Argentina’s ongoing policy Argentina’s ongoing policy challengeschallenges

Central Bank of Argentina

Alfonso Prat-GayGovernor

Lecture delivered at the London School of Economics, May 2004

The sunny side of the business cycle

Growth and Inflation(y.o.y. change)

-20

-15

-10

-5

0

5

10

15

20

QI-98 QI-99 QI-00 QI-01 QI-02 QI-03 QI-04*

%

-40

-30

-20

-10

0

10

20

30

40%

GDP

CPI (right axis)

* Calculated from a GDP growth 2,5% s.a. in the first quarter

And the right policy mixReal Interest Rate, Real Exchange Rate and Primary Surplus 2003-2004

(Real Exchange Rate % change and Real Interest Rate and Primary Surplus difference against 1994-2001 average)

3,9

-3,1

-49,2

-60

-50

-40

-30

-20

-10

0

10p.p.

Primary Surplus

Real Interest Rate (30-day CD)

Multilateral Real Exchange Rate

*

Fixed investment finally adding to the capital stock

Investment

10

12

14

16

18

20

22

I-95 IV-95 III-96 II-97 I-98 IV-98 III-99 II-00 I-01 IV-01 III-02 II-03

%

-50

-40

-30

-20

-10

0

10

20

30

40

50

60%

% of GDP

oya % change (right axis)

Human capital no longer falling

Unemployment and Poverty

10

15

20

25

30

35

40

45

50

55

60

May-88 May-90 May-92 May-94 May-96 May-98 May-00 May-02 H2-03

% of the population

32

33

34

35

36

37

38% of the LF

Poverty (Great Buenos Aires)

Employment (total urban; right axis)

Challenges for Monetary Policy

• Reputation: a poor track record

• Commercial banks: large counterparty

risk• Economic environment: shrinking

balance sheet and uncertain money demand

• Public sector: division of labor

• Central Bank: lack of× instruments× practice

TO TURN THE CENTRAL BANK INTO A CENTRAL BANK

History is not on our sideArgentine Inflation Histogram

7

17

10

1

13

64

41

0

5

10

15

20

25

30

35

40

45

< 0 0-5 5-10 10-15 15-20 20-25 25-30 > 30Annual Inflation, %

Relative Frequency, %

Main sources of money creation*(y-o-y change, annualized rate)

-20

-10

0

10

20

30

40

50

60

70

Government Financial Sector BCRA securities External Sector Broad Monetary

Base

%

2002

2003 and 2004

The aftershocks of the crisis

2003 and 2004

* Contribution by source of money creation

Developing the spot FX market

Central Bank daily purchases of foreign currency

0

20

40

60

80

100

120

140

160

180

200

Ene-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Ene-04 Mar-04 May-04

million US$

Central Bank intervention

Traded volume by third parties (20-day mov.average)

Creating a benchmark interest rateBCRA Securities in Pesos

0

50

100

150

200

250

300

Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04

days

0

20

40

60

80

100

120

140%

Average duration

Average cost (right axis)

Paving the way to a formal Inflation Targeting regime

Broad Monetary Base

35

40

45

50

55

60

Jun-03 Aug-03 Oct-03 Dec-03 Feb-04 Apr-04 Jun-04 Aug-04 Oct-04 Dec-04

billion of $

Observed

Observed - 30 days moving average

Monetary Program range 2003 (end of month)

Monetary Programa range 2004 (average)

Nearly there but not quite

CPI(y.o.y. change)

0

10

20

30

40

2003 2004 2005 2006

%

2003 Monetary Program

IMF targets

R.E.M. 2005

R.E.M. 2004

Inflation (last 12 months)

15

11

877

545

2004 Budget

23%

10,5%

2003 Budget

Challenges for Banking Policy

• Lack of resources

• Risk aversion and asymmetric

information• Balance-sheet mismatches

• Outdated rules

• Banks lack× instruments× practice

TO GUIDE BANKS TO FIX THEMSELVES

• Sovereign debt restructuring

Too many constraints, too few resources

Country Crisis

Deposits

real change (1)

NW real

change (2)

Fiscal Contribution (% of GDP)

IMF net

disbursements

(mill. US$)

Mexico '94 - '95 -15% -64% 19,3% 10.670

Venezuela '94 - '95 -43% -6% 15,0% -657

Korea '97 - '00 -6% 15% 31,2% 6.069

Indonesia '97 - '00 -13% -183% 56,8% 10.348

Thailand '97 - '00 -2% 58% 43,8% 3.212

Ecuador '98 - '01 -24% -59% 21,7% 298

Turkey '00 -'02 -27% 97% 30,5% 13.419

Simple average -19% -20% 31% 6.194

Argentina '81 - '82 -36% -9% 55% s.d

Argentina '02 - '03 -41,8% -37% 11,4% -930

(1) between the beginning of the crisis and the deposits trough

(2) Net Worth, two year after the crisis

-US$6.5 billion

including cash-flow

with IFI

approx. US$50 billion

including US Treasury

funds

Dealing with the past...

Foreign currency mismatch before crisis

(December 2001)

31%

37%

32%

0

10

20

30

40

50

60

70

80

90

Assets

billion $

Public goods sector

dollars

Private goods sector

dollars

Tradable goods sector

dollars

Non-tradable

sector

Liabilities and Net Worth

Liabilities in

dollars

…but focused on the future

Credit risk requirements / Weighted assets (weighted assets according to BCRA - including Public Sector)

3

4

5

6

7

8

9

10

11

1997 1998 1999 2000 2001 2003 Today 2005 2006 2007 2008

%

BCRA

Basel

Growth: progressive, reaching an assets portfolio / GDP ratio of 20% in 2008

Easy go, easy come

Private Sector Loans and Deposits(y-o-y change)

-40

-20

0

20

40

60

80

Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04

%

Loans

Deposits

Banks are back in black

Consolidated earnings

-8,9

-4,0

-5,0

-1,9

0,3

-10

-8

-6

-4

-2

0

2

2002 I. 03 II. 03 III. 03 IV. 03

ROA

Banking business: upside much greater than downside

Loans to Private Sector

25

40

55

70

85

100

Ene-98 Sep-98 May-99 Ene-00 Sep-00 May-01 Ene-02 Sep-02 May-03 Ene-04

ARS billion

Dec-98:

23% of GDP

Apr-04

7% of GDP

Change needed to

reach 23% of GDP:

200%

Apr-04

23% of GDP

Banks can now deploy AR$12.5 for every AR$1 of capital, to EVERY borrower, regardless of its nature.

Capital Change

Loans to: Formerly Now %

Public Sector $ 1,0 $ 25,0 $ 12,5 -50%

Large Firms $ 1,0 $ 8,7 $ 12,5 44%

SMEs $ 1,0 $ 7,0 $ 12,5 79%

Individuals $ 1,0 $ 5,0 $ 12,5 150%

Maximum Financing

No borrower discrimination

Banks need to lend to the private sector; they are free to do so now

The glass is half fullLoans to private sector in pesos

Excluding mortgages and pledge-backed loans

14,5

15,0

15,5

16,0

16,5

17,0

17,5

18,0

18,5

Ene-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Ene-04 Mar-04 May-04

billion $

15

20

25

30

35

40

45

50

55

60

%

Loans stock (excluding mortgages and pledge-backed loans)

Overdrafts interest rate (right axis)

Personal loans interest rate (right axis)

14,8

18,1