May 4, 2018 / 8:51 PM / 21 days ago

EXPLAINER-Argentina ends wild market week with 40 pct interest rate

BUENOS AIRES, May 4 (Reuters) - Argentina, which had been an investor darling for much of last year, curbed a sharp devaluation of its peso currency on Friday after hiking interest rates for the third time in a week, selling more than 10 percent of its dollar reserves and lowering its fiscal deficit goal.

Many analysts said the measures were overdue in an economy battling one of the world’s highest inflation rates, and which only recently moved to monetary policy focused on inflation targeting. The currency strengthened 5.12 percent on Friday but remained 6 percent weaker than a week earlier.

The peso has slid around 15 percent this year, complicating the central bank’s long battle with inflation.

Here are some key factors in this week’s stampede for the exits from Argentina:

INFLATION

President Mauricio Macri, the son of a wealthy businessman, quickly earned praise from investors after taking office late in 2015 for revamping the government’s economic statistics agency, regaining access to international capital markets by settling long-festering court cases with investors and lowering the budget deficit by cutting generous utility subsidies.

But inflation, a holdover from the previous government’s habit of printing money, has remained Argentina’s Achilles heel.

As of April, 12-month inflation was 25.4 percent, nowhere near the 15 percent target set by the central bank with a nod from the government.

A central bank survey of economists published on Thursday forecast 2018 inflation of 22 percent, up from the survey’s March forecast of 20.3 percent.

In recent months the bank had avoided raising the interest rate and repeatedly promised inflation would start falling in May when a series of hikes on regulated prices ends.

The higher rates will likely threaten the government’s forecast for 3 percent economic expansion this year, on top of the risk presented by a drought that could shave 1 percentage point off growth by curbing agricultural output.

CENTRAL BANK CREDIBILITY

The central bank, which is not officially independent from the government, started targeting inflation with monetary policy under Macri. It moved from a weekly meeting to holding a policy meeting every other Tuesday in January 2017 but abandoned that schedule with a surprise rate hike on Friday, April 27.

The bank’s credibility had been undermined in December, when the treasury minister announced the 2018 inflation target had been relaxed to 15 percent from 8 to 12 percent..

Neither the surprise Friday rate increase, nor a second hike on Thursday, nor massive market interventions, calmed the peso. The bank sold $451 million in reserves on Thursday on top of $500 million the day before. This week’s interventions followed sales of $6.771 billion in March and April.

SUBSIDY BATTLE

Macri’s opponents in Congress are trying to limit how much the government can raise utility rates, a process that has kept inflation high but helped lower the fiscal deficit. Argentines have grown accustomed to paying little for home heating gas although the administration has committed to gradually raising prices even when faced with protests.

In a sign of how perilous the issue is for Macri’s government, a poll by Tendencias consultancy on Thursday said 69 percent of Argentines had a negative view of the government and 65 percent thought higher utility prices, known locally as the “tarifazo” were “unfair and unjustifiable.”

CAPITAL GAINS TAX

In hopes of easing fiscal pressure by increasing its tax take, the government last month imposed a 5 to 15 percent capital gains tax on foreigners, which may have decreased investment in peso instruments. In a report, consultancy Delphos said the government would capture 16.2 billion pesos in taxes but forego 37.1 billion pesos in investment as a result. (Reporting by Caroline Stauffer; Editing by David Gregorio)

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