Martín Redrado: Presentation of the 2009 Monetary Program
Speech by Mr Martín Redrado, President of the Central Bank of Argentina, before the
Committee on Treasury and Budget of the National Senate, Buenos Aires, 30 December
2008.
* * *
1. Introduction
One year ago, when I last addressed the Honorable National Senate to present the 2008
monetary program, I already emphasized with concern the hostile international financial
scenario we had to face. On that occasion, I highlighted the uncertainty imposed by this
scenario on monetary policy. In particular, I underlined the advantages of our risk
management approach based on three pillars: the money market equilibrium, a managed
float, and countercyclical policies that includes a proper regulation and financial surveillance.
I also mentioned that, from the Central Bank, we successfully weathered the first turmoil
since the end of the 2001 crisis. Twelve months later, we have lived through three complex
situations, which proves us right in the actions we have taken. The first one was the
beginning of the sub-prime mortgage crisis in the United States (July-October 2007). The
second episode was the abrupt imbalance in the demand for money after the rural sector
conflict (April-June 2008); and the third relates to the worsening international crisis
(midSeptember 2008 onwards).
The performance of monetary-financial variables and the limited impact of these episodes on
the real economy prove the soundness of our policies. Throughout recent years we have
patiently and persistently built the right instruments to mitigate various shocks. Under a risk
management approach where a central scenario is defined for the main variables, our
strategy furnishes us with the right tools to face any deviation. We have mechanisms in place
to provide or absorb funds as needed while preserving money market equilibrium. We have a
sound, well-regulated financial system that is in a position to "cushion" any turmoil. All of this
in a framework of abundant liquidity in foreign currency and a managed float with mildly
fluctuating financial variables to reflect the natural convergence between the yields of
Argentine peso- and US dollar-denominated instruments. This regime - which provides
predictability and flexibility at the same time - is undoubtedly the best suited for the current
economic stage. Moreover, this regime takes into account both our long history of
macroeconomic volatility (and de facto dollarization of the peoples financial behavior) and
consistency with the macroeconomic program as a whole.
In this presentation, I will firstly highlight Central Bank actions to manage the different
volatility episodes during 2008, including the evolution of monetary aggregates vis-à-vis the
program for this period. Secondly, I will explain the rationale behind the different pillars
underpinning our strategy, especially the managed float. Finally, in the light of my forecasts
regarding the national and international economic scenario, I will state the monetary targets
and guidelines set forth by the Central Bank Board of Directors for 2009.
2. 2008: another challenge for the monetary regime
In my view, any recipe to overcome a crisis or financial turmoil should have three essential
things.
First: to have a definite reaction. Action should be forceful in order to curb expectations and
rebuild confidence - it should reflect that authorities are persuaded that the path to follow is
the correct one.
Second: simplicity. The instruments used should be transparent and clear in order to be
more effective. Action can be technically flawless but, if agents have trouble interpreting it, it
can cause uncertainty and become ineffective.
Third: delivery capacity. Effectiveness to overcome complexities related to the
implementation of any action is an important condition allowing, at the same time, to gain
credibility.
This is, in short, the Central Banks view in action. In order to face these crisis episodes, we
have sequentially adopted a series of measures. In the first place, we reacted in a definite
way, acting firmly in an attempt to normalize the money demand and stabilize the foreign
exchange market. Then, with simple instruments, we ensured liquidity provision to guarantee
systemic stability. Finally, in order to make it more "down-to-earth," we implemented an array
of measures including reforms on the markets for Central Bank securities, the development
of additional mechanisms for liquidity provision, changes to enhance futures market depth
and transparency, and instruments to facilitate US dollar supply.
During the three critical episodes, we noticed a marked mismatch in the demand for money
that activated the warning signals on our instrument panel. Private sector time deposits
showed a temporary decline, just as during previous financial crises. The same happened
with the size of the capital account reversal. Having adequately assessed the costs and
benefits of each instrument beforehand, we focused all our efforts on restoring money market
equilibrium. A quick and "surgical" reaction allowed us, in the first place, to strengthen the
demand for pesos and facilitate foreign currency supply. In this respect, and in order to put
the complexity of this task into perspective, it is worth remembering that the demand for
money is decided by the public and that our capacity to influence that decision is mostly
indirect and limited.
In fact, through transactions in the spot and futures markets, the potential pass-through of
depreciation trends to domestic prices has been avoided. At the same time, these actions
had a positive impact on the recovery of the demand for domestic assets and assurance of
systemic stability. Once the foreign exchange market was relatively calm, we undertook to
improve domestic currency liquidity so as to ensure financial stability and a smooth chain of
payments. The sterilization policy that we developed in recent years facilitated our job,
furnishing us with the necessary tools to efficiently provide funds this time. Central Bank
actions included the repurchase of LEBACs and NOBACs in the secondary market and a
partial renewal of those maturing. Thus, the liquidity reserve feature of these securities was
confirmed: issued in the face of excessive liquidity and redeemed when market conditions so
require. In fact, the Central Bank securities stock went from almost ARS 51.5 billion in late
2007 to approximately ARS 36.7 billion at present. This change in the composition of
liabilities is perhaps less visible than the trend of reserves, but is a part of our scheme as
well.
In turn, we also intervened by purchasing Government securities in pesos or US dollars in
the secondary market, aiming to provide liquidity beyond the financial system. This is
something that most central banks in the world do as part of their open market operations.
More precisely, we took eighteen steps to adapt our scheme to the new scenario:
• The repo market was reformed, offering liquidity at a fixed and floating interest rate;
•
The maturing Central Bank bills and notes (LEBACs and NOBACs) were partially
renewed, and there was repurchase in the secondary market;
•
We resorted to open market operations by purchasing Government securities that
can be liquidated in Argentine pesos so as to inject liquidity and preserve money
market equilibrium;
•
Minimum cash requirements were unified for June and July into a single bi-monthly
term, thus improving the system liquidity management;
•
A mechanism for US dollar-denominated repos was established, aimed to curb peso
depreciation expectations;
•
The Central Bank started trading in the non-deliverable forward (NDF) market, with
one-year-maximum operations and counterparties whose credit rating was AA or
above;
•
A new repo window was opened that allows for certain instruments to be used as
collateral (Bogar and guaranteed loans) that cannot be used in traditional repos;
•
The limits to operate in the futures market were extended, both for the Central Bank
and those agents associated with some of its counterparties. It is worth mentioning
that our institution only trades with contracts that are cleared in domestic currency;
•
The reference exchange rate for futures and forward transactions between the
Central Bank and its counterparties was allowed to be set by the Emerging Market
Traders Association;
•
New maturity options were offered for reverse repos, readjusting the terms and
conditions;
•
The liquidity provision scheme was extended, allowing banks that hold
(6-monthmaximum) LEBACs and NOBACs to have instant liquidity;
• Repo yields were adjusted twice;
•
A mechanism has been established for auctioning options on LEBACs and
NOBACs, allowing institutions to on-sell these securities to the Central Bank before
maturity at a pre-established discount (a spread over BADLAR rate);
• Minimum cash requirements were lowered for foreign currency deposits in order to
increase the availability of funds to finance foreign trade;
• Financial institutions' minimum cash requirement was unified for October and
November into a single bi-monthly term;
•
A new window was established to rate collaterals for the financial assistance regime;
•
In order to meet reserve requirements, institutions were temporarily allowed to
include their total cash holdings in the calculation, even items in transit (in the past,
they were only allowed to include two thirds);
•
The fixed-rate repo line was raised from ARS 3 to 10 billion.
These measures stressed the "buffer" role played by the Central Bank to limit the effects of
turmoil on the real economy. Also, adequate risk-management mechanisms and the proper
use of policy tools allowed us to discourage speculative attacks. Thus, even though we are
going through one of the worst crises in the history of the global financial system, the set of
policies implemented resulted in a satisfactory trend of the main monetary and financial
variables.
The means of payment (M2) for November reached a monthly average balance of ARS
159.470 million, growing by 14.1 percent y.o.y. This trend shows that we are about to
accomplish with the ones for the last quarter of 2008, thus complying for 22 consecutive
quarters with our monetary aggregate targets. In December, total means of payment are
likely to be between the midpoint and floor of the target set.
In turn, by year-end, private sector means of payment will fluctuate around 9 percent. This
figure is below the lower limit of the 2008 monetary program target due to a
steeper-thananticipated decline in the demand for money. This came about because, when the range was
established, the strength and magnitude of the adverse shocks that affected the demand for
money throughout the year were unforeseeable. Particularly important was the uncertainty
caused by a markedly deteriorated international scenario, which led to a change in the
composition of the citizens' investment portfolio. The outflow of funds, with capital taking
shelter exclusively in US Treasury bonds, had a strong impact on emerging economies as a
whole. Latin America was no exception. In perspective, the portfolio investment capital flow
in Brazil, for instance, decreased by 75 percent against the previous year. In September and
October alone, Brazil showed an investment capital outflow of almost USD 10 billion. Against
this backdrop, virtually all central banks in the region had to actively intervene in the foreign
exchange market to reduce pressure on their exchange rates and prevent a feedback loop
from the plummeting on the domestic demand for money. Thus, the two largest economies in
the region have sold around USD 30 billion in the spot market. Meanwhile, medium-sized
economies, such as Peru, have sold almost USD 6 billion in order to stabilize their money
markets as from October. Moreover, most central banks in the region have supplemented
this generalized direct intervention with strong operations in derivatives markets, especially in
the form of swaps. This explains why the private sector demand for money was below our
calculations.
Given this new scenario, which I will thoroughly address in a few moments, one can see that
any action towards forcing the trend of this monetary aggregate to comply with expectations
but under very different international conditions would have been more detrimental than
beneficial for the economy as a whole. Finally, the wider aggregate in pesos (means of
payment plus time deposits, or M3) is expected to reach an annual growth rate of 14.7
percent by year-end.
In spite of persistent volatility in international markets, domestic demand for money has
recovered as from the second half of November. In fact, M2 grew by 1.4 percent throughout
November, whereas M3 increased by 0.9 percent.
Bank funding to enterprises and households continues to grow, although at a lower pace,
against a background of limited credit risk. Loans to the private sector in pesos were
expected to grow by about 25 percent in 2008, and account for 12 percent of GDP,
anticipating a considerable potential for growth in years to come. Consumer loans and credit
card financing show annual growth rates of around 35 percent, which places them among the
most dynamic lines. Funding to businesses is still increasing in all productive sectors. Loans
to trade, industry and services sectors grew above average, with a higher share in overall
funding. Policies implemented by the Central Bank to favor lending, combined with a
favorable macroeconomic framework, have taken household and corporate financing to
around 40 percent of total assets in 2008, almost 4 percentage points higher in y.o.y. terms.
This took place against a backdrop of a historically low nonperforming loan portfolio (2.8
percent of loans to the private sector). Nonperforming loans fell more than half a percentage
point during the past 12 months due to corporate sector financing.
The counterpart of the increase in funding to the private sector has been the trend of the
system exposure to the public sector, which dropped by 3.3 percentage points of assets in
2008. It has already accumulated a 27.5 percentage point drop since late 2004, and is now
14 percent below total assets. These figures - which represent a third of total loans to the
private sector - are in line with those for other countries in the region. Setting a general
ceiling of 35 percent of assets and a maximum limit based on financial institutions' capital
and for different jurisdiction, and unbiasing minimum capital requirements, among other
actions, allowed us to reverse the crowding-out of loans to businesses and households.
Furthermore, if we take both deposits and loans into account, the Government has now
become a net creditor of the banking system.
One of the main structural reforms of recent years has been the establishment of a
regulatory framework preventing currency mismatches (with peso-denominated assets and
liabilities and a lender of last resort that lends in pesos as well) and maintaining prudence
when introducing financial innovations. Only 12 percent of deposits are currently
denominated in foreign currency, and funding is limited to those who can prove repayment
capability in the same currency. Our system is not funded with foreign resources (these only
amount to 4 percent of liabilities): peso-denominated deposits are the main source of funds
for local banks in times when the international financial conditions prevent them from getting
resources through the capital markets. After growing at a 22 percent annual rate in the past
four years, private sector placements have come to account for 49 percent of the system's
funding.
In turn, rediscounts granted due to illiquidity during the 2001 crisis have virtually disappeared
from the banks' balance sheets (and they represent only 0.3 percent of financial system
liabilities). There remains only one institution, out of the 24 that had borrowed under these
conditions, that is repaying its liabilities. The accumulated amortization of court-ordered
payments to depositors derived from asymmetric pesification amounts to around 93 percent
of such orders, the outstanding balance representing 0.2 percent of total assets.
Even in a markedly deteriorated global economic and financial framework, our system enjoys
high liquidity and solvency, mainly because of prudential regulations. Cash equivalents
represent around 40 percent of total deposits. During 2008, banks' liquid assets (including
the LEBAC and NOBAC position) have increased over one percentage point of total assets.
As opposed to the trend in the developed world, institutions have virtually doubled their net
worth in the past five years. As a result of Central Bank action, short-term fluctuations in
asset prices did not impact on financial intermediation, and turbulences only affected banks'
balance sheets moderately. Thus, we are about to achieve four consecutive years of positive
systemic profitability. Profits from banking activity, together with new capital injections by
financial institutions, boosted a readjustment of solvency.
Finally, the system is backed by a strong Central Bank in terms of its capital. Current reserve
levels are historically high and cover over 65 percent of private M3 (vis-à-vis less than 40
percent before the 2001 crisis). These levels are also 10 percentage points higher than they
were by the end of 2004. The same happens if we consider the coverage ratio against
Central Bank liabilities. This strength facilitates the conditions to stabilize the demand for
money, one of the monetary policy priorities during the past few months, in order to minimize
the impact of shocks on domestic savings and credit.
3. The pillars of the monetary regime
The actions I have described so far are not about a change of policy - they are about
applying the strategy of the past few years under a different scenario. This is a
monetaryfinancial regime that factors in the idiosyncrasy of the Argentine citizen who, in the past two
decades, has faced hyperinflation and seizing of deposits twice, among other crises.
Therefore, we have chosen a policy approach that consists in the early adoption of prudential
and countercyclical measures to reduce the vulnerability of the economy in the face of a
changing scenario.
The risk management approach to monetary policy seeks to prevent disruptions in the
money and financial market from spreading to the rest of the economy and affecting
macroeconomic sustainability. Under this scheme, we take into account scenarios that
traditionally involve high likelihood of having adverse effects. This entails the development of
action guidelines in case such scenarios come true. At the same time, it entails preventive
action to reduce their likelihood or minimize their potential impact on the economy. In our
country, the strategy jells due to the consistency and validity of its three main pillars: (1) a
robust monetary policy that ensures the equilibrium between supply and demand in the
money market; (2) a countercyclical scheme to mitigate vulnerabilities and reduce
macroeconomic volatility; and (3) a managed float.
The trend evidenced by the means of payment in 2008 reflects our prudence. And so do
financial regulations, which aim to prevent the growth of credit from being hampered and
jeopardizing the sustainability of the system. This balanced trend of the means of payment
was observed against a framework of multicausal inflation that requires coordinated action by
the economic policy and its different areas - fiscal policy, wages policy, income policy and
monetary policy. In a context of international commodity prices falling, performance in 2008
confirms the effects of this joint action. Bearing in mind the stage that Argentine economy
currently undergoes and the instruments available, overemphasizing only one policy would
be a proof of short-sightedness. Especially in a phase where we are still lacking many tools
that are typical in more developed economies. For instance, monetary policy transmission
channels are only just being rebuilt, since credit to the private sector accounts for only 12
percent of the economy, still far below the Latin American average. There are many
examples in Argentine history of monetary regimes unsuccessfully shifting from one extreme
to the other given it inconsistencies. The relatively stable periods were short due to
contradictions in the programs that should have ensured macroeconomic solvency. Suffice it
to recall the end of price stability in the 1990s, after a sharp appreciation of the domestic
currency resulting from an exchange rate that was inconsistent with the fiscal position and
external equilibrium.
Among the preventive measures, the reserve accumulation and management policy acts as
an insurance against temporary changes in external financial conditions. This is a strategic
option - not only a by-product of the managed float, but a prudential policy in itself. Among
other advantages, such a policy ensures macroeconomic stability, enhances confidence in
the domestic currency, and reduces the impact of external shocks as well as the cost of
public and private financing. While this insurance policy is generally a less visible benefit, in
cases of stress recalling to it provides specific advantages in terms of financial and monetary
stability, as we could see in the recent critical episodes.
Finally, one more thing about the managed float. Since several studies outlined the
theoretical basis and macroeconomic implications of these kinds of regime three decades
ago, their use has been growing among emerging countries. Indeed, early research on
exchange rate management came into being as a result of the collapse of the international
monetary system devised at Bretton Woods, where a sort of peg was established between
the various world currencies and the US dollar as the gold standard currency.
Empirical work expanding and fine-tuning the analysis of many scholars showed that several
developed and emerging countries can be considered "managed floaters." Less than a half of
inflation targeting countries effectively apply a pure float. In this sense, the literature states
that the reaction functions of central banks in inflation targeting emerging countries have a
significant coefficient for the nominal exchange rate. This means that the exchange rate is an
important variable for monetary policy conduct.
There are several reasons to avoid sharp fluctuations in the domestic currency and to
mitigate excessive volatility, above all in developing countries with a limited capacity to
absorb external resources through their capital markets. By mitigating fluctuations around a
trend, this regime combines the needs of the various segments of the economy while
preserving consistency with the whole of economic policy. Recent literature in foreign
exchange matters factors in segmentation of and restricted access to financial markets into
the analysis. The most relevant conclusions suggest that, in terms of maximizing social
welfare, the best choice is a less flexible foreign exchange regime with more limited access
to hedge instruments. This argument becomes more convincing where there is nothing like
an international monetary system and a weakening economy in the country with the main
reserve currency in the world.
This is the most realistic conceptual framework for the current stage at which our economy
is. Furthermore, in our case - with a long tradition of pegs, high inflation, devaluation
processes, runs to the US dollar, and a shallow capital market - it is necessary to "manage"
the float as a transition towards a long-term stage.
In short, through the interaction of these three pillars, the Central Bank of Argentina boasts
the adequate tools to provide two essential public goods that have been lacking in stress
situations during the past 30 years. Through a set of robust policies to face various kinds of
shocks, we are, for the first time in decades, in a position to provide monetary and financial
stability to the Argentine people.
4. The international scenario
A year ago, when I presented the 2008 Monetary Program asserting that we would be facing
the worst crisis since the Great Depression, many thought I was exaggerating. At that time,
the economies were still growing at a historically high pace and commodity prices were
showing an upward trend. Even though many expected a deterioration of the international
scenario, few of us foresaw that the consequences would be as harsh as they have proven
to be in the past few months.
The outlook nowadays is quite ominous. Every economy in the world is growing at a lower
pace, and the main developed countries have fallen into a recession. Commodities reached
their ceiling by mid-2008 and then started to plunge. Even today, they are lower that they
were a year ago. The crisis affects both advanced and emerging countries, and is not
showing any signs of finding a floor in the short term.
Throughout this year, financial trouble persisted, with a marked deterioration as from
September. The international turmoil that was apparent since mid-2007 had initially been
diagnosed as a liquidity shortage. Therefore, the main authorities in the world addressed it by
essentially providing liquidity to the market. The threats to systemic stability, however, were
evidenced by key institutions going bankrupt, which led to significant drops in asset prices.
Growing concern over insolvency in various economic sectors has prompted action to rebuild
confidence in the global financial system and to curb the damage to the real economy.
The current situation in the United States, for instance, shows some features that are
characteristic of a scenario known in the economic literature as "liquidity trap," such as that of
the Japanese recession in the 1990s or the Great Depression. Recession and financial
stability are coupled with a new challenge: flow deflation, where decreasing prices cause
financial losses to enterprises and households by posing a relative increase in their liabilities.
Such a scenario - characterized by short-term interest rates close to 0 percent (bonds and
money being virtually perfect substitutes) and a low expansionary transmission of
movements from the money supply to the other monetary aggregates, with banks reluctant to
lend - is likely to spiraling up, pressuring on the Federal Reserve to a monetization of the
financing.
On the backup of growing risk aversion, we saw in 2008 a widespread deterioration of
financial assets in emerging markets. As in advanced economies, this was combined with a
strong tendency towards the depreciation of domestic currencies against the US dollar. Thus,
some countries had to increase their interest rates (for instance, Indonesia and Hungary) or
stop the cutting cycle (for instance, South Africa, Turkey, and most of Latin America).
The better scenario suggests that developed economies' activity would only start picking up
slowly by mid-2009. In the meantime, emerging economies will face a significant
deceleration, affected mainly through the trade channel (lower exports and international
prices of our commodities) and the financial channel (capital outflows and credit constrains).
This scenario is based on the assumption that the policies implemented will have their impact
towards mid-2009. We expect the global economy to grow between 1.6 and 0.9 percent next
year, which is far below our estimates of last year of 3.8 percent.
During the first part of the year, there was a widespread increase of inflation rates, affecting
both advanced and emerging economies. The sharp drop in commodity prices since its
peaks in July, together with economic deceleration, is nevertheless helping mitigate
pressures. Inflation in developing economies is also moderating, although more gradually,
due to persistent wage demands, the pass-through effect of recent devaluations, and still
high inflationary expectations.
Commodity prices fell after July as a result of the financialization process experienced by
these products. Yet, in the case of agricultural commodities, there are still certain structural
factors that might act as a support for prices, preventing them from falling to early 2000s'
levels.
Lower inflationary pressures and a weakening economy led to a monetary policy loosening in
industrialized countries as well as some emerging countries. The bailout and capitalization of
several financial institutions were supplemented by several fiscal stimulus packages ranging
from selective tax cuts to increased public spending in infrastructure and subsidized credit
lines for consumption. Central banks in the main economies responded via, among other
actions, strong liquidity injections and reference rate cutbacks, thus changing the previous
year's trend. These cutbacks entailed an abrupt return to record low interest rates. On the
other hand, many countries extended the scope and the amount of government deposit
guarantees, while some banking institutions were nationalized.
Against this backdrop, while advanced countries are having negative growth rates, emerging
economies are expected to continue on a positive trend, though inevitably lower than in
recent years.
Given the current framework and the growth dynamics of the global economy, it is
fundamental to minimize the worldwide effects of the crisis - not only for the benefit of
emerging countries, but also due to the urgent need for global growth. Let us not forget that,
between 2003 and 2007, developing countries accounted for 75 percent of world economic
growth (in purchasing-power-parity terms).
In line with action taken by the main economies, and given the deceleration of domestic
demand and the expected fall of exports, we emerging countries are also implementing
economic policies aimed at ensuring financial system stability and supporting domestic
expenditure. So far, most governments have launched fiscal stimulus plans and credit
facilities protecting productive sectors, to name a few, even though the adoption of new
policies is not ruled out in the short term.
5. Monetary policy in 2009
5.1. The domestic economic scenario: macroeconomic forecasts
The magnitude of the world economic crisis not only affects developed countries, but also
emerging economies. In particular, the 2009 Monetary Program was developed on the basis
of a still growing Gross Domestic Product, though considerably lower than that for the current
growth cycle. Therefore, after growing at an average 8.3 percent in the past six years, with
the economy expanding over 60 percent in cumulative terms since the end of the crisis,
growth would be around 4 percent, due in part to stimulus measures taken by the Executive
branch.
Considering that investment would grow at a similar pace to that of economic activity, it
would still represent around 24 percent of GDP. This indicator is in line with 2008 levels,
which were record high for the past 25 years. Investment will reportedly exceed capital
amortizations once again, thus expanding productive capacity. Furthermore, domestic
savings still plays a fundamental role in investment financing, reducing the exposure to
external flow volatility.
As I said before, there has recently been a readjustment in international prices of the main
export products that sets them more in line with its long term fundamentals. Financial
turbulences and markedly weaker oil prices exerted downward pressure on the price of the
main grains used in biofuel generation, which, in turn, reduced the costs of transport and
agricultural production. Simultaneously, there was an increased estimate for world production
and stock of the main grains, in a framework of a relatively unchanging demand. Despite the
sudden drop, however, commodity prices are still at high historical levels.
Due to dwindling international prices, combined with reduced harvest and other factors,
exports are projected to amount to USD 69 billion - a somewhat lower figure than that for
2008. Nevertheless, the trade surplus is expected to enable the current account balance to
remain positive for the seventh year running, an unprecedented event in recent Argentine
economic history.
In line with this macroeconomic scenario, prices are expected to grow at a lower pace. As we
have already discussed, inflation in Argentina can be attributed to several factors and, thus,
should be tackled from various fronts at once. In this sense, in the second half of 2008,
inflation was kept in check through the joint efforts by the fiscal, wage, income and monetary
policies, as well as the effect of lower international foodstuff and en