Argentina switch rattles currencies

Market jitters reached as far as Tokyo

A seemingly minor change to Argentina's currency regime has sent shivers through foreign exchange markets throughout the world.

Last Friday Domingo Cavallo, Argentina's economy minister, announced that exporters and importers would be partially exempted from the mechanism by which the Argentine peso is pegged against the US dollar.

The behaviour of the market just shows they did not understand what we wanted to do

Domingo Cavallo
Economy Minister

Financial markets, sensitive to Argentine policy after a spate of dire economic news, interpreted the move as effectively a devaluation of the peso, and have this week started to pile pressure on other emerging market currencies.

Although Latin American currency markets have been hardest hit, with both the Brazilian real and Chilean peso hitting historic lows, the effect has been felt as far afield as Hungary and Hong Kong.

As a series of recent crises has shown, emerging financial markets are particularly vulnerable to "contagion", where bad news in one country is felt in completely unconnected regions.

Changing the rules

Mr Cavallo has grown increasingly frustrated by the reaction of international markets which he blamed on ignorance.

"The behaviour of the market just shows they did not understand what we wanted to do. But that should not surprise us. They didn't understand [the dollar-peso peg] introduced in 1991," he complained.

Mr Cavallo's changes are an attempt to shield the Argentine economy from the worst rigours of the country's ten-year-old peso-dollar currency regime, which fixes the peso to the dollar at parity.

Exporters will now receive more pesos for every dollar in sales, based on a combination of the euro and the dollar, and importers will be hit by a matching charge, making their goods more expensive.

Cavallo: Tinkering with the peso

The variance in either direction is roughly 7%.

Argentine officials have stressed that convertibility will be maintained.

The plan was conceived earlier this year, when Argentina's economy seemed to be teetering on the brink of collapse.

Argentina's economy has been in recession for three years.

A $30bn (£21bn) debt-swap deal in early June - postponing some $16bn in repayments - seemed to have bought the government some time.

In fear

But the currency reforms have renewed crisis fears.

Worse, financial markets were bamboozled by the complexity of the measures, which have little parallel in recent monetary history.

Confusion over the implications of the new currency regime triggered a sell-off in Argentine financial markets.

The benchmark Merval stock index lost up to 5.5% during the day's trading, before gaining some ground to close 4% lower.

Around the world

With Argentine markets closed on Monday for a public holiday, much of the immediate effect was felt overseas.

Traders get nervous

In Brazil, central bank intervention was unable to prevent a new historic low in the real, which has already lost one quarter of its value against the dollar this year.

Brazil's equity and bond markets were also hit.

And in Uruguay, fear of market turmoil forced the government to widen the bands within which the Uruguayan peso trades against the dollar.

Further afield, the strongest jitters were in economies that also have pegged currencies - notably Hong Kong, Bulgaria and the Baltic states.

In Hong Kong, the forward premium on the HK dollar - effectively the prediction of future currency movements - more than doubled.

All major Asian currencies, with the exception of the Thai baht, fell, prompting central bank intervention in Taiwan.

In Europe, the Spanish markets - which have close economic links with Latin America - were shaken.

Madrid's Ibex stock index lost 4% on Monday alone.

And emerging currencies around the continent, notably the Hungarian forint, have also dipped.