(MENAFN- AFP) Argentina's sharp devaluation of its currency was necessary but the move could fuel its already-high inflation and increase the fiscal deficit, posing the government tough new policy challenges.Still unable to tap global capital markets for funding because of its poor record on debt repayment, Buenos Aires will feel more pressure to tighten fiscal and monetary policy to slow price rises.But if it pursues more reforms, like cutting domestic subsidies and strengthening protections for investors, the economy could come out stronger, analysts told AFP on Friday.The Central Bank of Argentina cut the peso loose this week, reluctant to spend more of its depleted foreign exchange reserves to defend the currency.Facing a mounting outflow of dollars by panicked Argentinians and foreign investors, the central bank let the peso drop 3.2 percent on Wednesday and another 11 percent on Thursday, the sharpest single-day fall since 2002.This abandoned a more managed slide, which saw the currency lose around 30 percent last year. Since January 1, the fall has been nearly 19 percent.And on Friday it loosened controls on Argentinians buying foreign exchange, risking opening up the floodgates of capital flight but hoping it will calm the market.
The reason was clear: in protecting the peso, the country's foreign currency reserves sank to $29 billion this week from $52 billion in 2011. "The previous policies did not work... it shows that the government is reacting... It should help preserve reserves," said Gabriel Torres, a sovereign debt analyst at Moody's. On the other hand, he said: "It's bad news because it will increase inflation."Part of the reason for the rush into dollars is that inflation, by unofficial but generally accepted figures, rose to 26 percent last year and was expected to accelerate even before the peso plunged.Repeat of 2002 crisis?The devaluation and high inflation evoked memories of the economic crisis of 2002, when a four-year recession forced the country to default on some $100 billion in debt. Then, a sharp devaluation wiped out the savings of many people in the country, but the situation is much different now, and the economy is stronger overall.Argentina has shown "a good economic performance on the surface," said Joydeep Mukherji, a sovereign credit specialist at Standard & Poor's.The fiscal deficit last year was a modest 2.5 percent of GDP, and the country ran a $9.0 billion trade surplus, helped by strong demand for its farm products, soybeans, grains and beef."The world is still buying almost anything Argentina can sell," said Mukherji, and the devaluation will boost competitiveness.Moreover, in part because it has had virtually no ability to borrow new funds on the international market since the last crisis, the country's debt level is low. BNP Paribas estimates that privately-held debt is just 12 percent of GDP.Mostly the government has been printing pesos to fund its shortfalls, issuing debt to official institutions. But that fuels the deficit and inflation, analysts say.Still, the devaluation will bring home to roost problems the government has refused to address.In addition to the burden on the deficit of heightened subsidies for things like imported fuels, inflation will continue, as last year, to outpace the gains in tax revenues.And price protections that have already discouraged private investment will likely have an even greater distortionary effect on the market.More broadly, the devaluation could slow the economy this year to a halt, according to Neil Shearing of Capital Economics.."Our forecast that the economy would slide into recession this year looked bold a few months ago – all of a sudden that doesn't seem so implausible," he said.Arturo Porzecanski, an economist at American University in Washington DC, called the new measures "just patches to a longer-term problem" by President Cristina's Kirchner's "very amateur" economic team.He argued that Kirchner is just taking one step forward and then another back, not understanding how to respond to markets."The government does not know what to do... Inflation will continue to accelerate, stocks will continue to decline, there will be more social unrest," he predicted.Analysts say if the government cuts subsidies, loosens price controls and takes other pro-business measures, it might build investor confidence and reverse the outflow of dollars, helping the economy.But those proposals are not new, said Mukherji."A lot of people have been predicting a big change just around the corner for many many years. We really haven't seen that," he said. "So far there's no reason to believe that there's a big change just around the corner."<
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