The Argentinian central bank's decision to reduce sales of US dollars may signal a move to preserve its foreign exchange reserves, says Mike Simpson, Investment Manager, Baring Latin America Fund at Baring Asset Management.
The Argentinian central bank’s decision to reduce sales of US dollars may signal a move to preserve its foreign exchange reserves, says Mike Simpson, Investment Manager, Baring Latin America Fund at Baring Asset Management.
On the 22nd January, Argentina’s central bank took the decision to scale back support of the currency by reducing sales of US dollars from its foreign exchange reserves, giving way to a fall in both the peso and the equity market. By the 27th of January, the official peso to US dollar exchange rate had fallen by 12%*, while the MSCI Argentina Index recorded a fall of 11% in US dollar terms.
The central bank’s decision may signal a move to preserve its foreign exchange reserves, which have fallen by more than 30% year on year to US$29.7bn, the lowest level in seven years. In our view, the monetary authorities now face a difficult balancing act as the peso devaluation should add to already strong inflationary pressures; unofficial estimates put the rate of inflation at twice the official 10.9% rate published by the national statistics agency for December 2013.
While the recent volatility of the peso reflects specific economic and political developments in Argentina, in particular the authorities’ use of unorthodox economic policies, it came to pass alongside a broad weakening in emerging and frontier market currencies this year. The first sign of such weakness occurred when the US Federal Reserve indicated during the summer of 2013 that it would initiate ‘tapering’ of its quantitative easing programme in 2014. It has been more pronounced at the start of this year, however, particularly for countries reliant on foreign capital inflows to cover large current account deficits.
In our view, developments in Argentina will have a minimal impact on international capital markets, as the country has never fully returned to global debt markets after its sovereign bond default in 2002. Similarly, we do not believe peso depreciation will have a significant effect on global trade, save for, perhaps, businesses in neighbouring countries which may have closer commercial ties to the Argentine market.
Notwithstanding our expectation that the economic effects of the sharp peso devaluation will remain relatively contained, from a sentiment standpoint volatility in the market does little to help confidence at a time when risk aversion toward emerging and frontier markets appears to be on the rise.
The Baring Latin America Fund has no direct exposure to Argentina and we are likely to remain underweight any indirect exposure in companies outside of the country that have close commercial ties to the Argentine market. We expect that volatility in the exchange rate is likely to continue into the short-term, with further weakening of the peso a strong possibility.