Starting July 22, the ruling party had reportedly initiated the "second phase" of its economic plan, aiming to consolidate disinflation and reduce the gap they consider crucial for building a growth project. After a first phase dedicated to eliminating the financial fiscal deficit (a goal that has been far exceeded in the first six months of the year), the second phase aims to close, according to Minister Caputo himself, the two remaining sources of monetary issuance: the interest paid by the BCRA (Central Bank of Argentina) on its debt with financial institutions, and the purchase of foreign currency by the monetary authority in the MULC (official currency market). In this context, starting Monday, the BCRA would have removed from its balance sheet all its remunerated liabilities with banks, swapping them for a new debt instrument issued by the government: the LEFIs (fiscal notes). The financial burden of these titles would then fall on the National Treasury and would become the new instrument the BCRA would use to regulate the liquidity of the financial system: when a bank needs funds, the BCRA will commit to repurchasing these securities. In practice, the difference with the previous scheme is that this repurchase would not be financed by monetary issuance, but by withdrawing funds from an account established by the Treasury.
On the other hand, with the goal of eliminating the last source of money issuance, the BCRA would have committed to repurchasing in parallel currency markets the pesos issued by buying reserves in the MULC. In other words, part of the acquired reserves would be used to intervene in the MEP or the CCL to keep the monetary base stable.
All the announcements indicate changes in both the implementation of the government's monetary policy and exchange rate policy, and it may be difficult to discern how different all of this is from the policy already being carried out. The official communication was not the best in front of a market eagerly awaiting news of a different kind, perhaps related to the relaxation of exchange restrictions, which was reflected in an increase in the volatility of bonds, stocks, and financial dollars. The perspective of a government now seeking to freeze the amount of money available in the economy to conduct transactions naturally raises concerns about the evolution of activity levels. Likewise, many are bound to ask how the exchange controls will be lifted if the BCRA gives up accumulating reserves.
The first thing to understand is that under no circumstances has the government committed to keeping the monetary base constant or the amount of money in the economy. The objective they have set is to prevent the so-called broad monetary base, which includes the traditional monetary base and the BCRA's remunerated liabilities, from exceeding 48 trillion pesos, although it is logical to think that this nominal limit will be subject to changes over time. Today, the monetary authority's remunerated liabilities have been completely eliminated, and the traditional monetary base stands at a mere 21 trillion pesos. If one assumes that the government intends to keep the central bank’s remunerated liabilities at zero, the implication is that the government would allow a margin for the monetary base to increase by 27 trillion pesos, more than doubling it. This way, a recovery in money demand driven by an eventual improvement in confidence, a higher credit demand, and a recovery in activity levels could develop without being hindered by monetary policy. However, the question arises: if the government has supposedly closed the three sources of monetary issuance, how will the pesos enter the economy?
The first alternative is that in response to an increase in credit demand, financial institutions would liquidate their positions in the new LEFIs and allocate the resulting liquidity to investments in the private sector. It is therefore appropriate to highlight a false distinction between phase one and phase two of this program; although the government has insisted on communicating that the BCRA's remunerated liabilities constituted a contingency that necessarily had to be eliminated, the reality is that little has changed with the transfer from remunerated repos to fiscal notes. Until July 22, when a bank wanted to liquidate a position in remunerated repos, the central bank would repurchase it against monetary issuance, and that injection of liquidity would enter the financial system. Simultaneously, the national treasury constantly sought to withdraw surplus pesos from the economy through the fiscal surplus and the oversubscription of sovereign debt. Today, the only thing that has changed is who pays the bank that wants to increase its liquidity. Whether fresh pesos come from a Treasury deposit in the Central Bank or from "the printing press," the effect of monetary expansion is the same. The key, as it has been since this government took office, is how much contractionary pressure the Treasury will exert to ensure that, at the end of the day, surplus pesos are not circulating on the streets.
On the other hand, the headline "no longer issuing to buy reserves" is not entirely transparent either. First, although it is usual for the Central Bank to be the buyer of reserves in the MULC, and for the Treasury to eventually buy reserves from the Central using its peso deposits, the Treasury could also bypass the intermediary and directly purchase reserves in the official market. Since neither the Treasury nor the BCRA have explicitly stipulated that they will sterilize the pesos resulting from such an operation, this would be another way through which the Treasury could increase the economy's liquidity, against a decrease in its deposits. Furthermore, just by reading the BCRA's press release explaining the new measures, it becomes clear that the BCRA's interventions in parallel markets are subject to a high degree of discretion: "both the pace and the total amount of sterilization (...) will be managed by the BCRA based on the quarterly evolution of liquidity."
It is clear that, although significant, the changes in exchange rate policy do not indiscriminately restrict the BCRA's accumulation of reserves. As money demand recovers and the economy requires a greater degree of liquidity, the monetary authority will understand that intervention is unnecessary and will be able to continue accumulating reserves more broadly. However, it reserves the right to use those reserves to cool the parallel markets when necessary. Ultimately, the gap will continue to be the thermometer of confidence in the program, indicating whether pesos are surplus or lacking in the economy. Some will argue that lifting the exchange controls will take longer if the BCRA sacrifices reserves in this process, but it is hard to imagine the monetary authority managing to accumulate reserves if it does not stabilize market expectations.
Whether called phase 1 or phase 2, the core of the program and its functioning have not changed. The government must, above all, maintain its fiscal discipline, continuing to use this tool to ensure that the peso is scarce, subject to liquidity expansion that may originate in the financial system. As this allows the stabilization of expectations and recovery in money demand, the government will gradually be able to loosen the grip without causing shocks in the gap or inflation, accompanying the recovery of credit and economic activity. Likewise, any increase in the demand for pesos not met by the government or banks will have to be supplemented by the sale of reserves to the central bank. Conversely, failing to control expectations, repudiation of the peso will mean that greater sterilization by the Treasury and the Central Bank will be necessary. The cost will be lower reserve accumulation and a prolonged recession.
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