Federico Sturzenegger, president of the Central Bank, and Lucas Llach, vice president of the Central Bank, participated in the Argentine Economic Congress (CEA 2018) that took place within the framework of the 5th edition of ExpoEFI, on April 4 and 5, at the Hilton Buenos Aires hotel.
This was the sixth edition of the CEA, an annual event where the country’s leading economists and analysts meet to analyze and discuss, throughout its two days, the state and prospects of the Argentine economy.
We present here the speech of Federico Sturzenegger:
Thank you very much for the invitation to this meeting, it is a pleasure to open these two intense days of discussion about the Argentine economy and its financial and payment system. In about ten days we will be presenting the BCRA’s quarterly Monetary Policy Report (“IPOM”), where we are going to discuss in depth the future of the macro and the monetary variables of the economy, but it seemed to me that, given the events of the last few weeks, it was appropriate to briefly share with you what the Central Bank’s current view is on the progress of the disinflation process.
I would also like to take this opportunity to bring up a couple of comments on how our agenda is coming in terms of the development of the financial system and the modernization of means of payment, although I will be very brief about it, given that tomorrow the vice president of the BCRA, Lucas Llach, will be delving into these issues.
As you know, in 2016 we began to go through a process of fighting inflation, based on a novel scheme for Argentina: inflation targets with a floating exchange rate. I say novel because Argentina was accustomed to deflating through short-term shortcuts, for example, through fixed exchange rate schemes, which perhaps had a short-term effectiveness, but which in the long run led, almost without exception, to macroeconomic crises of magnitude.
The inflation targeting system is easy to understand. Inflation targets are set for a certain term, and the BCRA uses the instruments at its disposal in order to achieve that goal. Since the anchor of the system is the goal itself, the exchange rate should not be used. It can float, thus generating a “cushion” that protects the progress of the economy, cushioning the external or internal shocks that may occur. The most common mechanism for implementing monetary policy in inflation-targeting regimes is the determination of the reference interest rate, which is set by the Central Bank. In this scheme, the monetary authority supplies all the agents’ demand for money at the chosen rate, and absorbs all excesses, endogenizing the amount of money in the system. The rate is regulated in order to converge to the inflation target set. A higher rate corresponds to a more restrictive monetary stance and pushes disinflation.
Let’s review the result of the application of this scheme in Argentina. Once the corrections that had to be made during the first part of 2016 have been overcome, if we analyse the evolution of prices from June of that year to February 2018 (latest available data), core year-on-year inflation fell in all but two months, and, starting from a figure of 39.4%, stood at a year-on-year value of 21.6% in February. This disinflation process, in turn, was accompanied by a notorious recovery of the economy, which has not only already had 7 quarters of growth, but grew 4% end-to-end last year, with investment leading the rise. The latter grew 21% year-on-year in the fourth quarter, and represented 22% of GDP. There was also a strong expansion in credit, which increased by 21% in real terms in 2017. And the floating exchange rate allowed the economic growth close to 1% quarterly that we have been seeing since the fourth quarter of 2016 to be the least volatile rate of growth in activity in the last 20 years.
In the course of these months of 2018, the disinflation process has not been so linear. After achieving core inflation of approximately 1.4% per month in the last quarter of 2017 (equivalent to 18.5% in annualized values), the lowering of our reference rate in January of this year from 28.75% to 27.25% generated uncertainty about the future of monetary policy, producing an upward movement of expectations. It should be noted that in the two statements of December 2017 the Central Bank had already been warning of the visible fall in core inflation, which somewhat anticipated the probability of a rate reduction in the following months. The change in targets gave even more room to implement these cuts, but when we put them into practice, the market interpreted them differently than we did, reading them as a prelude to excessive monetary policy easing. This led to a dynamic of depreciation of the peso that marked a divergence between the market’s interpretation of the planned monetary policy and the BCRA’s own interpretation. In this context, we stopped the rate cut on January 23, and then decided to intervene in the foreign exchange market to interrupt that dynamic that, in our opinion, arose from an erroneous reading of the expected monetary policy (more on this point in a minute).
Despite observing not very encouraging inflation records in the first quarter of the year, the Central Bank considers that the current level of rates, at 27.25%, is adequate, for four main reasons: 1) Monetary policy has a more contractionary bias than that observed during most of last year; 2) wage negotiations are being agreed in line with the 15% target; 3) the correction of regulated prices will slow down sharply after this month; and 4) finally, the current level of the real exchange rate and the BCRA’s own action lead us not to expect, in the coming months, significant depreciations of the peso.
In addition, we should add two more reasons to take into account when assessing monetary policy going forward. First, the rapid pace of credit growth led to a gradual decline in the large bank liquidity that existed at the beginning of last year. The buffer of pesos not channeled to loans by banks has been reduced considerably, so that little by little the system’s passive rates will face greater downward resistance, as banks need to react more decisively to attract liquidity from savers, in order to continue with the dynamism of credit that we are seeing. There are already signs that this is starting to happen: the spread of the BADLAR1 rate against the shorter LEBAC has narrowed by about three percentage points from the values it had for most of last year and stands at around 3 percentage points overall. This spread is likely to continue to decrease in the immediate and immediate future. Therefore, as financial intermediation deepens, the transmission of the monetary policy rate to the rest of the system’s rates will be strengthened. This will probably lead to us having to demand less overreaction to the policy rate so that it begins to impact the other rates with equal power.
The second issue I wanted to focus attention on is that the inflationary pressure that originates from monetary financing to the Treasury is about to disappear completely. As you know, in line with the gradual fiscal convergence that this government maintained as a premise, transfers from the BCRA to the Treasury were also gradually decreasing. In 2016 they were 160,000 million pesos, in 2017 150,000 million pesos, and in 2018 they will be 140,000 million pesos, as stated in this year’s Budget Law. In December, it was also announced that in 2019, these transfers would be only $70,000 million pesos, and that from 2020 financing to the treasury with inflation will disappear completely. From that moment on, a figure equivalent to the real growth in the demand for money will be transferred to the Treasury, which will be put into practice through a seigniorage rule based on multiplying economic growth by the monetary base.
I would also like to point out that, within the 140,000 and 70,000 scheduled for 2018 and 2019, a part of these amounts also finds support in the growth of the real demand for money. Therefore, the remaining inflationary pressure is even lower than what would be deduced from a crude contemplation of the impact of these figures on the monetary base. Let me explain. The monetary base closed 2017 at around one trillion pesos. The 140,000 scheduled for this year represent approximately 14% of it. But if economic growth is around 3%, as expected by a large part of analysts, the inflationary pressure of those 140 would actually be 11%2. Making the same calculation for 2019, it turns out that the inflationary pressures accumulated by monetary assistance to the treasury, for 2018 and 2019 as a whole, would be less than 15%, and zero thereafter. In other words, what remains of inflation to be financed by the treasury is rapidly coming to an end.
Therefore, we are currently going through the challenge that arises in this first four months, but, once overcome, all factors coincide in anticipating that inflation will consolidate the downward trend that it already experienced between 2016 and 2017. This context is what has convinced the monetary authority to maintain the rate, waiting for signs of disinflation, especially now, when, after two years, the increase in regulated prices has finally entered another phase, much more aligned with the rest of the general price level.
However, returning to what I mentioned before, the market’s view of monetary policy in recent months is not consistent with the view that the BCRA authorities themselves have about its future future.
As we know, the exchange rate summarizes expectations about future monetary policy. A looser monetary policy will imply more inflation and therefore a more depreciated exchange rate. The beauty of the floating exchange rate is that it immediately “signals” that reading by society3 . In the first months of the year, our 150 bps cut was read as the prelude to further monetary policy easing. However, as I said, this view of the market does not coincide with what the BCRA has done since January, nor with what the bank’s own authorities expect for the future4.
In this context, the foreign exchange intervention of the last few weeks fulfills several functions: it consolidates a quasi-fiscal gain, breaks expectations of depreciation and inflation, and allows the monetary authority to point out that its vision of future monetary policy differs from that of the market.
Once these expectations are aligned with those of the BCRA, the arbitrage opportunities for the monetary authority (derived from the explicit divergence) will be reduced and the exchange rate will float again as it has been doing in the last two years. In short, what the Central Bank has done is to compensate for a nominal depreciation, driven in our understanding by the anticipation of a nominal shock that does not find a correlation in the vision of the monetary authority itself.
I would like to conclude this brief review of the BCRA’s vision by bringing to your attention some additional data. As I said at the beginning, credit growth is the second of our management priorities. 2017 represented a breakthrough in this regard. Credit grew to reach 14.3% of GDP, the highest value in the last 16 years. And not only that, but the 21% real year-on-year growth during 2017 (which I mentioned at the beginning of this presentation) was the highest increase in the last ten years. Obviously, the revolution of UVA loans was central to this growth, generating access on the demand side, and, by eliminating the rate risk for the offeror, it also generated a significant boost to the supply of credit. But beyond this innovation, growth was even and significant across all lines and all currencies.
The performance of deposits was somewhat more moderate, but also showed encouraging results. Private sector deposits stood at 16.5% of GDP, the highest level since early 2004. The challenge remains to increase them further. And just as we insisted that UVA loans would be a revolution on the credit side, we are equally convinced that they have the capacity to be so on the deposit side. For more than 60 years, Argentines have been waiting for a savings vehicle in their own currency and the UVA offers them just that. I hope you will touch on the subject at this conference!
The third priority we have is the modernization of means of payment and the eradication of cash. In this we are also beginning to see the progress of a very intense agenda that we have been carrying out and that Lucas Llach will surely comment on in greater detail tomorrow. This agenda, by having as its goal to give greater competition to the payment market, has managed to reduce costs for businesses for credit card payments from 3% to 2.35% this year (a percentage that will progressively reach 1.8% in 2021), and for debit card payments from 1.5% progressively to 0.8% in 2021. The PEI (Immediate Electronic Payment) modality, which brings these costs to approximately 0.6% (that is, a quarter of those that businesses pay to use the credit card system), will become increasingly popular. At the same time, by opening up competition to Fintechs, banking products are beginning to emerge at increasingly affordable prices. One Fintech in particular, to give an example, has just placed more than 100,000 credit cards, totally free cards, where the customer does not pay anything to have access to that means of payment. In addition, obviously, access the product via digital onboarding.
The consolidation of the disinflation process with a floating exchange rate, the deepening of credit and the volume of deposits, together with the modernization of payments in Argentina, are the three priorities that this BCRA imposed as management axes. We believe that in these two years we have made a lot of progress in all these aspects, but we also know that there is still a long way to go, so we will continue working to achieve our objectives. I am confident that, with the dedication, effort and desire that we Argentines show day by day to continue advancing, we can achieve all our goals.
Thanks a lot.
During the second day, April 5, Lucas Llach spoke on the panel “Present and future of the financial system”
