Two exchange rates, still one big problem

Argentina's latest president Eduardo Duhalde faces the almost impossible task of restoring the country's economy to health while holding on to his wobbly political base.

This weekend's economic plan attempts to square that circle. The president finally confirmed what the markets have been expecting for months - Argentina's 10-year one-to-one lock between the peso and the dollar is over.

To shield the country's rapidly dwindling middle classes from further impoverishment, the government has promised that existing dollar loans will be converted to pesos at the current rate. That decision effectively transfers the cost of the devaluation from consumers to the banking system - while households will be able to pay their debts in pesos, banks still have to service expensive foreign loans.

The banks have estimated their losses from the measure will be $10-20bn. To compensate them, the government has promised to set up a fund using a tax on oil exporters, but analysts warn that the surcharge will have to be substantial to provide enough money to bail out the banks.

With no money in its coffers, Buenos Aires may be hoping that the International Monetary Fund will provide support for its overstretched banking system. The government is officially in default on its $140bn public debt, but it may try to repay the IMF, to stay on good terms with it.

The signals from Washington yesterday were not encouraging. IMF director Horst Köhler said the onus was on Argentina to resolve a "home grown" problem, though he said he was ready to work with the new government.

The second threat to Mr Duhalde's plan is whether the new dollar-peso peg is sustainable. Exchange controls will continue to prevent open trading of the peso in the short term, but the IMF would prefer to see the currency floating freely, and Buenos Aires has promised to remove controls on the peso in four or five months.

On the shadow peso market yesterday, traders were anticipating a sharp fall in the peso by the year's end. "The market doesn't expect the peso to be a freely floating currency, but to be a freely sinking one," said Nick Parsons, currency strategist at Commerzbank.

A collapse in the peso will push up the price of foreign imports and could cause a widespread rise in basic goods and services. The government has promised price caps to prevent an inflationary spiral but they will be hard to police and many Argentines fear a return to the hyperinflation of the 1970s and 80s.

The final conundrum is how plans for the new dual currency system will work. Other countries which have experimented with two exchange rates have found them unsustainable in the long term. In the short term they are usually an invitation to fraud - encouraging firms to over- and under-invoice on exports and imports in order to obtain a more competitive exchange rate.

The best hope for the country is that the devaluation will spur a return to growth of the sort Britain experienced after sterling crashed out of the exchange rate mechanism in 1992. In a relatively closed economy, such as Argentina's, exports have less chance of acting as motor for growth. Argentina's agony does not yet appear to be over.