Stocks across Latin America and in Spain plunged Monday after Argentina stunned the financial community with a new policy on exchange rates that some analysts saw as a de facto devaluation.
The policy changes, announced over the weekend, obliterated much of the confidence earned when Argentina exchanged $29 billion in debt this month, a move that seemed to give the country some breathing room from worried creditors. But the nation's ongoing political turmoil and worsening economy apparently forced it to take drastic new steps.
Effective immediately, the government said it will fix the peso's exchange rate for trade purposes at the mid-point between the U.S. dollar and the euro. It amounts to a 7% devaluation in all such transactions, based on the euro's value Monday of 86 U.S. cents.
Until the announcement, Argentina's peso was worth one U.S. dollar. The switch is a partial abandonment of the dollar peg that Argentina adopted in the early 1990s in a successful bid to end hyper-inflation that crippled the economy for much of the decade.
Although Argentina has tamed the inflation beast, its goods and services have suffered in foreign and domestic markets. Argentina has opened its economy to foreign investment but it suffers from bloated government payrolls and inefficient health and pension systems that effectively drain income from government coffers.
Despite a $40-billion international bailout in December, Argentina has been hamstrung by a three-year recession and political resistance to further austerity measures demanded by the international community to stabilize the economy.
The government presented the new plan as a package of economic and trade incentives designed to boost domestic consumption of home-grown products because imports are now more expensive. But many economists weren't buying that, seeing it instead as a possible precursor to a general devaluation.
"This could be the first step in a more profound change in the currency regime," said Jose Carlos Faria, an economist with Deutsche Bank in Sao Paulo, Brazil.
Argentina's stock market was closed for a national holiday Monday but its bonds were clobbered in international trading with yields rising on some issues by more than 2 percentage points. All eyes will be on Argentine banks when they reopen today to see whether depositors try to protect their savings by withdrawing pesos while still convertible to dollars at an equal rate.
Damage was severe elsewhere in the hemisphere as Brazil's main stock index fell 4.2% and Mexico's stocks lost 2.7%. The Brazilian currency, the real, fell to a record low 2.452 per dollar, down 26% so far this year, on fears that its economy will suffer along with Argentina's in a devaluation.
About 11% of Brazil's exports are sold in Argentina and the devaluation will make those exports suddenly more expensive, probably hurting sales. Many Brazilian banks and investors own Argentine bonds.
Spanish stocks lost 3.7%. Spanish companies have invested billions of dollars in Argentine energy, telecommunications and banking in recent years, investments that could lose value immediately if Argentina devalues.
"This contagion effect is one we have observed for quite some time," said Arturo Porzecanski, Latin America economist with the investment bank ABN Amro in New York. "In this globalized world, good news travels fast, and bad news travels fast."
Domingo Cavallo, the nation's third finance minister this year, engineered the debt swap after winning extraordinary powers from the Argentine Congress in March. Up to now, Wall Street had placed its faith in Cavallo to bring Argentina back from the brink.
"This is a surprise after Cavallo had emphasized predictability and had played by the rules of the game," said Jorge Mariscal of Goldman, Sachs & Co. in New York. "This leaves the market wondering what's next."
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Brazil's Currency Sinks
The Brazilian real, already in a steep slide this year, sank to record lows against the dollar Monday, in part on fears that Argentina's economic woes will spread.
Brazilian reals per U.S. dollar
Monday: 2.452 Brazilian reals per U.S. dollar
Source: Bloomberg News