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    There’s a Crisis in Argentina: Central Bank Moves to Prop Up Peso with 40 percent Interest Rate

    Updated: Apr 27, 2020  

    Spare a thought for the Argentine peso. The ill-fated currency of South America’s second largest economy lost 6 percent of its value last week, taking its twelve-month loss to 30 percent. Now at 21.82 per US dollar, the peso is worth less than at any point since Argentina’s fixed exchange rate system was abandoned in 2001. As recently as 2011, there were only 4 pesos to the dollar.

    Realizing that they were “going to need a bigger boat” in order to avoid a run on the peso, the Central Bank of Argentina raised interest rates by 675 basis points on Friday, adding to hikes of 300 basis points on Thursday and the Friday before. The decision took interest rates to a remarkable 40 percent.

    “The monetary authority made these decisions with the objective to prevent disruptive behaviors in the foreign exchange market as well as to guarantee the process of disinflation, and it is ready to act again if necessary,” the bank said in a statement.

    Supporting the central bank’s efforts was the Argentine government, which announced on Friday that it had cut its 2018 target for the fiscal deficit to 2.7 percent, from 3.2 percent. This will, according to analysts, save the government around $3 billion.

    There is no single factor driving peso weakness; it is the result of “large twin budget and current account deficits, a heavy dollar debt burden, entrenched high inflation and an overvalued currency,” says Edward Glossop, economist for Latin America at Capital Economics.

    In a note to clients on Friday, Glossop wrote that “risks to the peso have been brewing for a while,” but he expressed surprise at “how quickly and suddenly things seem to be escalating.”

    Measures introduced on Friday did at least produce the desired effects – the peso gained nearly 3 percent during the New York session – but whether those effects last for any meaningful amount of time is yet to be seen. If not for those measures, dollar-peso would, at best, have settled for the week in the mid-22s, at which it traded prior to the announcement on interest rates.

    The peso’s immediate future, according to Glossop, hinges on the Argentine government’s response to the developing currency crisis.

    “A sizeable fiscal tightening is planned for this year, but that might now need to be larger and front-loaded. Unless or until that happens, the peso is likely to remain under pressure and there remains a real risk of a messy economic adjustment.”

    Taken along for the ride by developments in Argentina were other emerging markets, most of all the Turkish lira and the Mexican peso.

    The lira, which wrestles with economic problems similar to those faced by the Argentine peso, weakened by 4.5 percent to a record low of 4.29 per dollar; and the Mexican peso lost 3.2 percent to 19.25, although that remains higher on the year.

    In other foreign exchange news, the Swiss franc fell last week to parity with the dollar for the first time in six months and the euro fell through 1.20.

    Holding its own was the New Zealand dollar, which refused to give way at the 70 cents level. The kiwi had to deal with minor breaches of the level on four of the week’s five trading days but was resolute and settled at 70.20.


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