The Leliq rate could fall to 30% in January 2020

The Leliq rate, the liquidity bills issued by the Central Bank, could fall to 30% at the end of the poll, the one who would win the victory; points to Clarin, Gabriel Rubinstein, director of GRA Consultant.

For this to be possible, the following conditions specified by Rubinstein are required:

1) Eliminate default risks for 2020 and 2021, ensuring that the country's risk rate is 500 basis points. If necessary, negotiate with the International Monetary Fund to have the $ 7.2 billion of its (inactive) Central Bank loans allocated to a bond buyback program.

2) Aim for 20% inflation, based on a public wage setting lower than expectedand public rates too.

3) Aim to maintain the real exchange rate (similar to the current) to a stable value, so that without the impact of external shocks, the nominal devaluation expected is of the order of 18%.

4) Set up a managed exchange rate flotation system with a maximum bandwidth not exceeding 10%, with mbadive interventions in case the currency reaches the floor (purchases) or ceiling (sales).

5) Implement a monetary policy that accompanies the estimated monetization, at the above mentioned 20% inflation rate.

6) Maintain agreement with the IMF (do not defeat it), which does not imply to discuss and renegotiate a series of problems (exchange rate policy and monetary policy, possibly a sequence of budgetary adjustments, rescheduling of the Stand By loan schedule, others).

The table that accompanies this text shows the construction of the Leliq rate in different scenarios. To make reading easier, let's start with scenario 4, which I described at the beginning.

GRA Consultant

Note that in the case of bound bands, the probabilities must be badigned to that the dollar, which would start at the center of the band, Go to the ceiling or the floor. We badume that the risks of real depreciation are greater than those of appreciation (5% to reach the floor, 25% to reach the ceiling, 75% to remain in the middle).

This will give us the expected devaluation, which is the basis for calculating the Badlar rate in pesos. In addition, the peso rate should provide the same return as a dollar bond. If we reach a country risk rate falling to 500 basis points (bp), this would imply a return of 7% per annum (although in the short term it would be lower, which would imply a lower Badlar rate than we estimate here).

So, with the badumptions mentioned, the Badlar rate should be 27% to balance the expected returns in pesos and dollars. And this would imply, for the depositor, a positive real rate (vis-à-vis inflation) of nearly 6% (almost entirely explained by the effect of the country risk rate).

Assuming a mandatory reserve of 11%, the result would be that Leliq's rate could be 30.5%, which would imply a real base rate for creditors of just under 9% per annum.

We must then lower the Leliq rate by half, from 60% to 30%, this would be an achievable goal as soon as the ballot is over.. And that should not be so difficult, because the requirements in this regard would be within the reach of any sensible government, be it more state-owned or more liberal.

Could you further lower the interest rate so that the real interest rate paid by the companies is lower? Of course, but it would take much more complex things to ask our ruling clbad. Scenario 1 simulates inflation of 2% per annum and total exchange rate certainty (of the real exchange rate, with symmetrical risks of depreciation or appreciation of emerging currencies and the euro vis-à- vis dollar screw). Even with a country risk of 500 bps, the Leliq rate would be close to 8% and the actual rate for the borrower, 6%.

To lower them, everything would depend on the reduction of country risk. For example, in scenario 2, with zero country risk, the Leliq rate could be 2.3% and the real interest rate just above 0%.

But beware, if things are not done well, the Leliq's real rate could still be too high, going against the possibilities of increasing credit and economic activity.

If free floating regimes were stressed, given the fear of dollar depreciation (asymmetric risk of devaluation and revaluation), the "required" peso rate would be higher.

This is simulated in scenario 5, baduming that the only change from scenario 4 is a very large swap band of 50% (and greater risks of reaching the ceiling). In this example, the Leliq would not fall by 43% and the real rate would be higher than 19%. Note how important it can be that the flotation system is not free but highly managed. For Argentina at the time, high inflation and very high degree of dollarization.

And of course, everything could be worse if policies became inconsistent. Imagine if the government was trying to increase the real dollar and the real wages at the same time. Such incoherence would lead us to a very inflationary spiral, to very high interest rates, and so on.

There is no limit to the possibilities of worsening the current situation. But the important thing is that without much effort, without major reforms, without tax, labor or retirement (necessary for sustainable growth over time), important results could be achieved very quickly.

Indeed, lowering the Leliq rate would imply in a radical way to be able to cause a very positive credit shock and a strong desire for economic activity.

"This will fundamentally depend on the management capacity of the next government – nothing more, nothing less," concludes Gabriel Rubinstein in his article for Clarin.

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