Federico Sturzenegger, governor of the Central Bank, and Lucas Llach, deputy governor, took part in the Argentine Economic Congress (CEA 2018) within the framework of the fifth edition of ExpoEFI(Presentation on Argentine Economy, Finance and Investment), which took place at Hilton Buenos Aires hotel on April 4-5.
This was the sixth edition of CEA, a two-day meeting, where the country’s leading economists and analysts meet to discuss Argentine economy’s state and perspectives.
Federico Sturzenegger’s full speech:
Thank you for inviting me. It is a pleasure to open these two-day meetings to discuss Argentine economy along with its financial and payment systems. In about ten days’ time we will present the BCRA’s quarterly Monetary Policy Report (IPOM) in which we will deeply discuss the evolution of macroeconomy and monetary variables. However, given last weeks’ circumstances, I consider it relevant to share the Central Bank’s views on the disinflation process.
I would also like to comment on the progress of our agenda regarding the development of the financial system and of the payment system modernization. Anyway, I will be brief because Lucas Llach, deputy governor of the BCRA, will delve into those topics tomorrow.
As you know, in 2016 we started a struggle against inflation based on a novel scheme for Argentina: inflation targeting with a floating exchange rate. I say “novel” because Argentina usually took short-term shortcuts to achieve disinflation, such as fixed exchange rate schemes. This might mean short-term efficacy but, in the long run, shortcuts would lead for sure to large scale macroeconomic crises.
Inflation targeting can be easily understood. The BCRA sets its fixed inflation targets to a certain period of time and makes use of its tools to reach those targets. The system’s anchor is the target itself so there is no need to use the exchange rate. It may float, generating a kind of “buffer” which protects the development of economy against potential external or internal shocks. The most common mechanism to implement monetary policy within inflation targeting is the benchmark interest rate fixed by the Central Bank. In this scheme, the monetary authority replaces all the money demanded by economic agents by setting a rate, and absorbs all the pesos in excess. Thus, the amount of money in the system is endogenous. Interest rate is regulated with the aim of meeting the inflation targets. A higher interest rate restricts monetary position and favors disinflation.
Let us go over the results of this scheme application in Argentina. Corrections were overcome during the first part of year 2016. If we analyzed price evolution from June 2016 to February 2018 (latest data available), we could notice that y.o.y. core inflation decreased every month except for two—dropping from 39.4% to 21.6% y.o.y. in February. In turn, this disinflation process was accompanied by a significant economic recovery which has not only grown for the last seven quarters but also increased 4% on a y.o.y. basis, with investment following an upward trend. The latter went up 21% y.o.y. in the fourth quarter, thus representing a 22% of the GDP. Likewise, lending underwent a sharp expansion rising by 21% in real terms in 2017. The floating exchange rate allowed the economic growth of about 1% quarterly—which we are experiencing since the fourth quarter of 2016—to be the least volatile activity in the last 20 years.
The disinflation process has not shown such a linear trend during 2018 so far. After achieving a core inflation of about 1.4% monthly in the last quarter of 2017 (which equals 18.5% in annualized figures), a decline in our benchmark rate from 28.75% to 27.25% in January this year generated uncertainty regarding the future of monetary policy and thus produced an upward trend in expectations. It is worth mentioning that, in the two press releases of December 2017, the Central Bank had noticed the significant fall in core inflation, which anticipated to a certain extent potential rate reductions in the following months. The change in inflation targets gave room for implementing these drops but, when we put them into practice, the market interpreted them differently, as the beginning of an excessive relaxation of monetary policy. This led to a peso depreciation dynamics that highlighted differences between the interpretation of the market regarding the projected monetary policy and that of the BCRA. In this context, on January 23 we put a halt to rate falls and decided to take actions in the exchange rate market to interrupt this dynamics which, in our opinion, implied a misunderstanding about the expected monetary policy (we will discuss this in a while).
In spite of the not very promising inflation records noticed in the first quarter of the year, the Central Bank considers that the current rate level of 27.25% is adequate for four main reasons:1) monetary policy shows a more contractive bias than that observed during most of last year; 2) salary negotiations are conducted in line with the 15 % inflation target; 3) the corrections of regulated prices will come to a sudden halt after this month; and finally 4) the current real exchange rate and the BCRA’s participation in the market lead us to expect no significant peso depreciations in the months to come.
Moreover, we should consider two more reasons for assessing the coming monetary policy. In the first place, the sharp increase in lending produced a progressive reduction of the abundant bank liquidity witnessed at the beginning of last year. The buffer in pesos that banks channeled to purposes other than loans greatly decreased. For this reason, deposit rates will progressively face a greater downward resistance as banks will need to react more decidedly to raise depositors’ liquidity in order to keep with the credit dynamism observed. There is evidence that this is starting to take place: the spread as adjusted by the BADLAR rate1 against the shortest LEBAC rate declined nearly 3 p.p. vis-à-vis the values observed during most of last year and stands at about 3 p.p. in all. Possibly, this spread will go on decreasing in the near future. So, as financial intermediation deepens, the pass-through of the monetary policy rate to the rest of the rates in the financial system will strengthen. This will probably lead us to demand a lower overreaction of the monetary policy rate so that it starts making an impact on the remaining rates with the same effect.
Secondly, I would like to focus on the fact that the inflationary pressure exerted by monetary financing to the Treasure is about to disappear completely. As you know, in line with the gradual fiscal implementation that this government has upheld, transfers from the BCRA to the Treasure will decrease gradually. In 2016, transfers amounted to AR$160 billion; in 2017, they equaled AR$150 billion and, in 2018, they will be of AR$140 billion as allocated in this year’s Budget Law. In December 2017, it was informed that transfers will only add up to AR$70 billion in 2019, and that financing to the public sector in the presence of inflation will completely disappear in 2020. From that time on, the Treasure will be transferred an amount equal to the real growth of money demand. This will be carried out through a seigniorage rule based on the product of economic growth and the monetary base. I would like to underscore that a portion of the 140 billion and 70 billion to be transferred in 2018 and 2019, respectively, is also supported by the growth in real money demand. As a result, the inflationary pressure is even lower than that one might anticipate if the growth of the monetary base itself is taken as a basis for calculation. Let me elaborate on this. The monetary base ended 2017 at around a trillion pesos. The 140 billion pesos projected for this year account for about 14% of the monetary base. However, if economic growth is around 3%, as is expected by many analysts, the inflationary pressure of those 140 billion will actually amount to 11%2. If we make the same calculation for 2019, the inflationary pressure accumulated as a result of the assistance provided to the Treasury for 2018 and 2019 as a whole would be less than 15%, and zero from then onwards. In other words, the remaining inflation derived from financing the Treasury is rapidly coming to an end.
We are currently tackling the first quarter’s challenge. As all factors suggest, once turbulence is overcome, inflation will consolidate its downward trend which was already observed between 2016 and 2017. It is precisely this context that has convinced the monetary authority to maintain the rate, waiting for signs of disinflation to come, especially now—after two years—when a rise in regulated prices has finally entered another stage, much more in line with the rest of the general level of prices. However, as I have already said, the market players' latest outlook for monetary policy has not agreed with that of the Central Bank authorities.
As we all know, the exchange rate summarizes market's expectations regarding future monetary policy actions. A more flexible monetary policy will entail more inflation and, thus, a more depreciated exchange rate. The significance of a floating exchange rate lies in that it immediately “signals” that interpretation by society.3 In the first months of the year, the 150 b.p. reduction was understood as a prelude to future loosening of monetary policy. However, the market’s outlook, as I was saying, does not agree with the actions taken by the BCRA since January or the BCRA’s expectations for the future.4 Against this background, the BCRA intervention in forex market in the past few weeks has had various purposes: to consolidate a quasi-fiscal gain, to break depreciation and inflation expectations, and to make known that the BCRA’s outlook for monetary policy is different from that of the market.
Once these expectations are in line with those of the BCRA, the monetary authority will have little arbitrage opportunities (derived from the different outlooks described) and the exchange rate will float again as in the last two years. In short, what the Central Bank has done is to counterbalance nominal depreciation which, in our opinion, was triggered by expectations of a nominal shock that is inconsistent with the authority’s outlook.
I would like to finish this brief account of the BCRA's outlook with some additional facts. As I have said at the beginning, the growth in lending comes second in our list of priorities. The year 2017 witnessed considerable progress in this sense. Credit grew to 14.3% of GDP, the highest figure in the past sixteen years. Moreover, the real growth rate of 21% year-on-year in 2017 (which I’ve mentioned at the beginning of this presentation) was the highest rise in the past ten years. The revolution caused by UVA-adjusted loans was certainly key to this growth, as this mechanism increased demand and significantly boosted supply thanks to the elimination of the interest rate risk. But apart from this innovation, growth was similar and significant in all credit lines and currencies.
The performance of deposits was somehow more moderate, but also proved to be encouraging. Private sector deposits stood at 16.5% of GDP, the highest level since early 2004. The challenge is to continue boosting them. And as we insisted that UVA-adjusted loans would mean a revolution in credit, we are also convinced the same could happen with UVA-adjusted deposits. Argentinians have been waiting for a saving vehicle in their own currency for more than 60 years, and UVA-denominated loans offers exactly that. I hope this topic will be discussed at this conference.
Our third priority is to streamline the payment system and to replace cash with digital payment systems. In this regard, we have already started to observe some progress in a tight agenda, about which Lucas Llach is probably going to talk in depth tomorrow. As this agenda seeks to boost competition in the payment market, credit card charges for merchants have fallen from 3% to 2.35% this year (which will gradually be reduced and reach 1.8% in 2021); likewise, debit card charges will gradually decrease from 1.5% to 0.8% in 2021. The Immediate Electronic Payment Channel, which reduces these charges to about 0.6% (that is, one fourth of credit card charges for merchants) will become increasingly popular. In turn, by opening competition to fintechs, banks are offering products at lower fees on the market. For example, a fintech business has just issued more than 100,000 credit cards which are totally free; clients pay nothing for having access to this means of payment. And, of course, they have access to this product through digital onboarding.
The consolidation of the disinflation process with a floating exchange rate, the deepening of credit and an increase in the volume of deposits, along with the modernization of the payment system in Argentina are the top three priorities in the BCRA's agenda. We believe we made considerable progress in all these aspects in the past two years, but we know there is still much work ahead, so we will keep on doing our best to achieve our objectives. Considering Argentinians’ dedication, effort and enthusiasm to keep moving forward, I am sure we will be able to reach our goals.
On April 5, Lucas Llach gave a presentation in the panel titled “Present and Future of the Financial System”.
1. Average interest rate paid by financial institutions on time deposits over one million pesos.
2. Our estimates of the real money demand indicate that its elasticity is statistically close to one.
3. A description of the floating exchange rate as a mechanism that flags society’s view of economic policies implemented by governments. Tornell, A. and Velasco, A. (2000): “Fixed Versus Flexible Exchange Rates: Which Provides More Fiscal Discipline?,” Journal of Monetary Economics, vol. 45(2), pp. 399-436, April.
4. One of the simplest theoretical models to explain the floating exchange rate, with capital mobility, combines the interest arbitrage condition:
With the quantitative theory of money:
With the quantitative theory of money:
which, assuming Y=1, a functional form for: using logarithms (lower-case notation) and considering
Where:i_tis the domestic interest rate, i_t^* is the international interest rate,
Is the expected devaluation of the domestic exchange rate (where e_t is the logarithm of the exchange rate at t), M is the amount of money, Pis the level of prices, Y is GDP, and V(i)is the velocity of circulation of money. In turn, considering the relative purchasing power parity:
Replacing (3) and (1) in (2), and assuming
fter solving the equation recursively, the exchange rate is expressed as follows:
This equation (a simplified version of the monetary approach of the exchange rate) shows that the exchange rate reflects, in a floating scheme, the players’ perspective of future monetary policy. It is actually the difference between market and BCRA's expectations that shows the divergence mentioned in the text.
April 4th, 2018