By The Wall Street Journal
Argentina’s new government on Wednesday lifted currency controls, allowing its citizens to buy dollars freely for the first time in four years and setting the stage for a sharp depreciation of the peso.
The move, which officials hope will kick-start the faltering economy, is the strongest President Mauricio Macri has yet made in his bid to roll back the government interference that marked the country’s economy under the previous presidencies of Néstor and Cristina Kirchner.
“Ending the currency controls is the starting point for getting the economy back on its feet,” Finance Minister Alfonso Prat-Gay told a news conference.
The decision carries significant short-term risks but equally big long-term rewards if it triggers greater investment and lifts the country’s sagging export sector, economists said.
In the short term, the move is likely to spark the biggest currency depreciation since Argentina’s messy economic meltdown in 2002. Economists expect the peso to fall from its current official price of 9.8 to the dollar to the black-market rate of between 14 and 15 per dollar, losing a third of its value.
Underscoring the risks, the step came on the same day the U.S. Federal Reserve raised its benchmark short-term interest rate for the first time in eight years, making it relatively harder for other countries, including Argentina, to attract investment.
A weaker peso will make imports more expensive and add to the country’s already high inflation rate of 25%. To keep the lid on price hikes and attract investment, Argentina’s central bank on Tuesday raised its benchmark rate as high as 38%.
Argentina has precious little money with which to defend its currency in an open market: In the past four years, the central bank’s listed foreign currency reserves have plummeted from more than $52 billion to around $24 billion. Economists say the bank’s real net reserves are far lower considering liabilities like money owed to importers and outstanding bond payments.
“In the end, nobody knows how fast the depreciation is going to be, if it will occur in a matter of days, or it may take a little longer. And, of course, that is going to depend on the intervention of the central bank,” Goldman Sachs economist Mauro Roca said from New York.
To address those fears, Mr. Prat-Gay said Argentina is on track to obtain between $15 billion and $25 billion in fresh cash from a combination of agreements with international banks, grain exporters and China’s central bank. He said grain exporters have agreed to turn over $400 million a day in coming weeks from farm sales.
That amount of available dollars is greater than expected and should provide a short-term cushion for the central bank, said Siobhan Morden, the head of Latin America fixed-income strategy for Nomura Securities.
“It is not in itself a solution, but it certainly buys them time to resolve the main problem which is the high fiscal deficit,” she said.
Argentina’s fiscal shortfall is about 7% of annual economic output, a gap that has largely been bridged in the past few years by the central bank printing money, and thus fueling inflation. Mr. Macri has promised to narrow the gap, and has already announced cuts to fuel subsidies.
The cheaper peso will hit multinational companies differently. Some may have to take an accounting write-down, but the vast majority are likely to welcome the policy U-turn.
“We are extremely encouraged by what’s happening in the country,” said Alexander Nickolatos, chief financial officer of Eco-Stim Energy Solutions, Inc., a Houston-based oilfield services company. Mr. Nickolatos said the company’s contracts are dollar-denominated and that it kept a low amount of pesos on hand in anticipation of a depreciation.
Freeing currency controls was the latest in a dizzying series of moves Mr. Macri has made since he took office on Thursday.
His administration has eliminated most farm export taxes, cut personal income taxes, begun re-staffing Argentina’s discredited statistics agency, replaced the central bank president, and appointed two Supreme Court justices.
While many Argentines want to overhaul the sickly economy, they also fear the changes. Retailers and their suppliers have been marking up prices in anticipation of a decrease in the peso’s value.
“We raised our prices by 40% before the exchange-rate changes so we wouldn’t lose money,” said Marcela Ledesma, 48, who runs a retail store selling imported orthopedic equipment such as wheelchairs and walkers.
Prices rose 1.2% in the first week of December alone, the fastest clip since Argentina devalued the peso by 20% in January 2014, according to Elypsis, an economic research firm.
Mr. Roca at Goldman Sachs said inflation will likely rise and economic activity will remain subdued in the short-term. “When you take the medicine, you are going to have some side effects at the beginning,” he said. “But the trade-off is that you will get better economic prospects in the medium and long term.”
Amid rampant inflation and a lack of faith in the peso, Argentines have for years sought refuge in dollars. The demand for greenbacks, combined with rising demand from the government—which itself needed dollars to make debt payments and pay for energy imports—acted like a pressure cooker on Argentina’s financial system, eventually leading to a scarcity of hard cash.
To stanch the bleeding, former President Cristina Kirchner largely banned the sale of dollars in 2011.
To police the strict measures, Argentina’s tax agency trained dogs to patrol the borders and sniff out dollar bills carried by travelers in and out of the country. The agency often arrested people crossing the border with rolls of dollar bills taped to their legs or hidden in automobile compartments.
But the currency controls merely fueled more demand for dollars, leading to the creation of a vast underground currency market where people paid a 50% premium to buy greenbacks. Illegal money changers popped up across the country and individual traders—known as “little trees” for the dollars they figuratively sprouted—became commonplace in certain sectors of Buenos Aires.
Mrs. Kirchner let the peso depreciate very slowly, in the belief that a strong exchange rate boosted people’s purchasing power. But that approach devastated Argentina’s real-estate market, where transactions are done in cash using dollars. It also hurt exporters whose goods became less competitive abroad.
The measures also failed to contain inflation, which was among the world’s highest throughout Mrs. Kirchner’s eight years in office.
Companies, meanwhile, struggled to obtain dollars to buy parts and equipment, stifling growth and sometimes causing critical shortages at places like hospitals, which depend on imported supplies and equipment. In January, Argentina faced a national tampon shortage, prompting women here to take to Twitter to ask friends traveling abroad to bring back supplies.
Now, Argentina is entering uncharted territory.
Exporters would benefit from depreciation, obtaining up to 50% more pesos for the same product from one day to the next. The housing market could also rebound if people can again buy dollars needed for transactions.
But many ordinary Argentines are anxious.
“Last week, my wholesaler raised prices by 50% on headphones,” said Moises Grinberg, 45, who runs a cellphone and audio accessories shop in Almagro, a middle-class neighborhood in Buenos Aires. “If I raise prices that much on my clients before the holidays they won’t buy anything. So I have to absorb the cost. I’m afraid the devaluation will bankrupt my business.”