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BUENOS AIRES/NEW YORK (Reuters) - The surprise decision by benchmark investment index provider MSCI to not promote Argentina to its emerging markets stock index could delay much-needed investment in the country, showing that President Mauricio Macri's reform agenda is still far from complete, investors said on Wednesday.
Many funds use the MSCI benchmark stock and bond markets indices as guides for allocating investments into emerging markets.
Argentina's benchmark Merval stock index .MERV rose nearly 25 percent in 2017 as traders bet on the inclusion of the country's stocks in the benchmark index, a move which could have triggered close to $2 billion in additional capital inflows.
The decision was also a blow to Argentine companies hoping for more liquidity in their equities market to raise funds.
"The real damage that the MSCI's decision may cause is the delay of IPOs and investments," said Fausto Spotorno, economist at Buenos Aires consultancy Orlando Ferreres.
The Merval index slumped 4.8 percent on Wednesday, its steepest drop this year, while the Argentine peso currency ARS=RASL fell as much as 2.0 percent to a record low 16.48 per U.S. dollar.
President Macri declared Argentina open for business after a decade of interventionist rule scared away foreign investors but progress has been uneven since he took office 18 months ago.
MSCI's decision underlined how Macri has struggled to lure private investments crucial to boosting a sluggish economy and to pass market-friendly legislation which has stalled in the opposition-controlled congress.
Key among those bills is a capital markets reform which the administration proposed last year and which would undo measures allowing the market regulator wide leeway to intervene in company affairs.
The legislation would also allow licensed wealth managers to invest Argentine citizens' funds in overseas assets, as well as lowering some taxes.
"The local market is still hard to access," said Asha Mehta, senior portfolio manager at Acadian Asset Management in Boston. "It's costly. I consider the capital gains tax environment in Argentina to be prohibitive."
Argentine Finance Minister Luis Caputo has said Congress could approve the reform this year, and local media have reported that the CNV securities regulator is mulling a decree that would accomplish some of the reform's aims. A spokeswomen for the CNV said she had no information about a possible decree.
Shortly after taking office in December 2015, Macri got rid of the most glaring distortions put in place by his populist predecessor Cristina Fernandez, including capital controls and foreign exchange restrictions. The capital controls were cited by MSCI in 2009 as the reason for downgrading Argentina to "frontier" market status in the first place.
A surprise $2.75 billion sale of 100-year bonds on Monday, which was more than three times oversubscribed, reflected improving investor confidence in Macri, but foreign direct investment has been slower to come, with many eyeing midterm elections in October and a presidential vote in 2019 for signs of the longevity of Macri's reforms.
Similarly, MSCI said it needed more signs that the changes were "irreversible" to reincorporate the country's shares into its emerging markets index .MSCIEF, which guides major developing country stock allocations worldwide by investment funds.
Still, investors said the MSCI decision did not change fundamental optimism about Argentina, where the economy is expected to grow around 3.0 percent this year after falling 2.3 percent in 2016, and inflation is seen at half last year's 40 percent.
Data published on Wednesday afternoon showed the Argentine economy grew 0.3 percent in the first quarter of 2017 versus the same period the prior year, snapping three straight quarters of year-on-year declines.
"It probably makes us a bit more negative in the very short term, but in the long term what we're focused on is the direction of the reforms," said Leigh Innes, lead portfolio specialist for frontier markets strategy at T Rowe Price.
Additional reporting by Trevor Hunnicutt and Caroline Valetkevich in New York, Bruno Federowski in Sao Paulo, Jorge Otaola in Buenos Aires and Michelle Price in Hong Kong; Writing by Luc Cohen; Editing by Christian Plumb