Latin American Stocks Slip Amid Talk of Argentine Devaluation

The emerging-markets crisis is supposed to be over, but the signals from Latin America suggested otherwise Monday as rumors of a currency devaluation in Argentina accelerated across the region and sent stocks down sharply.

Economists insisted that a devaluation and an abandonment by Argentina of the peso’s peg to the U.S. dollar are unlikely, but several warning signs--including provocative comments last week by financier George Soros--have rattled much of Latin America.

Soros said Friday that Argentina’s money was overvalued, and his backtracking Monday failed to reassure markets. The leading Merval index of stocks fell 2.7% to 497.42, continuing a decline that had shaved 13% off the market in the previous two weeks.

In Mexico, the IPC stock index tumbled 2.5%, while Brazil’s main index fell 4.9% and Venezuela’s lost 1.4%.

Soros’ comments were the latest in a series of events stoking fears that the government might abandon the peso’s “convertibility” to the dollar, a policy in effect since 1991.

By law, Argentina can issue only one peso for each dollar it holds in reserve, a self-imposed discipline enforced by a currency board that has been partially credited for Argentina’s economic recovery in recent years.

But Argentina’s peso has been on crisis watch ever since the January devaluation and currency crisis in Brazil, which robbed Brazilians of 20% of their purchasing power. That has sent sales of Argentine grain, cars, livestock and other exports plummeting in Brazil, the customer for one-third of all Argentine exports.

Ironically, Brazil is beginning to pull itself away from the brink of collapse and toward economic growth as Argentina finds itself mired in its third straight quarter of recession. Total output of Argentina’s economy probably contracted 4% over the three months ended March 31, compared with last year, said Salomon Smith Barney market strategist Brian Gendreau.

“You could say that Argentina has been hit harder by the Brazilian crisis than Brazil has,” Gendreau said.

The legislature’s failure two weeks ago to pass a $1-billion cut in education spending put forward by President Carlos Menem, raised fresh fears that Argentina might be losing fiscal discipline. Still, Argentina’s projected fiscal deficit of 1.7% of economic output is puny compared with the 8% to 10% expected in Brazil this year.

“It’s going too far to conclude that the [legislative defeat] means the entire economic plan will be abandoned,” said PaineWebber Latin America debt strategist Siobhan Manning.

Signs from the U.S. Federal Reserve that American interest rates might climb also hurt because rates in Argentina would move up by a corresponding amount, “not the sort of thing you want to hear in a recession,” Gendreau said.

“I don’t see any scenarios resulting in a devaluation, but people are getting nervous. Ultimately, there is distrust because Brazil devalued,” Manning said.

Soros’ comments Friday merely echoed the beliefs of many economists who say the Argentine peso is 6% to 12% too rich. On Monday, responding to the uproar he had caused, Soros wrote Menem that he is not speculating against the peso and that he does not believe the government should abandon the dollar peg, but instead should deal with it by reducing labor costs and taxes.

Observers downplayed the likelihood that Argentina would jettison its strict monetary policy, which has helped the nation maintain stability in recent years. Argentina has even proposed adopting the U.S. dollar as its official currency.

“The question is not whether Argentina’s currency is overvalued or not but how to overcome the situation,” said Fernando Losada, ING Barings chief economist.

Devaluation is not the way, Losada said, because the short-term advantages of a more competitive currency and cheaper exports would be outweighed by a host of negative consequences, including the higher cost of Argentina’s mostly dollar denominated public and private debt.

“They went through the tequila, Russian and Brazilian crises, got caught up in the contagion in 1995, the banking problems, massive withdrawals from banks and massive unemployment. They made it through that, and this being less severe, I don’t see what doing away with convertibility accomplishes,” PaineWebber’s Manning said.

Argentina’s predicament is comparable to that of Hong Kong, which also has an overvalued currency and a currency board, said analyst Gendreau.

“If you have a currency that is pegged to dollars and it’s overvalued, the only way you can get it down is by drops in [domestic] price. And that’s what’s happening in Hong Kong. We are projecting deflation of 2.5% in Hong Kong this year and 0.6% price deflation in Argentina,” Gendreau said.

* WALL STREET SLUMPS: Latin American woes helped drive the Dow down 174 points. C4

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Rumors Hurt

Speculation that Argentina will be the next to devalue its currency has sent the benchmark Argentine stock index, the Merval, tumbling more than 13 % in two weeks. Daily closes since Jan. 4:

Monday: 497.42

Source: Bloomberg News