Speech by the Deputy Governor at the IAEF Congress

The Deputy Governor of the BCRA, Vladimir Werning, participated in the 41st Annual Congress titled “Argentina: A Different Opportunity. Essential Agreements for a Sustainable Future,” organized by the Argentine Institute of Finance Executives (Instituto Argentino de Ejecutivos en Finanzas, IAEF), held in Buenos Aires on May 21, 2024.

The speech, in full, is reproduced below.

Thank You Words

Good morning, everyone. It's a pleasure to represent the BCRA here at the IAEF Congress, a very well-rounded meeting both in terms of the agenda and the speakers’ experience.

I would also like to thank all the attendees for their participation and the shared effort required to journey across a new and challenging transition in Argentina day by day.

During the second half of 2023, we all watched helplessly how the fuse of a new hyperinflationary bomb burnt away. Today, in the first half of 2024, we have been witnessing how Argentina has suddenly changed course to recover stability and predictability, both of which are necessary to achieve the shared ambition of prosperity and sustainability.

The Creation of LEBACs: A Benchmark Interest Rate

In the short time available, I hope to be able to convey the Board of the BCRA’s view on the ongoing stabilization program.

This is not my first time as a speaker at an IAEF congress; however, this is my first time as a public servant. Back in 2012, I remember having shared a panel with a former Governor of the BCRA, Mario Blejer, on the risks and opportunities raised by the international context. On March 13, 2002, it was Mario Blejer who, from the BCRA, steered the crisis that began after the exit from the convertibility system (ARS1/USD1).

One of the challenges was to establish a benchmark interest rate in pesos for the economy since the Treasury could not establish one through the placement of securities due to the public debt default. To that end, Mario Blejer issued LEBAC bills—a new instrument—at an interest rate over 140% APR, similar to the interest rate on LELIQs inherited by the current BCRA's administration at the end of 2023.

Like at the end of 2023, the 2002 monetary/foreign exchange context was devastating: there was a foreign exchange clamp, bank accounts were feezed (called “corralito”), deposits and loans were compulsorily converted into pesos, a bank run was on the move, and the provinces issued quasi-currencies.

If I remember correctly, the most popular forecasts in the City of Buenos Aires showed that the country was heading towards an exchange rate of more than ARS10/USD1.

Today, from a historical point of view, we can understand that such forecasts were based on the fear of “everything that could go wrong.”

However, it turned out that “everything that could go wrong did not go wrong at all and some of the things that could go right did eventually go right.” Thus, at the end of 2002 the exchange rate was ARS2.9/USD1, while prices-far from hyperinflation-rose 41%, showing a limited exchange rate pass-through to inflation.

What happened? It should be remembered that, between the beginning and the end of 2002, the government of President Duhalde and Minister of Economy Lavagna set a fundamental anchor to the stabilization program through a significant fiscal adjustment. Inflation convergence-which seemed to be an unattainable goal-was soon consolidated at around 3-4% per year by the end of 2003.

The LEBAC/LELIQ Snowball Effect: Sterilization and Endogenous Creation of Money

Unfortunately, over the years, the monetary instrument created under Mario Blejer's administration to establish a benchmark interest rate became just another financial asset for the general public.

Thus, LEBACs rose from an amount equal to USD2,000 million in 2002 to USD28,300 million in 2015 (with forex controls) and, after they were renamed as LELIQs, they reached USD63,000 million in 2018 (without forex controls). This evolution contributed to an unusual banking disintermediation in an economy that had to go through stabilization and monetization.

More recently, at the end of 2023, the current BCRA’s administration inherited a balance sheet with negative net international reserves of -USD11,500 million and remunerated liabilities in pesos (LELIQs + REVERSE REPOS) that exceeded USD23,000 million at the official exchange rate, almost three times the monetary base.

Before the new administration took office, the interest rate on BCRA's remunerated liabilities was 133% APR, a rate similar to that of LEBACs in March 2002. This raised the annualized quasi-fiscal deficit to a level near 10% of GDP.

Given this financial disaster, the debate among macroeconomists was divided into two groups that suggested alternative solutions:

(1) Compulsory exchange: The first suggestion consisted in applying a BONEX Plan-as in 1989-with the desperate intention of kicking the problem down the road for 10 years. That is to say, to break the existing contracts again through a compulsory asset exchange. An escape route out to the future.

(2) Interest rate hikes: The second idea was to raise the interest rate in order to sustain the demand for money, though artificially. In other words, to continue doing what had been done throughout 2023, but expecting a different result. An escape route to the past.

Macroeconomic Measures for Stabilizing the Economy

Only within a context in which a BONEX Plan had been considered as a possibility, the idea of raising interest rates could have been considered by many as a “rational” path. An interest rate increase would be compatible with the mechanics of an inflation targeting regime. However, Argentina had neither an inflation targeting regime nor the credibility to implement it. Additionally, and appealing to common sense, it was clear that by simply maintaining the benchmark interest rate at its current level, 133% APR, an EAR over 260% would be validated. This scenario implied multiplying the monetary base by 9.

Therefore, if either of these two “solutions” had been applied, they would have led to the bankruptcy of the banking system, raising inflationary expectations due to the endogenous creation of money resulting from the domestic carry trade.

Therefore, given the Executive Branch's commitment to zero fiscal deficit and the Ministry of Economy's ability to design and implement it, the Board chose an alternative and uncertain path, though much more promising:

(1) Concerns regarding the implementation of a BONEX Plan were dissipated.

(2) The BCRA stopped financing the Treasury, in net terms.

(3) LELIQ issuance was discontinued to send a unique message about the monetary policy rate.

(4) Interest rate cuts on BCRA's repos/reverse repos were carefully implemented.

These initial measures to curb hyperinflation were adopted together with measures aimed at avoiding an impending default of the Treasury and starting a process of relative price correction.

This process began with an exchange rate adjustment that immediately initiated a sustained recovery of international reserves, and was consolidated with negotiations to come back to the International Monetary Fund program as well as its disbursements.

Microeconomic Measures to Guide the Banking System

Although these emergency measures attracted great public attention, they were supplemented by many others aimed at beginning the transformation of the banking system. It was necessary to remove the banks from the role of required partner of the National State in monetizing and sterilizing fiscal deficits in order to assign them a “healthy” role to channel financing towards private sector development.

To this end, the BCRA is working at a regulatory level and in coordination with the National Securities Commission (Comisión Nacional de Valores, CNV) to: (5) reestablish the free competition of interest rates among institutions; (6) close the access to the BCRA’s repo/reverse repo window to non-bank institutions; (7) reduce the waiver scheme that converted the prudential policy of minimum reserve requirements into a source of non-budgetary subsidies; (8) reform the incentive scheme to truly promote financing to SMEs; (9) work on the (repeatedly delayed) integration of the traditional banking system with non-bank digital payment systems; and (10) start to distribute, this month at last, higher denomination banknotes in pesos, ordered abroad earlier this year because the Mint was in debt and unable to fulfill its role.

Immediate Results: The Collapse of Inflation

The outcome of these macroeconomic and microeconomic decisions is visible:

April’s wholesale inflation rate was around 3.4%, private retail inflation expectation for May dropped to around 4%-5%, and the high-frequency indicators of the food basket inflation are running at an even slower pace.

It should be remembered that, in December 2023, the Market Expectations Survey (Relevamiento de Expectativas de Mercado, REM) anticipated that between December and May 48 points of inflation would be accumulated above what the macroeconomic balance—based on the announced policies—ended up validating.

Economic Ordering: The Pillars of the New General Balance

These results are not explained by the exclusive virtue of an economic policy instrument, but by the internal consistency of the macroeconomic pillars that, taken as a whole, have defined a new general macroeconomic balance since December.

First, a fiscal anchor was set to free monetary policy from the so-called “fiscal dominance.” This fiscal policy also acts as an anchor for domestic absorption, contributing to the simultaneous convergence of the economy’s internal and external balances. Second, foreign exchange policy was used as a lever of relative price change to ensure the recovery of international reserves and, subsequently, as a nominal anchor that has contributed to lower inflation in a country where the dollar has become a unit of account.

The implementation of both anchors has been crucial to making monetary policy flexible and effective. It is also closely related to the BCRA´s ability to lower interest rates to levels consistent with the dynamics of economic fundamentals.

Additional Contingencies: The “Banking and Importing Dominance” of Monetary Policy

The true consistency of the new general balance is finally appreciated when recognizing that this path of interest rate reduction could be carried out in spite of the Swords of Damocles represented by two inherited contingent sources of instability:

(1) Puts and bids: Contingent sources of monetary issuance derived from the issuance of puts and bids, options in banks' portfolios establishing a “banking dominance of monetary policy,” during the previous two years.

(2) Importers' debt: Contingent sources of international reserves demand arising from importers' commercial debts accumulated over the past two years (including large, short-term bilateral debts in the form of swaps).

The BCRA chose again to avoid disruptive solutions and decided to implement realistic and voluntary proposals to face these challenges.

The need of dollars to pay importers' debts was managed through the sale of currency swaps (BOPREALs), at market price. Through these swaps, the BCRA receives pesos and agrees to deliver dollars at a future date (said payment should have been made during 2023). This tool restored predictability to importers’ external payments and financing and, thus, brought relief to the domestic production and payments chain. In turn, contacts with high level Chinese authorities over the bilateral swap agreement enabled technical teams to work on addressing uncertainty.

Meanwhile, the remaining limitations to the full control of monetary programming, puts and bids, are being reduced at a firm pace. This was achieved by discontinuing bids and reducing eligible Treasury securities for puts while replacing such American puts by European ones. This effort was supplemented by the BCRA’s commitment to ensuring market transparency, enhancing its supervisory power to guarantee good practices in domestic markets including those related to the exercise of put options.

Last week, fixed price bids on Treasury securities were also discontinued. From now on, the BCRA will intervene in secondary market rates to ensure adequate liquidity in the system, but no longer be conditioned, either in time or amounts, by pre-established prices.

Transparency and Correction of the BCRA’s Balance Sheet

In order to continue recovering monetary policy tools and credibility, the BCRA decided to adjust the valuation of Non-Transferable Bills and Temporary Advances to the National Government. Since December 31, 2023, the accounting criteria established in the current Argentine professional accounting standards has been applied.

This change is the first step to submit financial statements based on the International Financial Reporting Standards (IFRS), as applied to financial institutions in Argentina. Even though the BCRA required financial institutions to follow these standards, it did not comply with them itself for years. The reason was that in doing so it should have given up a mechanism through which paper currency was transferred to the Treasury.

This accounting valuation adjustment means the recognition of a ARS44 trillion loss. Revealing this loss has the consequence of eliminating the possibility of using in the future transfers of accounting profits as an alternative mechanism for monetary financing to the Treasury.

A Big Turnaround in the Current Balance of Risks

The beginning of the Board of the BCRA's current administration was marked by a quarter in which the low seasonality generated risks, both in terms of the demand for pesos and the supply of dollars. This challenging period in terms of currency and foreign exchange was overcome with encouraging results: a visible and systematic fall in inflation, and a fast and steady increase in international reserves. At the same time, the recovery of credibility in the use of economic policy tools, evidenced by the convergence of asset prices in the monetary and foreign exchange markets, is also an important step on the path for stability.

Normalizing the economy is a long way forward. The conviction and pragmatism that characterized economic policy decisions and produced these results will continue to be essential in the assessment of risks ahead. The BCRA will continue patiently and prudently working towards the normalization of the monetary, foreign exchange and banking regime so as not to put at risk the results obtained with a lot of sacrifice, but rather to consolidate them.

Looking ahead, it is worth highlighting two important assets that the Argentine private sector has, which have the potential to contribute to accelerating convergence towards macroeconomic equilibrium.

First, the strong expansion of the energy sector is changing the balance of payments outlook very favorably. Usually, macroeconomic results spill over on microeconomic sectors, but this structural change implies that there will be a sustained spillover in the opposite direction.

Second, after several years of financial leverage reduction, particularly in terms of external debt, the large companies of Argentina have balances with significant room for growth. The very good financial health of the private sector constitutes an important counterbalance to the financial health of the public sector, which has begun a necessary process of reorganization.

Last year, the possibility of financial survival in a context of growing macroeconomic instability required a diagnosis anticipating “everything that can go wrong.” Today, the ongoing stabilization program has dramatically changed the balance of risks. With this scenario, it is expected that the diagnoses required by the private sector will be those that also include “everything that can go right.”

Thank you.

May 24, 2024