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Argentina Raises Key Rate to 40%, Bringing Economic Uncertainty

May 4, 2018

The global economic backdrop was also changing. With the United States economy on solid footing, its short-term interest rates are rising. That puts upward pressure on the United States dollar, and also resulted in a slide for the peso. That decline in the peso has accelerated in recent days, as foreign investors began to see their returns vaporized by the falling currency.

More people moved to the exits, in part related to a new income tax on foreign investors. And as they began to pull out en masse, Argentina was suddenly facing a currency run.

Governments have a few tools they can use to stem the outflows of capital. One of them is to sharply raise interest rates. Those higher rates translate into potentially stronger returns for investors. As such, they can attract money into an economy, which helps to prop up a currency.

Argentina Raises Key Rate to 40%, Bringing Economic UncertaintyArgentina Raises Key Rate to 40%, Bringing Economic Uncertainty

But it’s a tricky play to pull off.

Brazil raised interest rates sharply to stop an outflow of capital in the late 1990s, ultimately pushing benchmark interest rates to roughly 40 percent. More recently, in 2014, Turkey suddenly ratcheted a key central bank rate from 4.5 percent to 10 percent, in order to stop a sell-off in the lira.

That same year, the Central Bank of Russia pushed interest rates sharply higher — from 10.5 percent to 17 percent — to keep the ruble from collapsing in response to sanctions over the annexation of Crimea and a sharp drop in oil prices. Russia also has one of the biggest interest-rate jumps on record, when in 1998 it rates reached 150 percent in an effort to try to stem another impending collapse of the ruble.

But high interest rates have economic costs. They makes it particularly difficult for businesses and consumer to borrow money. The lack of spending, in turn, can slow growth, and can ultimately spark a recession.

The key for Argentina will be to keep rates high just long enough to inspire confidence that policymakers have halted the currency run, but not so long that it drains the economy.

“This was done in order to stop the bleeding. It’s like you have someone in the E.R. You need to take very short-term, bold decisions, ” said Mr. Gersztein, of BNP Paribas. “Then once you stabilize the patient, you need to take different decisions in order to make the patient get better and recover.”

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