Soy is loaded onto a ship at the Luis Dreyfus industrial complex in Argentina in September 2013. (CARLOS CARRION/AFP/Getty Images)
Summary
Amid a steep but anticipated decline in the value of the peso, the Argentine government is forcing banks to sell off foreign exchange reserves. In a ruling issued Feb. 5, the Argentine central bank will require all Argentine banks to cap their foreign exchange holdings to 30 percent of reserves and 10 percent of all futures positions. In effect, the rule will force banks to sell off their holdings of foreign currency and foreign-denominated assets, including bonds and futures contracts.
The move is designed to relieve pressure on Argentina's struggling local currency markets but will reduce the country's long-term buffer against a currency crisis. The development will put increased pressure on the relationship between the Argentine government and the agricultural sector, creating the possibility of greater conflict.
Analysis
Argentina's currency markets are in serious turmoil. The central bank has engaged in a steep but controlled decline of the peso, from about 6.9 pesos per dollar Jan. 24 to 7.9 pesos per dollar Jan. 25. Since then, the official rate for the peso has hovered around 8 pesos to the dollar, while the black market rate (known as the "blue dollar") sank to nearly 13 pesos per dollar. The devaluation was inevitable due to the growing spread between the black market peso value and the official rate over recent months. The growing spread was a growing demand for dollars to hedge against the peso's growing inflation. The increased demand for dollars also forced the central bank to intervene to stabilize its value, draining precious central bank reserves. The devaluation will slow down the drain on central bank reserves by increasing the cost of each dollar in peso terms.
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In order to calm consumers, the government announced Jan. 24 that it would be lifting some of the restrictions for the purchasing of dollars, allowing individual Argentines to buy up to $2,000 per month, determined by personal income. The express purpose of the move was to enable Argentines to save in dollars, preferred over pesos, which are subject to more than 30 percent price inflation on an annual basis in Argentina. However, some restrictions remain, since people who want to purchase dollars at the official exchange rate still have to fill out some paperwork. This gives Argentine authorities the power to keep some control over the amount of dollars households buy. The combination of opening the dollar savings exchange and the Feb. 5 cap on foreign exchange holdings seems to have stabilized the black market rate, which was down to 12.15 pesos Feb. 7. However, the bank decrees' effects, which will include banks selling off their dollar holdings, have only begun to be felt.
Deeper Problems
The core problem threatening Argentina's reserves of foreign currency is the decline in industrial output and the overreliance on the agricultural sector to export enough goods to supply foreign currency reserves. Despite significant national hydrocarbon reserves, Argentina has become a net importer of energy. Though the country does export some minerals, the most significant export sector is agriculture, which is increasingly dominated by soybean producers. In 2012, net exports of primarily plant-based agricultural products to China, Indonesia, India, Colombia, Brazil and other countries brought in more than $30 billion to Argentina. This foreign exchange is critical for paying for net imports of natural gas, fuel, machinery, electronics and cars. In fact, thanks to the combined impact of both agriculture and smaller export industries, Argentina has managed to maintain a positive trade balance despite becoming a net importer of energy products.
Nevertheless, the government made enormous populist spending commitments in the wake of the 2001-02 economic crisis to keep domestic prices for consumers low. These policies included large subsidies in energy and public transportation as well as social plans and price controls. The impact has been to spur consumption of everything from beef to natural gas without increasing revenues to the companies producing those goods. As a result, productive capacity has declined as companies became unable or unwilling to increase investments to meet rising demand. The government has stepped in to ensure stability by expanding the money supply by an amount equal to about 40 percent of gross domestic product annually, triggering persistent inflation. Inflation has in turn driven a severe crisis of confidence in the peso, and Argentines have been pulling billions of dollars out of the economy every year for several years now. This capital flight has meant that despite trade surpluses, the Argentine economy is locked in a fierce internal battle for control of hard assets and foreign currency.
It is this struggle that led to the 2008 nationalization of the country's pension funds as well as a major confrontation between the government of Argentine President Cristina Fernandez de Kirchner and farmers after a failed effort to raise export taxes to 45 percent. The 2012 decision to seize control of oil company YPF from Spanish energy firm Repsol also stems from this, since the government has struggled to get resource extraction companies, including YPF, to increase investment and output in order to limit the country's reliance on imports.
The Agricultural Sector's Influence
With the government liquidating reserves held by the country's banking center, it is clear that the crisis has entered a new phase. The country's last stable reserve buffer of foreign currency in the banks is now the center of efforts to stabilize the flow of dollars inside the country, and although the move does not fully drain banks' dollar reserves, it is taking a strong step in that direction. Persistent capital flight will mean that many of the dollars released through recent changes will make their way into international banks or be saved in cash rather than being kept in the financial system. The government is unlikely to convert savings deposits to pesos outright because of the severe public backlash associated with that policy during the 2001-02 crisis, but reducing bank reserves of dollars effectively raises the risk of a banking crisis in the event of a deterioration in public confidence.
Ultimately, the government is counting on agricultural exports after the harvest in March and April to replenish draining reserves. This will give Argentine farmers an enormous amount of political leverage, which may lead them to push back harder against the government on key issues. Argentine regulations have made it so that Argentina's farmers export dollar-denominated goods but receive payments in pesos at an unfavorable rate set by the government. In protest, and in anticipation of the recent devaluation, farmers have been withholding exports, with just over 4 million tons that the industry estimates are stockpiled in reserves. In addition to these reserves, Argentina is expecting a very good harvest this year. As a result, prospects for a strong influx of foreign capital are good -- if the government can persuade farmers to actually export. This need will give the farmers a strong basis from which to negotiate for better terms in their contracts with the government.
Failing an acceptable compromise, protests are likely and could get as contentious as the 2008 protests -- in which the farmers were ultimately successful. Nevertheless, there will also be strong incentives for the government to compromise in order to facilitate the inflow of foreign exchange. No matter what happens, amid mass speculation about currency markets, the farmers in Argentina are once again central figures in Argentine politics.
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