Argentina is facing an economic crisis and the central bank has hiked interest rates three times in a span of eight days. On May 4, the interest rate was hiked to 40% from 33.25%, a day after it was raised from 30.25%, which shows an abnormal increase on any economic parameter. The situation has arrived as peso has reached a record low of 25 against the dollar (9% decrease). To make up for this downfall in the first week of May the central bank of Argentina has spent $3 billion on stabilizing its currency (Read: ETFs in Focus on Growth Forecasts for Latin America).
Financial Institutions Observing the Movement
Seemingly, IMF is irked by this policy of the Argentinean government as it does not make sense to it. The institution is not sure whether in case of another depression, IMF should come forward or not. In 2001, when the institution failed to rescue the country, Argentina went into a sovereign debt default. So, this time, Argentinean president Mauricio Macri has indicated that he would like a flexible credit line which is risky and political in nature. The country has a history of hyperinflation, bank deposit confiscation which has reduced the importance of the currency.
Credit Suisse Argentina strategist has observed that this step has basically given two signals. Clearly, the government is willing to use all instruments that are available like interest rate and FX interventions. Secondly with this kind of drastic measures it can crumble the market in the short to medium term. Indonesia, which had a similar story in February and March, used $126 billion to reduce the weakening rupiah. But the move with rate hikes did not stabilize the market. Brazil continued with currency swaps from 2013 to 2015 but failed to stabilize the rial.
So globally it is a proven fact that this measure of increasing the interest rates does not work but the president has asked for a $30 billion credit line. Protests are on as previously the tough conditions imposed by IMF resulted in a large number of job losses. Investors have also been selling off the 100 year peso bond.
Why the Crisis in Argentina Matters
In 2015, Argentina’s external debt was $178.9 billion (20.9% of GDP) and was expected to rise to 38.8% by the end of FY18. The speculation that the Federal Reserve might increase rates 3 times in 2018 on account of inflation within the 2% mark has been closely observed in the market. The benchmark 10-year US Treasury yield was performing steadily and on May 14 stood at 2.9% in the Asian market. The current account deficit of Argentina has widened to $30.792 billion in 2017 which has increased from $14.693 billion in 2016.
In Argentina, the average annual inflation has been around 20% for the past three years. Subsidies, price control and other populist measures to win people’s confidence have finally put the Argentinean economy in trouble. The government of Argentina also did not publish clear statistics to avoid deeper scrutiny and settled with some of the creditors for reducing budget deficit.
Investors are now confused about the performance of the emerging markets which was their preferred investment domain sometime back. Not only Argentina, countries like Thailand, Turkey and Indonesia have been rocked by the sudden depreciation of the currency and none of these have been able to stabilize in spite of taking multiple measures. In Argentina, inflation is getting out of hand and there is a sudden trigger of money outflow on account of selling bonds from the country (read: Are EM ETFs the New Definition of Developed Market Investing?).
In the present world, every single crisis has some repercussion in the neighboring countries dampens investor confidence globally. The emerging markets now will be more scrutinized than ever before as the boom period is expected to be over. Bail-out is not an easy option for Argentina as most agencies like World Bank and IMF have observed economic mismanagement on the part of the government which has given rise to this situation. Presently, there is growing suspicion that that whatever is happening in Argentina could happen to other countries also. In 2017, $1.2 trillion was invested in 25 emerging countries as per reports published by the Institute of International Finance. So the risk is if these inflows subsequently reduce, most of these countries will have to increase their interest rates for defending their currencies and avoid devaluation.
ETFs in trouble
Let us talk about two ETFs in the volatile Argentina market.
Global X MSCI Argentina ETF (ARGT - Free Report)
The ETF seeks to provide investment results of the FTSE Argentina 20 Index. It has an expense ratio of 0.59%.The fund has $165.7 million of assets under its control and has a daily trading volume of 108,110. It has 25 holdings and MercadoLibre Inc (22.3%), Tenaris SA (12.9%) and Grupo Financiero Galicia SA (10.7%) are the top three stocks in the fund. In this ETF, the top three sectors include Information Technology (25.7%), Financials (23.8%), Energy (21.9%). The fund lost 12.4% over the past one-month and has Zacks ETF Rank #5 (Strong Sell) (read: What Lies Ahead for Argentina ETFs?).
iShares MSCI Argentina and Global Exposure ETF (AGT - Free Report)
The ETF seeks to track the investment results of a broad-based index with exposure to MSCI All Argentina 25-50 Index. The expense ratio of the fund is 0.59% and daily volume of trade is 32,000. The fund consists of 25 stocks with Mercadolibre Inc (21.8%), Tenaris SA (16.4%) and Grupo Financiero Galicia Adr Reptg (8.8%) being the top three stocks. Assets under management of this ETF are $55.6 million. In terms of sector holdings, Information Technology (25.6%), Energy (25.3%) and Financials (18.8%) control the largest stakes. Also, on the basis of geographical location, this fund has exposure in Argentina (47%), United States (21.8%) and Italy (16.4%). AGT has lost 12.4% in a month and has a Zacks ETF Rank #4 (Sell).
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