Argentina’s peso is poised to extend losses after the government devalued the currency 12.7 percent in a bid to arrest a decline in foreign reserves.

The devaluation, the biggest since 2002, marked the latest effort by President Cristina Fernandez de Kirchner to shore up an economy buffeted by inflation running at an estimated 28.4 percent and falling reserves. Without a broader policy change to bolster confidence by restraining spending and raising interest rates, the peso is likely to depreciate further, according to Eurasia Group Ltd and JPMorgan Chase & Co.

“Argentina is ‘biting the bullet’ but without a full set of teeth,” Vladimir Werning, an economist at JPMorgan, wrote in a report yesterday. “Insufficient interest rate or fiscal adjustment leaves the devaluation vulnerable to generating more inflation pass-through than achieving real competitiveness gains the government desires.”

The peso dropped as much as 16.5 percent over the last two days to 8.2435 against the U.S. dollar before the central bank intervened in the market by selling $100 million. The move helped trim yesterday’s losses to 9.4 percent from the central bank’s closing price Jan. 22, the biggest daily decline since the financial crisis that followed the country’s record $95 billion default in late 2001. The peso closed at 7.8825 per dollar, and changed hands in the illegal street market at 13.06 pesos per dollar, according to Buenos Aires daily Ambito Financiero, which tracks the rate.

“If the bank hadn’t stepped in I don’t know where it would have gone -- surely 10 or 11,” said Francisco Diaz Mayer, a currency trader at ABC Mercado de Cambio in Buenos Aires.

Steepest Decline

The central bank has spent a net of $5.9 billion in the last year to control the peso’s decline. This year, the peso has weakened 17 percent against the U.S. dollar, more than any currency in the world. In the same period of 2013, the peso weakened 0.95 percent.

The central bank didn’t sell dollars on Jan. 22, allowing the peso to decline 3.6 percent, according to the bank’s prices.

Cabinet Chief Jorge Capitanich told reporters yesterday the government was allowing the market, which is mostly closed to buyers of dollars, to adjust prices.

“It wasn’t a devaluation induced by the state,” Capitanich said. “For the lovers of free markets, supply and demand was expressed in the capital markets.”

Government dollar bonds tumbled an average 3.8 percent yesterday, bringing the year-to-date losses to 10.5 percent, according to JPMorgan Chase & Co. That’s the worst among more than 50 emerging market economies.

Energy Deficit

Reserves have tumbled at a rate of $1.1 billion a month over the past year to a seven-year low of $29.3 billion. Energy imports increased 23 percent to $11.4 billion in 2013 while exports fell 24 percent to $5.3 billion. Argentine tourists traveling abroad spent $630 million more than foreign visitors to Argentina in the first 11 months of last year.

In the first three quarters of 2013, the nation posted a current account deficit of $1.27 billion, the largest for that period since its economic crisis.

Since 2010, Fernandez has used central bank funds to pay foreign debt. Argentina, which remains locked out of capital markets as it battles owners of defaulted bonds in U.S. courts, has set aside a record $9.9 billion to pay foreign debt obligations in this year’s budget.

Since her re-election in 2011, Fernandez has restricted access to foreign currency, including a ban on most dollar purchases by individuals, to stem capital outflows and shore up reserves.

Shrinking Surplus

Argentina’s trade surplus narrowed 27 percent to $9 billion in 2013 as fuel imports rose and soy prices dropped 28 percent, while producers withheld stocks of the oilseed waiting for the peso to weaken further.

The government may allow the peso to decline more in coming days, said Hernan Yellati, head of research at BancTrust & Co.

“I don’t think that level is written in stone, 8 pesos per dollar,” Yellati said in a telephone interview from Miami. “It is the exchange rate that’s going to prevail only for now. Tomorrow maybe the central bank is going to withdraw again.”

While devaluing the peso will accelerate inflation and curb growth in the short-term it will close the gap between the two exchange rates and shore up reserves, said Eric Ritondale, senior economist at Buenos Aires-based research company Econviews, who expects the economy to contract in the first quarter as purchasing power weakens due to declining salaries.

Inflation Disparity

Annual inflation quickened to 28.4 percent in December, according to private estimates published by opposition lawmakers. Inflation was 11 percent, according to the government, which plans to introduce a new index next month after being censured by the International Monetary Fund for misreporting economic data.

“It’s better to do this now than never,” Ritondale said in a phone interview. “In the medium term this will have a positive effect.”

It’s key that the central bank complement the devaluation with an increase in short-term interest rates to boost demand for the peso, said Jorge Mariscal, regional chief investment officer for emerging markets at UBS Wealth Management. Argentina’s benchmark deposit rate, known as the badlar, has fallen 0.62 percentage points this year to 21 percent.

“This is what the forces of supply and demand have been asking for some time, so the depreciation of the exchange rate in Argentina is part of the beginning of the solution.” Mariscal, whose firm oversees $968 billion, said in a telephone interview from Washington. “It will really test the skills and independence of the central bank preventing this from becoming a downward spiral.”

Bloomberg