(Bloomberg) — Four months into office, Argentine President Javier Miley has achieved a momentous achievement in a country long torn by hyperinflation: He has stabilized the currency.
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In fact, not only has the peso stopped falling by the day, but in one of the major foreign exchange markets – there are plenty of them here, a byproduct of the country's byzantine network of rules – it is actually rising sharply. The peso has risen 25% against the dollar over the past three months in the market, known as preferred stock swaps, which is used by many investors and companies. That's more than the gains any of the 148 currencies tracked by Bloomberg have achieved against the dollar.
It's a shocking statistic in a country where the currency seems to be in a never-ending free fall. (The lowest annual decline in the past decade was 15%). This highlights Miley's efforts to rein in bloated government spending, stifle demand for everything in the economy, including the dollar, and tame inflation that has soared to a massive level. An annual pace of approximately 300%.
Miley likes to describe his budget cuts as “the largest in human history.” Sure, he's exaggerating, of course, but not by much. The cuts he imposed add the equivalent of nearly 4% to the country's economic output, a modification so powerful that central bank officials estimate it is larger than 90% of all those implemented in the world over the past several decades.
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To be clear, there are risks all around for Milley and his strong peso policy. On the one hand, spending cuts plunged the economy into a deep recession. With Argentines already suffering from inflation losing their jobs, analysts warn that political pressure to scale back his fiscal program will mount. He had to rely on stop-gap measures to scrape the budget because his broader reform package faced resistance in Congress, a sign of how politically fragile his economic plan is.
“What is new in Argentina is that the person in charge is not worried about paying the political cost that comes with austerity — that is unusual,” said Javier Casabal, head of research at AdCap Grupo Financiero in Buenos Aires. “The government's goal will remain to break the back of inflation.”
Which leads to the next big risk: that inflation does not fall as quickly as the Miley team imagines.
This would not only anger Argentine consumers, but would increase the inflation-adjusted value of the currency. Since the peso first began stabilizing in January, it has risen about 72% after adjusting for inflation, a measure that Argentine investors watch closely because it measures changes in the currency's actual purchasing power.
Read more: Miley's team sees inflation slowing faster from a market perspective
These gains are beneficial for a country until it reaches the point where it discourages companies from exporting products and keeps foreign tourists away. There are already rumblings that this is starting to happen in some sectors.
“When exporters stop selling, the parallel peso weakens,” said Melina Edner, an economist at financial brokerage PPI in Buenos Aires.
For now, though, he's still making gains. On some days this year, it has jumped as much as 4%. Even in the formal market, where most major import and export transactions take place, the peso is largely stable. Policymakers guide it down a little each day – about 0.05% or so – in a highly regulated system designed to smooth out volatility.
The peso is holding up so well now that the central bank has been able to enter the market on a daily basis to buy dollars and replenish very low hard currency reserves. This is a clear sign of how different Argentina is from global markets; Now central bankers in most parts of the world are doing, or considering doing, just the opposite in an attempt to prop up their currencies against the dollar.
Critics point out that some of Argentina's supply-and-demand dynamics are a result of the fact that Miley left the currency restrictions he inherited in place. But these rules did little to slow the collapse of the peso under the previous administration.
What's different now is that Argentines, at least for now, have more confidence in the peso, which limits demand for the safe dollar. (This allowed the central bank to cut interest rates on Thursday for the fourth time since Miley took office.) Furthermore, with budget cuts in place, the central bank no longer directly finances government spending by printing money, putting an end to sustained monetary policy. Source of pressure on the currency.
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“Under this government, economic policy is starting to become rational,” said Carlos Perez, director of Fundacion Capital, a consulting firm. In addition, Perez points out that many people who converted their surplus money into dollars are now having to sell those dollars again to get the pesos they need to pay for everyday items after inflation soared. “Their salaries are not enough,” he said.
Miley unleashed this surge in inflation in December by taking painful — but in his view necessary — steps to liberalize the economy. It removed some price controls that artificially lowered inflation, and allowed the official exchange rate to fall toward the rate set in the preferred stock swap market.
The fact that he is now overseeing a sharp rise in the peso is an ironic development for a man who had deemed the currency so worthless during the election campaign that he likened it to “feces” and said it should be abolished entirely.
The question is how long can he maintain this new stability? To Casabal, in AdCap, it should be smooth sailing through July at least. After that, he became less confident. He's worried about politics and the pressure Miley might be under.
“Political fragility in Argentina can disconnect you from fundamentals and lead to a sharp appreciation in the exchange rate,” says Casabal.
-With assistance from Patrick Gillespie.
(Adds central bank interest rate cut in paragraph 14)
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