Argentine inflation spike shows clock is ticking for Sergio Massa

Argentina's surge in inflation last month shows the magnitude of the challenge facing new Economy Minister Sergio Massa and threatens to halt the rally that the country's dollar bonds have experienced since his appointment.

Consumer prices rose 78.5 percent in August from a year earlier, the biggest increase in three decades, as the government prints money to finance spending. That prompted the Central Bank last Thursday to raise its key interest rate by 5.5 percentage points to 75 percent, leaving the economy at greater risk of recession.

While some fear that inflation will be in the triple digits by end of the year, pressure is growing on Massa to control fiscal spending. He has said he will meet the 1.9 percent primary deficit spending target set in the US$44-billion programme with the International Monetary Fund.

"It's clear he received a political mandate to do whatever it takes to prevent a time bomb from going off," said Gorky Urquieta, an investor at Neuberger Berman, whose firm holds about US$25 billion in emerging market debt. But "are we going to see a complete turn to an orthodox government? No."

Argentine dollar bonds maturing in 2030 rose from their lows after Massa's appointment in late July, but soon pared gains and have traded around 25 cents on the dollar. The nation's debt is still down more than 26 percent on average this year, according to data compiled from a Bloomberg index, and is among the worst performers in the region, better only than Ecuador and El Salvador.

The country's foreign currency reserves shortage also led the government to temporarily devalue the exchange rate for soybean exporters in September in an attempt to attract more dollars. The official exchange rate currently stands at 143 to the dollar, while the contado con liquidación, or spot rate – an implicit exchange rate based on the difference in prices between shares traded in Argentina and in markets abroad – is 297 to the dollar.

Although risks are growing in Argentina, there are still some bulls. Since taking office, Massa has assured investors and the IMF that he is committed to lowering inflation. Keeping rates above inflation is also a key pillar of the Fund's programme with the country, which has defaulted on its international obligations nine times in just over 200 years since independence.

Oxford Economics Ltd has a "strong overweight" on Argentina given the view that a peso devaluation will be necessary to stem dollar flight, boost reserves and avoid a full-blown default.

"The new economy minister faces enormous challenges in restoring financial stability," the firm's analysts wrote. "But we believe a peso devaluation (of around 10 percent) is likely, which would contain the risk of default."