THE ARGENTINE CRISIS

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THE ARGENTINE CRISIS

• International Finance
• Dr. Michel Henry Bouchet
• Group 1

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1.The causes of economic collapse

• Fiscal weakness. The unsustainable growth of
  public debt.
• Weak institutions and political instability.
• The growing REER imbalance. Convertibility and
  external shocks.

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The Argentine economy during Convertibility
1992/98 1999/2001 real GDP 5,21
-2,77 inflation 4,50
-1,33 unemployment 12,60 15,60 public deficit
0,80 2,76

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The fiscal problem

• According to official data, debt/GDP grows
  gradually after 1993 and speeds up remarkably
  after 1998.
• Official figures underestimate debt during the
  first half of the 90s. Hence, effective debt
  growth in the period was smaller. Moreover, part
  of the debt after 1995 reflects the reform in the
  pension system.

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The primary surplus prevents debt from getting
out of control until 1998. Since then, debt
dynamic became unsustainable. The primary balance
remains stable during the whole period. Indeed,
what changes after 1998 is growth and interest
rates. The deepening recession, coupled with
deflation and increasing interest rates cause
fiscal unsustainability.
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Why did Convertibility fail?

• Monetary discipline does not guarantee fiscal
  discipline, at least as long as there is access
  to capital markets.
• The labor market was not sufficiently flexible to
  facilitate deflation without recession.
• Argentina suffered considerable foreign shocks,
  in particular, the Russian crisis which caused a
  sudden and persistent change in investors risk
  perception with regard to emerging markets

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2. Some lessons from Argentina

• Exchange rate regimes
• Hard pegs are extremely demanding. In particular
  they require price flexibility and very prudent
  fiscal policies. Otherwise it is better to float.
• The banking system and sovereign risk
• It is critical to isolate the private financial
  sector from sovereign risk. Solvent banks may
  suffer contagion from an insolvent sovereign. In
  Argentina doubts about sovereign solvency caused
  a bank run.
• Sovereign default would undermine banks assets.
  An eventual devaluation would boost NPL. Together
  with doubts about the solvency of public banks,
  this gave rise to

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Incorrect Pricing of Risk
During the year before the crisis, the loan loss
reserve ratio declined even though the ratio of
foreign-denominated loans to total loans
increased.
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3.The role of the IMF in Argentina

• During the 90s Argentina became the darling of
  the international community, especially the IMF.
  It was widely considered a model that other
  emerging economies should folow.
• The Fund actively monitored and supported
  Argentina during the whole decade.

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Anatomy of a Crisis

• The Fund supported the relatively strict macro
  policies and the structural reforms (financial
  liberalization, privatizations, reform of the
  pension system, etc.) implemented by Argentine
  authorities.
• At first, the IMF was somewhat skeptical about
  Convertibility. However, the ability of Argentina
  to weather the Tequila crisis appeared to
  convince the Fund staff.
• Despite the fast growth macroeconomic stability,
  a large part of the population did not benefit
  from the economic success during the 90s
  unemployment increased, poverty remained high and
  inequality was on the rise.

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• The summer of 1998 was a turning point for
  Argentina (Russia), but it did not require large
  multilateral assistance until the beginning of
  2000 (about US7billion from the Fund).
• However, the economic situation deteriorated
  further and a large package, el blindaje (US 7
  billion additional from the IMF and US 5 billion
  from the WB and the IDB) was approved in December
  2000.
• After an initial short period of apparent
  success, the program began to go off track due to
  the worse than expected performance of the
  economy.
• An additional augmentation of the program was
  approved in September 2001, but the economic
  situation continued to deteriorate and the
  targets could not be met.

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The Fund in Argentina today

• The behavior of the IMF in Argentina, on behalf
  of the international community, does not
  necessarily respond to a hard interpretation of
  the Prague framework.
• The unilateral breach of contracts by Argentina
  is yet to be corrected.
• Argentina has still to take some further measures
  to comply with the IMF prior actions
• The credibility of Argentine authorities has been
  undermined.
• Resources are limited. The IMF (as well as the
  WB and the IDB) has a large exposure to Argentina
  that they have a responsibility to carefully
  manage.
• However, both Argentina and the IFIs need to
  reach an agreement as soon as possible.

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Currency risks and fiscal deficits
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Argentine interest rates
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Dependence on BIS-bank creditors
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Vulnerabilities
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4. Dollarization

• The rise and fall of Argentinas currency board
• Good times financial deepening, increased
  financial dollarization, and RER exposure
• Bad times a currency-growth-debt (CGD) trap
• The meltdown anatomy of a currency run in a
  financially dollarized country
• A reappraisal of hard pegs (no discipline, quite
  reversible, prudential concerns, exit strategies)
• Refocus the exchange rate debate to the currency
  problem

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The Costs and Benefits Depend on Country
Circumstances

• Dollarization to consolidate a reform agenda
• El Salvador 2001 Argentina 1999?
• Dollarization as an element of crisis resolution
• Ecuador 2000 Argentina 2002?

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Devaluation and Default RiskArgentina
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Argentina 1999Dollarization, A missed
opportunity?

• Would Argentina have avoided crisis?
• Depends on preferred crisis explanation - see
  Powell 2002.
• Dollarization would have helped
• reducing devaluation risk/default risk
• increasing confidence/investment/growth
• Dollarization would not have helped
• problems of competitiveness
• fiscal problems not related to growth

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Would dollarization havebeen permanent?

• If dollarization had been perceived as permanent,
  had reduced default risk and enhanced fiscal
  sustainability sufficiently, then it would have
  been permanent!
• If dollarization had not been perceived as
  permanent or competitiveness problems had been
  paramount then it might not.
• A monetary treaty would have provided some
  incentives towards permanence

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Motives for DollarizationEl Salvador (2001)

• Locking in successful reforms
• Deeper trade and financial integration into US
  dollar area (?70 of trade with US or
  dollarized, remittances are ?15 of GDP)
• Lower interest rates but El Salvador was not
  highly dollarized previously, reduction in
  interest rates due to replacement of colon with
  dollar rates and wider credit availability

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Argentina 2002

• Authorities caught between
• political and economic costs of the financial
  system restrictions (el corralito).
• potential exchange rate instability and
  inflationary consequences if lifted
• Argentina cannot grow until this solved
• if solved without generating an inflationary
  spiral, it may be possible to create some
  monetary instruments and hence an independent
  monetary policy (a First Best).
• if not, Argentina will most likely have to
  reinvent Convertibility or Dollarize

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Conclusions

• Dollarization has been thought of in two ways
• to consolidate reforms deepen integration
• as crisis resolution.
• In the case of an El Salvador or Argentina
  (1999)
• the main costs are related to notions of
  sovereignty and (possibly) giving up future
  monetary policy
• the main immediate gain is lower interest rates
  especially in dollarized economies (Powell
  Sturzenegger).
• In the case of Ecuador dollarization helped to
  stabilise the financial system.
• Argentina 2002 dollarization should not be ruled
  out, otherwise it may very well still happen!