3Q18 July 2018 Key messages Global growth continues, but risks are - - PowerPoint PPT Presentation

BBVA Research – Argentina Economic Outlook 3Q18 / 1

Argentina Economic Outlook 3Q18

July 2018

Key messages

Global growth continues, but risks are intensifying. due to the possibility of a trade war and the tightening of global financing conditions The lack of access to external credit thwarted the gradualist strategy of the Argentinian government and to avoid a disorderly adjustment, a Stand-By agreement was negotiated with the IMF, subject to compliance of stricter fiscal targets and a commitment to reinforce the independence of the Central Bank of Argentina The economy will contract in 2Q and 3Q18, due to the impact of the drought and the exchange rate crisis, before beginning to recover in the last quarter. After a very good 1Q, GDP will grow 0.5% in 2018 and 1.5% in 2019. Inflation will accelerate in 2018 to 29.6% YoY and 20% in 2019 due to the impact of currency depreciation, the increase in the price of oil and hike in utilities’ rates. The new targets agreed with the IMF are more relaxed but could be exceeded if pass-through from the devaluation is not contained Monetary policy was tightened substantially to moderate the volatility of the exchange rate and the acceleration of

• inflation. The drop in rates will be very gradual and more volatile following the decision to complement the

monetary policy rate scheme with the monitoring of monetary aggregates. The fiscal target commitments made with the IMF for 2018 can be achieved with comfort but in the medium term they involve an adjustment of the accumulated primary expenditure of 3.7 pp of GDP in 3 years and their achievement will require political agreements with the opposition to be reflected in the 2019 Budget The adjustment of the external sector deficit will be slow, amounting to 0.8% of GDP between 2017-19, mainly based on the reduction of imports, and particularly of services such as tourism, since increasing the dynamism of exports requires not only a depreciated but also a stable real exchange rate.

BBVA Research – Argentina Economic Outlook 3Q18 / 3

Contents

01

Global environment: global growth continues, but risks are intensifying

02

Argentina: The abrupt end of the gradualist dream

BBVA Research – Argentina Economic Outlook 3Q18 / 4

01

Global environment: global growth is continuing, but risks are intensifying

BBVA Research – Argentina Economic Outlook 3Q18 / 5

Global growth continues, but risks are intensifying

The pace of global expansion is being maintained, but is less synchronised Growth is robust in the US due to the fiscal stimulus and stable in China, but is declining in Europe

01

Increased protectionism For now, its impact on growth is limited, but it could be greater if the measures under discussion were to be implemented

02

Increase in the price of oil Higher inflation and drag on growth in oil-importing countries

03

Different pace of monetary normalisation in Europe and the United States Strengthening of the dollar and tightening of global financial conditions

04

More volatility in emerging markets Increased financial tensions due to increased financing costs and protectionist threats

05

Global risks are intensifying The possibility of a trade war comes together with greater risks in emerging economies and in Europe

06

BBVA Research – Argentina Economic Outlook 3Q18 / 6

Stable growth in the US, but a slowdown in other areas

Source: BBVA Research 2018

2.8

2019

2.8

USA

2018

2.6

2019

2.0

Mexico

2018

0.9

2019

2.1

South America

2018

2.0

2019

1.7

Euro zone

2018

6.3

2019

6.0

China

Down Up Unchanged

2018

3.8

2019

3.8

World

BBVA Research – Argentina Economic Outlook 3Q18 / 7

Limited effect of approved tariff increases, but significant if those being discussed are implemented

The tariff increases approved by the US would have a limited direct

• impact. Indirect effects, via

economic confidence and financial channel, could be felt in 2H18 With a protectionist escalation, the negative effect on growth would also be significant in the US. The effect, smaller in Europe, would differ by country and would, above all, affect Germany and the countries in Eastern Europe The growth of global GDP could be reduced by around 0.2 pp through the trade channel alone Effect on GDP growth of US tariff increases and the response by other countries

(2018-19, pp)

Measures announced: tariff increase to 25% on steel, 10% on aluminium and 25% on Chinese imports for a value of US$50 billion Measures under discussion: tariff increases up to 20% on cars and Chinese imports for a value of US$200 billion Source: BBVA Research

• 0.45
• 0.40
• 0.35
• 0.30
• 0.25
• 0.20
• 0.15
• 0.10
• 0.05

0.00 Current measures Measures under discussion World US China Eurozone

BBVA Research – Argentina Economic Outlook 3Q18 / 8

Brent Crude

(US$ per barrel)

Source: BBVA Research and Bloomberg

Deterioration of the terms of trade: rise in oil price due to geopolitical factors and fall in soybean prices due to trade war

Soybeans

(US$ per metric ton)

Copper

(US$ per lb.)

The increase in the price of oil stems from a reduction in

• supply. The price will remain relatively stable in 2018 and
• 2019. It will begin to flex downwards as export capacity

recovers in the US and demand stabilises. Strong correction of the price of soybeans due to a good harvest in the US and the incipient trade war. China’s retaliation with tariffs on US soybeans places downward pressures on the price in CBOT but not on Argentina-Brazil prices. Greater weakening

• f China’s economy would affect global commodity prices

30 40 50 60 70 80 90 100 110 120 I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III 2014 2015 2016 2017 2018 2019 2020 Jul-18 Apr-18 300 350 400 450 500 550 I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III 2014 2015 2016 2017 2018 2019 2020 Jul-18 Apr-18 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III 2014 2015 2016 2017 2018 2019 2020 Jul-18 Apr-18

BBVA Research – Argentina Economic Outlook 3Q18 / 9

Protectionism and political factors lead to a growing risk aversion

Investor sentiment has shifted from risk-taking mode (and even a certain complacency) to one of risk aversion The change is causing a rotation of flows between assets: from emerging markets to developed

• nes, and from equities to bonds

Trade tensions could lead to an environment of flight to quality Risk appetite/aversion indicator

Source: BBVA Research

• 1.5
• 1.0
• 0.5

0.0 0.5 1.0 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Average since 2014 (maximum & minimum)

"Preference for risk" "Risk aversion"

BBVA Research – Argentina Economic Outlook 3Q18 / 10

The strength of the US dollar and higher interest rates are causing an adjustment in emerging markets

The most vulnerable countries are those with the greatest trade deficits and the greatest need

• f external financing

Shift towards a tightening of monetary policy in emerging countries (except China) to avoid further depreciation of their currencies The increase in financial tensions also reflects the intensification of the trade dispute EUR-USD exchange rate and BBVA index of financial tensions in emerging markets

Source: BBVA Research based on Bloomberg

1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40

• 2.0
• 1.5
• 1.0
• 0.5

0.0 0.5 1.0 1.5 2.0 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Financial stress in emerging markets EURUSD (RHS, inverted)

BBVA Research – Argentina Economic Outlook 3Q18 / 11

In Brazil, growth forecasts have been revised downwards, estimating a slower recovery than was expected

Despite the reduced optimism, growth will continue to recover, supported by a relatively solid global demand, the performance of the agricultural sector, the expansive tone of monetary policy and the adjustments made in previous years Growth could slow if there is no progress in resolving fiscal problems, especially if global risk aversion increases

2017 2019 2018

2.4%

(now)

2.1%

(before)

1.6%

(now)

3.0%

(before)

1.0%

Source: : BBVA Research

BBVA Research – Argentina Economic Outlook 3Q18 / 12

The Brazilian real will remain at more depreciated levels than those observed until a few months ago, generating greater inflationary pressures

Exchange rate

(R$/US$)

Source: : BBVA Research

3,1 3,2 3,3 3,4 3,5 3,6 3,7 2016 2017 2018 (p) 2019 (p) Previsiones actuales Previsiones anteriores (abril 2018)

Inflation: IPCA

(in %, end of period)

Source: BBVA Research

1 2 3 4 5 6 7 2016 2017 2018 (p) 2019 (p) Previsiones actuales Previsiones anteriores (abril 2018)

Little margin for the Brazilian real to appreciate in the short term; volatility will remain high at least until the October

• elections. Less uncertainty after the elections and possible positive signals from the new government on the fiscal issue

should allow some appreciation of the Brazilian real towards the end of the year. Inflation on the upside due to the greater depreciation and an increase in the price of oil, in addition to the shortage caused by the truckers’ strike. The BCB will maintain the rate at 6.50% until inflationary pressures force it to tighten monetary policy.

BBVA Research – Argentina Economic Outlook 3Q18 / 13

03

Argentina: The abrupt end of the gradualist dream...

BBVA Research – Argentina Economic Outlook 3Q18 / 14

The failure of the gradualist strategy led to the implementation of Plan B

The increased cost of international financing led to a devaluation of the peso, which by mid-May had weakened by 32% despite a sharp loss of reserves due to Central Bank intervention The lack of credibility of the Central Bank of Argentina to stem the run on the currency and capital flight led to the request for IMF assistance to achieve an

• rderly adjustment process without

crowding out the private sector A Stand-By Arrangement of US$50.5 billion over 3 years was signed in mid- June subject to compliance with stricter fiscal targets, international reserve targets and reforms to reinforce the independence of the Central Bank. IMF Stand-By Arrangement Disbursement Schedule

(Millions of dollars)

Source: : BBVA Research, IMF

Each disbursement is made after the revision of primary fiscal deficit criteria and monetary targets of the immediately preceding quarter 15,000 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,917 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 20/Jun/18 15/Sep/18 15/Dic/18 15/Mar-18 15/Jun/19 15/Sep/19 15/Dic/19 15/Mar-19 15/Jun/20 15/Sep/20 15/Dic/20 15/Mar-20 15/Jun/21

BBVA Research – Argentina Economic Outlook 3Q18 / 15

GDP and private consumption

(% change QoQ, seasonally adjusted)

Source: BBVA Research, INDEC

The economy will grow by only 0.5% in 2018 due to the impact of the drought and the currency crisis, but growth will recover to 1.5% in 2019

Activity will begin to recover in 4Q18 thanks to good prospects for agriculture, after contracting in 2Q and 3Q. In 2019 the economy will maintain an expansion rate of around 0.8% QoQ, but due to the negative drag of 2018 it will grow by only1.5% on average The impact of the Fx crisis will be reflected in private consumption due to a fall in real income and public consumption due to fiscal adjustment. Unemployment, after falling back in 2017, is likely to increase as a result of lower economic activity if the labour force participation rate does not fall significantly

Labour force, employment and unemployment rates

(% of urban population and % of working population)

Source: BBVA Research, INDEC

• 3%
• 2%
• 1%

0% 1% 2% 3% 1Q2018 2Q2018 3Q2018 4Q2018 1Q2019 2Q2019 3Q2019 4Q2019 GDP Private Comsumption

8.4% 8.9% 8.6% 7.9% 7.4% 7.6% 7.8% 8.0% 8.2% 8.4% 8.6% 8.8% 9.0% 35% 37% 39% 41% 43% 45% 2017 2018 2019 2020 Labour force participation rate (left) Employment rate (left) Unemployment rate (right)

BBVA Research – Argentina Economic Outlook 3Q18 / 16

IMF targets and inflation estimates

(% YoY)

Source: BBVA Research and Central Bank of Argentina

The impact of the devaluation is accounted for in looser inflation targets but they could be overshot again...

The inflation targets were reduced to 27% y/y (2018) and 17% (2019) but it will be necessary to consult the IMF board if inflation exceeds 32% and 21% respectively. The stabilisation of the exchange rate and a relatively contained pass-through are key for inflation to fall to 29.6% YoY at eop 2018 and 20.8% YoY in 2019 Additional inflationary pressures could come from the increase in energy prices given the strong depreciation of the peso and the increase in the international price of oil and potential renegotiation of wage agreements

International price of oil and local price

• f petrol (gasoline) in dollars

(US$)

Source: BBVA Research, Haver and Confederation of Hydrocarbon and Related Trade Entities of the Argentine Republic

20 40 60 80 100 120 140 160 180 200 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 WTI Gasoline 0% 5% 10% 15% 20% 25% 30% 35% Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb-19 Apr-19 Jun-19 Aug-19 Oct-19 Dec-19 External Boundary Central Range CPI BBVA(e) CB Expectations Survey

BBVA Research – Argentina Economic Outlook 3Q18 / 17

Monetary Policy Rate, Lebac secondary market and expected inflation

(%)

Source: BBVA Research and Central Bank of Argentina

The strong tightening of monetary policy to combat exchange rate volatility will continue in the short term

The Central Bank set the MPR at 40% at the beginning of the crisis and we expect a slow decline in 4Q18 as inflation converges to lower levels. The Lebac rate is higher than the MPR and shows more volatility due to the commitment with the IMF to reduce the stock of CB bills while restricting liquidity in order to avoid impact on the exchange rate The Central Bank of Argentina announced that it would complement the interest rate based inflation targeting scheme with a stronger focus on following monetary aggregates. The trajectory of M2 and the wider liabilities of the CB already reflect the increased monetary tightening

Monetary Base, Central bank liabilities and M2

(Change % YoY)

Source: BBVA Research and Central Bank of Argentina

10% 20% 30% 40% 50% 60% 70% Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Total Central Bank liabilities Monetary Base Private M2 10 20 30 40 50 60 Central Bank policy rate Lebac secondary market Inflation expectations for 2018 Nov-17 eop Jan-18 eop Mar-18 eop June 18 eop 07/10/2018

BBVA Research – Argentina Economic Outlook 3Q18 / 18

Fiscal adjustment at a faster pace will require political agreements to reach the targets agreed with the IMF in 2019

The revised target of 2.7% of GDP for 2018 can possibly be overachieved since in the 1st half of 2018, the primary deficit fell to 0.8% of GDP Our forecast of total deficit after interest remains at 5.3% of GDP due to the fact that the improvement of the primary deficit will be neutralised by higher interest charges on dollarized debt. The reduction of the primary deficit by 1.3%

• f GDP committed to for 2019 will require

continued adjustments in primary spending since no increases in tax pressure are contemplated Pensions and social benefits will continue to increase slightly, but a reduction of energy and transport subsidies is expected. Additional cuts in capital spending, in the public sector wage bill and transfers to provinces that will require negotiations with the opposition

IMF agreement, income and primary expenditure variation targets

(% of GDP)

Source: BBVA Research and Treasury

2018 2019 2020 Acum. Total income

• 0,4

0,4 0,1 0,1 Primary expenditures

• 1,5
• 1,1
• 1,1
• 3,7

Pensions & Social benefits 0,1 0,5

• 0,2

0,4 Energy & transport subsidies

• 0,3
• 0,4
• 0,4
• 1,1

Salaries, goods and services

• 0,4
• 0,2
• 0,1
• 0,7

Transfers to provinces

• 0,2
• 0,3
• 0,1
• 0,6

Other expenditures 0,0

• 0,1
• 0,1

Capital expenditures

• 0,7
• 0,6
• 0,3
• 1,6

BBVA Research – Argentina Economic Outlook 3Q18 / 19

Argentina will avoid accessing international markets in the remainder

• f 2018 and 2019

The official financial programme for 2019 envisages the issuance of US$8 billion in net terms, to be placed in the domestic market. Most of the deficit will be covered by the disbursements from the IMF and the Multilateral Credit Agency. The programme assumes the renewal

• f the maturing debt including Letes in

dollars (about USD 18 billion in 2018). The gradual replacement of Lebac by Treasury debt agreed on with the IMF, in addition to the objective of replacing Letes with longer-term bonds could add some volatility to the markets during the year.

Official Financial Programme

(USD billions)

Assumptions: Excludes Letes and assumes full renewal of maturities in 2018 and 2019. Gross financial needs of 2019 will be financed in the domestic market.

Source: BBVA Research and Treasury

Jul-Dec 2018 2019

Financial needs 19,6 32,3 Primary deficit 8,4 7,4 Interest payments (private sector) 6,0 14,0 Principal payments (private sector) 5,2 10,9 International bonds 0,3 2,8 Repo 3,9 3,2 Domestic bonds 1,0 5,0 Sources of financing 19,6 32,3 International markets (gross) 0,0 3,0 Repo 0,0 4,0 IFIs 16,4 13,0 IMF 13,4 11,7 Other 3,0 1,3 Domestic markets (gross) 3,2 12,3 Intra public sector 0,0 0,0 Net financing from markets 8,0 GDP (%) 0,4 1,4 Exchange rate (28/Jun/18) 27,81 27,81

BBVA Research – Argentina Economic Outlook 3Q18 / 20

Multilateral Real Exchange Rate and IMF bands

(Index Base 2015:11=1)

Source: BBVA Research and Central Bank of Argentina

The adjustment of the external sector requires a depreciated and stable real exchange rate

The adjustment in the current account will be slow: 0.2 pp in 2018 and 0.6 pp in 2019 due to the drought. The real depreciation of the peso of 25% in 2018, if pass-through remains contained, will reduce the imports of goods but above all of services, with a strong adjustment in tourism Reduced portfolio dollarization, together with the reduction of the current account deficit, will allow the level of net reserves to recover by around US$5.5 million in 2H18, as agreed with the IMF.

Exchange market Balance 2018: main items

(Millions of dollars)

Source: BBVA Research and Central Bank of Argentina

• 11,000
• 6,000
• 1,000

4,000 9,000 14,000 19,000 Trade balance Tourism and Real Services Interests & dividends Direct & portfolio investment Portfolio dollarization Public Sector Other net movements Current account Capital account IQ-18 IIQ-18e IIIQ-18e IVQ-18e 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Aug-18 Dec-18 Apr-19 Aug-19 Dec-19 Multilateral real FX index IMF Lower band IMF Upper Band 1,47 1,29

BBVA Research – Argentina Economic Outlook 3Q18 / 21

The potential of Argentina as an FDI destination not only depends on its endowment of natural resources and the size

• f its market, but legal and institutional stability is also a key

variable when determining the attractiveness of an economy for long-term investors.

Argentina could reduce its external vulnerability with more FDI but this requires avoiding frequent changes in the ground rules

Comparative ranking: receipt of FDI, attractive potential and extended potential appeal (2010-2017)

Total countries: 189

Source: BBVA Research, World Bank, IMF, Heritage Foundation

Focus on day to day emergencies, along with the political cost of rebalancing the economy towards greater savings could generate setbacks in the progress of structural reforms and the improvement of institutional quality

Country Actual FDI received Potential for FDI attraction Potential FDI attraction including Institutional Variable

Brazil 19 46 58 Colombia 25 77 57 China 27 5 39 Spain 37 27 30 Mexico 41 23 28 Czech Republic 46 12 11 Uruguay 52 71 52 India 61 21 47 Turkey 79 2 5 Argentina 86 33 60 Egypt 89 43 61

BBVA Research – Argentina Economic Outlook 3Q18 / 22

Annual macroeconomic forecasts

2016 2017 2018 (f) 2019 (f)

GDP, INDEC base 2004 (% y/y)

• 1,8

2,9 0,5 1,5 Inflation, National CPI (% y/y, eop) 39,4 24,8 29,6 20,8 Exchange rate (vs. USD, eop) 15,8 17,7 28,9 32,9 Policy rate (%, eop) 24,8 28,8 32,0 21,0 Private consumption (% y/y)

• 1,0

3,5 0,5 0,1 Government consumption (% y/y) 0,3 2,2

• 1,1
• 0,1

Invertment (% a/a)

• 4,9

11,0 6,4 0,3 Fiscal balance (% GDP)

• 5,8
• 6,0
• 5,3
• 4,0

Current account (% GDP)

• 2,7
• 4,9
• 4,7
• 4,1

(f) Forecast. Source: BBVA Research