Jul 30, 2019 | 20:20 GMT

3 mins read

Argentina: A Central Bank Bond Program Could Face an Uncertain Future

Forecast Update

In our third-quarter forecast, Stratfor pointed to the likelihood that the opposition presidential candidate in Argentina would seek to capitalize on public anti-government sentiment stemming from years of austerity policies. Statements by Alberto Fernandez advocating higher pensions at the expense of the country's banking sector are in line with that assessment.

What Happened

The chief Argentine opposition presidential candidate, Alberto Fernandez, on July 29 reiterated a proposal he first surfaced last week that once in office, he would look at reducing interest payments by the Central Bank of Argentina to local banks that buy short-term bonds and instead use that money to increase pensions. Fernandez characterized the interest rates on Central Bank Liquidity Letters (Leliqs), a mechanism through which the central bank manages the monetary supply, as too high.

Why It Matters

Leliqs are one-week bonds that local banks routinely purchase from the Argentine Central Bank. They were first offered in 2018 as a tool to regulate the monetary supply in an effort to reduce inflation, which last year reached 47 percent. The central bank pays a roughly 60 percent interest rate for the bonds, reflecting the high degree of general mistrust in the country's financial system at a time of high inflation, low growth and economic uncertainty. The Leliqs have added about $1.2 billion to the central bank's current debt pile, a figure representing roughly 40 percent of its reserves.

Without buyers for its bonds, the central bank would have to print more money, generating inflation.

Should the central bank drastically reduce Leliq interest rates, or decide to stop paying interest on them altogether, it would reduce their attractiveness, likely leading commercial banks to stop purchasing them. Without buyers for its bonds, the central bank would have to print more money, generating inflation.

At the same time, if the Argentine banks decide to stop periodically renewing their Leliqs and demand what they are owed, the central bank would face the stark choice of either defaulting on its debt (and thus hurting the banks holding the bonds) or printing even more money to pay the debt (and thus generating more inflation). There is an additional problem: Argentine banks tend to use the Leliq's interest rates as a reference for their loans to customers. Lower interest rates in a context of high inflation could make many Argentine savers look for other places to put their money, such as purchasing dollars (increasing the value of the U.S. currency as compared with the peso).

A Source of Concern

The first round of the Argentine presidential election is set for Oct. 27. Current opinion polls give Fernandez and his ticket partner, former president and vice presidential candidate Cristina Fernandez de Kirchner, a slight lead over incumbent President Mauricio Macri. Polls also suggest that a Nov. 24 runoff pitting Macri and Fernandez would be close. 

Years of recession, high inflation and controversial decisions such as seeking a new International Monetary Fund loan have damaged Macri's popularity. But the policies that Fernandez and Fernandez de Kirchner have championed have created concerns among certain local and foreign investors. They worry about the possibility of greater state intervention in the economy and policies that could increase public spending and inflation. Fernandez's comments on the Leliqs do little to appease these concerns.

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