The BCRA inaugurated a monetary framework aimed at consolidating price stability

I. PHASE 1: First stage of the stabilization program

The elimination of the fiscal deficit and its monetization: In order to curb the ongoing inflationary spiral, a macroeconomic stabilization program was launched in December 2023 based on the immediate elimination of the fiscal deficit and the balance of payments deficit, the main sources of monetary issuance and loss of reserves. During 2023 and until December 10, the total net financing of the Treasury provided by the BCRA (under the definition of the 7th IMF review) accumulated $50 billion at constant pesos of June 2024. Since the launch of the stabilization program, the Treasury assumed the commitment to bring the fiscal deficit to zero and the BCRA assumed the commitment to eliminate net financing to the Treasury, both by monetary issuance and through operations in dollars.

Expanding access to the free exchange market (MLC) for importers: At the beginning of the stabilization programme, importers’ access to the free exchange market (MLC) covered only less than 20 per cent of imports. In order to normalize the foreign trade payment chain and private financing, the BCRA defined a transparent schedule of incremental access for the payment of imports and offered the private sector the voluntary subscription of BOPREAL to be able to cancel accumulated commercial debts. ¹ In the course of the first half of 2024, import payments made by the MLC returned to around 100% of the average monthly amount of imports. ² Considering that the sum of import payments through access to the MLC and the cash settlement market (CCL) exceeds 100% as of March, an early reduction in the balance of this debt is corroborated. The BCRA considers it a priority to continue making progress in making the access of the productive private sector to the MLC more flexible as one of the steps prior to the eventual unification of the exchange rate, lifting of exchange controls and establishment of a currency competition regime.

The reduction of the monetary policy interest rate: In parallel to the aforementioned measures, the BCRA began a process aimed at eliminating the second source of surplus money supply: interest on its remunerated liabilities. During the second half of 2023, the latter, between LELIQ and passive passes, had reached $58.3 billion, a figure only surpassed by the April 2018 peak of $72.8 billion (both at constant June 2024 prices). The monetary flexibility applied throughout the first half of the year was supported by the consistency of the macroeconomic program and resulted in the possibility that the BCRA would guide the monetary policy rate (on passive passes) from 130% to 40% TNA and that the monthly retail inflation records decrease.

The reduction of the BCRA’s remunerated liabilities and the fall in inflation: The accrual of interest on the BCRA’s remunerated liabilities fell from $5.4 trillion per month in November 2023 at June 2024 prices (equivalent to 32% of the monetary base) to just $0.6 trillion per month in June 2024. In turn, the broad monetary base (BMA) at constant prices in June 2024 was reduced from $56.7 billion (as of December 10) to $36.1 billion at the end of June 2024; a drop of 36.4% in real terms. Consistent with this monetary contraction, over the course of this period core CPI inflation fell from a monthly rate of 28.3% in December 2023 to 3.7% in June 2024. The consolidation of this downward path of inflation and the reordering of budgetary priorities carried out by the Executive Branch have resulted in the real recomposition of social benefits, including pensions and social assistance programs (such as the AUH), in real terms.

II. PHASE 2: Second stage of the stabilization program:

The new monetary policy framework: fixing the quantity of money in relation to the broad monetary base. In order to consolidate the process of eliminating inflation and lay the foundations of the regulatory framework for the implementation of currency competition, the BCRA inaugurated the second stage of the stabilization program under exchange controls. 3 In this stage, the objective is to limit the amount of pesos to the nominal amount existing on April 30 of the broad monetary base (BMA), that is, $47.7 trillion current pesos (or 9.1% of GDP). This recent value of the BMA is similar in real terms to the entire monetary base (BM) with which the Argentine economy normally operated prior to the imposition of exchange controls in August 2019. The setting of this ceiling on the expansion of demand by the World Bank allows us to anticipate that, from the introduction of currency competition, the peso will become the “scarce currency.” ⁴

The same objective of monetary policy: eliminating inflation. This concludes phase 1 of the program in which monetary policy was mainly aimed at guiding the monetary policy interest rate towards lower and more negative levels in real terms, reducing endogenous interest issuance. Phase 2 of the program assumes that this objective has been met, so that the BCRA will gain a greater degree of freedom in the management of liquidity regulation instruments. In particular, this flexibility is reinforced by the fact that, while maintaining the firm commitment to fiscal balance, progress is being made in eliminating or sterilizing the other sources of new money supply: (a) the BCRA’s interest-bearing liabilities, (b) the indirect financing of the Treasury through “BIDs” and “PUTs” and, as long as exchange controls persist, (c) the accumulation of international reserves.

The improvement in the balance sheet and the definition of the BCRA’s monetary instruments: The limit established on the maximum amount of money (taking the nominal BMA of April 30 as a reference) will contribute to the resolution of two important challenges facing the BCRA: (1) the consolidation of its balance sheet through the elimination of all forms of “dominance” (whether fiscal, banking or exchange) over the exercise of monetary policy and (2) the definition of the instruments necessary to efficiently pursue its objectives, in particular in terms of guiding private sector inflation expectations downwards.

1. The clean-up of the BCRA’s balance sheet:

• Measures such as the transfer of all interest-bearing liabilities to the Treasury and the termination of most of the American “PUTs” by the participating banks, will allow the BCRA authorities to ensure greater control in the management of the liquidity of the banking system. Indeed, this set of measures reduces the sources of unwanted supply of pesos that in recent years limited the BCRA’s ability to fulfill its mandate to safeguard price stability.

• • The beginning of the transfer of interest-bearing liabilities of the BCRA (placement of LECAPs by the Treasury). The BCRA’s latest pass rate cut was implemented on May 14 and was aimed exclusively at encouraging a new monetary process: the migration of remaining monetary liabilities from the BCRA’s balance sheet to the Treasury’s balance sheet. This transfer of bank liquidity began to be implemented through the issuance of Treasury capitalization bills (LECAPs), with an initial transfer of $8.6 trillion from the BCRA’s passive passes to Treasury LECAPs on May 20. Thanks to the transfer of interest-bearing liabilities to LECAPs, the monthly financial cost for the BCRA of keeping the fiscal deficits accumulated during previous years sterilized decreased to $1.3 trillion in May and $0.6 trillion in June (at June 2024 prices).
  • The elimination of all the BCRA’s remunerated liabilities (placement of LEFIs by the Treasury): In order to establish a liquidity regulation mechanism (without incurring the cost of sterilization) that complements that of the active passes on LECAPs (and other Treasury instruments) and, at the same time, fulfills the function of absorbing excess liquidity, on July 17 the Treasury issued 1-year liquidity fiscal bills (LEFI) for a term of $20 billion. On the first day that the LEFIs were available, banks subscribed, through the BCRA, a total of $10.85 trillion. ⁵ The BCRA decided to eliminate the passive pass window as of July 22, thus completing a process of reducing its interest-bearing liabilities from $52 billion in November 2023 (at constant June 2024 prices) to completely eliminate them in July 2024.
  • The elimination of the regulations that gave rise to indirect tax monetization (BIDs): On May 15, the BCRA began a process of reducing contingent monetary liabilities, eliminating the “automatic BIDs” on Treasury securities. The “BIDs” were established in 2022 in order to sustain banks’ demand for Treasury securities in primary auctions through the commitment that the BCRA would adopt the role of buyer of securities under predetermined parameters. Along with similar regulations (“automatic purchase” by the BCRA of integrable securities for “reserve requirements”) and the sale of derivative instruments to banks (put options or “PUTs”), the BCRA enabled multiple mechanisms for indirect monetization of the fiscal deficit. These indirect mechanisms allowed the Treasury to exceed the limits on fiscal monetization (based on its direct sources, transitory advances and dividend remittances from the BCRA) agreed in the IMF program signed in March 2022. In total, these monetary contingencies of the BCRA represented a stock of 3% of GDP in December 2023 (0.93 times the monetary base at that time).
  • The rescission of options on Treasury securities in banks’ portfolios (PUTs): Through a cooperative dialogue with most banks, on July 16 the BCRA launched a comprehensive and voluntary proposal for the rescission of American and European “PUTs” options on the portfolio of Treasury securities of banks for a maximum value of $17.7 billion. The premiums paid by the BCRA were established on the basis of the original acquisition price (adjusted for residual maturity and for CER) and represented only 0.6% (equivalent to approximately $90 billion) of the potential monetization that the exercise of the “PUTs” could imply. Banks that, through their participation, contributed to reducing macroeconomic risk will have a period of 12 months (counted from the original amortization of the corresponding public securities) to converge to comply with the credit fractionation rules⁶.
  • The sterilization of pesos issued by the purchase of international reserves in the MLC since April 30: In order to ensure the reduction of inflation, the BCRA will proceed to sterilize the pesos issued for the purchase of the balance of payments balance after April 30, the date on which the amount of money was limited in relation to the BMA level. The maximum monetary contraction expected in this way would be in the order of $2.4 trillion and begins by choosing as an operating mechanism the sale of dollars in the parallel exchange markets, including the MEP and CCL. Both the pace and the total amount of sterilization and the market through which it will be implemented will be administered by the BCRA based on the quarterly evolution of liquidity and the consequences for price stability that may result from the deviation of its evolution with respect to the trajectory determined in the monetary programming.

2. The definition of liquidity regulation instruments within the new monetary framework:

• Based on the limit imposed on the amount of pesos in relation to the BMA of April 30, in phase 2 of the stabilization program the BCRA will carry out conventional domestic liquidity management with an orthodox bias. This orientation will be supported by the BCRA’s quantitative monetary programming models and will benefit from the full recovery of the monetary policy instruments required to pursue the price stability and financial stability objectives included in the BCRA’s Charter. The implementation of this new framework is supported by the banking liquidity regulation instruments detailed below.

• • Provision of liquidity to banks through the active passes window: LECAPs allow banks and mutual funds to activate their peso balances at a fixed rate paid by the Treasury and can be traded on the secondary market. The LECAPs also fulfill the role of the BCRA’s bank liquidity regulation instrument. Banks may only use their holdings of LECAPs (and other Treasury securities) as collateral to request temporary liquidity from the BCRA, within 1 or 7 days, when they so determine. This provision of liquidity by the BCRA is implemented through the active pass window at a cost for banks currently set at 48% TNA.
  • Absorption of liquidity from banks through purchases and sales of LEFI: LEFIs are an instrument whose acquisition is exclusive to banks and capitalize daily the monetary policy rate, currently 40% TNA. LEFIs are not traded in the secondary market, but are operated exclusively between banks and the BCRA. Due to the tax treatment of LEFIs (they are not subject to gross income tax) at the start of operations the net monetary policy rate received by banks will be automatically raised from 3.00% to 3.34% TEM. The Board of Directors of the BCRA will regulate the liquidity of the banking system by establishing the level of the interest rate of the LEFIs and the rate of active passes, based on the monetary programming of the BCRA.

3. The BCRA’s monetary programming anticipates the continuation of the growth in real demand for money during 2H2024:

Between April and June, there has been a real and unseasonal increase in the circulating currency in the hands of the public and in the monetary base (including reserve requirements) of $2.1 trillion and $6.2 trillion, respectively. In this way, the WB would have shown a turning point from its minimum of 2.5% of GDP set in March 2024. The BCRA’s monetary programming models anticipate the continuity of a process of remonetization of the economy throughout the 2nd half of 2024. In the BCRA’s base scenario, the degree of expected monetization could absorb 21% of the idle liquidity determined at the time of setting the maximum amount of money (the level of the BMA of April 30).

4. An increase in the monetary multiplier would be consistent with the real expansion of the expected demand for money. The remonetization process is also expected to translate into the growth of broader monetary aggregates, after several years of contraction in real terms. The incentives of the new monetary framework have been defined by the BCRA with the aim of reversing the crowding out of credit to the private sector produced by fiscal deficits accumulated in the past. These deficits have contributed to the collapse of the stock of bank credit to the private sector to just 4% of GDP. The crowding in process anticipated by the BCRA would be accompanied by an increase in the monetary multiplier. To date, it can be seen that the growth observed in credit in pesos (in real terms) and in dollars has been 6.8% and 79.8% compared to the end of 2023.

References

1 Given the lack of availability of dollars, the supply and placement of BOPREAL prevented the collapse of economic activity and employment due to lack of inputs, allowing the private sector to access a commitment to deliver foreign currency in the future for foreign trade debts pre-existing on December 10. In turn, the placement of the BOPREAL allowed the BCRA to sterilize surplus pesos at the exchange rate in force on the date of subscription, for the equivalent of USD10 billion between January and May 2024.
² At the same time, the BCRA made access to the MLC more flexible for 80% of MSMEs and, more recently, additionally made the payment of interest to related entities more flexible when the financing is associated with terms of two years or more.
³ The design and launch of the new monetary policy framework makes it possible to meet the structural benchmark of the end of June that was agreed with the IMF under the current program.
⁴ The peso will continue to be demanded as an exclusive means of payment of taxes and the BCRA will continue to adapt the regulations in order to facilitate the incorporation of foreign currency into the domestic banking system. Recently, the BCRA equated the conditions for opening bank accounts in foreign currency with those of the peso and eliminated limits on the number of transfers allowed to and from accounts in foreign currency.
⁵ The LEFIs were incorporated into the BCRA’s assets through an exchange with the Treasury. That is, against the delivery of CER Treasury securities in the BCRA portfolio, without increasing the gross debt of the Treasury. On the contrary, as banks unwind their LEFI positions to lend those funds to the private sector, the Treasury’s gross debt may decrease. The interest rate on LEFIs is floating, reflecting the monetary policy rate. In the immediate term, the transfer of interest-bearing liabilities from the BCRA to the Treasury does not imply an increase in the financial cost in real terms for the Treasury since the monetary policy rate is 3.3% TEM, slightly lower than June’s monthly inflation of 4.6%. In the future and given the possibility that the monetary policy rate becomes positive in real terms, the financial cost of the LEFIs may impact the Treasury’s accounts.
⁶ The remainder of American PUTs (representing 22% of the total original PUTs) may be acquired by the BCRA in the future to reduce this risk completely or, on the contrary, it may be exercised but the executing institutions will not benefit from the deferral in relation to compliance with the credit fractionation regulations.