Global Policy Forum

By Mark Egan

The International Monetary Fund advised Argentina not to alter its currency peg to include the euro because Europe's currency could rise in value, causing the peso to appreciate too, IMF sources said on Monday.

Senior IMF sources said the lender's point man on Argentina, Claudio Loser, told Economy Minister Domingo Cavallo in April that the timing was wrong to alter the currency peg and that doing so by targeting one sector of the economy -- exporters and importers -- ran counter to the IMF's dogma.

On Friday, Cavallo unveiled plans to alter its currency peg, which links the peso one for one to the U.S. dollar, in the hope of reviving the flagging economy. Cavallo said the government would exclude exporters and importers from the peg. Exporters will receive more pesos for every dollar in sales, based on a rate that is a combination of the euro and the dollar. The plan includes a matching charge against importers, making their goods more expensive.

On Monday the fund declined official comment on whether it approved of the change to Argentina's currency regime, saying only that it was studying the new measures. The IMF's Latin America spokesman, Francisco Baker, said in a brief statement, "We took note of the most recent economic measures announced by the Argentine government and are now in the process of studying them."

But privately, IMF officials despaired at the move, saying the result of Cavallo's plan could cause the peso to appreciate -- something that would negate the purpose of the move. One senior IMF decision-maker told Reuters that the lender had told Cavallo in April that, "Given the potential for appreciation of the euro, it was too early to change the peg ... because the peso could continue to appreciate in real effective terms, which is what they wanted to avoid." Acknowledging that Cavallo finds himself in a "tricky position," he said that "in terms of transparency, this was not the best way to do it."

CAVALLO IGNORES IMF ADVICE

The source said the IMF told Cavallo that if he insisted on pushing ahead with changing the peg now, he ought to do so across the entire economy instead of just targeting exporters and importers. The unorthodox minister ignored the advice. The move effectively depreciates the peso for exporters by about 7 percent -- a move that has led some on Wall Street to fear a broader devaluation could follow.

A second source within the Washington-based lender said Cavallo pushed ahead with his latest plan without consulting the IMF on his timing, giving the fund "only a couple of moments notice," -- something the source said has raised tempers at the fund considerably. The Argentine economy has been struggling to shake off its economic doldrums in recent years. Some in the South American nation believe that the peg to the U.S. dollar is depressing the export sector because the dollar has continued to strengthen compared to other currencies, making Argentine exports more expensive. "They should have taken more time and announced this after the euro had appreciated more," the IMF decision maker said.

In December, the IMF led a $40 billion rescue package for Argentina after fears in financial markets that the South American nation might be forced to default on its debts. Almost immediately, Argentina has missed a vital IMF-mandated fiscal deficit target -- causing the frenzied negotiation of a waiver and renewing fears of default.

SWIMMING AGAINST THE STREAM

Cavallo's latest initiative on the peg flies in the face of IMF teachings, which dictate that governments treat all sector of the economy in the same manner. Cavallo, drafted by President Fernando de la Rua to pull the economy out of a three-year slump, announced in April plans to include the euro in the dollar peg across the economy, but only when the euro reaches parity with the dollar.

His latest move raises concerns about how the multiple exchange rates will work in practice and that a full devaluation could follow -- a sentiment underlined on Monday by a research note from Brown Brothers Harriman in New York. "The change ... has many market participants very concerned that it is the first step towards a general devaluation," the investment bank wrote.

The note added that many on Wall Street were, "skeptical about the ability of the government to maintain a dual-rate foreign exchange regime." The change in the currency peg was announced with a raft of other measures aimed at boosting economic activity, including lowering income taxes for many Argentines and lowering the value added tax.

Wall Street's skepticism was reflected in spreads on Argentine debt widening in early trading on Monday. But a fuller reaction to the news will have to wait until Tuesday when Argentine financial markets reopen after being closed for the Flag Day public holiday.

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