Steady Dollar Strategy: key mechanisms economist Javier Milei is wagering on to stabilize currency rates until polling day
Javier Milei's campaign strategy continues to revolve around the value of the dollar, five months after the legislative elections. The dollar acts as a key component to reduce inflation and boost the government's chances in October.
With certain savings restrictions lifted (although some remain for businesses), the dollar trades below the floating band's center -initially set between $1,000 and $1,400, expanding by 1% each month in both directions-. This restriction limits devaluation and the predicted pass-through to inflation, as suggested by the Bloomberg agency.
A stronger peso might foster optimism among Argentines about the economic outlook. Conversely, it could also hurt margins and competitiveness, according to Alejandro Cuadrado, BBVA's Global Head of Latin America FX Strategy.
Here's how the Milei administration plans to prevent dollar appreciation, as reported by Bloomberg:
- Soybean Seasonal Flows: The soybean harvest usually leads to a flood of dollars during Q2. This trend is further enhanced by the end of temporary retention reductions on June 30, pushing soybean producers and exporters to sell dollars, contributing to Milei's objective.
- Dollar-Denominated Bonds: The Central Bank is considering issuing peso bonds that can be purchased in dollars. Federico Furiase, one of the entity's directors, announced this last week. The initiative intends to increase currency supply in the market and aid the monetary authority in accumulating reserves.
- "Carry Trade": A recent regulatory change allows foreign investors to participate in the official currency market as long as they maintain their investments in Argentina for six months or more. This attracts foreign money from investors seeking to exploit the "carry trade". This strategy involves selling their bills, placing those pesos in high-yield bonds, and then buying dollars, earning an attractive yield in a hard currency.
- Amnesty for Savers: Caputo aims to encourage Argentines to deposit around US$200 billion currently outside the financial system into banks. The Minister of Economy intends to channel these savings towards daily transactions and monetize economic activity in dollars, as the government seeks to limit the amount of pesos in circulation.
- Energy Exports: Energy exports, which have grown significantly in recent years, could become the country's second major source of foreign currency, ranking only behind agriculture. The key to this lies with Vaca Muerta, Argentina's largest oil field.
- Foreign Direct Investment: The government expects an increase in dollar supply due to the lifting of exchange controls. The idea is that companies will be more motivated to bring dollars to the country if they can sell them freely on the forex market or withdraw them whenever they wish. The RIGI program adds to this by offering incentives for large investments.
- Fiscal Surplus: The Argentine Treasury aims to maintain its fiscal surplus and withdraw pesos from the market, according to Furiase's announcement. The government's greater need for pesos, coupled with the Central Bank limiting the money amount, removes fuel from dollar demand and alleviates exchange rate pressure.
The Central Bank's decision not to buy dollars until the peso strengthens signals to the market that policymakers will not inject pesos into the system. The entity also announced that it will issue a dollar-denominated bond, which can be bought in pesos, for companies that need to send dividends abroad, adding to the monetary institution's toolkit for absorbing pesos.
The implementation of these tools strengthens the government's commitment to maintaining the strength of the peso, which was one of the best-performing currencies in the world in 2024 and is currently at its highest level in 10 years.
A strong currency may not come without risks. "The peso had already appreciated in real terms, so lowering it would deepen that trend," said BBVA's Cuadrado. The lower limit of the peso's band, at 1.000, should not be sought, Cuadrado added, given Argentina's objectives as part of its financing agreement with the International Monetary Fund and a potentially less favorable environment in the second half of the year.
In an effort to boost the purchasing power of Argentine salaries in dollars and real terms, and to gain votes before the October elections, some fear that the strengthening of the peso could slow activity in some sectors or fuel expectations of devaluation.
"This could create an opportunity to buy dollars," said Federico Filippini, Adcap's Chief Economist. "But as long as the government remains focused on its inflation target, this will be sustainable," said Filippini.
Business leaders called for fiscal cuts or structural measures during an event in Buenos Aires on Tuesday. "You can't have all variables working against you. The burden of withheld taxes, the strong exchange rate, and a host of unfavorable factors are holding back many sectors," said Manuel Santos Uribelarrea, CEO of power generator MSU.
Extra Insight:The Milei government employs a multifaceted approach to limit the appreciation of the dollar and stabilize the economy amid inflationary challenges. Strategies include:
- Seasonal Soybean Flows: The government leverages seasonal inflows of foreign currency from soybean exports to support the peso and dollar liquidity.
- Dollar-Denominated Bonds: Issuing dollar-denominated bonds helps contain dollar appreciation by attracting dollar inflows through financial markets.
- Carry Trade Incentives: The government encourages "carry trade," where investors borrow pesos at relatively low interest rates to buy higher-yielding dollar assets.
- Amnesty for Savers: Milei's administration has granted an amnesty or eased restrictions to encourage savers to repatriate or hold dollars within the formal banking system rather than informal channels.
- Energy Exports: Boosting energy exports is part of the strategy to increase foreign currency earnings. Higher energy export revenues translate into more dollars entering the country, helping stabilize the official exchange rate and build reserves.
- Foreign Direct Investment: The government has introduced fiscal and regulatory reforms to attract FDI, creating sustained foreign currency inflows that reduce dollar appreciation linked to speculative flows.
- Fiscal Surplus: Milei aims to generate a fiscal surplus by cutting public spending and dismantling subsidies, thereby reducing inflationary pressures and dollar depreciation.
- Central Bank Tools for Absorbing Pesos: The Central Bank employs monetary tools to absorb excess pesos circulating in the economy, such as issuing debt instruments or raising interest rates.
In the strategies employed by the Milei administration to stabilize the economy and prevent dollar appreciation, the issuance of dollar-denominated bonds serves as a tool to attract dollar inflows through financial markets, thereby helping to counteract dollar appreciation. Also, in an effort to encourage Argentines to bring their savings back into the formal banking system, the administration has granted an amnesty or eased restrictions, which could potentially increase the supply of dollars in the business sector.
