UPDATE 1-Argentine province says paid dollar bonds in pesos
* Payment of dollar debt in local currency may set precedent
* Province cites central bank crackdown on dollar buying
* Argentina restricts dollar access to slow capital flight
BUENOS AIRES, Oct 7 (Reuters) - Argentina's Chaco province set a worrying precedent for investors last week by making a dollar-denominated bond payment in local pesos, saying it was forced to do so by the central bank's policy of limiting access to greenbacks.
The payment of about $260,000 in pesos rather than U.S. dollars surprised the local capital markets, and may set the stage for other borrowers in the South American country to pay dollar-denominated debt in pesos.
"Compliance in a timely manner of the obligation was carried out in accordance with existing foreign exchange regulations established by the Central Bank of Argentina," said the northern province.
The central bank has cracked down on access to dollars this year to protect its reserves and stem capital flight as the peso weakens against the greenback. The Chaco bonds were issued in 2006 and come due in 2015 and 2023.
"This sets a very concerning precedent," Goldman Sachs emerging markets analyst Alberto Ramos said of the payment not being made in dollars as called for in the bond contracts.
"The irony is that the government wants desperately to hold on to every dollar that it can find, but it is denying the same right to its own citizens," he added. "There are multiple sound reasons why people favor the dollar in Argentina."
The country, with its vast Pampas farm belt, is a top world grains supplier. Rising soy and corn prices have helped it recover from a severe 2001-2002 financial crisis punctuated by a massive sovereign debt default.
The crisis was followed by a long economic boom which has since lost steam, leaving double-digit inflation in its wake.
President Cristina Fernandez has meanwhile beefed up intervention in Latin America's No. 3 economy, imposing currency controls along with import curbs and new lending requirements that have raised jitters among local bankers.
These measures, along with the government's decision this year to seize a majority stake in Argentina's top energy company, YPF, have further dented investor confidence.
Hit as well by fallout from Europe's debt crisis, lower demand from key trade partner Brazil, the country's economic expansion came to a screeching halt in the second quarter of this year, according to government data.
"Now it appears that Chaco cannot meet its obligations. You would think that a semi-sovereign entity such as a province would be able to access the dollars it needs," said Beth Morrissey, managing partner at Washington-based emerging markets consultancy Kleiman International.
"The scary question is whether this the first of many, and will we have pesification of all dollar-denominated debt in Argentina," she said.