Argentina's stock market finally posted a solid rally on Tuesday after a week of sickening swoons. But ripples from the country's economic crisis will continue washing up on other regional economies even well after its presidential election in October.

And a change of guards might not do much to restore confidence in a nation that has $3 billion in refinancing needs and an economy that is expected to contract for the next year and a half.

Even as Argentine Economy Minister Roque Fernandez told local press that Monday's 8.7% plunge in the benchmark MerVal stock index "did not reflect the real economic situation, which is solid," traders in Brazil were biting their fingernails over the prospect of more trouble for a region already hammered by devaluations.

Argentina's Swooning Stocks
MerVal from June 1 through July 12
Source: Baseline.

At one point today, Brazil's benchmark Bovespa fell more than 1% (although it later recovered) as traders scrambled over each other to take money out of the country.

"The political rhetoric, as well as the country's financing needs of $3 billion this year, will continue to sway the market until the elections are over," said Upender Rao, Latin American corporate strategist for Conseco Capital Management.

Particularly troubling to international investors: concern that the continued erosion of President Carlos Menem's power will postpone much-needed economic reforms

The reforms include legislation to limit government debt levels and create transparency of budgeting, reduction of provincial taxes, deregulation of telecommunications and other key industries and restructuring of union-industry negotiation practices.

The government, analysts note, now has the unenviable task of raising more money while keeping a lid on taxes. Its last attempt, a vehicle tax, ended in failure last Thursday when the government backed off after truckers went on strike. The fiasco sent the market skidding on Friday.

"These small points of volatility are an indication that the administration is not strong on fiscal discipline," says Riordan Roett, professor of Latin American studies at Johns Hopkins University School of Advanced International Studies and board member of six Salomon Brothers asset management funds.

The government's forecasting credibility is also on the line. A 3.5% shrinkage in GDP is more likely than the 1.5% contraction forecast by the government, says Pedro Lacoste, an independent political consultant based in Buenos Aires.

Recent figures released by the government itself bolster Lacoste's prediction. Industrial production fell 10.2% year on year in May; GDP fell 3% in the first quarter. Even Fernandez, the economics minister, admitted in June that the economy wouldn't produce growth until sometime next year.

All this could mean trouble for investors in an interconnected region. Moody's attributes Argentina's crisis, in part, to low growth in Brazil and weak global commodity prices.

A renewed regional crisis, of course, could cause an increase in the cost of debt financing and provoke capital flight across the continent.

Observers say that if Argentina sticks to the terms of its 1991 Convertibility Plan, which pegs the country's peso to the U.S. dollar, the transition period will be relatively brief.

"Although the situation appears grim, Argentina can survive the crisis if it fully adheres to the Convertibility Plan," says Walter Molano, head of economics and research at BCP Securities. "The key question is whether Argentine society will be patient enough to sustain such a painful adjustment."

Given the current political banter between the presidential candidates, it seems unlikely that anyone, particularly those who will be vacating their positions in the next six months, will be willing to tackle the difficult and long-term reforms that must come before the elections.

International Monetary Fund funding, either in the form of a rescue package or in extended credit facilities, could make adherence the Convertibility Plan less traumatic, as long as the usual conditions of fiscal rectitude are suspended.

"The IMF will swallow its pride and provide additional funds prior to the elections," predicts Molano. The IMF will do this to avoid the impression that it is favoring either the lame-duck government or any of the candidates, Molano says. That will avoid a default in a major Latin American country and a major shock to the region.

Until the IMF extends such an offer, however, international investors should expect to see storm waves in the MerVal and ripples on neighboring exchanges.

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