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Argentina central bank faces peso test ahead of fraught election

(Adds fresh analyst comment, bond, stock prices)

By Walter Bianchi and Jorge Otaola

BUENOS AIRES, Aug 16 (Reuters) – Argentina’s central bank will have to toe a politically fraught line between providing support for the crumbling peso without blasting through its reserves to salvage the currency as a presidential election looms in October, analysts said on Friday.

The peso was in free-fall for most of this week after a shock primary election result on Sunday, when center-left presidential candidate Alberto Fernandez trounced center-right President Mauricio Macri.

The scale of Fernandez’ victory suggested he could win the upcoming ballot in the first round, but potentially be left as leader of a country that has very few foreign reserves left, raising the chances of a debt default.

“One strategic element for the government and the opposition is how the current reserves of the central bank are used,” consultancy Fundacion Mediterranea said in a note.

“The opposition does not want the current administration to leave the central bank with very few reserves, and it is convenient for the government that the proposals announced by the opposition are reasonable for the markets.”

The central bank, which is nominally independent but has long been prone to executive interference, has about $66 billion in reserves, of which about $20 billion are free resources that can used to pay debt and stabilize the peso, according to an Argentine government official. Since Sunday’s vote, the central bank has auctioned a total of $503 million.

After losing about a quarter of its value in the first three days of the week, the peso has since stabilized. On Friday morning it was up over 2% at 56.25 pesos per U.S. dollar, giving policymakers a bit of breathing room.

The peso’s collapse, which comes amid growing fears of a global recession, forced the central bank to sell dollars and oblige private banks to trim their dollar holdings and provide liquidity to the market.

Macri announced on Thursday that sales taxes of around 21 percent on basic foodstuffs would be axed until the end of the year to soften the impact of an International Monetary Fund-backed austerity program on the poor. The government estimated the sales tax freeze will cost about 10 billion pesos ($174.2 million).

The shelving of the taxes was the boldest in a series of fiscal loosening measures totaling hundreds of millions of dollars that Macri has unveiled since the primary vote as he seeks to salvage his re-election bid and breathe some life into the recession-battered economy.

But it was also an awkward about-turn for a president who took office in 2015 vowing to slash public subsidies and to correct what he called years of leftist economic mismanagement.

Argentine over-the-counter sovereign bonds rose an average of 1.6% on Friday, traders said, while the Merval stock index was up over 1%.

In a client note, Citi said Macri will want the central bank to continue using reserves to defend the peso. A further collapse of the currency could be the final nail in his re-election chances.

“Fernandez is the big favorite to win the elections. But with Macri and Fernandez still in campaign mode, the transition will be difficult, with little incentive to calm the markets,” Citi said in a note. “Macri has an incentive to continue intervening to stabilize the peso.”

That leaves Fernandez in a bind, relying on a Macri-controlled central bank to deliver him a country with both healthy reserves and a healthy currency. As such, some analysts suggested he could lessen his reliance on the central bank by doing a better job of communicating with investors.

“The initial signals (from Fernandez) have all been worrisome with no apparent understanding of basic economic principles through the populist campaign rhetoric and no sensitivity to the recent financial stress,” Amherst Pierpont Securities said in a note.

($1=57.15 pesos) (Writing by Gabriel Stargardter; Editing by Hugh Bronstein and Alistair Bell)

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