is locked-in in a bad equilibrium, with the virus in its ascending phase in PBA and CABA and the population already showing “lockdown fatigue”.
On the other hand, there are huge fiscal and monetary imbalances, the consequences of which are not yet fully felt. Money Aggregates have grown at a speed with almost no precedents in the last half-century. The ratio M2/GDP increased by 76% (!!!) between May 2019 and May 2020, in line with the previous peak in 1986, and above 55% of 1974. Most of this growth happened in the last three months, with a 53% change in M2/GDP.Speed of growth of Money
M2/GDP ratio YoY change
Signs of the monetary overhang are widespread, contained by the lockdown’s transitory impact on a frozen velocity of circulation. Cash holdings are 5.4% GDP, +2pp vs February, and in line with 28D-2017 levels. Meanwhile, private sight deposits stand at 9.5% GDP, +4pp vs February and 3pp above 2008/2017 average, and total deposits are 15.4% GDP, +5pp above February, and +4pp above 28D levels.
as % of GDP
Monetary policy faces a sterilization riddle, as it’s easier to pump money in that to pump it out. Using a back of the envelope calculation, M3 growth (ARS 1,230bn since December) can be traced back to ARS 910bn from transfers to the Treasury due to expansionary fiscal policy and ARS 320bn from forced credit lines expansion. Secondary creation of money is already very low, but, at the same time, money overhang does not lie on banks’ liquidity and cannot be easily sterilized through open market operations. It requires some extent of credit unwinding, highly contractionary under current circumstances. On top of that, “sleeping” money overhang held by the retail sector is even harder to sterilize.
How can money evolve over time? We did some unpleasant monetary arithmetic, designing alternative scenarios to simulate likely dynamics, money financing needs, and monetary policy responses.
We assume the money supply will grow ARS 1,760bn from May to December driven by
- Primary deficit: ARS 1,243bn, 4.3% since May, totaling 5.6% of GDP in 2020
- ARS denominated interest payments: ARS 141bn. On the other hand, we assume that ARS capital amortizations are fully rolled over
- Leliqs Interest: ARS 650bn
- Official FX interventions: minus ARS 280bn, about USD 1bn per month for 4 months).
This adds up to ARS 1,760bn in the low inflation scenario and ARS 1,660bn in the high inflation scenario, the difference coming from higher tax collection in Q4.
Treasury ARS Financial Program
Money aggregates scenarios
% of GDP
Low inflation: In the first scenario, we assume that prices climb 2% per month (27% EOP YoY), that December 2020 activity is 5% below December 2019 and, more importantly, that cash balance, M2 and M3 ratios to GDP can be sustained at current levels (5.4%, 14.9%, and 20.8% respectively) with no inflationary consequences.
In this scenario: (A) Money base grows ARS 782bn or 44% of money supply growth; (B) LELIQ + REPO stocks have to grow ARS 978, pushing their GDP ratio from 8.2% to 9.2%. In one line, if the government can hold money demand at current levels, the primary deficit of 5.6% GDP can be financed without increasing imbalances and requiring only 1pp of additional sterilization to banks.
High inflation: We created an alternative scenario where we reversed the causality, what is the inflation needed to wipe excess money if money aggregates were to return to February levels (Cash 3.5% of GDP, M2 9.1%, M3 14.1%)? The answer depends on how many public assets are forced into the bank’s balance sheets. Different inflation levels determine nominal cash, base money, and deposits demand, thus changing the need of sterilization:
- Required inflation is 6.5% per month (or 97% EOP) to liquify the stock of LELIQs + Repo down from 8.2% to 5.8% GDP, with its ratio vs private deposits stable at 55%.
- 4.4% per month (or 64% EOP) if we allow the stock of LELIQs + Repo to stay in 8.2% GDP, but its ratio vs deposits to climb to 75%.
- With 3.7% inflation (or 54% EOP) the stock would be 9.2% GDP (like in the low inflation scenario) and 86% of private deposits.
Money Sources, Sterilization and Money Base
Intermediate 4.4% inflation scenario
Central Bank’s Liabilities on Bank’s Balance sheets
Lelis + REPO / Deposits
These results help expose the trade-off that the monetary authority is facing in the context of big monetary imbalances plus total fiscal dominance. In the – very likely – event of a falling money demand or raising the velocity of circulation a number of options appear. The inflationary pressures can be transitorily repressed – the early 70s “Gelbard” strategy -, they can be sterilized by forcing more illiquid assets on banks or depositors – the “Erman Gonzalez / Bonex” strategy – or they can be unleashed – “the Celestino Rodrigo” strategy.
Looking at the size of the imbalances a combination of the three strategies still looks feasible: Some price repression, some financial repression, and more inflation. However, they rely on fiscal and BOP assumption – not discussed in depth in this report – that lie on the optimistic side of the distribution, and policy response so far has been quite erratic. In this context, we still believe that the odds of a disorderly outburst of monetary and fx imbalance later this year are quite high.