Dear ArgenGrowther,

Rough. Very rough. This is the moment Argentina is experiencing, as the EMAE shows a -8.4% year-over-year. A week filled with dollar volatility ends with solid government support during the May 25th celebration. April shows early signs of green numbers.

Financial ArgenGuide:

Data:

• MEP: 1,205.73; 12.57%

• Country Risk: 1,443; +14.25%

• AL30: 54.44; -7.02%

• BCRA: Bought USD 550 million in foreign currency. Reserves increased by USD 315 million, totaling USD 29.113 billion.

• Bopreal Auctions: USD 60.3 million

• March Monthly Economic Activity Estimator (EMAE): -8.4% year-over-year; -1.4% monthly.

Now, what does all this mean?

Positive or negative? Spoiler alert: NEG-A-TIVE. The destroyed economic activity and a volatile dollar made this one of the worst weeks since the government began. Neither the BCRA's purchases nor the reserve accumulation could save the week.

Dollar and Strong Peso. Last week, we said that no significant movements were expected here and that lower interest rates would put more pressure on the exchange rate, but nothing happened at the time. Then we saw the year's strongest movement by far, with the dollar waking up to a +12% after an auction left many pesos out and last week's rate cut. To confirm that the dollar effectively moved, we should see these values over the next few days; otherwise, it will have been just noise along the way. Remember, the MEP has risen 21% this year (mainly in the last ten days) compared to a 10% rise in the wholesale dollar with 70% cumulative inflation in 2024.

Lower interest rates = Greater pressure on the exchange rate

Greater pressure on the exchange rate = Little to nothing happens (for now)

While the movement seems large, it isn't that much in perspective of recent years in Argentina. However, it is significant that this government has enjoyed exchange rate stability since taking office. Despite the substantial rise this week, unlike previous major dollar movements, there were no substantial changes beyond those mentioned, and the noise seems to come from the political side with the confirmation that there was no “pact of May” and the ongoing delay in passing the Bases law.

The feeling of exchange rate lag increases as days go by, and coupled with slow agricultural liquidation; it sparks a dollar that always has fuel in Argentina. This will likely continue until various macroeconomic variables normalize and there are instruments to protect against inflation in pesos. Despite this volatility, as we have been saying, there are no pesos, and the monetary tightening makes it difficult for this to end in a currency run, with the BCRA buying dollars daily in parallel.

The President's speech aims to anchor expectations by stating: "We will eliminate the PAIS tax and then the withholdings so that the agricultural sector is free." Since the PAIS tax has set a floor for the gap, if it ceases to exist, one could presume a smaller gap, And possibly a lower MEP dollar?

The 2% crawling peg not only has the monetary policy rate (REPO) very close, but also inflation is approaching week by week. Despite the movement in the MEP, we continue to think that a significant exchange rate jump is not foreseen. Will the government shake things up and modify some exchange rate policy schemes? Difficult but less impossible than last week. People began to talk about how we are increasingly closer to a liberalization of the currency clamp, but being closer doesn't mean it's imminent. The government plays with the speech and does not provide certainties it cannot fulfill. Will we reach the three ducks: 2% devaluation, 2% rate, and 2% inflation in the coming months?

Recomposition of Public Accounts. A long and complex road. The BCRA was bankrupt (and still is with negative net reserves), and by disclosing the numbers, we see that even the equity was inflated. On the national side, a significant fiscal deficit reduction has been achieved, transitioning to a surplus. Still, the journey is just beginning, and the sustainability of the numbers will be the challenge in a country that does not grow today.

Tariffs. Pragmatism continues with freezes in a historically cold winter. The government goes against its premise in the energy sector of a smaller state amid the difficult economic situation the majority of the population faces.

Postponing tariff increases = Continuing energy subsidies

Continuing energy subsidies = Higher public spending until tariffs increase

Revenue. The big question is where the income currently represented by the PAIS tax will come from. We mentioned that the only two taxes that grew in real terms are export duties (DEX) and PAIS. For a sustainable fiscal path, it will be essential to reconfigure the relative weight of each tax since the PAIS tax should not exist in an economy without a clamp, and it is becoming increasingly significant. The President also said he wants to eliminate withholdings—will the two fastest-growing taxes no longer exist? The year-over-year real results for the first four months show a striking difference, -8% vs. +1.4%. Here are the expectations anchor we talked about so much, but at the same time, it leaves many doubts about its composition.

Fiscal Surplus = Contractive Fiscal Policy Contractive

Fiscal Policy = Economic Activity Decline

BCRA. On the way to destroying remunerated liabilities but accumulating fewer reserves than expected?

After last week's auction's massive peso migration, there wasn't much movement this week. Will we see a new mountain moving in this week's auction? We will see if the market validates the government's idea of shifting risk from BCRA to Treasury to the following scale, although private banks have only 8 trillion pesos in Repos. In the coming weeks, public banks will likely auction Lecaps, and we will see the end of remunerated liabilities as a problem (changing the problem's name, we agree, right?).

Revealing numbers and changing the valuation of BCRA's Non-transferable Letters. This valuation change recognized a USD 52.200 million accounting loss for these titles. Where do the non-transferable letters come from? The Treasury placed debt with the BCRA amounting to USD 69.200 million with a future payment commitment. From the financing granted by the BCRA to the Treasury, the BCRA expects to recover only USD 17.000 million. When talking about emptying the BCRA, here is a clear example: the central bank financing the deficit for so many years created a loss in the BCRA's equity that will probably take many years to recover.

Rates. Convergence. Against almost all forecasts, the government is achieving economic convergence to the 2% crawling peg. Is a new rate cut coming to equalize the crawling? The government already said it was not uncomfortable with the MEP's rise in recent weeks, so if it considers it has room for maneuvering and with inflation still falling, logically, given what it has been doing, it would be another rate cut.

Lower interest rate = Lower money creation

Lower money creation = Lower inflation expectations

Lower inflation expectations = Lower inflation

Lower inflation = Lower interest rate

Lower interest rate = Expansive monetary policy

Expansive monetary policy = Economic activity rise

Contractive Fiscal Policy + Expansive Monetary Policy = ?

Auctions. Completing Bopreal series 3 and looking forward to next week. The auction will be crucial to continue the path of shifting pesos from BCRA to Treasury. It remains to be seen what Lecaps the government offers and what minimum TEM it offers to make the auction attractive; remember that there was a prize in the last auction. Another week will define the government's path forward.

The modest USD 60 million in Bopreal is not very relevant, but it continues to validate an exchange rate above the market.

Debt. With excess pesos from last week's auction, the Treasury bought AL35 from BCRA for USD 1,329 in VN, approximately $700.000 million. Remember, this is one of the sterilization mechanisms the government has been using (reducing the monetary base).

Economic activity. Alarming. The EMAE leaves us with a brutal number for March: -8.4% y.o.y. and -1.4% against February, fiery red.

Excluding COVID, the EMAE for construction experienced the largest y.o.y. drop since the index began: 29.9%. In the quarter, the y.o.y. drop was 5.3%. Excluding Agriculture, Livestock, Hunting, and Forestry, it rises to -6.1% y.o.y., as the agricultural sector, without drought, grew by 11% y.o.y.

Economic recovery. We continue with the question, will it be achieved with credit, as the President said? Peso loans are at rock bottom, mortgage loans are in the basement, and dollar loans are increasing. Are peso loans on their way to extinction, and will we shift to dollar loans (excluding UVA mortgages that have already begun to circulate)?

The substantial rise in dollar deposits also starts to mark a change of era, coupled with the new regulation that equates the requirements to open a USD account with a peso account. Is the ground being prepared for currency competition and the extinction of the peso?

Lower Interest Rate = Greater incentive to take credit

Greater incentive to take credit = More credit?

More credit = More economic activity

Several indicators in April turned green monthly, suggesting that April's month-to-month activity may have turned positive or is close to it. Did we hit bottom in March or April?

The streets. Very calm and with solid support for the government at the May 25th event. The dollar's rise doesn't seem to have taken a toll, and the government's approval rating remains high in the most challenging moments of the recession, even though job creation hasn't picked up (at least until March)

Capital Markets - Actionables

We had already mentioned that the carry trade was over. Given this dollar spike, will there be brave souls selling dollars to earn interest in pesos? With such a low rate, there won't be many.

It is relevant to mention those in pesos who need to stay there to reinforce last week's point about moving from T+0 funds to T+1. Although much of T+1's return this week came from rate compression due to the Lecaps' price increase, we continue to see value in these funds over T+0. Here's a relevant example between T+0 and T+1 funds from Invertir En Bolsa (IEB).

The pesos, which we have been investing in T+0 without thinking about for years, will now be managed with a much higher percentage of T+1.

Hard-dollar sovereign bonds stopped lateralizing and took a significant hit for those who boarded the train at the last stops. The lack of political support seems to be the main reason behind the rise in country risk and the drop in bonds. We remain optimistic, with extraordinary returns when measured against comparables. While political noise can create short-term volatility, the government's willingness to pay is unwavering. The question is whether the capacity to pay is the same without the Bases law. For now, it seems so, but last week showed that Argentina's payment commitments for the coming years require much more than willingness.

The noise was total, and stocks also saw a sharp drop after a steep rise during the year. Investing in Argentine stocks involves high risk, volatility, and (hopefully) high returns only for risk-tolerant investors.

The peso curve is gaining more points in its construction, beginning to take on a healthier color, with several more points expected in the curve next week. Will it be worth entering the auction again in search of a prize?

We assert that as long as the government shows good numbers, the drop in country risk will eventually resume, and hard-dollar bond rates will continue to compress.

Rate Compression = Price Increase

Brief Reflection

After a historic week, a reality check followed. Argentina still has a long way to go to become a normal country, and this week demonstrates that.

Expert Outlook: The feeling is that financial measures alone are not enough, that a significant economic team alone is not enough. After decades of decline, Argentina needs broad consensus and a collective effort to move the country forward. Argentina today is hanging by a thread of expectations. If expectations change, all the effort the population has been making could mean that economic fruits will not arrive as soon as expected, with associated social consequences.

Aligning macro variables is just a tiny part of what the country needs to even think about attracting investments, generating jobs, and growing. The political part has to accompany it, and the lack of government governability makes an already arduous path even harder. But that's not all; let's not forget the legal part. All three branches need to be up to the moment Argentina is experiencing, understanding that the policies tried in recent decades have not borne fruit and that today, there is an opportunity to try something different.

This experiment, which is Argentina for the world, could be an inflection point for Argentina to emerge as the new beacon of the Western world. The board is on the table; we have the world's political figure of the moment (whether we like it or not), a high-level economic team, a population making great efforts daily to move forward, broad government support across all socioeconomic sectors, and at the same time, players who play to subtract points. If Argentina doesn't play as a team, the world will continue to see us from afar as the experiment we are, and investments and the recovery of the growth path will take longer to arrive.

The week's reflection leads me to wonder if politics and justice will be up to the changes the country needs. Are we heading to a country where politicians represent the population and act according to Argentina's needs? Will judges be up to the task and adjust to a liberal Argentina? The alignment of all three branches will be a fundamental pillar that shows the world that Argentina has changed.

Argentina needs a highway to do business, not a road full of potholes. Are we closer? Today, clearly not.

See you next week, Vamos Argentina!

Nau Bernués
Founder, ArgenGrowth

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