ANALYSIS: Argentine peso devaluation sparks talk of contagion

The currency devaluation carried out by the Argentine authorities this week has left many scratching their heads. With the Argentine peso falling to around 8 pesos to the US dollar in the space of just two days, talk of a contagion has spooked markets.

After allowing the currency to depreciate steadily in the second half of 2013, the government allowed the rate to weaken by 3.5% to 7.15 pesos per US dollar on Wednesday (Jan 22) as it ceased to intervene in the currency. The peso weakened further on Thursday to reach 8.50 before stabilizing at around 8, according to a note from investment bank Credit Suisse.

The move in the currency marked its biggest fall since the 2002 economic crisis in the country and comes just days after Venezuela moved to further weaken its currency and introduce a dual currency system, with speculation continuing that Argentina could be set to introduce a similar system.

It also comes following a seven-month period which has seen currencies fall across the region relative to the US dollar as expectations of a tapering of stimulus by the US Federal Reserve spooked markets and led to sharp outflows of fund out of regional markets.

An appearance on Friday morning by cabinet chief Jorge Capitanich to announce a relaxation of some currency controls was only a tad less pitiful than the school kid-like impatience of economy minister Axel Kicillof as they attempted to claim credit for the moves, with many remembering that it was President Cristina Fernández herself who pointedly stated in the past that no devaluation would take place under her watch.

Another interpretation is of course possible, that is, the country is rapidly running out of international reserves and could not afford to carry on with its bizarre economic experiment.

ANALYST VIEWS

Alberto Ramos at Goldman Sachs, talking to BNamericas, noted that "the authorities seem to have lost the grip on the currency dynamics," suggesting that the ARS could overshoot in the short term. "The economy needs a weaker currency, but that is taking place on top of a very weak macro picture," added Ramos.

According to Rafael De La Fuente, chief LatAm economist at investment bank UBS, the moves are a "reflection of the fact that they are running out of reserves and are now faced with conflicting objectives."

Talking to BNamericas, De La Fuente explained, "On the one hand they want to keep a stable exchange rate as an anchor for inflation," which has led to the introduction of capital controls and currency intervention. "On the other hand they continue to run a very large and widening fiscal deficit, which in the absence of higher taxes and funding for the government they have tended to monetize those deficits, leaning on the central bank to print money."

In a note to clients, Tony Volpon, Nomura's fixed income strategist, said that the devaluation was "the inevitable result of an unsustainable mix of monetary and fiscal policies."

Bulltick Capital markets' head of research, Alberto Bernal, was more positive however, pointing out to BNamericas that "it is good policy to bring the shadow exchange rate and the official rate closer. The faster they do it and take the pain, the better."

CONTAGION?

The sharp devaluation also triggered talk of contagion following recent events in Turkey, Ukraine and Venezuela with market view split.

"Greater exchange rate volatility could open up a series of political and economic uncertainties. Developments in Argentina have generated knock-on effects in Brazil, and the risk of contagion across EM has now become more real," said Volpon.

At SocGenthe views were even stronger. According to Benoit Anne, head of emerging market strategy at the investment bank, "Global emerging markets (GEM) are now trading in full-blown panic mode", adding that "In any case, that panic mode has now spread to all regions and all asset classes including-until recently resilient-hard-currency debt."

According to Ramos, however, "most of what is going on in Argentina is home brewed. This is an idiosyncratic story that has very little connection to global developments.

De La Fuente was in agreement, noting that the "type of balance of payments and fiscal crisis that you are seeing unfold in Argentina and in Venezuela is very much a traditional emerging markets crisis," which most emerging market economies have moved away from. "This is self inflicting pain without question."

With such polarized views in the market, only the coming days will tell if Argentina's economic experiment will be allowed to continue.

However, uncertainty is never a good sign in financial markets and as JP Morgan's Vladimir Werning noted, "Unfortunately, authorities have not signaled whether the decision to stop guiding the official FX level through spot intervention represents either (a) a formal end to the long-standing crawling-peg regime or (b) a temporary deviation from it which will end once the market reaches an (undisclosed) new preferred level."