SEIDO Macro Update: How may a second wave shock look like?

April 16th, 2021

Q1:2021 macro dynamics were mostly in line with expectations, though activity surprised positively and inflation negatively and looking ahead, our base scenario (presented in previous Macro Updates, see here) does not warrant major adjustments. However, the odds of alternative - worse - scenario are growing. With the pandemic’s second wave reaching our shores, the economy might deteriorate more than expected.

What follows is an early simulation of our Second Wave scenario, in which the government reimposes restrictions, milder than those implemented in Q2-20. We simulate the activity dynamics and its impact on inflation, fiscal accounts, monetary aggregates, and forex market. The underlying logic of our Second Wave scenario is as follows:

  1. Activity would drop in Q2 (-6.5% QoQ sa) and then recover sequentially, ending 2021 at the same level as in our base scenario. This would yield a growth rate of almost 5% for the entire year (vs our base forecast of 7%). Basically, the statistical carry-over from last year. December would be barely above end-2021's level (+0.7% YoY).

  2. With the economy tanking, fiscal accounts will deteriorate from both the revenue (lower taxes) and the spending sides. Assuming that the official response only differs from our base scenario in terms of transfers to families, 2021's primary deficit would be 6.2% (vs 4.5% of our base scenario). It should be noted that our base scenario already included some social spending, as we expected last year's Covid-19 related programs to be cut down only by half in real terms.

  3. The higher deficit would increase the financing gap, with the BCRA printing about ARS 634bn or 5.7% GDP to assist the Treasury. Again, most of this financing would take place in H2, when uncertainty about the elections increases and foreign currency inflows decrease.

  4. Monetary aggregates would increase, even more, aggravating imbalances. After some short-term moderation (as occurred last year during the first phase of the lockdown), this would put upward pressure on H2 monthly inflation rates. Nevertheless, 2021 would end with an inflation rate below our base case forecast (41% vs 47% YoY). As for the FX premium, it could climb up to almost 100%, a combination of lower nominal depreciation rate of the official FX and higher depreciation of the BCS rate.

Long story short: even if activity does not suffer much, the government would have to increase fiscal spending and the higher deficit would be monetized. This would aggravate monetary imbalances even more, and the chances of an FX crisis that "washes" imbalances through inflation would increase substantially.

Summary of Forecasts Summary

SEIDO Macro Update: Calm before the second wave

Economic activity continues recovering, though at a very gradual pace and with sectoral heterogeneity. In fact, most of Q4-20 growth (+4.5% QoQ sa, -4.7% YoY) has come from services, particularly those most affected by the government-imposed lockdown. This year started with a 1.9% MoM sa increase of economic activity, with sectoral variation ranging from -2.4% MoM sa (Electricity, Gas & Water) to +23% MoM sa (Hotels & Restaurants).

The recovery continued in early 2021, but data sends mixed signals. On the bright side, Q1 performance has been better than expected (we adjusted our Q1 growth forecast to +2.9% QoQ sa, from previous 2% QoQ). On the negative side, early indicators shows that activity is losing momentum, which deteriorates Q2 outlook even without considering the possible impact of Covid-19’s “second wave” and the official policy response.

The inflation front also surprised in Q1, particularly in March. Prices increased 4% MoM in January, 3.6% MoM in February and 4.8% in March (vs our early estimate of 4.2% MoM -see here- and REM's expectation of 3.9%). Latest official data reported acceleration of all price groups: core inflation (4.5% MoM vs 4.1% MoM in February, explained mostly by Meat and Dairy products), regulated prices (4.5% vs 2.2%, due to Fuels and Public transportation) and seasonal prices (7.2% vs 3.1%, due to Education and Vegetables). Our monthly estimate was somewhat off, though it captured weekly dynamics relatively well.

Absent any FX shock, inflation is accelerating, possibly because of last year’s monetary expansion and BCRA’s restrictions over both the Current and the Capital account.

However, our high-frequency price monitoring showed relatively low core inflation printings (about 0.5% WoW) during March, a combination of real appreciation (REER decreased -2.9% MoM) and higher imports (import related taxes -in USD- increased 29% MoM). Recent data reports that core inflation deceleration came to an abrupt end (latest data: +1.3% WoW), which early data from this week confirms.

Our view already internalized the official strategy of using the FX as a nominal anchor and we expected inflation to slow down somewhat. We adjusted our forecast marginally (47% YoY vs previous 48% YoY), with inflation decelerating in coming months and stabilizing at 3% MoM in H2. A downward risk to our forecast comes from weaker than expected activity, although the imposition of new restrictions and the associated policy response could change the overall macro scenario (more on this below).

Fiscal accounts started 2021 with the “right foot”, but a less superficial analysis reveals no significant change of trend. January reported a fiscal surplus (!) of ARS 24bn, which turned into a deficit of ARS 18.7bn in February. Real, seasonally adjusted data, shows that fiscal income increased but has still much ground to cover in order to return to pre-2020 levels. Meanwhile, fiscal expenditure decreased from last year’s peak, as expected considering the government has scaled down most of Covid-19 related spending. However, primary expenditure still remains relatively high compared to previous years levels. Capital spending and economic subsidies have increased substantially in recent months, even adjusting for inflation and seasonality.

March’s tax collection data was positive, with real tax collection increasing 22% YoY. Fiscal income was helped by the economic recovery, higher tax pressure (on Income and Wealth taxes), higher commodity prices (export taxes) and the FX premium (tends to increase imports and, thus, import related taxes). The Extraordinary Wealth Tax collected only ARS 6bn in March, though it is expected to increase in coming months.

Despite decent tax performance, fiscal accounts could report a relatively high primary deficit. We can “reverse engineer” March’s primary balance moving backward through the financial program. On the one hand, we know financial sources: ARS 135bn from central bank’s monetary assistance, ARS 105bn from debt issuances and we can assume 100% debt rollover with IFIs. On the other hand, we know most of the financial needs: ARS 87.1bn of capital amortizations (including the equivalent of ARS 22bn with IFIs) and ARS 21.5bn of interest payments. The difference, about ARS 154bn, can be attributed to the primary deficit and/or a "financial cushion" to be used in April. This sum is higher than our forecast (ARS 108bn, recently adjusted upwards).

March's fiscal risk aside, the financial program is mostly unchanged, with a heavier burden in H2. We have updated debt statistics (see our Debt Stats report here) and adjusted our monthly deficit figures (though we maintained our primary deficit forecast of 4.5% GDP). Assuming an optimistic net debt rollover rate of 150% (higher than recent performance) and that debt with IFIs is either rolled over, renegotiated or paid using the extra SDR allocation, that would still leave a financing gap of 3.9% GDP, which would have to be covered by the BCRA. Most of the assistance would be required in H2 (3.1% GDP vs 0.8% of H1), putting pressure on monetary aggregates and the forex market at a time of the year in which foreign currency inflows tend to diminish.

Financial Program: 2021 Financial Program

Monetary aggregates growth continues decelerating while the forex market remained relatively stable. In real, seasonally adjusted terms, money aggregates have decreased during most of H2, a trend that continued in early 2021. As for the forex market, the FX premiums were either stable or decreased during March. Implied interest rates in the Rofex market dropped and it is estimated that the central bank’s short USD futures position continued decreasing (latest data was USD 1,628mn in February, vs USD 4,103mn in December). The BCRA was even able to increase its stock of net international reserves, which totaled almost USD 4bn as of April 5th (+489mn MoM).

Summing up, Q1 macro dynamics were mostly in line with expectations, though activity surprised positively and inflation negatively. Looking ahead, our base scenario (presented in previous Macro Updates, see here) does not warrant major adjustments, though we have started thinking about an alternative (worse) scenario. With the pandemic’s second wave reaching our shores, the economy might deteriorate more than expected. The possibility of this scenario has increased recently, as the government is taking measures to reduce contagion without hurting economic activity. But should these measures prove ineffective, stronger restrictions might be enforced and the socio-economic damage would be greater.

What follows is an early simulation of our Second Wave scenario, in which the government reimposes restrictions, milder than those implemented in Q2-20. We simulate activity dynamic and its impact on inflation, fiscal accounts, monetary aggregates and forex market. The underlying logic of our Second Wave scenario is as follows:

  1. Activity would drop in Q2 (-6.5% QoQ sa) and then recover sequentially, ending 2021 at the same level as in our base scenario. This would yield a growth rate of almost 5% for the entire year (vs our base forecast of 7%). Basically, the statistical carry-over from last year. December would be barely above end-2021's level (+0.7% YoY).
  1. With the economy tanking, fiscal accounts will deteriorate from both the revenue (lower taxes) and the spending sides. Assuming that the official response only differs from our base scenario in terms of transfers to families, 2021's primary deficit would be of 6.2% (vs 4.5% of our base scenario). It should be noted that our base scenario already included some social spending, as we expected last year's Covid-19 related programs to be cut down only by half in real terms.
  1. The higher deficit would increase the financing gap, with the BCRA printing about ARS 634bn or 5.7% GDP to assist the Treasury. Again, most of this financing would take place in H2, when uncertainty about the elections increases and foreign currency inflows decreases.

Financial Program: 2021 Financial Program

  1. Monetary aggregates would increase, even more, aggravating imbalances. After some short-term moderation (as occurred last year during the first phase of the lockdown), this would put upward pressure on H2 monthly inflation rates. Nevertheless, 2021 would end with an inflation rate below our base case forecast (41% vs 47% YoY). As for the FX premium, it could climb up to almost 100%, a combination of a lower nominal depreciation rate of the official FX and higher depreciation of the BCS rate.

Long story short: even if activity does not suffer much, the government would have to increase fiscal spending and the higher deficit would be monetized. This would aggravate monetary imbalances even more, and the chances of a FX crisis that "washes" imbalances through inflation would increase substantially.

Summary of Forecasts Summary

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