Understanding the benefits of a free Argentine Peso.

With the decision to allow free flow of the peso, and “the clamp” lifted, Argentina might reap some immediate benefits. ¿Will these last beyond the near future?

IN RECENT years el cepo (or “the clamp”) has made life uncomfortable for Argentines. Introduced by Cristina Fernández de Kirchner’s government in November 2011, currency controls made it almost impossible for ordinary Argentines to purchase dollars, preferred by savers to the inflation-prone peso. The measure was designed to protect the government’s stock of foreign reserves. But it resulted in the creation of a parallel foreign-exchange market. Instead of exchanging money through official channels, Argentines sold pesos at the “blue-dollar” rate. This week it was 14.5 pesos to the dollar, compared with an official exchange rate of 9.9.

On December 16th Alfonso Prat-Gay, the finance minister named by Argentina’s new centre-right president, Mauricio Macri, announced that he would lift el cepo immediately, allowing the peso to float freely. He had little choice. Exporters were hobbled by the overvalued peso. Importers could not obtain dollars, which starved factories of supplies. Instead of shoring up foreign-exchange reserves, the clamp forced the central bank to spend them to defend the official exchange rate. “The objective is to get the wheel turning again,” said Mr Prat-Gay as he announced its removal.

But it comes with a risk: an uncontrolled devaluation of the peso that could push inflation much higher. Axel Kicillof, the finance minister in Ms Fernández’s government, denounced the lifting of currency controls as “a blow to the pockets of workers.” In trading following the announcement, the peso fell by 29% to 13.9 per dollar.

The measure marks the beginning of Mr Macri’s programme to normalise the economy after a dozen years of populism under Ms Fernández and her late husband, Néstor Kirchner, who preceded her as president. The new president has inherited inflation running at around 25% a year, a fiscal deficit forecast to reach 7% of GDP by the end of the year and depleted foreign-exchange reserves. “The country was in a situation where it couldn’t continue without a resolution,” says Maximiliano Castillo, director of ACM, an economic consultancy.

The unclamping of foreign exchange will bring immediate benefits. Farmers had been hoarding grain—in sacks 60 metres (200 feet) long—in response to steep tariffs imposed by Ms Fernández’s government and in anticipation of the peso’s devaluation. On December 14th Mr Macri scrapped tariffs on agricultural products such as wheat, beef and corn and reduced from 35% to 30% the tariff on soya, Argentina’s biggest export. The lifting of currency controls will further encourage exports of hoarded grain. Grain exporters assured Mr Prat-Gay that sales will bring in $400m a day over the next few weeks.

Multinationals operating in Argentina will also get relief. In November American Airlines—which flies 27 times a week to Buenos Aires—stopped selling tickets in pesos because it was not allowed to repatriate the earnings. Coca-Cola, Clorox and Telefónica faced the same problem. That should now change. But companies’ current peso holdings will take a hit from the devaluation. Some, such as Prosegur, a Spanish security firm, have tried to protect the value of their peso holdings in recent months by buying property.

When announcing the removal of exchange controls Mr Prat-Gay would not be drawn on how far he thought the peso would depreciate. Economists guess it will fall to close to its blue-dollar rate. Since Mr Macri’s election victory on November 22nd, his finance team has been working behind the scenes to replenish dollar reserves ahead of the devaluation. The government expects to raise $15-25 billion over the next month from international banks and other sources. The central bank has also converted to dollars $3.1 billion-worth of its holdings of yuan, which it obtained in a currency swap with China. The hope is that the fresh supply of dollars will stop the peso from “overshooting” the rate of 15 per dollar.

The economic credibility of Mr Macri and his market-minded ministers will help contain the currency’s decline. If “the devaluation started to unravel more quickly than they were comfortable with then there is substantial goodwill in the market”, says Neil Shearing, chief emerging-markets economist of Capital Economics, a research firm. “Credit lines could be extended. There are ways in which they could probably start to stabilise the currency through swaps.”

But that may not be enough. On December 15th the central bank raised interest rates on short-term fixed deposits by 8 percentage points to 38%. They may have to rise further to stabilise the peso and contain inflation. To show his commitment to such containment, and to reduce upward pressure on interest rates, Mr Macri will soon have to begin cutting the enormous budget deficit. This will hurt economic growth, which is already weak. Tightening the belt may prove more painful than releasing the clamp.

The Economist |

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