Global Macro Views – Argentina’s Sudden Stop

August 22, 2019

Robin Brooks, Managing Director & Chief Economist, rbrooks@iif.com, @RobinBrooksIIF
Martín Castellano, Head of LatAm Research, mcastellano@iif.com, @mcastellano44
Greg Basile, Associate Economist, gbasile@iif.com, @GregBasileIIF

• The sharp drop in the Peso reflects another BoP “sudden stop,” ...
• which is likely to carry far-reaching consequences for the economy.
• The IMF forecast of -1.3% growth in 2019 assumes a recovery in H2, ...
• but that is now unlikely and a number at or below -2.5% is conceivable.
• As a counterpart to this, current account adjustment will accelerate, ...
• with the Peso now significantly undervalued in our fair value model.

Recent sharp declines in Argentina’s Peso have taken it back to levels seen a year ago, when the EM sell-off was at its peak. The
severity of recent depreciation reflects another BoP “sudden stop” in capital flows, which will have far-reaching consequences
for the economy. The IMF program forecast of -1.3 percent growth this year is predicated on a recovery in the second half of the
year, which is now unlikely. Instead, activity is likely to contract, which means that 2019 growth could be below our estimate for
statistical breakeven growth (the rate that assumes zero quarter-on-quarter growth for the rest of 2019), i.e. at or below 2.5
percent. The counterpart to economic contraction is a faster adjustment in the current account, with the Peso now significantly
undervalued for the first time in our EM FX fair value model.

Exhibit 1. The Peso has fallen sharply, ... Exhibit 2. ... and is now significantly undervalued.
150 20
Real effective exchange rates (Jan. 2006 - Aug. 2019), Range
indexed to 100 in Jan. 2014 EM
140 Argentina
Turkish Lira 15 Turkey
Argentinian Peso
130
10
120

110 5
Aug.
2019
100 0

90
-5
80
-10
70
Cross-section of EM current account positions,
in % GDP (4qma)
60 -15
2006 2008 2010 2012 2014 2016 2019 2002 2004 2007 2009 2011 2014 2016 2019
Source: Haver, IIF Source: Haver, IIF

We flagged significant overvaluation of Argentina’s Peso in early 2018, as part of the roll-out of our current account-based EM
FX fair value model. That overvaluation stemmed from two sources: (i) substantial real appreciation (Exhibit 1), due to high
inflation and a relatively stable nominal exchange rate; and (ii) rapid widening in the current account deficit (Exhibit 2),
reflecting easy access to external financing after years of quasi-autarky. Last year’s devaluation, even though it was sizeable, only
managed to bring the Peso to fair value, i.e. erased its overvaluation, but wasn’t enough to generate undervaluation. This is
because our fair value model discounts that part of current account adjustment stemming from domestic demand compression,
meaning that – in cyclically-adjusted terms – Peso depreciation was not yet enough to turn our estimate for the underlying
current account deficit, where adjustment has been comparatively slow (Exhibit 3), in part due to the large weight of interest
payments on external borrowing (Exhibit 4).

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 Exhibit 3. C/A adjustment has been slow, ... Exhibit 4. ... in part due to large interest payments.
20
Current account balances in Q1, in $ bn (annualized) 30 Argentina's current account, in $ bn (annualized
quarterly data)

0 20
2019

10
-20

0
-40
-10
-60
-20
Income balance
-80 Goods balance
-30 Services balance
Turkey Transfers balance
Argentina Current account
-100 -40
2000 2003 2006 2009 2012 2015 2018 2000 2003 2006 2009 2012 2015 2018
Source: Haver, IIF Source: Haver, IIF

The challenge facing Argentina’s current account adjustment can be seen looking at import versus export volumes. Import
compression has borne the brunt of current account adjustment so far (Exhibit 5), much as in Turkey, so that our EM FX fair
value model sets a significant portion of the narrowing in the current account deficit aside as due to cyclical factors. This means
that the burden on the exchange rate is higher than might at first appear, i.e. the need to depreciate is greater than otherwise.
However, with the latest round of Peso declines, that hurdle has been crossed (Exhibit 6). Our model shows that the cumulative
impact of past depreciation (red) is now so large that – even adjusting for a substantial output gap (yellow) – the underlying
current account is positive (black). This is above our estimate for Argentina’s equilibrium position (a small deficit), which means
that the Peso is now significantly (10 percent) undervalued.

Exhibit 5. Import compression has been big, ... Exhibit 6. ... but lagged FX effects have grown.
170 16
Export & import volumes (indexed to 100 at t) in EM BoP FX Effects
crises. EM includes Mexico (1994/5), Argentina (2001/2), Output gap (foreign)
160 Brazil (1998), Turkey (2000/1) and Asian crisis episodes 14
Output gap (upper bound)
(1997/8). Output gap (lower bound)
12
150 Quarters following start of Actual C/A
BoP crisis in period t 10 Underlying C/A
140
8
130
6
120 4
110 2

100 0

90
EM exports -2
EM imports
Turkey exports -4
80 Turkey imports
Argentina exports -6
Argentina imports Headline (blue) versus underlying (black) current account
70 positions for Argentina, in % GDP
-8
t+10
t+11
t+12

t+14

t+16
t+13

t+15
t+3
t-4

t-2

t+2

t+4

t+6

t+8
t+9
t-3

t-1
t
t+1

t+5

t+7

2000 2003 2006 2009 2012 2015 2018

Source: Haver, IIF Source: Haver, IIF

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