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Argentina's dollar reserves evaporate, making a bad situation worse

Argentina's central bank is running out of cash.

Facing a persistent economic decline and rampant inflation in addition to fallout from the COVID-19 pandemic, Banco Central de la República Argentina's net liquid international reserves are now estimated to be at or near zero, or even in the red.

The central bank does not report its net liquid reserves, leaving economists and analysts to make educated guesses based on the data they do get. Those estimates vary depending on which assets are considered readily available to sell to contain currency depreciation.

"All we know is what they are not using right now, and that means net liquid reserves could lie anywhere between negative $2 billion and $2 billion, depending on how strict you are with your methodology," Axel Cardin, an economist at the Buenos Aires-based Bull Market Brokers, said. By comparison, he estimates that those reserves stood at about $8.6 billion late last year, when President Alberto Fernández took office, and at $15.2 billion in August 2019, before the country's primary elections.

If those reserves have already fallen into the red, experts say that the central bank is likely tapping into commercial banks' dollar deposits as a short-term move to support the peso while it works to liquidate gold reserves and other assets.

Negative reserves essentially "means that the central bank has greater foreign-currency liabilities than assets, and that to intervene in the FX market by selling dollars it is effectively using the savings of Argentina depositors held as reserve requirements," Todd Martinez, a director in Fitch Ratings' sovereigns group, noted.

Experts say that BCRA dipping into commercial bank deposits as a stopgap should not pose an immediate risk to private lenders. And more broadly, "Argentina's banks are in a decent position to weather the storm of a potential currency adjustment, particularly compared to the 2001-02 crisis, as private sector FX debts are smaller than they were back then, and banks have fewer currency mismatches on their balance sheets," Nikhil Sanghani, a Latin America economist at the London-based Capital Economics, said.

However, as Fitch's Martinez noted, the market's perception of a cash-strapped central bank meddling with banks' dollar reserve requirements would cause significant damage to Argentina's already precarious financial and economic position, which impacts everything.

"Negative net reserves would be an unnerving signal and may cause a further loss of confidence in the peso, leading to an even larger gap between the official and unofficial exchange rates, and even more pressure on the central bank's reserves," Sanghani said. The economist estimates that the country's net liquid reserves are still barely positive, at about $700 million.

Despite aggressive government intervention, including tighter capital controls and purchase restrictions, the Argentine peso has continued to fall precipitously. The official exchange rate is down about 23% so far this year; the informal rate, meanwhile, has plunged 60%. At about 195 pesos to a dollar, the black market rate is now nearly 2.5x the official rate. The country's Aug. 4 deal to restructure $65 billion in foreign debt, as well as minor reductions of tariffs on key exports like soy, similarly has failed to stem the tide.

The government had been working on a "uniform daily devaluation" strategy but recently said it would step away from the plan and allow the pesos to have a controlled float instead.

"If the government keeps selling what it has it will definitely run dry of reserves, and the market will make the official exchange rate converge with the informal one," said Iván Carrino, founding partner of Iván Carrino & Asociados, an economic advisory firm.

Consequences and solutions

Argentina is facing one of the sharpest economic contractions in Latin America this year — an expected 12.5% decline — as well as one of the slowest recoveries in 2021. At the same, time inflation has continued to skyrocket, running at an annual clip of about 50%.

There is little hope for a turnaround without a major catalyst, experts say. What that should be, however, remains up for debate.

"A steep and large depreciation would probably fail to bring stability because there's no evidence that the official exchange rate is overvalued in real terms," said Pamela Ramos, a Mexico City-based Latin America economist at Oxford Economics. As result, she said, "the current piecemeal approach to stabilizing the FX market is bound to fail unless authorities present a comprehensive policy package that includes a fiscal consolidation path and a reduction of monetary financing."

Capital Economics' Sanghani said the country will need a new IMF agreement, "not only to help the government to pay its existing obligations to the Fund, but also to give the central bank a bit more firepower in its battle to manage the peso."

Bondholders who agreed to restructure Argentine debt in August are pushing for exactly that. "Creditors have already played their part, providing a historic opportunity to Argentina for a fresh start. It is now up to Argentina and the IMF to play theirs," they said in a recent statement.

Carrino, however, argued that "the government does not need help from the international community. Rather, it needs to help itself by rebuilding its own trust and credibility, because without that, there is no help that would be sufficient."

Sanghani echoed that sentiment. "Until there is an overhaul of the monetary policy regime, including a phasing out of deficit monetization and looser capital controls, the central bank's reserves will remain under severe pressure."