The fallout from the financial crisis in Argentina continued to be felt around the world yesterday, with fears growing that the South American country will be forced to default on its $128 billion in foreign debt, and that all of Latin America could be engulfed in economic turmoil.
The worldwide rush out of emerging markets' currencies helped propel the euro upwards on Wednesday from the eight-month low it hit against the US dollar on Friday, although it eased back yesterday from 86.13 cents to 85.22. Shares rose on Wall Street and on European stock markets yesterday partly because global investors were seeking safe havens, analysts said.
Treasury markets also went up because of a "flight to quality" as the contagion effect of the Argentinian crisis threatened the world economy, said Jeff Dennis, Latin America analyst at Solomon Smith Barney in New York. The risk was default rather than devaluation, he said, adding, "we don't expect it but that is where the pressure point is".
The contagion effect of the Argentina crisis is already being felt acutely in neighbouring Brazil, the largest recipient of foreign investment with $30 billion flowing in last year, and to a lesser extent in Chile and Mexico, and it has spooked markets as far away as Taiwan, Russia and Turkey.
For the second day yesterday the Brazilian real fell to a record low against the US dollar. The Colombian peso also slipped against the greenback, with one trader in Bogota reported as saying, "People are scared stiff by Argentina".
Many European banks and American financial institutions are exposed in both Argentina and Brazil. US banks' exposure to Argentina at the end of March amounted to $11.7 billion and in Brazil to $24.3 billion.
The world weathered financial crises in Asia and Russia in the last five years but this time observers worry that the global economy is much weaker because of a slowdown in the European Union and in the United States, where a decade-long boom has flattened out.
In Buenos Aires stocks fell sharply yesterday after Argentinian President Fernando De la Rua's proposed spending cuts and other economic measures designed to reduce the deficit. The Merval Index of leading shares plunged 12 per cent to 298.38 points in early trading while the broader General Index plummeted 4 per cent.
"Our current situation is impossible to sustain," said President De La Rua in a televised address in which he promised to curb state salaries and pensions while protecting social programmes and employment. Argentina's economy Minister Domingo Cavallo said the country could no longer run up debt at the double-digit interest rates paid this week in a Treasury bill auction. Argentina had to pay 14 per cent interest rates to sell $828 million in three-month bills.
This proved to be a catalyst in the crisis, signalling that the market was unwilling to fund the debt until Argentina began to live within its means, said Jose Luis Daza, head of emerging markets research at Deutsche Banc Alex Brown.
The International Monetary Fund has said Argentina must keep its fiscal deficit to $6.5 billion this year. However, the premium Argentina must offer over safe-haven US Treasuries in order to attract investors to its debt instruments has now risen higher than that of Ecuador which defaulted on its debt in 1999. It stands at 1,470 basis points, compared to 1,441 in Ecuador, according to JP Morgan's EMBI index.
The economy in Mexico, with its close ties to the United States, is considered immune from the crisis in Latin America, but the Mexican peso slipped against the US dollar in the last two days as worries about the crisis spread.
