Latin Currency and Debt Woes Worsen

Latin American currencies and bonds dropped Wednesday as contagion from Argentina’s deepening financial crisis spread. Argentina’s stocks were whipsawed, with the Merval exchange average plummeting 7.1% before ending the day down 2.2%.

Shaken by a treasury auction Tuesday in which Argentina was forced to sell short-term notes at exorbitant rates to refinance its debt, investors bailed on bonds across the hemisphere. In a wave of selling, the Mexican, Brazilian and Chilean currencies all lost value.

The Mexican stock market slumped 2.2%.

Argentina has been hurt by a shrinking economy, the carrying costs of its $128 billion in external debt and political divisions that have stymied efforts to cut the government’s budget. Investors are losing confidence that the nation can avoid a default on its debt or a devaluation of its currency, which is pegged to the dollar.

“Argentina needs to do two things: convince the markets that it’s actually making a major dent in the fiscal deficits, and second for the economy to show some growth,” said William Cline of the Washington-based Institute of International Finance. “We haven’t seen tangible signs of that coming yet.”

The high rates seen in Tuesday’s auction were especially worrisome to the markets because, if they persist, they could knock the country out of compliance with the fiscal targets set by multinational lenders, including the International Monetary Fund, as a condition to continuing financial aid.

But the end could come sooner if depositors lose confidence in the stability of the currency and rush to withdraw their pesos and convert them to dollars, said Renato Grandmont, an economist with Deutsche Bank. For that reason one of the most closely watched statistics is bank deposits, which have been stable so far, suggesting consumers are staying calm.

The declines come despite brave talk Wednesday by Domingo Cavallo, Argentina’s economy minister. He called on Argentines to rally behind a proposed “zero deficit” emergency budget proposal. The plan would mean spending cuts that would erase Argentina’s projected $6-billion budget deficit this year.

Analysts agreed that such a program might save the country from implosion, but Argentina’s political factions have yet to rally behind Cavallo, the third economy minister this year. His emergency package includes massive social security and health benefits cuts, which are certain to be unpopular.

The Mexican peso, which had been one of the world’s strongest currencies this year, fell 1.1% to 9.25 to the dollar, continuing the July swoon that has cost it 3% of its value, pushing it to its lowest value since May. The Brazilian real closed down slightly at 2.4965 to the dollar, the lowest level ever. The Chilean peso closed down 2.2% at 664.75, and is now off 14% this year.

“Although it was overvalued, the Mexican peso has been mostly affected by the volatility in Argentina. Everything starts there,” said Omar Borla, senior economist at Santander Central Hispano Investments in New York.

Bonds were punished on fears that an Argentine default would tar the entire emerging-market class of debt investments. The yield on Brazil’s C bond due in 2014 closed up 0.53 percentage point at 14.94%, nearly 10 points above U.S. Treasury bonds.

A widely followed J.P. Morgan index of Argentine bonds showed average yields rose nearly three- quarters of a percentage point. Yields on Mexican bonds also rose to the highest levels since mid-May, causing a corresponding drop in value.

Observers also noted the decline in Argentina’s foreign reserves, from $25 billion at the beginning of the year to the current $21 billion. That reflects capital flight and the lack of “liquidity,” or money that the economic system needs to get growing again.

Meanwhile, some economists have begun contemplating the fallout from a possible debt default and devaluation by Argentina, not a pretty scenario for Argentina or its neighbors, especially Brazil and other members of the Mercosur trading bloc.

“Mercosur has been disintegrating, and without Mercosur and with a weak Argentina, Brazil becomes less attractive to foreign investment. Without investment, Brazil cannot sustain its large deficits, and the real would have to weaken to make imports more expensive and its exports more attractive,” said Sebastian Edwards, a Latin America economist at UCLA’s Anderson School.

“We’re seeing that now. It’s how equilibrium is established,” Edwards said.

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Debt Burden

Argentina’s government debt has ballooned from $80.7 billion at year-end 1994 to about $128 billion, and creditors increasingly fear the nation will be unable to pay its bills.

Argentine government debt (in billions)

QI 2001: $127.4 billion

*First quarter of 2001

Source: Bloomberg News