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Capital Economics: Argentina to dip into recession in 2018 even with IMF bailout

Capital Economics believes Argentina will fall into recession in 2018 even as the country is trying to prevent a financial crisis and is in talks with the International Monetary Fund over a possible bailout.

The London-based research company said it now expects Argentina's GDP to contract 0.5% this year, compared to a previous forecast of 2.5% growth. Meanwhile, its GDP growth forecast for 2019 was revised to 1.5% from 3.2%. "The news that Argentina has started talks with the IMF over a full-blown bailout has masked the fact that – deal or no deal – the economy is likely to fall into recession this year," Capital Economics said in a report.

The Argentine government is currently negotiating with the IMF for a lifeline, which could come in the form of a full-blown bailout, known as a stand-by agreement, as opposed to a flexible credit line or precautionary liquidity line. Earlier in May, Banco Central de la República Argentina raised its benchmark rate to a record 40% as the country faces above-target inflation and a sliding peso.

According to Capital Economics, domestic demand will be adversely impacted by Argentina's plan to further cut spending and an extremely high interest rate regime until the end of the year. The government aims to reduce spending by 1.8% of GDP in 2018, but the research firm expects the IMF to insist on a bigger slash because of Argentina's large budget deficit.

In addition, the research firm expects the benchmark interest rate to remain at 40% for the rest of the year, with the central bank only employing rate hikes if necessary. If the IMF grants Argentina a full-blown bailout, it would probably require rates to stay high as it looks to narrow the country's current account deficit, Capital Economics added. "Admittedly, an IMF deal would help to prevent large falls in the currency and stabilize capital inflows. But that wouldn’t allow interest rates to come back down immediately."

However, the report said that Argentina's economic downturn this time would not be as bad as previous slumps, given that investor confidence has not completely evaporated. Capital Economics also expects inflation to reach 30% by year-end, lower than the 50% recorded in 2016.

Still, the report said that, "If an IMF deal is agreed, any conditions stipulating even tighter fiscal (and possibly monetary) policy would push the economy into a deeper downturn. And if IMF talks stall or even fail, the currency crisis could resume."

Argentine finance minister: IMF funding to provide security

In contrast to Capital Economics' forecasts, Argentine Finance Minister Luis Caputo said that the IMF funding would reduce the risk of a recession in the short term. "As an Argentine I prefer to have security, regardless of what happens in the markets. We must take comfort that people can keep their jobs, their business ... This is what this preventive agreement with the fund allows," Caputo said in an interview with Infobae.

Caputo added that the IMF discussions are happening at a good time. "We went to the fund because we are with a solid economy and it is better to negotiate when we are growing and with $55 billion of reserves," the official said.

Meanwhile, IMF Managing Director Christine Lagarde said she ordered the IMF team to continue its discussions with Argentina over a fund-supported program after meeting with Argentine Treasury Minister Nicolas Dujovne. Lagarde said that she and Dujovne decided "to reach a rapid conclusion of these discussions," adding that the IMF is ready "to continue to assist the government."

Dujovne said that the IMF and Argentina agreed not to disclose the amount and conditions of financing until they arrive at an agreement, Reuters reported.