Peso devaluation and Argentine government's poor policy credibility likely to undermine banking sector

Argentine government efforts to stabilise the peso and prevent the continuing depletion of foreign-exchange reserves (now about USD28 billion, compared with USD52 billion in 2010) are threatening to hurt the banking sector. Although the sector is still robust, Argentine banks face the risk of increasing government intervention if existing measures fail to stop the peso rout. Recent measures have tried to tackle the serious macroeconomic imbalances afflicting Argentina, but it is far from certain that they will succeed.

On 23 January 2014, the Argentine authorities abandoned their efforts to support the peso, triggering a sharp devaluation of its official rate by 20% to ARS8.01:USD1.00. This was followed by relaxation of controls on dollar purchases by Argentine nationals. Access to dollars for personal saving, which had been restricted since October 2011, was blocked totally in July 2012. However, under the new measures, from 27 January Argentina nationals with a minimum monthly income of ARS7,200 (USD900) are allowed to buy up to USD2,000 dollars per month for personal savings. Furthermore, a tax imposed on dollar purchases since March 2013 was cut back substantially, from 35% to 20%, although this reduction did not apply to credit-card operations abroad.

The authorities’ expectations are that with fewer controls and a more realistic exchange rate, people will have less need to seek dollars on the black market (the so-called ‘blue dollar’). Also, in order to make investment in pesos more attractive, the central bank raised interest rates by 600 basis points to 25.9% on 28 January. Both of these measures are consistent with the government's policy of seeking to reduce the use of the black market, and narrowing the differential between the official and black market rates.

Credibility is still lacking

The official exchange rate currently remains at ARS8.01:USD1.00, while the parallel exchange rate (blue dollar) is around ARS12.7:USD1.00. The gap between the two rates has stayed broadly unchanged since the devaluation measures were announced, suggesting that economic actors are not yet convinced by the recent policy measures. Political uncertainty and stubborn inflation of more than 28% – which in large part explains the tendency of Argentines to rely on the dollar – represent major obstacles to government efforts to stabilise the peso. On the political front, the long absence of President Cristina Fernández de Kirchner due to health problems raises serious concerns of a leadership vacuum. In practice, the country is being run by Chief of Cabinet Jorge Capitanich and Minister of Economy Alex Kicilloff. So far, they appear to be in agreement on the core economic policies recently adopted, but if President Fernández remains hands-off the risk of internal infighting remains significant.

Inflation is likely to be higher in 2014 than last year given the cost impacts of the recent peso depreciation and the unwillingness of the government to rein in public spending and printing of money. On average, independent local economic consultancies are predicting that inflation will rise above 40% by end-2014. Given this expectation, economic actors are expected to behave rationally and seek renewed protection by increasing their dollar holdings. Similarly, labour unions will seek wage settlements that match expected inflation, as they have done successfully so far, increasing the upward pressure on prices.

Attraction of peso-denominated accounts key to banks' stability

Argentine capital controls, in place since October 2011, have forced a rapid reduction of dollar use within the banking sector and significant maturity shortening of the peso-denominated deposit base. The constant reduction of dollar deposits within the banking sector (amounting to 25% of the dollar deposit base in October 2011), in turn, has resulted in a similar de-dollarisation of the credit portfolio, with the proportion of dollar loans progressively dropping from 15% to 6.7% of total credit at present. More importantly, depositor unease, public distrust in the financial system, and continued fear of currency devaluation have all combined to damage the stability of the peso-denominated deposit base. Argentine deposit-holders have moved their savings to shorter maturities or have taken pesos out of the banking sector altogether to exchange them for dollars in the parallel market.

As a result, Argentine banks have faced increasing difficulties capturing stable domestic deposits. This has increased bank funding costs, shown by the gradual rise of the benchmark interest rate paid by private banks on large fixed-term deposits, the Badlar, from 17.8% to 24.0% in the last six months to the end of January 2014. The scarcity of term deposits and higher funding costs make it more challenging for Argentine banks to supply long-term credit into the economy, increasing their asset/liability mismatch (gap) risks and reducing their margins. Banks also have to cope with compulsory lending quotas, which mandate forced lending of 5% of deposits to small and medium-sized enterprises at preferential interest rates. Therefore, record-high costs for fixed-term deposits and government pressures on the sector to maintain low lending rates are eroding overall interest-rate margins.

Nevertheless, the banking sector still reports good bottom-line profitability, with pre-tax returns on average assets averaging 4% in 2013. However, the gradual squeezing of margins could undermine the sector's ability to replenish its capital base with net profits in the near future. Ironically, one of the main factors contributing to the preservation of the sector's capital base is the government's restriction on dividend payments since early 2012, especially for foreign-owned banks, which aimed to contain the outflow of foreign reserves.

Outlook and implications

We assess that normalisation of the domestic credit market is unlikely given the volatility of funding, distorted credit demand, and real negative interest rates. The continued attractiveness of the informal blue dollar as a store of wealth means than banks will struggle to secure a stable and solid funding base. Meanwhile, expected higher inflation of close to 40% will keep real interest rates in negative territory. Although debt-servicing burdens are effectively smaller under these circumstances, low borrowing costs act as a disincentive to saving while encouraging indebtedness. Heavy indebtedness exposes borrowers to sudden increases in real lending interest rates and to economic shocks, exacerbating the risk of debt delinquency.

Economic slowdown and fiscal deficit deterioration make it likely that the government will put increased pressure on banks to channel credit towards targeted economic groups as well as supporting fiscal policy through the purchase of government debt. At present, bank holdings of government debt are relatively low compared to pre-2001 levels: this could change rapidly if the fiscal deficit widens through 2014.

In the event of the crisis worsening, it is likely that the government would step up its intervention in the banking sector by using different methods of control. Regulatory restrictions on online shopping and foreign purchases with credit cards are already in place and the government also undertakes frequent queries on bank transactions via the tax collection agency, AFIP (Administración Federal de Ingresos Públicos). In addition, stronger emphasis on import-substitution and industrialisation as part of a broader strategy to defend the currency is likely to result in an expansion of mandatory loan disbursements to targeted corporate borrowers or the introduction of regulatory caps on loan interest rates for favoured categories of borrower. This would undercut efficient credit allocation and would elevate the public perception that private banks are not a reliable and safe destination for private savings.

If attempts to stabilise the peso and foreign-exchange reserve levels fail, the government is likely to resort to more desperate measures that will affect the banking sector. The government has already considered mandating banks to raise funds overseas in order to boost foreign currency inflows and elevate the level of central bank reserves. Under such plans, the proceeds of foreign fundraising would be deposited immediately at the central bank, potentially to be used to finance exporting companies.