Within the framework of the International Conference on Economics and Finance titled “Financial Opportunities and Challenges for Argentina and Other Emerging Economies,” organized jointly by Universidad Torcuato Di Tella, Banco Ciudad, and the Latin American Committee on Financial Affairs (Comité Latinoamericano de Asuntos Financieros, CLAAF), Federico Sturzenegger (Governor of the BCRA) and Lucas Llach (Deputy Governor of the BCRA) participated in the panels on Disinflation in an Inflation Targeting Regime: Keys to Understanding the Future and International Financial Regulation in Transition and Growth of Banking and Non-Banking Systems: What are the Implications for Latin America and Argentina? at the Park Hyatt Hotel on December 14.
Federico Sturzenegger’s full speech:
First of all, I would like to thank Javier Ortiz and Pablo Guidotti for the invitation to participate in this panel. I have little time today, so I will come to the point to share 10 very brief thoughts on the progress of the disinflation process and monetary policy.
1. Inflation in Argentina is falling without resorting to the false shortcuts of the past, without outdated utility rates, with free prices and exchange rates.
The disinflation process is well consolidated. The year-on-year change in core inflation has been decreasing month after month since June last year. Sometimes a little faster, sometimes a little slower. Today, year-on-year core inflation is 21.2%. But the most important thing is that this is being achieved without outdated rates (in any case, just the opposite) and with free prices and exchange rates. If we look at how fast core inflation is moving, we see that the improvement is even more noticeable. The moving average of core inflation for the last three months is improving at an 18.4% APR. It has been the lowest figure since we started to have CABA’s core inflation data available to make the comparison, that is, since September 2012; also, it is much lower than the figures reported during the previous government. December’s data confirm this trend so far. As published by FIEL, the basic food basket increased by 17.9% in the last 12 months. Given the importance of this basket for the most vulnerable families, it is a great joy to have achieved such pronounced disinflation in these goods.
2. Inflation expectations for next year are the lowest since 2009.
Inflation expectations are firmly anchored. They are not really within our targets of 10 ± 2% for next year and 5 ± 1.5% for 2019. However, in the last 14 months, considering all the achievements and setbacks, inflation dropped from 40% to 22%, while inflation expectations for 2018 have only moved 2.5 p.p. (2.3 for 2019). Almost 1 p.p. is explained by higher than expected increases in rates, as can be seen from the expectations survey. The correction of rates will end in 2018, but it was previously thought that it would extend to 2019. Also, the inflation rate for next year is expected to be the lowest since 2008-2009, and the rate for the following year will approach one digit. This is very valuable in terms of stability, which has been achieved over the past two years.
3. Huge credit expansion in Argentina.
The anchoring of expectations; the decline in inflation; the use of repos as a monetary instrument, which has given stability to the cost of money; the numerous micro changes in the financial sector; and the adoption of units of purchasing power (unidades de valor adquisitivo, UVA) based on the Chilean model of units of development (unidades de fomento, UF) have generated a great credit expansion in Argentina. Thus, the level of short-term interest rates, which precisely achieved this anchoring of expectations and the reduction of inflation, has paradoxically been essential for credit growth. In November, mortgage-backed loans grew 91% y.o.y.; pledge-backed loans, 70%; personal loans, 59%; and corporate loans, 51%.
4. Disinflation accompanies growth.
This increase in credit has accompanied a solid growth of the economy, which has already been rising for six quarters, at an annualized rate of 4% for more than a year. As we have said many times, disinflation gets along very well with reactivation; this is something that has been observed in other countries1 and Argentina as well.
5. Monetary policy achieved this disinflation.
The whole process took place by virtue of a monetary policy that increased its restrictive bias in 2017. It is a huge satisfaction for the BCRA to see core inflation break the values held for a year, though there is always great anxiety for achieving faster results.
6. Disinflation without an appreciated exchange rate.
The exchange rate has moved with complete flexibility over this period. The result has been a sharp disinflation with no appreciation of the real effective exchange rate (REER). In fact, it has fluctuated around a very stable value over the past year. The floating exchange rate ensures the absorption of external shocks and safeguards the macroeconomic balance. The fact that the economy has grown for five quarters in a row at 1% s.a., unaffected by external fluctuations, is key to our economic program.
7. A floating exchange rate is a defense against short-term capital flows.
The floating exchange rate has been a powerful antidote to short-term capital flows. This issue has been discussed at length so far. Whenever the exchange rate is appreciated, the LEBAC issue is discussed. However, when the exchange rate depreciates and the LEBAC is not considered good business anymore, the issue disappears from the public debate for a while. Until the new cycle. This is cyclical in the media, though not in the markets. Those who take risks know that the exchange rate can sweep in only a few days the earnings obtained in several months. And this keeps them at bay. Notice this. From 2016 to November 2017, USD310 billion entered Argentina through the current account and the capital account in gross terms (exports of goods and services, tourism in the country, interest collected, debt placement, capital inflows, among others). However, the net capital inflows for portfolio investments was USD11 billion. As you can see, this figure does not bear the relative importance that is often attributed to it. But what’s also interesting is that these flows move in the opposite direction to the exchange rate movements, giving surprising stability to the real effective exchange rate (REER).
8. Coordination with fiscal policy.
Coordination with fiscal policy has been an issue addressed and planned from the very beginning of our administration. Inflation targets were set consistently with the anticipated transfers that the BCRA would make to the Treasury while pursuing gradual fiscal convergence. In this way, monetary assistance to the Treasury aligns with the expected increases in the nominal demand for money, and thus, there is no need to sterilize it. Furthermore, the government would choose a path for fiscal deficit. The portion of this deficit not financed through BCRA transfers would need to be covered by the government through other sources of financing. This scheme was implemented exactly as planned, which explains why the LEBACs, not matched by increases in international reserves, remained constant in relation to the GDP.
9. The increase in LEBACs is explained by the increase in reserves.
On the other hand, the growth in the LEBAC stock is entirely explained by another reason: the sterilized purchase of reserves, which has already exceeded USD30 billion, with successive reserve records by the BCRA. Growth in the balance sheet with reserves on the asset side and LEBACs on the liability side is a predictable and repeated trajectory in countries that stabilize in monetary terms. It does not generate a quasi-fiscal deficit in the medium term because the return on external assets in pesos normally equals that of the domestic rate, while it provides insurance against macroeconomic fluctuations that Argentina previously lacked.2
10. Towards a normal country’s inflation rate.
A few weeks ago, I said that Argentina would have “normal” inflation in about 4 or 5 years. Today, normal inflation in the world is 2%. We have piled up so many frustrations with the issue of inflation, and we have gone through so many alchemies over the years, that many people interpreted that phrase as a surrender in the fight against inflation, thinking that this delayed our goal of reaching a single-digit inflation rate. This interpretation shows to what extent we have become out of touch from the world. An inflation rate of 10% hardly exists anywhere. Moreover, 10% is our target for next year! When in four or five years’ time we look back and see the path taken, when Argentina is probably debating whether to move from our inflation target of 5% per year to a more normal target of 2% per year, we will look back with some amazement at that time when we lived with such unusually high inflation that seemed so difficult to overcome.
1 For further empirical evidence, see the paper “Desinflación y crecimiento” (Disinflation and Growth), published on the BCRA blog “Ideas de Peso” on April 20, 2017.
2 Two papers that address this issue, analyze the empirical evidence and reach the conclusions mentioned are: Levy-Yeyati, E. (2008): “The Cost of Reserves,” Economic Letters, vol. 100 (1), pp. 39-42; and De la Torre, A.; Levy-Yeyati, E. and Pienknagura, S. (2013): “La desaceleración en América Latina y el tipo de cambio como amortiguador” (The Slowdown in Latin America and the Exchange Rate as a Buffer). LAC Semiannual Report, October, World Bank.
