Rainfed crops, shock therapy, and the four exchange rates of Argentina

Earlier this month, President Javier Milei, the newly elected leader of Argentina came to power amid both great pomp and plenty of controversy.

His mandate has been to reverse the devastating economic slide being experienced by the nation.

In the run-up to the election, supporters hoped that President Milei would unshackle the country’s subdued animal spirits from the tight grip of excessive capital controls, tackle runaway inflation and economic stagnation, and strengthen the overstretched foreign exchange balance sheet.

The devaluation

Having just assumed office, President Milei administered “shock therapy” to the second-largest economy in South America.

On Tuesday night, December 12^th, it was announced that in a single swoop, the value of the Argentine peso (‘peso’) would be more than halved from around 400 pesos per dollar to 800 pesos per dollar.

The peso has been tightly controlled by the government since 2019.

Although expected, the magnitude was sharper than what markets had originally forecast.

On close on December 12^th, the USDARS was trading at 366.49, and at the time of writing, stands at 800.12.

The sharp move by President Milei follows an 18% devaluation by economic policymakers in recent months, resulting in the currency being devalued by 352.6% in dollar terms since the beginning of the year.

Put differently, on international currency markets, 352.6% more pesos are required in exchange for a dollar compared to the first trading session of the year.

Other policies

In addition to the currency devaluation, fresh economic policies included a sharp reduction in energy and transportation subsidies, rationalisation of public expenditure by cutting government spending by a mammoth 2.9% of GDP, targeting a zero-deficit budget, clamping down on wasteful public works projects, and plans to initiate a monthly devaluation of 2% of the peso.

Argentina’s many exchange rates

Unlike the dollar or some other strong currencies, the peso has been unable to establish itself as a reliable store of value.

While the government has tightly controlled the ‘official rate’ of the peso since 2019, both local and international actors do not see the official rate as an accurate depiction of reality.

In practice, the peso trades quite differently against the dollar through both legitimate and regulated processes, as well as on the black market.

These rates have emerged in response to the lack of credibility of the peso due to frequent devaluations.

‘Dollar MEP’ is used for local transactions of stocks and bonds, while ‘dollar CCL’ is the accepted rate for overseas operations.

‘Dollar blue’ is the ‘all-cash’ rate which is used for everyday local transactions.

As a result, there is no clear consensus benchmark on the unofficial peso rate.

Following the recent announcement, the graph below shows the sharp narrowing in the gap between these rates with the official rate, as the government looks to protect the peso against an all-out run on the currency which would dislodge central bank credibility and threaten official coffers.

A Bloomberg story published earlier today draws on the ‘so-called blue-chip swap market Argentines’ and estimates that the gap with the official peso rate is now at 23%.

The central bank also announced that policy rates would be maintained at 133%, even as November inflation sped to 161% YoY.

The immediate danger to the economy could come from higher import prices as a result of the 54% devaluation, which means already elevated inflation may only get worse, while also triggering a full-on recession.

For instance, reports suggest that the sudden devaluation has been met with an immediate counteraction by fuel refiners who have passed on the additional costs downstream by jacking up prices by 40% overnight.

On a monthly basis, consumer prices rose 12.8% compared to October 2023.

Rationale, agricultural exports, and improved weather

Farming is crucial to the Argentine economy, which is the world’s top exporter of processed soy and stands at the third position for corn exports.

It is also the seventh-largest exporter of wheat.

In addition to all the institutional bottlenecks and heavy taxation that farms have to contend with, this year witnessed the worst drought in over six decades, destroying vast hectares of crops and threatening mass defaults in the agricultural sector.

Earlier in the year, Julio Calzada, head of economic research at the Rosario exchange noted,

It’s unprecedented that the three crops fail.

Thus, agricultural exports, a key source of revenue and employment have been closing in on collapse.

The logic behind this move is to power Argentina’s export economy by making the peso much more competitive in the foreign exchange markets.

Since the greenback is the international currency, i.e. global commodity contracts are priced in the dollar, the devaluation acts as a much-needed discount to overseas buyers.

This discount means that Argentine farmers get more pesos for every dollar they earn on the international market, while also encouraging them to sell more of their product to global buyers.

Winds of change

Despite the terrible conditions during the year, Argentina has been blessed with plentiful rain in recent weeks.

Thanks to the El Nino forces, a Reuters report published yesterday suggested that nearly 120 millimeters of rainfall fell in certain regions within a 24-hour window.

Analysts are optimistic that this would offer favourable conditions and ‘optimal moisture’ for soybean, corn, and wheat businesses.

As a result of the sharp devaluation and favourable weather, supply is expected to see an uptick.

Prices

Near-month futures of wheat, corn, and soybean traded on the Chicago Board of Trade (CBOT) have each fallen since close on December 12^th.

Source: CBOT, MarketWatch, Investing.com

Expectations are that this devaluation could aid in the export of reserves of 2 million metric tonnes of soybeans, 5 to 6 million tonnes of corn, and 11 million tonnes of wheat which are stockpiled in the country.

Potential challenges

As discussed above, the immediate challenge would come with an increase in input costs since these are purchased in dollars.

For agricultural enterprises, the difficulty will likely be concentrated in the cost burden of fertilizers, which may dent revenues.

In essence, government economists are betting that the downsides of higher import costs will be outweighed by thicker inflows from more competitive exports.

Forecasts

Market estimates suggest that the 2023/24 harvests for soybean and corn shall reach 50 million tonnes and 56 million tonnes, respectively.

For wheat harvests, the Rosario Grains Exchange has improved its 2023/2024 forecast from 13.5  million tonnes to 14.5 million tonnes.

On a contract-for-difference basis, in the coming twelve months, analysts at TradingEconomics.com expect soybean, corn, and wheat to trade at 1211.07 USd/BU, 552.75 USd/BU, and 418.09 USd/BU, respectively.

In the weeks and months to come, the key concern, however, will remain the possibility of inflation getting further out of hand.

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