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Managing the Financial Crisis: Argentina 2002

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Capital Flow s and Economic Activity (Accumulated 4 quarters - U$Sm. GDP Cyclical Component) ... ST Bills (LEBAC) was actively developed, initially with 7 days ... – PowerPoint PPT presentation

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Title: Managing the Financial Crisis: Argentina 2002


1
Managing the Financial Crisis Argentina (2002)
  • Mario I. Blejer
  • Director
  • Centre for Central Banking Studies
  • Bank of England

2
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3
Managing the crisis
  • Assess the Nature and the Root Causes of the
    Crisis
  • Define the Tradeoffs
  • Define and Operational Strategy
  • Persevere in the Implementation
  • Learn some Lessons

4
The Nature of the Argentina Crisis
  • The Argentine crisis was both a CURRENCY and a
    BANK crisis Inter-related but caused by a
    combination of different factors. Analytically,
    better to distinguish between them in an explicit
    manner.
  • The third crisis, the DEBT crisis embodied in
    the larger sovereign DEFAULT in history is
    closely related to the other two.

5
THE CURRENCY CRISIS
  • The Currency Crisis reached its peak with the
    January 2002 devaluation. It is usually analyzed
    in the context of the ARGENTINE CURRENCY BOARD
    SYSTEM, established in 1991 as an
    anti-inflationary devise.
  • The question to be analyzed is
    What were the
    weaknesses and the main causes for the demise of
    the convertibility regime?

6
  • THREE APPROACHES
  • 1. The loss of competitiveness of the Argentine
    economy
  • 2. Macroeconomic policy inconsistencies
  • 3. The Sudden Stop argument

7
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8
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9
The Trade Account (in current prices)
10
The Trade Account (in current prices)
11
Fiscal DeficitsArgentina 1975-2001
Convertibility Period
12
The Use of Privatization Receipts to Reduce the
Deficit
Privatization Revenue
Total Deficit
13
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14
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15
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16
Capital Flow s and Economic Activity
(Accumulated 4 quarters - USm. GDP Cyclical
Component)
Capital Flows Private Sector
8
15.000
10.000
6
5.000
4
0
2
-5.000
0
-10.000
-2
-15.000
-4
-20.000
Russian Crisis
GDP Growth
-6
-25.000
-8
-30.000
-10
-35.000
IV 94
IV 95
IV 96
IV 98
IV 01
IV 97
IV. 99
IV. 00
17
Sudden Stops in Argentina and Chile (Private
Capital Flows, Percentage of GDP
4
8
7
3
6
2
5
Argentina
4
Argentina
Chile
1
3
0
2
1
-1
Chile
0
-2
-1
1998-I
1999-I
2000-I
2001-I
1998-II
1999-II
2000-II
2001-II
1998-III
1999-III
2000-III
1999-V
1998-IV
2000-IV
18
Economic Activity GDP and Investments (1998.II10
0)
GDP
Investment
105
107
100
105
95
Chile
Chile
103
90
101
85
80
99
75
97
70
Argentina
Argentina
95
65
60
93
1999.I
2000.I
1998.II
1999.II
2000.II
2001.II
1998.II
1999.II
2000.II
2001. I
2001.II
1998.IV
1999.IV
2000.IV
1998.III
1998.IV
1999.III
1999.IV
2000.III
2000.IV
2001.III
19
Financial Vulnerabilities to Capital Flows
Reversals
Brasil
Chile
Argentina
Public Debt ( of GDP)
Public Sector External Unhedged Exposure
Private Sector External Unhedged Exposure
Banking Sector Exposure To the Public Sector
High Vulnerability
Medium Vulnerability
Low Vulnerability
20
  • THE BANKING CRISIS
  • While the problems of convertibility and the
    consequent exchange rate uncertainty played a
    role, the banking crisis was largely caused by
    the government abuse of the banking sector,
    given its inability to to adjust the budget
    deficit

21
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22
Credit to Private Sector
23
  • The main cause for the banking crisis was the
    fear was that banks would be rendered insolvent
    by government policy and that deposits would be
    confiscated.
  • An important reason behind this fear was the fact
    that private sector assets were being displaced
    by public sector assets in banks balance sheets.

24
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25
  • The increasing banking exposure to the public
    sector was accompanied by
  • 1. a rapid decrease in deposits and
  • 2. a sharp increase in country risk

26
EMBI Index Public Sector Loans / Net Worth ()
Private Deposists - Index Dec 00 100
(2nd axis)
27
  • November 2001withdrawal restrictions on bank
    deposits (corralito).
  • December 2001 Riots the De la Rua and Cavallo
    government.
  • First two weeks of January 2002
    --public debt default

    --currency board is abandoned and the currency
    devalued
    --bank assets and
    liabilities are pesified asymmetrically - i.e.
    at different rates

28
The abandonment of the currency board was
traumatic
  • -- Complete loss of confidence in the banks, the
    currency, and the government
  • -- Continuous bank run
  • -- A run on the peso that pressured strongly the
    exchange rate
  • -- No money market or debt instruments for open
    market operations

29
The Tradeoffs and The dilemma for the central bank
  • Having regained the LOLR function the CB could
    provide the liquidity needed to finance the bank
    run. Pesos would fly to the exchange market
    risk of hyperdevaluation and hyperinflation.
  • OR

30
  • The CB could restrain the rediscount facility and
    let banks deal with the deposit run. May prevent
    hyperinflation, at the risk of the total collapse
    of the banking sector.

31
  • Only feasible intermediate solution
  • slow the pace of the bank run
  • and, at the same time, try to avoid excessive
    liquidity expansion.

32
The Strategy Followed
  • -- Provide liquidity support to banks to prevent
    massive bank closures.
  • -- Develop sterilization instruments at the
    Central Bank --the LEBAC-- to mop up liquidity
    and to compete with the US.
  • -- Utilize part of CB reserves to intervene in
    the foreign exchange market to slow the pace of
    depreciation and to avoid chaotic conditions.

33
  • Choice of Foreign Exchange Market Strategy
  • high interest rates
  • vs.
  • FE market intervention
  • substitutes or complements?

34
  • persevere to the point where
  • greed gt panic

35
4. Implementation
36
The central bank provided rediscounts to illiquid
banks and financed about 1/3 of the deposit drop
37
  • The market for Central Bank ST Bills (LEBAC) was
    actively developed, initially with 7 days
    maturities and then with 14 and 28 days, in Pesos
    and US. Interest rates reached 140 initially.

38
  • Intervention in the foreign exchange market
    prevented disorderly behavior but did not peg the
    rate, that devalued from 1 to 3.6 Pesos per
    Dollar. Intervention in the first five months was
    about US 2 bn.

39
Initially deposit withdrawals continued
40
However, the trend reversed after four months
41
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42
  • The need for the provision of liquidity from the
    Central Bank where largely reduced

43
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44
  • The demand for LEBACs grew strongly.
  • -- LEBACs with up to one year maturities were
    introduced successfully.
  • -- By October interest rate has fallen to 8-45
    range, according to maturities.

45
Decrease of average cost and duration of LEBACs
46
  • The exchange rate stabilized and started to
    appreciate. The CB has stopped selling and is
    actively buying reserves to prevent a large
    appreciation in the exchange rate.
  • In total the CB has regained, in a few months,
    all the initial stock of intervention

47
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48
The stabilization of the exchange rate has also
resulted in a sharp decline in level of inflation
49
Total GDPQuarterly Seasonally Adjusted
50
Labor Demand
51
Consumers and Business CONFIDENCE
52
  • Indeed, as always,
    greed gt panic

53
  • 5. Lessons from the Crisis

54
  • The Potential Fragility of Financial Institutions
  • Experience indicate that solid and solvent
    financial structures could deteriorate quickly.
  • This is particularly true in the face of
    inadequate interventions, distorted incentives
    and misguided policies.

55
  • The fact is that weak financial sectors are not
    necessarily crisis prone. Financial crises have
    been generated, in many instances, by
    inconsistent policies and by an unstable
    macroeconomic environment.
  • In this context one need to rethink the emphasis
    put on the enforcement of conventional
    standards and codes vis-à-vis inappropriate
    policy actions.

56
  • 2. Financing the Public Sector and the Crowding
    Out Effect

57
The Financial System needs restructuring
Financial statements situation - Dec2001/Dec2002

180
160
Loans to Private Sector
140
120
100
45
17
80
60
54
21
40
20
0
Dec 01
Dec 02
Loans to
the Public Sector

58
  • 3. The Importance of Proper Liquidity Management
  • Availability of liquidity is a crucial element in
    the prevention and the management of financial
    crises
  • LOLR does not guarantee stability but its
    absence accelerates the erosion of confidence

59
  • 4. The Role of Foreign Banks
  • -- Do they reduce financial vulnerability?
  • -- Can they provide, implicitly, LOLR function?

60
  • The Currency Problem
  • Financial vulnerability arises from the publics
    reticence to use domestic currency as a store of
    value

61
  • -- Trade-off between shallow financial
    intermediation and financial dollarization and
    the risks of balance sheet mismatches
  • -- The original sin is not such but just a
    corollary of the currency problem

62
  • If full dollarization is not an option, the
    policy question to reduce vulnerabilities is how
    to solve the currency problem
  • -- Macroeconomic and Institutional credibility
    and in the transition Indexation
  • -- Pesification a la Argentina

63
  • 6. Capital Controls
  • Does capital account integration reduce financial
    vulnerability?
  • Long run desirability vs. short run,
    transitional, risks
  • Capital controls and crisis management
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