Oct. 22 (Bloomberg) -- Argentine stocks had their biggest two-day drop since 1990 and dollar bond yields topped 30 percent as a planned takeover of pension funds heightened concern the government is headed for its second default this decade.

The benchmark Merval stock index sank as much as 18 percent on speculation President Cristina Fernandez de Kirchner plans to use the funds' $29 billion to meet financing needs that have swelled as prices on the country's commodity exports tumbled. Argentina hasn't had access to international debt markets since its 2001 default and demand for its local bonds has dried up on concern the government is underreporting inflation.

``It's yet another unorthodox approach to trying to deal with the country's economic situation rather than taking the bitter medicine,'' said David Bessey, who manages more than $8 billion of emerging-market debt in Newark, New Jersey, for Prudential Financial Inc. ``It seems confiscatory.''

Yields on Argentina's 8.28 percent bonds due in 2033 surged 4.64 percentage points to 29.33 percent, after earlier climbing over 30 percent, according to JPMorgan Chase & Co. The bonds yielded 12.16 percent a month ago.

The price on the bonds, which were issued as part of a 2005 debt restructuring, dropped 5.61 cents today to 23.5 cents on the dollar after falling 7.8 cents yesterday. The benchmark Merval stock index ended the day down 10.1 percent, following an 11 percent slide yesterday.

Region-Wide Declines

``The state of panic has turned into a state of near- desperation,'' said Alejandro Bianchi, a portfolio manager with InvertirOnline, a Buenos Aires-based brokerage.

The rout in Argentine markets sparked declines across developing nations. Neighboring Brazil's currency, the real, sank 5.9 percent while South Africa's rand dropped 6.6 percent. The extra yield investors demand to own developing-nation debt swelled 83 basis points, or 0.83 percentage point, to 7.72 percentage points, the most since December 2002, according to JPMorgan's EMBI+ index.

Fernandez, 55, announced her plan to take over 10 private pension funds during a speech in Buenos Aires yesterday. She said the proposal would protect retirees from the global financial crisis and denied trying to ``grab the cash'' to pay off debt or to finance new programs or projects. The last time Argentina sought to tap workers' savings was in 2001, just before it halted payments on $95 billion of bonds.

``Tapping into the pension funds makes it blatantly obvious that it needs funds,'' said Aryam Vazquez, an emerging markets economist with Wells Fargo & Co. in New York. ``This is bad news any way you look at it.''

International Lawsuits

The government's proposal to take control of the funds, including units of London-based HSBC Holdings Plc and Bilbao, Spain-based Banco Bilbao Vizcaya Argentaria SA, needs congressional approval. Former President Carlos Menem created the private funds in 1994 to phase out the government's responsibility to support retirees.

Argentina's borrowing needs will swell to as much as $14 billion next year from $7 billion in 2008, RBC Capital Markets, a Toronto-based unit of Canada's largest bank, said yesterday.

Fernandez made a bid to regain access to international markets last month, instructing her economic aides to pursue a renegotiation with the creditors who rejected the country's 2005 payout of 30 cents for every dollar of defaulted debt.

Holders of about $20 billion of bonds turned down that 30- cent offer, which was the harshest sovereign restructuring since World War II, and many have filed lawsuits against Argentina.

`Cartoon Price'

The cost of protecting Argentina's bonds against default soared today. Five-year credit-default swaps based on Argentina's debt jumped 4.90 percentage points to 37.07 percentage points, according to Bloomberg data.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality.

Trading in Argentine default swaps has dried up as the cost has climbed, said Edwin Gutierrez, who manages about $5.5 billion of emerging-market debt, including Argentine bonds, for Aberdeen Asset Management Plc in London.

``It is a cartoon price,'' Gutierrez said. ``It just gets marked up and down accordingly.''

The peso was little changed today, sliding 0.2 percent to 3.2238 per dollar, as traders said the central bank sold dollars in the foreign exchange market to shore up the currency. A central bank spokesman didn't return a phone call seeking comment.

Economic Slump

About 55 percent of the 94.4 billion pesos held by the private pension funds is invested in Argentine government debt, according to the pension regulator's Web site. A takeover would allow the Fernandez administration to write off those bonds, said Javier Salvucci, an analyst with Buenos Aires-based Silver Cloud Advisors.

Nestor Kirchner, Fernandez's husband and predecessor as president, began tightening restrictions on private pension funds last year, requiring them to keep more investments in the country to sustain economic growth.

South America's second-biggest economy is faltering as the global financial crisis erodes demand for the country's wheat, soybean and corn exports. Commodities are down 43 percent from a record high in July, according to the UBS Bloomberg CMCI Index.

The slump was evident in August: Argentina's construction sector shrank while industrial output growth slowed.

Growth will weaken to 6.8 percent this year and 1 percent in 2009, JPMorgan forecasts. The economy grew 8.8 percent on average over the past five years, halting a recession that led to the 2001 default, as Kirchner and Fernandez used surging tax receipts to boost government spending.

`Much, Much Worse'

The government pressured the pension funds seven years ago to participate in bond swaps that extended repayment dates in a failed bid to stave off default. Strapped for cash to pay salaries, the government also ordered the funds to transfer $3.2 billion in bank deposits that December to state-owned Banco de la Nacion.

Fernandez's move is ``much, much worse,'' said Paul McNamara, who helps manage $1.2 billion of emerging-market assets at Augustus Asset Managers Ltd. in London. ``It's not just shoving a little bit of debt in at the edge, it's taking over the whole system.''

To contact the reporters on this story: James Attwood in Santiago at jattwood3@bloomberg.netDrew Benson in Buenos Aires at Abenson9@bloomberg.net

Last Updated: October 22, 2008 16:58 EDT