Hearing that Argentina is in financial trouble is so predictable that it reminds us of Benjamin Franklin's comment about the certainty of death and taxes. Still, the broader market reacted with shock late last week when the Central Bank of Argentina (BCRA) raised interest rates to an eye-popping 40 percent from an already eye-catching 27 percent.
The move was taken in reaction to the freefall of the Argentine peso. It dropped more than 12 percent in just over one week.
The peso actually has been weak for a couple of months. And since early March, markets have been uneasy about Argentina's finances as its exports have been falling after the worst drought in 30 years.
Back in early March, the BCRA intervened to prop up the currency a little. But foreign exchange currency traders can smell a nervous market participant better than a shark can smell blood in the water, and markets have been extremely suspicious recently as the BCRA has repeatedly tried to prop up the currency beyond what would normally be required.
Finally, in concert with other emerging market currencies, the FX market called the BCRA's bluff and attacked the Argentine currency. The predictable response was for Argentina to spend some reserves to support the currency and increase interest rates to attract new investments.
When that did not work, the BCRA immediately pulled out the 40 percent interest rate bazooka, which did little to stem the tide. FX sharks knew they had a bloody victim in deep water.
But the world does have a lifeguard - one who likes to lecture countries on the evils of fiscal and monetary irresponsibility: The International Monetary Fund. Argentina has asked for a $30 billion line of credit from the Fund, where negotiations have started. And for now, the run on the Argentine peso appears to have been stemmed.
Our view: While the bleeding of the ARS has stopped for now, given the sobering actions taken by the BCRA, it will certainly slow down the much-needed economic reforms for the country, together with taking time to restore credibility with the central bank.
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