Federico Sturzenegger gave the closing speech on the Export Day titled “Exports: From Transition to Growth,” an activity organized by the Chamber of Exporters of Argentina.
The full speech is as follows:
It is a pleasure to participate in this forum at a time that, in my opinion, calls for a lot of optimism about the country.
In fact, we are confident that we are at a turning point that will mark the beginning of several decades of sustained growth.
Speaking here is very important to me because sustained growth processes are those in which society successfully mobilizes its productive resources in order to increase the supply of what they produce. Economies grow consistently over the long term only if they improve their productive capacity, rather than relying solely on temporary boosts in demand. This is crucial for the exporting sector because it faces a defined demand that is largely consistent worldwide. Therefore, tapping into new markets has to do with improving productive capacity to lower costs and prices.
We have a country that for too many years has been committed to the “magical” thought that only increasing demand could generate sustained growth. This thinking has clouded our eyes, confused us and worn us out. And. more seriously, it has diverted our energies away from where they should be: always focused on improving the productive capacity of our Nation, the only way we can all live better.
Specifically, “developing our productive potential” involves accumulating physical capital, which requires both public and private savings, and clear property rights; accumulating human capital, which needs a quality education system; accumulating technology, which depends on policies that foster competition and innovation; and using our natural resources, which requires the rule of law and intelligent regulation. All of this depends on a necessary condition: the guarantee of stable macroeconomic conditions, with fiscal sustainability and low inflation. If the fiscal path is not sustainable, crisis will eventually occur, affecting property rights, regulatory frameworks, and the functioning of the economic system as a whole. If inflation is not kept low, investment horizons shorten, savings in domestic assets decrease, and market competition weakens (because consumers do not know the true value of goods).
There are no other secrets beyond this. Whoever speaks of growth without addressing supply and productive capacity will be looking at the next step without moving forward with a coherent strategy, thus failing to transform progress into a true path to follow.
That is why the current situation deserves optimism. For the first time in many years, we have a government that is looking ahead to think long-term.
For example, infrastructure is one of the areas where the greatest productivity gains are being achieved. Not only because the same projects were 50% more expensive under the previous government, but because today they are prioritized according to their economic performance rather than political considerations.
Let us use some numbers to grasp the magnitude of the benefits this entails. Capital expenditure in Argentina over the last ten years have averaged 2.5% of GDP per year. Transparent management of this expenditure means that the same amount now allows for the construction of projects that would have previously cost 3.75% of GDP. This major impact would be the dividend of eliminating corruption in public works. In turn, prioritizing projects according to their social return would further enhance their performance. For example, if optimal allocation doubled the productivity of that investment, 2.5% of initial GDP turning into 3.75% would then be equivalent to 7.5% of GDP. In short, reducing corruption and doubling the rate of return on projects could triple (i.e., increase by 200%) the impact of infrastructure investment on the economy.
Let me illustrate this potential improvement in the productivity of spending with an example you are all familiar with: the Metrobus. For example: the La Matanza Metrobus will allow 220,000 people to save 40 minutes per day. If we take into account only working days (that is, not accounting for benefits for car drivers, reduced pollution, lower incidence of accidents, increased passenger safety, decreased wear and tear on the public transport fleet, etc.), this means a saving of more than 2,900,000 hours per month for all those people. At an average of ARS77 per hour, the Metrobus produces an annual saving of at least ARS2,700 million. Given that the project cost ARS1,700 million, this means the cost will be recovered after only 230 days of use. Assuming an investment horizon of ten years, the internal rate of return (IRR) of the project would be 159% per year. Therefore, I have no doubt that this 2.5% of capital expenditure mentioned in the previous example could significantly increase its yield, and if we have projects with annual returns of 159%, I think the point that I want to emphasize is understood.
But these are areas where government interlocutors are different. Today, I want to focus on the issues that fall within my responsibilities: monetary balance, fight against inflation, and the role of the floating exchange rate in that scheme.
Current macroeconomic situation
Let us start with the macroeconomic overview. Where is the economy today? We have had four quarters of growth since the recovery began, and everything indicates that the current quarter will be the fifth in this positive sequence. Economic activity is growing at an annualized rate of 4%, and we expect this dynamism to continue in the coming months.
Regarding the factors that explain this growth, exports made the initial boost during the second half of last year and in the first quarter of this year. Investment began to invigorate in the last quarter of 2016, and gradually gained strength to become the main driver of growth in the second quarter of this year. Consumption came into play in 2017, posting two consecutive quarters of seasonally adjusted increases.
A whole range of indicators shows the robustness of the ongoing recovery. Investment levels in durable production equipment are at record highs, with year-on-year increases exceeding 13% in real terms. The import of capital goods is growing at the rate of 19% y.o.y. in dollars in the second quarter. And the green shoots are already seen in the vast majority of productive sectors. Construction activity increased 17% compared to last year, according to the latest data available. The industrial sector also grew, with the monthly industrial estimate posting an increase of 6.6% y.o.y., in which 11 of the 12 components exhibited positive changes.
The real estate sector is also showing surprising dynamism thanks to the introduction of units of purchasing power (UVAs). The UVAs are the instrument that has restored Argentina’s possibility of entering into long-term contracts. In July, ARS255 million in mortgage loans were granted per day, a figure not seen in years, which will fuel sustained growth in construction. In fact, overall access to financing is increasing at very high rates. No only are mortgage, pledge and personal loans rising at 41%, 64% and 55% y.o.y., respectively, but also total commercial loans increased by 45% vis-à-vis the previous year. This set of factors tells us nothing but that the Argentine economy is underway. The challenge now is to boost this growth and sustain it in the long term.
Export situation
As regards the situation faced by our export sector, I would like to offer you a broader perspective today. We should remember that in 2011 we managed to reached an export level close to USD83,000 million, but since then, exports have declined steadily, reaching just under USD57,000 million in 2015. Of course, the prices of our exportable goods were a relevant factor to explain that phenomenon, but the quantities exported fell by 18% in those years. In 2016, the trend was reversed, increasing by 6.6%; but the point I want to emphasize is that we have the capacity to return to that peak of USD83,000 million.
It is not new that exporters, during this period of sharp deterioration of foreign sales, were victims of a series of attacks that undermined their daily activity. The foreign exchange clamp, the tax burden through export duties and other taxes, quantitative restrictions, and corruption were all factors that led to that decline.
If from that peak of USD83,000 million in 2011 we had grown at 3% per year, today we would be exporting the equivalent of around USD99,000 million, 73% more than the current level.
In 2016, an upturn in foreign sales began to be evident. The measures implemented by the National Government allowed the total harvest to reach 137 million tons, growing by 9.3% compared to the previous one. This is an amount that the most optimistic forecasts predicted for several years, but which has been achieved in only two years. That demonstrates our capabilities as a country to move forward and grow.
It is also worth highlighting our potential for the export of services, which increased by 30% in 2016 compared to 2015 and, for 2017, they are accumulating a 50% increase compared to the time of the change of administration. In turn, industrial exports have begun to reverse the steady decline they have been suffering since 2011. They experienced a 38% cumulative decline between that year and 2015 . In the first part of 2017, they were growing by 10% compared to the same period of the previous year. This phenomenon can be largely explained by the dynamic performance of the automotive and metalworking sectors, but it also shows a significant spread across the different categories of manufactured goods of industrial origin.
The renewed strength of industrial exports is also explained by the fact that we can see a greater diversification of the destinations in which we place our products. Given the economic situation in Brazil, destinations such as Chile, Central America, Peru, the United States and China have served as support for this growth. For example, the automotive sector is one of the sectors that is beginning to explore new market alternatives more deeply.
Macroeconomic framework
What is the framework that makes this reactivation possible and what guarantees does it provide for a recovery like this one, which Argentina has experienced many times, to become a sustained growth process?
In 2015, a team of people sat down to think through the details of the macroeconomic program to be implemented if Argentines voted for the change of government. Almost all those who were at that broad table hold positions in the national administration now. The basic outlines of the path we are following emerged from there. The plan began with a political definition: the correction of fiscal numbers, essential for building a stable macroeconomic environment, would be gradual.
The purpose was to address Argentina’s reorganization process with a strong focus on social issues. Consider the following: each percentage point of growth in Argentina’s GDP implies an increase in the State resources of 0.3% of GDP. A growth of 9.2%, as expected by the Market Expectations Survey (Relevamiento de Expectativas de Mercado,REM) published by the BCRA for 2017, 2018 and 2019, implies an improvement in fiscal resources of 2.8% of GDP. This means that, by managing current public resources well, and not automatically increasing spending in reaction to improved revenues, the path to fiscal sustainability is laid out. Some criticize this government by saying that the approach is too passive for public accounts reorganization. I say it’s something that never happened. So far, no government has had the responsibility to restrain spending when it benefited from an increase in revenues. In addition, we must add the efficiency improvements in the use of resources. A few moments ago, we discussed what is happening in infrastructure, but this reasoning can be extended, with honest and professional management, to all areas of government. Another chapter would correspond to the tax reform, which will improve the efficiency of our tax system. The team that today carries out these initiatives today in the Ministry of the Treasury and Public Finance is, in my opinion, one of the most qualified and competent that the country could have chosen to carry out this task. As you know from your companies, such changes are not achieved with great ideas about things that someone did not realize needed to be done, but with hard and consistent work over a long period of time.
Given this definition of gradual fiscal convergence, a second one was then derived: the need for transitional and declining financing from the BCRA to the Treasury. This situation simultaneously imposed the need for a gradual disinflation plan. The key decision taken was that such a plan would not use the exchange rate as an anchor, but rather the inflation targets, adopting a flexible exchange rate. Likewise, as in all countries, liquidity conditions would be managed with the interest rate, thus calibrating monetary conditions in such a way as to drive inflation in line with the stipulated targets.
This scheme was not an improvised invention, but was based on two basic lessons. It is a scheme that had served very successfully in economies like ours. And, second, Argentina had tried to use the exchange rate as an anchor on countless occasions, with disastrous results in the long run, especially for the group that is listening to me today.
Thus, the macro program is summarized as follows: gradual fiscal convergence, gradual reduction of inflation through targets and a floating exchange rate.
A year and a half after launching such program, we can say that the calling card for this macroeconomic scheme is that Argentina has resumed the path of growth, with expectations of continued growth, and that inflation is the lowest in the last seven years, with prospects of decline. It is a process that has been achieved without sweeping imbalances under the rug, permanently ensuring its sustainability. As regards the evolution of prices, disinflation began to be felt throughout the second half of last year, when inflation accumulated to 8.9% , which meant an annualized rate of 18.5%.
Now, what can we expect from monetary policy and the disinflation process in the future? In an inflation targeting scheme, the nominal interest rate is chosen in such a way that the ex-ante real interest rate generates the necessary monetary conditions to induce the disinflation process. Thus, during the second half of last year we accompanied the evident drop in inflation with a reduction in the benchmark rate. Every time the monetary authority decides to lower rates, it has to weigh its assessment of the progress of the disinflation process in order to calibrate the speed and magnitude of the actions to be taken. Our diagnosis today, in light of this monitoring, is that the rate drop was more abrupt than the process required, and over too short a period, which relaxed monetary conditions more than necessary, and generated a rise in inflation above the BCRA’s target in the quarter from February to April this year.
As a result, the BCRA has tightened the money supply since March 2, by raising the benchmark rate by 150 b.p. and conducting open market operations to constrain available liquidity, resulting in an increase in the shortest LEBAC rate by 430 b.p., while the longest rate rose by 480 b.p. The persistence of core inflation convinced us that we had to remain firm in this position, and in fact, today we believe that it is essential to maintain it in order to bring disinflation closer to the values we seek.
The monthly inflation rates of 1.4% in May and 1.2% in June showed encouraging signs, bringing year-on-year inflation to 21.7%, the lowest in seven years. July, on the other hand, showed an increase of 1.7%. Although the year-on-year interest rate continued to fall to 21.4%, this figure that does not satisfy the BCRA, even knowing that it was a month in which most of the increases were decisions on regulated prices (gas, prepaid health plans, etc.). Nor are we satisfied with the fact that, in the last three months, inflation has returned to an annualized rate close to 18%. Therefore, the BCRA will persist in its restrictive stance, and intensify it if necessary, to reach a monthly inflation rate of around 1% monthly by the end of the year. This value is required to steer the process consistently with next year’s annual inflation target of 10 percent.
The path followed in the last 12 months implied a 23 p.p. drop in year-on-year inflation rate, from 44.2% in July last year to 21.4% at present. Perhaps, lowering the inflation towards the proposed target for next year seems a bit ambitious, but wouldn’t the same have been said last year when we aimed at reducing inflation drastically this year?
One of the most important elements is that this disinflation process has been carried out in the context of a floating exchange rate. This implies that the exchange rate cannot deviate significantly from its equilibrium values, as was reflected in the evolution of the last few months.
In fact, we said in a conference at the UIA back in November last year: “(…) In this exchange rate scheme, nominal depreciations or appreciations cannot be forecast. The reason is simple, if everyone knew that currency would depreciate, it would depreciate immediately and people would stop thinking that currency would depreciate because it would have already happened.”
Considering this, let us evaluate the evolution of different measures of our exchange rate competitiveness in recent times. The real effective exchange rate (REER) is 23% higher than it was before lifting of foreign exchange clamp, and what is very, very important to highlight, taking into account Argentina’s historical experience, is that today the real exchange rate is at virtually the same value as it was at this time last year (1.7% lower), but with an inflation that has been reduced by half in the meantime. We are lowering inflation without appealing to an exchange rate anchor, without that exchange rate anchor that has been tried many times in the past, and that has caused so many headaches to our country.
If we delve a little deeper into the analysis, we will see that the real bilateral exchange rate with Brazil, one of our most relevant trading partners, is 46% more depreciated than before lifting the clamp. We should not forget that the reduction in withholding taxes and the modification of reimbursement created better conditions for our exports. Considering this effect, the REER is 32% above the value prior to the exchange rate unification. Of course, these are average values for the whole economy, since there is a certain sectorial diversity. If we focus only on industrial manufacturing, the improvement is close to 28%. Within this category, the automotive sector has been one of those that experienced the greatest increase in exchange rate competitiveness, which increased by about 33%.
But, I repeat, the most important thing is that, regardless of the current situation, this exchange rate scheme guarantees that the exchange rate will be more or less at the right levels. I consider that this gives you a lot of peace of mind for the future. Because it implies the certainty that the exchange rate will not be used as a mechanism or anchor to meet other objectives.
The flexible exchange rate has two central functions for the economy. On the one hand, it allows us to adjust to external shocks. For example, a crisis in Brazil, which depreciates its exchange rate, requires a movement in the same direction of the peso. This flexibility is important to protect domestic activity and our productive framework from this event. Over the last year and a half, the exchange rate has been fulfilling this role very effectively and fast. It has enabled the Brexit, the US elections and the political crisis in Brazil not to affect domestic recovery.
The second function has to do with the role of the exchange rate in keeping the economy on a path of sustained growth. For example, as we said, in the last few months a reactivation process has been consolidated in which economic activity is growing at a 4% annualized rate. Now, the challenge is to sustain this dynamism over time, and this is where the floating exchange rate comes into play, which Argentina has never managed to implement. It is well known that every growth cycle generates a certain import impetus, especially when investment drives this growth, which often increases the demand for imported capital goods. However, it is precisely the movement in the exchange rate parity that allows the external sector to adjust to this situation, thus ensuring the sustainability of our balance of payments over time.
To quantify a bit what the change in the monetary-exchange rate scheme we are implementing has already meant, the correlation between the monthly devaluation rate and monthly inflation has plummeted markedly since December 2015. As an example, between 2011 and 2015, the correlation between inflation and devaluation was 73%. In contrast, from December 2015 until today, this correlation was around 18%. Yesterday, I saw an advertisement on TV of a commercial chain that froze the prices of its brand products between June and next January. This is a relevant example because, for these products, the correlation between prices and the exchange rate falls to zero by definition. Over time, this dissociation will become increasingly clear.
This shows that the inflation targeting regime with a floating exchange rate is progressively achieving the goal of dissociating exchange rate movements from the rest of domestic prices, which gives the exchange rate enormous potential as a buffer against international fluctuations.
This phenomenon is the result of allowing it to rise and fall alternately over time. Since the lifting of the clamp, the exchange rate has risen 53% of the days and fallen 47% of the days. The only way to make exchange rate movements more frequent and less dramatic for society is by ensuring sufficient flexibility so that it can rise and fall according to currency flows in the foreign exchange market, without these fluctuations harming our general economic activity.
Of course, this does not prevent that, at times, the market may present liquidity conditions that generate disruptive movements in the exchange rate parity, where the BCRA may decide to intervene if deemed appropriate. In the last year and a half, we did this on five occasions (February, March, April, June of last year, and during the weeks prior to last Sunday’s primary, open, simultaneous and mandatory elections (elecciones primarias, abiertas, simultáneas y obligatorias, PASO).
Now, in this context of a rising and falling exchange rate, the optimal financial management strategy for all those companies whose cash flow is exposed to exchange rate volatility (as is obviously your case) is to take hedges on the futures market. Adopting these hedges drastically limits the volatility of your income in pesos, and allows for financial planning with a much greater degree of certainty. Moreover, given that the expected devaluation in the futures market is arbitraged with the interest rate in pesos2 , and in view of the fact that the BCRA will seek to guarantee a positive real interest rate, hedging in the futures market may imply an additional positive real return for the business cash flow. Just to mention a specific term here, future dollar contracts to December are trading at around ARS19.30. Keep that in mind. I hope that, little by little, you will be encouraged to venture into hedging in these markets. In Chile’s experience with floating exchange rates, we can see how companies increasingly turned to using these instruments to limit uncertainty in their business plans.
Access to credit
I end my description of the macroeconomic framework with a supplementary but informative issue: the cost of financing for exporting companies. As you know, the Argentine financial system holds deposits in dollars and in pesos. The idea is that deposits in dollars can be channeled towards financing export activities.
Over the past year and a half, we have reinterpreted what “export activities” mean in a way that is both safe from a regulatory point of view, but also somewhat broader from a practical standpoint. Thus, we expanded the destinations to which financial institutions can apply their lending capacity in foreign currency and allowed, for example, suppliers of exporting companies to access this funding. A part of the dollar deposits could also be allocated to loans for projects related to cattle rearing and energy. At the end of April, the possibility of financing importers of Argentine products or services was opened, a mechanism through which Argentine banks could become funding sources for customers of Argentine exporting companies abroad, thus fulfilling a role comparable to that of development banks in other countries, (such as BNDES in Brazil and EXIM Bank in the USA). This is the first time in many years that Argentine companies can go out into the world, and offer goods and loans.
This has brought about a real change. You may have already seen how interest rates on domestic loans in dollars aimed at exporting companies plummeted to unprecedentedly low levels of 5%-6% at the end of 2015 to a current range of 2%-3% per year. Also, its volume grew from USD2,900 million to USD13,900 million today, accounting for a cumulative growth of 379%.
Considering that commercial interest rates in pesos have also fallen significantly (between 20% and 23% during the year), it is understood that business credit is growing at 45% annually. It should be noted that the export sector has benefited the most from the improved conditions to credit access.
This is all I wanted to convey to you today. You play a key role in the success of this country. This BCRA is well aware of it. I would like to express my confidence that Argentina will go through its disinflation process without exchange rate anchors, and that we will make all our efforts to ensure that the conditions are favorable for the country’s sustained growth.
Thank you.
1Calculated on the main employment average income arising from the Permanent Household Survey (Encuesta Permanente de Hogares, EPH) of the first quarter 2017, for the total of urban agglomerations.
2 Further references: ¿Existe bicicleta financiera en Argentina? (Is There Carry Trade in Argentina?), published on the BCRA’s blog “Ideas de Peso” on May 8, 2017.
