September 21, 2018 / 3:43 PM / 3 months ago

UPDATE 2-Argentine peso rises on optimism over IMF deal, challenges remain

(Adds analysts comments, economic and policy context)

By Hugh Bronstein and Jorge Otaola

BUENOS AIRES, Sept 21 (Reuters) - Argentina’s peso strengthened for the third straight day on Friday, driven by optimism that the government would sign a revised financing deal with the International Monetary Fund to include stricter fiscal measures and faster cash disbursements.

But with the economy shrinking, inflation rising and the president facing opposition to budget cuts ahead of his 2019 re-election campaign, analysts said the peso would remain unstable over the months ahead.

The currency rose 2.6 percent to close at 37.28 per U.S. dollar on Friday, benefiting from dollar inflows as investors piled into Treasury notes offered this week at interest rates about 50 percent. The peso gained 6.95 percent since Monday, after losing about half its value so far this year.

While giving an immediate boost to the currency, paying 50 percent interest rates will be an added expense for a government already struggling to cuts its fiscal deficit.

“The peso has definitely not touched bottom,” said Martin Guzman, an economist at Columbia University Business School.

“Inflation will lead to further depreciation of the nominal exchange rate. The fiscal budget presented by the government assumes that in 2019 the nominal exchange rate will stabilize at the current value, but that’s unrealistic,” Guzman said.

The peso sell-off started in May, driven by doubts about the central bank’s ability to roll over its growing stock of short-term ‘Lebac’ notes. The economy has since slipped into recession, with inflation at more than 34 percent.

Argentine authorities have agreed with the IMF to reduce the amount of outstanding Lebac debt and to slash the primary fiscal deficit to zero in 2019 from an estimated 2.6 percent of gross domestic product in this year.

Last month, President Mauricio Macri was forced by the sinking peso to renegotiate the $50 billion IMF standby deal he signed in June. The Fund said this week that “important progress” was being made in the talks and that it wants the revamped financing agreement to be signed “in short order.”

On Monday the government unveiled its 2019 budget bill, offering additional spending cuts and tax hikes as the path to fiscal equilibrium.

Macri is expected to run for a second term next year and getting his spending cuts through Congress will be “an enormous challenge”, Sebastian Briozzo, who analyses Argentina for Standard & Poor’s, told Reuters.

Macri took office in late 2015 and swiftly ditched the heavy-handed currency controls favored by his populist predecessor Cristina Fernandez. He promised that his orthodox policies would put and end to the cyclical financial crises that have bedeviled Argentina over the last 60 years.

The last meltdown of Latin America’s No. 3 economy, in 2002, tossed millions of middle-class Argentines into poverty.

Macri has cut public utility subsidies as part of his fiscal push. This has saved the government money but also contributed to inflation by pushing household electricity bills higher. More subsidy reductions are expected before the end of the year, which will further jack up utility rates paid by consumers.

“The Argentine pocketbook has not yet felt the ramifications of the utility rate hikes that kick in over the next two to three months,” said Daniel Osorio, head of consultancy Andean Capital Advisors.

“This latest Argentine saga, sadly, is far from over.”

Additional reporting by Gabriel Burin and Walter Bianchi; Editing by Clive McKeef

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