Currency Forecast - ARS: Real Rates A Source Of Strength - SEPT 2017

BMI Argentina Currency Forecasts
Spot 2017 2018
Last updated July 18 2017; Source: Bloomberg, BMI
ARS/USD, ave 17.03 16.26 16.73
ARS/EUR, ave 19.74 17.89 18.07
Policy Rate, % eop 26.25 23.25 10.50

BMI View : We are neutral on the Argentine peso over the short term . Over the long term, a robust growth outlook and rising real rates will drive outperformance in total return terms .

Short-Term Outlook (three-to-six months)

We are broadly neutral on the Argentine peso over the short-term. We believe the unit will pare back some of its losses following an event-driven sell-off ( see ' ARS Sell-Off Unlikely To Extend Much Further ' , July 7), although some spot depreciation is likely. Daily momentum indicators suggest the unit is overstretched and its fundamentals are improving. Real interest rates are rising, as inflation falls while the Banco Central de la Republica Argentina (BCRA) maintains elevated interest rates. Additionally, Argentina's terms of trade are improving, as prices of soybean exports are surging while oil import prices remain constrained.

Floor Likely Found
Argentina - Exchange Rate, ARS/USD
Source: Bloomberg, BMI

Nonetheless, we do not expect substantial upside in the near term, in large part because Banco Central de la Republica Argentina (BCRA) policy will favour a weaker currency. In April, the bank declared its intention to increase the pace of reserve accumulation, which would remove dollars from the local market. Over recent days, policymakers have since voiced approval of the unit's recent selloff, which supports the government's fiscal consolidation efforts and bolsters exports ( see 'ARS Sell-Off Unlikely To Extend Much Further', July 7).

We have downwardly revised our Argentine peso forecasts in light of the unit's lower trading range. We now see the currency ending 2017 at ARS17.12/USD, from ARS16.35/USD previously, with an annual average of ARS16.26/USD, from ARS15.82/USD.

Long-Term Outlook (six-to-24 months)

While we have similarly downgraded our forecasts for 2018, we remain positive on the unit over the long term, particularly on a total returns basis. We project the peso to average ARS16.73/USD, but finish the year stronger at ARS16.21/USD and rise in the quarters beyond.

Our view is based on robust economic activity growth, rapidly decelerating inflation and the resultant attractive real interest rates, which will support robust capital inflows ( see ' Growth Will Accelerate In H217 ' , May 31). We expect real GDP growth of 3.2% in 2018, while we project inflation will fall from 21.7% y-o-y in June 2017 to 7.7% by end-2018, within the BCRA's target band.

We expect the October 2017 municipal elections to bolster the President Macri's ruling coalition, supporting economic reforms and lowering the risk premium on Argentine assets ( see ' Cambiemos Will Benefit From Stronger Economy ' , June 1). With a reaffirmed mandate, the government will continue to narrow the fiscal deficit and bolster its sovereign credentials. Additionally, this will likely ensure that MSCI upgrades Argentina's market classification when it is due for review in June 2018, which will open up Argentine assets to significant foreign capital.

Weakness A Boost To Competitiveness
Argentina - CPI-Based Real Effective Exchange Rate
Source: JPMorgan, Bloomberg, BMI

That said, our expectations for upside are limited by the peso's valuation. At current levels, the peso is slightly above its 10-year average real effective exchange rate, which suggests that appreciation could render the unit comparatively expensive.

Risk To Outlook

Risks to our view are weighted to the downside. A poorer than expected performance in the October elections by President Macri's coalition could lower Argentina's growth outlook, lift the risk premium on its assets, or result in higher than anticipated inflation, which would imply weaker real interest rates over the coming quarters and undermine capital inflows.