The foreign exchange market in the spotlight. Transition to unification

The current exchange rate regime does not meet any of its possible objectives. It does not buffer external shocks, it does not promote local production or competitiveness, and it is definitely not helping to curb inflation or improve income distribution. It is also clearly unsustainable, given the ongoing loss of international reserves by the Central Bank (BCRA). A reform is imperative. Argentina should transition towards a unified exchange market that would eliminate the existing incentives, which preclude any growth or disinflation process. This transition is by no means simple. Immediate unification may result in a significant rise in the exchange rate and unleash a very dangerous inflationary spiral.

Even in the current economic climate, there is plenty of room for action. How can we move towards unification? This paper proposes the use of a temporary dual exchange rate to moderate the initial jump in the exchange rate and its inflationary effects, while also allowing for the accumulation of international reserves to prepare for the definitive unification regime. We have evaluated this option and compared it against unification compensated by an increase in export duties withholdings, and analyzed the considerations to be taken into account in making this choice.

What is behind the dollar exchange rate

The value of the dollar has significant implications in countries like Argentina. It impacts the domestic price of goods and services, as well as the convenience of manufacturing products locally, importing them or eventually exporting them. Additionally, it affects financial decisions involving the negotiation or performance of dollar-denominated contracts. Understanding this can help determine the best way to maintain or increase the purchasing power of savings. The value of the dollar also has a considerable impact on economic and employment growth, inflation, income distribution and poverty. All in all, a consistent exchange policy is critical to set the country’s macroeconomic policy.

Exchange rate and policy objectives

Exchange rate. It is the amount of one currency required to acquire the currency of another country. In general, we refer to the quotation of the U.S. dollar in Argentine pesos.

Exchange rate fluctuations (or lack thereof) may be desirable for a variety of reasons:

  • To facilitate the absorption of external shocks. An adjustment of the exchange rate can prevent the full impact of an increase in the international price of goods exported by an economy from affecting domestic prices.
  • To contribute to the competitiveness of the economy. A high exchange rate can reduce costs in dollars, ultimately improving competitiveness.
  • To attempt to curb inflation. When the value of the dollar increases less than prices, this usually slows down inflation rates.


Some of these objectives may seem contradictory. Some will be better served by a lower exchange rate (in the context of inflation and income distribution), while others need a higher exchange rate (competitiveness). Similarly, some require a greater degree of stability (competitiveness and currency mismatch), while more flexibility is needed in other situations (buffer of exogenous shocks).

Exchange rate adjustments can be used as a tool to achieve some of these goals, but not all at once. In fact, frequent changes in the prioritization of exchange rate objectives may lead to a highly volatile, erratic and counterproductive exchange rate policy.

Argentina’s experience in recent years

Foreign exchange market. A market in which foreign currency is bought and sold and where the exchange rate is hence determined.

Exchange rate regime/scheme. Rules and practices that determine how the exchange rate is set. Specifically, these regimes are defined in terms of the degree of freedom with which the price of the dollar can respond to changes in supply and demand. Regimes with greater flexibility allow the exchange rate to be defined mainly by private and non-financial public sector supply and demand. In contrast, under less flexible regimes, the central bank establishes a target price and intervenes by buying and selling dollars to keep it within a certain range.

Our country has historically experienced tensions in the foreign exchange market; however, the policies adopted and the nature (and origin) of these tensions have varied over time. Since 1991, Argentina has implemented numerous combinations of exchange rate, monetary and capital flow regulation policies: fixed exchange rate (1991-2001); dirty floating exchange rate—high (2002-09); dirty floating exchange rate—low (2010-23); at times, with free movement capital (2010-11 and 2016-19); at times, with capital movement restrictions (2011-15 and 2019-23); and, even brief attempts have been made to implement inflation target regimes or target-zone flotation schemes.

The current situation

Exchange rate gap. It describes the difference between the official exchange rate and non-official rates. For instance, the official value of the dollar versus the “blue” or “informal” dollar.

The current exchange rate system operates as a split scheme with a heavily regulated commercial segment and a “free” financial segment, where the authorities have intervened in a less-than-transparent manner. The exchange rate gap serves as a thermometer of expectations and fuels constant incentives to arbitrage between different dollar markets, in search of high returns for those who can buy at low rates and sell at higher ones. This scheme makes it difficult to secure US dollars to finance investments or receive foreign payments, which discourages productive activities and investments.

The relative price structure resulting from the current exchange rate system is also inadequate for boosting growth. Ideally, the price system should encourage local tradable supply. The current scheme is the result of a tangle of rules that, as a whole, fail to promote, or even block, the development of key sectors. In fact, a major part of the current system generates a transfer of resources from exporters to importers and to companies with dollar-denominated liabilities.

Establishing a transitional system

When a system becomes unsustainable, reform is a must. In practice, reserves are drained and —if the possibility to acquire dollars at the official exchange rate is barred by administrative decision— alternative exchange rates become increasingly relevant for decision-making.

Abandoning a less flexible regime, such as the one Argentina has today, can be extremely costly. In addition to inflationary and distributive problems, many consumption, production and financial decisions have been made on the assumption that authorities would sustain the value of the dollar. Any change in this value could generate inconveniences and lead to bankruptcies and disruptions in the payment chain, which can cause significant harm and be detrimental to financial stability.

In view of the unsustainability of the current regime and the risk of spiralization of an abrupt unification, we suggest exploring the adoption of a transitional regime within the framework of a comprehensive plan. Two alternatives are proposed:

  • Formal dual system. It involves the temporary establishment of two official exchange rates, defining criteria for which activities and flows can obtain dollars at each rate.
  • Unification of currency exchange rates by increasing taxes. It seeks to eliminate the existence of multiple foreign currency rates, while distributing part of the costs and benefits through taxation.

In a way, a formal dual exchange rate or unification with an increase in export withholdings are not that different, since any dual scheme can be replicated through taxes. Nevertheless, there are some practical differences worth exploring.

Formal dual exchange rate

Establishing a transitory system entails creating two exchange rate regimes: One with a lower exchange rate (and more significant interventions by the BCRA), and another segment with a higher exchange rate (relatively freely floating). The main challenge lies in determining and implementing which products, industries, and trade and financial flows would be grouped in each segment. Historically, a lower exchange rate is usually established for commercial transactions while a higher one is applied to services, financial transactions and luxury goods.

This alternative:

  • Formalizes and simplifies the current context, while maintaining more than one value for the dollar.
  • Requires capping the gap between the two exchange rates (in order not to reproduce the negative incentives of the current regime).
  • Faces the additional complexity of determining the exchange rate at which pre-existing dollar-denominated contracts should be valued.
  • Makes regulation of capital flows more complex. The high exchange rate should clearly be used for new capital inflows and outflows, but some issues require consideration. For example, how to deal with the payment of interest and principal on previously contracted debt, as well as other capital flows, such as dividends of foreign companies based in the country.
  • Prioritizes the BCRA’s balance sheet, allowing the bank to purchase dollars at a low exchange rate and print fewer pesos for the accumulation of reserves.
  • The Articles of Agreement of the IMF do not allow the coexistence of multiple exchange rates, so that an exception from the Fund is needed.
  • Requires a higher level of state capabilities.

Despite the complexities detailed above, a dual regime offers sufficient flexibility to move gradually towards unification. The strategy is to transition products, sectors, and trade and financial flows from the low-rate segment to the high-rate segment, either entirely or partially. The ultimate goal is to narrow the gap as the Central Bank rebuilds international reserves and inflation decreases, increasing the number of sectors operating within the high exchange rate segment until the low segment finally disappears and unification is achieved.

Unification with an increase in withholding taxes

The alternative to the dual exchange rate system is implementing a single exchange rate, presumably along the lines of the unofficial exchange rate, offset by higher export taxes (both in terms of the rates and the products covered). The main challenge posed by this scheme lies in establishing the new level of withholding taxes and determining their scope. In other words, what goods and sectors would be impacted by the proposed measure? Would they be the same as those currently subject to tariffs or is the scope likely to expand?

This alternative:

  • Circumvents problems associated with the existence of more than one dollar value and eliminates the distortion that results from having multiple prices for the same asset.
  • Is not in conflict with the IMF’s Articles of Agreement.
  • Prioritizes the Treasury’s balance, since it increases tax collection, to the detriment of the Central Bank’s balance, which has to print more pesos for settlement of exports.
  • It implies a greater risk of currency mismatch.
  • Withholding taxes represent a politically sensitive tool and their implementation is not at all simple in political terms, especially considering that any amendments thereto must necessarily be approved by Congress.

As with the previous regime, this one is also temporary. Certain sectors may be subject to withholding taxes for a certain period of time, while others may face this tax permanently, and not necessarily at the same rate, as has been the case for the last 20 years.

One dollar, two dollars: the same challenges

Exchange rate reform alone is not sufficient to guarantee economic stabilization. It must be accompanied by a set of economic policies. In particular, fiscal policy and ensuring sustainable levels of public and private indebtedness. This is essential to protect domestic financing dynamics and manage external debt burden, as well as to ensure sustainability of the balance of payments.

The temporary exchange regime, as a step towards unification, must be driven by a primary objective: improving the transparency of the exchange market intervention process. In the case of a dual regime, it is necessary to determine who can intervene in each market, the method employed and which transactions must be carried out in each market until both eventually merge into a single market. In the case of unification with an increase in withholdings, it implies defining this increase and the subsequent normalization process. In both scenarios, the aim is to reduce the costs associated with exiting the current regime, particularly those related to inflation, activity slow-down, deterioration in income distribution and increased poverty.

Similarly, any temporary regime must allow the Central Bank to accumulate international reserves as a means of transitioning into a stable single exchange rate system. Therefore, any decision must be accompanied by a rigorous quantitative analysis of possible accumulation scenarios.

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