Analysis: Argentina currency policy creates multi-headed monster

BUENOS AIRES Wed Sep 12, 2012 4:10pm EDT

BUENOS AIRES (Reuters) - Argentina's increasingly tough currency controls have spawned multiple exchange rates that hurt savers without helping exporters, and they could backfire by depressing investment and driving up inflation.

President Cristina Fernandez is trying to lock in currency stability and end Argentines' long obsession with dollars in a country scarred by devaluations, most recently in 2002. The onerous controls are distorting the economy.

The multiple exchange rate system - which the government does not acknowledge - forces wealthier Argentines to pay more to buy dollars on the black market.

Exporters who would benefit most from a weaker peso must sell all their proceeds at the official rate, which some say overvalues the local currency by at least 15 percent.

An Argentine broker who sells food products abroad said he used to travel overseas 10 times a year on business but he has cut that back to two trips because buying dollars is so pricey.

"You make your sales on the road, not by email," the broker said on condition of anonymity for fear of government reprisals.

"It's very difficult for small companies to travel abroad, first because they don't know if they'll be able to sell their products because they're no longer competitive, and secondly because they have to buy dollars at 7 (pesos per dollar)."

The broker said some exporters have stayed afloat by teaming up with importers, who must match their purchases with sales abroad under the leftist government's offbeat rules. The importers pay exporters to sell on their behalf and end up compensating for the exchange rate's loss of competitiveness.

He said commodities suppliers are still doing well thanks to sky-high global grains prices but sales of processed goods are declining, due to the overvalued currency, surging production costs and anemic demand linked to Europe's debt crisis.

The official exchange rate in Latin America's No. 3 economy is 4.66 pesos per dollar. But a virtual ban on foreign currency purchases has pushed the black-market rate to about 6.30 per dollar, marking a 35 percent premium.

Some companies pay about 6.50 pesos per dollar to buy stocks and bonds that can be sold abroad for greenbacks. And a new 15 percent tax on credit card use abroad effectively creates another exchange rate of 5.37 per dollar.

The measures are similar to those in socialist Venezuela. Economists say they will hit investment and growth by sowing uncertainty over the direction of exchange rate policy. They could worsen annual inflation now near 25 percent as merchants price their goods in line with the rising black-market dollar rate.

The controls encourage Argentines to take illegal shortcuts to get dollars, ranging from fictitious credit card purchases to exchange deals in school yards and local shops.

Exporters say the real solution is a weaker official rate.

"I think the dollar should be at 6.50. That's the competitive rate we need," the food broker said. "Exporters' margins are so low, we all think (the official rate) will be modified in the coming months. This can't last."

PURCHASING POWER

The Argentine obsession with saving in dollars is understandable given the collapse of a decade-long currency peg in 2002, which led to a freeze and devaluation of bank deposits.

Since 2003, the central bank has intervened on the foreign exchange market to avoid volatility and bought dollars to bulk up its reserves. It has allowed the peso to depreciate gradually in nominal terms but high inflation has meant local costs as measured in dollars are no longer cheap.

Fernandez's late husband and presidential predecessor, Nestor Kirchner, emphasized the need for a competitive exchange rate to encourage exports.

Fernandez is more interested in stoking the domestic market as the economy slows sharply after a nearly nine year boom. Exports are expected to fall to 17 percent of gross domestic product this year from 22 percent in 2005, private data shows.

After winning a landslide re-election in October, Fernandez imposed new currency controls to stem capital flight and safeguard the central bank's foreign reserves, which the government uses to pay debt.

"We need an equilibrium exchange rate that doesn't hurt workers' purchasing power," Fernandez said last week. "The dollars that we get from foreign trade are the dollars we have to use to pay for imports ... and at the same time, debt."

Consumer and business confidence have sunk since the government began limiting dollar purchases and curbing imports to increase the trade surplus, a key source of hard currency.

Fernandez's approval ratings have also fallen. A poll last month by local firm Management & Fit showed 72 percent of respondents disapproved of the way the government is managing the economy.

Political analyst Roberto Bacman said Fernandez's popularity has not been hurt much by the foreign exchange restrictions, HOWEVER, since voters tend to view the economy more broadly.

"This hasn't sparked problems or protests, although many people complain," Bacman said. "In this sense, it was a successful maneuver."

ECONOMIC IMPACT

From an economic perspective, the multiple exchange rate system is fundamentally inefficient, said Daniel Oks, a former World Bank economist.

"It opens up a ton of possibilities for flouting the controls. The underreporting of export sales and over-reporting of imports are typical capital flight mechanisms when currency controls are in place," Oks said.

"The cost of this policy is less investment and less supply ... and in the long run, less employment," he added.

The foreign currency restrictions have already hurt sales in the real estate market, where historically properties were bought and sold in dollars.

The overvalued peso has hurt exports of everything from apples to olive oil while discouraging investment in industries such as plastics, electronics and car parts.

Argentina's lucrative grains exports remain competitive, however, and its auto sector is buffered by advantageous trade accords with Brazil.

Nonetheless, the multiple exchange rate system takes a toll on companies and investors.

"They presume they're facing a scenario of currency instability so they stop making long-term decisions and wait for an adjustment to the exchange rate," said Marcelo Elizondo, who runs foreign trade consultancy DNI.

The central bank has been allowing the official exchange rate to depreciate at a faster rate. The peso has already weakened 7.7 percent against the dollar so far this year, topping the 7.6 percent slump seen in 2011 as a whole.

Analysts are divided over whether the government will allow an even sharper depreciation. Nomura investment bank sees the peso at 5.65 per dollar by the end of 2013, whereas Morgan Stanley forecasts the rate at 7 per dollar.

Fernandez may take it slow to avoid alienating voters ahead of a mid-term election, scheduled for October next year.

"When you devalue, salaried workers lose out and this is the government's electoral base. So they'll try to avoid this at all costs, at least until the election," a source in the foreign exchange market said.

(Additional reporting by Jorge Otaola; Editing by Kieran Murray and Andrew Hay)

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