Argentina 2001-2009 From the financial crisis to the present Rosanna Zaza
An easy-to-read analysis of the 2001 Argentinaâ€™s crisis that summarizes a wide part of the 2001 crisisâ€™ economic literature. The book describes the causes of the 2001 crisis and its effect on the countryâ€™s economy; the economic, fiscal and monetary policies adopted by the Argentine governments from early 2002 to the present in order to recover from the devastating financial collapse and to boost the national economy. A final note on the present situation of the country in the midst of the recent global recession closes up the review.
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1 - The causes of the crisis The seeds of Argentina’s financial and political crisis were planted in the early 1990s with the adoption of the Convertibility Act and the setting of the Currency Board, a strategy conceived to fight the hyperinflation that plagued the country during the 1980’s by constraining long-term undisciplined monetary and fiscal governance. Before 1991, consumer prices in Argentina were raising at a rate of 200% per month, more than 5000% per year. The market had almost ceased to function and productivity declined. The Convertibility Law, passed in 1991, established the Argentine Currency Board charged with guaranteeing the convertibility of the Argentine peso with the U.S. dollar on a one-to-one parity. To ensure credibility of such regime, the government provided that each peso in circulation would have to be backed by a dollar (or similar hard currency) at the Central Bank level. The Currency Board’s monetary restriction effectively required a fiscal constraint because the government deficit had to be covered by debt rather than by printing money. Box 1 - The Currency Board and the 1-to-1 peso-U.S. dollar regime Unlike previous stabilisation plans, the convertibility was incorporated in an Act (the Convertibility Act) committing the central bank to exchange dollars for pesos at the fixed exchange rate. In addition, the Act required the central bank to hold liquid international reserves at its disposal that (almost) covered 100 per cent of base money. This central element of the Act prevented monetary financing of the budget deficit. In principle, the Act made it virtually impossible to devalue, which increased the credibility of the regime. Devaluation would require a new Act to be passed by Argentina’s Congress, but by the time the Bill had been debated, the reserves of the central bank would have evaporated because of capital flight. If the Bill were debated over a bank holiday instead, the government would be liable to private actions for damages. It is worth noting that the Argentine Currency Board was not an orthodox currency board. Rather, it was a currency-board-like system: a mixture of currency board and central banking features. The central bank (that was never officially renamed a currency board) maintained some room for manoeuvre. For instance, it might purchase Argentine government bonds denominated in dollars, provided that the stock of international reserves (excluding government bonds) did not fall below 2/3 of the base money. In addition, the central bank might change the reserve requirements imposed on the banks. Source: Sørensen 2001; Spiegel 2002
The Currency Board was the centrepiece of a major economic structural adjustment program implemented by President Carlos Menem during his two mandates (1989-1994 and 1995-1999) and by his Minister of Economy, Domingo Cavallo. It was designed to encourage foreign trade and investments, the privatization of previously state-owned industries, partial deregulation, pension reform and financial liberalization.
With such reforms, Argentina made a break from its troubled financial past and embraced almost in full the recommendations of the Washington Consensus1. During these years, the country looked like a successful advertisement for free-market reforms and became the poster child of the IMF’s most pure doctrine. The monetary policy adopted with the Convertibility Law, i.e. the hard peg with the US dollar, was aimed at restoring investor confidence in the Argentine currency and initially appeared to be a great success. From 1991 to 1997 Argentina enjoyed impressive economic growth, expanding at an average real rate of around 7%, one of the highest growth rates anywhere during those years. Inflation rate that in 1989-90 was running at an annual average of 3,177 per cent, fell drastically to 3.8 per cent in 1994-5. Price stability was assured, and the value of the currency was preserved. This period of monetary stability and economic growth lasted almost uninterrupted until 1998, resulting in high GDP growth throughout the whole period 1991-1997 (Table 1). Table 1 - Real GDP growth rate (percentages)
Source: World Development Indicators Database and the Unified Survey
With all risk of devaluation apparently removed, and in a business-friendly environment, capital poured in from abroad, and productivity increased as investment modernized farms, factories and ports (see Chart 1). Chart 1 - Argentina’s Gross Capital Inflows (12 month moving average)
Source: Perry and Servén 2003
1 The term “Washington Consensus” describes a set economic policy prescriptions constituting the “standard” reform package promoted by Washington, DC-based institutions such as the International Monetary Fund (IMF), World Bank and the US Treasury Department, for the recovery of Latin America from the economic and financial crises of the 1980s. 22
But when the global economic system started to suffer from a series of financial crises erupted in strategic areas – the “Tequila crisis” in Mexico in 1994, the Asian crisis in 1997, the Russian crisis in 1998 and the quasi-default by Brazil in 1999 (see paragraph 1.2) – things began to get worse and worse for Argentina, and the rigidities and limitations of the Convertibility became apparent. Indeed, such crises determined: • huge capital outflows from developing countries, and thus from Argentina too, as a consequence of growing international investors’ concern and nervousness about risky deals; • soaring international interest rates, since investors who chose to remain in emerging markets demanded higher returns for their increased risk; • a strong appreciation of the U.S. dollar vs. European and Asian currencies from 1995 to 1999, that resulted in similar appreciation of the Argentine peso relative to its trading partners. Such appreciation hurt sensibly both Argentine exports and its capacity to honour its foreign debt. When Brazil (the major Argentina’s trading partner absorbing almost 30% of its export) devalued its currency in 1999 in order to cope with its own financial crisis, the terms of trade shock made the situation almost unsustainable, and Argentina entered into a profound recession. Chart 2 - Argentina’s GDP, % change on year earlier 12 8 4 + 0 4 1991
Source: EIU - Economist Intelligence Unit
In order to keep the peso’s peg to the dollar as it was losing overall competitiveness, the Argentine government tightened macroeconomic policy and dramatically cut spending. From 1999 to 2001 a series of laws were passed designed to remedy Argentina’s economic difficulties through reduced government expenditure 2. Public-sector pension and wages 2 In September 1999 the “Fiscal Responsibility Law” was passed; in January 2000 the De la Rúa administration started with a major fiscal adjustment, the “impuestazo”, which did not generate an expansionary contraction but instead was later blamed for having killed an incipient recovery in its bud. Three additional attempts at this strategy were made in 2001 (among which the “Zero Deficit Law” of July 2001) without any expansionary consequences (Hausmann and Velasco 2002). 23
were reduced3, pension benefits for over 1.4 million families were delayed4 and, as official unemployment skyrocketed to nearly 20% and with real joblessness substantially higher5, more people sought unemployment insurance and other social services, i.e. the services being slashed. Such measures further depressed the internal demand and exacerbated the downturn. In order to cope with recession, Argentina tried to avoid financial turmoil and outright default on its debt obligations by swapping its short-term foreign debt for longer-term issues, renegotiating its outstanding domestic debt and lining up emergency financial packages led by the International Monetary Fund (IMF). In March 2000 the International Monetary Fund agreed to a $7.2 billion financial package to be spread over three years which was contingent on fiscal reform and public budget cuts, on the assumption that such slashes would help restore foreign investors’ confidence in the economy6. In January 2001, an increase in the original agreement by $7.2 billion was negotiated (the “blindaje”), as part of a larger $40 billion assistance package provided by multiple international lenders7 and coordinated by the International Monetary Fund. When it became clear that the initial program was not working, it was increased by about $8 billion in the fall of 2001. This brought the IMF’s total commitment in Argentina to $23.8 billion (8.2% of GDP). The financial community was advancing these funds with an expectation that the Argentine economy would grow by 2.5% in 2001, which proved unattainable. Furthermore, the IMF financing was conditional on the government’s commitment to public budget cuts and to a revenue sharing reform with the provinces. In fact, the country’s fiscal sharing guaranteed federal payments to provincial governments that served as a significant portion of their revenue, an arrangement that discouraged discipline at the local level8. None of the IMF financing proved effective, and the last increase agreed was withdrawn in December, triggering the collapse. From 1999 to 2001 Argentina’s financial situation continued to deteriorate inexorably and its economy showed no signs of improvement. As it continued to shrink, external private creditors were less and less willing to provide additional financing, and capital flight along with domestic bank runs were adding pressure on reserves.
3 Pastor and Wise 2001. 4 Lewis 2002. 5 Stiglitz 2002; Lewis 2002. 6 In the view of the IMF, the austerity pursued by the governments would have caused investors to perceive that Argentina was serious in paying its debt, interest rates would have fallen and the economy would have turned around. 7 Inter-American Development Bank (IADB) and the World Bank ($5 billion in loan commitment), Spain ($1 billion) and voluntary refinancing from the private sector ($20 billion). 8 Wise and Pastor 2001. A constitutional revenue sharing rule turned any increase in central government revenue into extra source of finance for provincial government spending. Even with these funds though, the Provinces were running large deficits financed by substantial capital inflows from abroad. 24
Besides the recession, which was the real cause of the significant reduction in government revenues and thus of the budget deficits, the country’s financial situation was also suffering from the combination of low private saving rates, a banking system increasingly exposed to government risk9, a significant plummet in commodity prices and deficits due to widespread tax evasion. All these factors, exacerbated by an overvalued currency, combined in straining the economy thus determining mushrooming fiscal imbalances and current account deficits. The increase in external borrowing was the obvious consequence. As Table 2 shows, the consolidated government debt increased from 28.7% to 54.1% of GDP between 1993 and 2001. Table 2 - Argentina’s consolidated government debt (Percentage of GDP)
1993 1994 1995 1996 1997 1998 1999 2000 2001
Total 28.7 30.9 34.8 36.6 38.1 41.3 47.4 51.0 54.1
External 22.1 23.5 26.8 27.3 28.2 30.5 33.2 33.9 33.2
Domestic 6.6 7.4 8.0 9.3 9.9 10.8 14.2 17.1 20.9
Source: Perry and Servén 2003
9 Although direct exposure of banks to Government risk was not high until 2000 (less than 20% of total assets), in 2001 the Government began to fund itself using available liquidity in the banking system in response to increasing external borrowing constraints. By August 2001, the banks exposure to government risk peaked at about 27%. Other components of the financial system, most notably private pension funds, had even higher exposure to Government risk (Perry and Servén 2003). It is worth pointing out that domestic bank financing is generally an imperfect substitute for external financing, since there is no net inflow from abroad. However, in 2001, the government loosened reserve requirements, allowing the banks to sell U.S treasuries and similar high quality external assets to increase their holdings of domestic government bonds, generating a capital inflow of $2 billion (Setser and Gelpern 2005). 25
Table 3 - Argentina: Selected economic and financial indicators
GDP Growth (%)
Inflation - CPI (%)
Consolidated Overall Fiscal Balance (% of GDP)a Consolidated Primary Fiscal Balance (% of GDP)b Current Acct. Bal. (% of GDP) Debt Service
Terms of Trade
a. Includes federal and provincial government budgets, trust funds, and capitalization of interest. b. Primary balance excludes interest payments. c. Public sector debt as a percent of exports of goods and nonfactor services. Source: IMF (www.imf.org)
With an overvalued peso though, such heavy borrowing caused further borrowing in order to honour the debt itself, much of which was foreign currency denominated and externally held. As may be seen in Table 3, since 1995 the consolidated primary fiscal balance, which excludes interest payments, was slightly negative or positive, but the overall balance, with interest, grew to become a serious deficit by 1999. The difference between the two deficit measures shows how between 1995 and 2001 the portion of the budget spent on servicing public debt (interest payments) grew from less than 2% to over 5% of GDP10. The debt service ratio, a measure of the foreign component of public debt, was equally dismal, more than doubling from 29.5% in 1995 to 65.7% in 200111. In late 2001, on the edge of default, the country was running a debt of 50% of GDP, with around U.S. $2 billion becoming due in 2002. As many analysts point out, it was not the level of debt itself the real problem. Major economies regularly run even higher debt to GDP ratios12. The real problem with such an increasing external borrowing was the progressive fall of market confidence in the Argentine economy and in its capacity to honour such a debt.
10 Hornbeck 2003. 11 Ibid. 12 For istance, Japanâ€™s debt-to-GDP ratio stands at around 173%, and Italyâ€™s at 113%. (OECD 2008) 26
Indeed, as exit costs from the 1-to-1 peg kept mounting, financial markets become increasingly concerned about the dire implications of devaluation, which in turn compelled the government to raise exit costs further, offering higher interest rates and exchanging short-term debt for new debt with longer maturities and higher interest rates,. thus increasing the country risk spread and further harming its capacity to sustain the debt burden. Table 4 - Fiscal and public debt indicators
Interest payments on debt (% of GDP) 2,8
Implicit interest rate
Debt to GDP
RER adjusted Debt to GDP
Source: Perry and Servén 2003
Chart 3 - Argentina’s Total Public Debt (% of GDP) 140.00
% of GDP
120.00 100.00 80.00 60.00 40.00 20.00
Source: Argentina’s Ministry of Economy and Production (MECON)
The country was caught in a debt tailspin, a vicious circle in which it felt compelled to raise the exit costs from the Convertibility in order to maintain the regime’s credibility. In March 2001 international rating agencies lowered Argentina’s long-term sovereign rating from BB- to B+. In June 2001 the $29.5 billion voluntary debt swap (“Mega-canje”) conducted by the De la Rúa government in which short-term debt was exchanged for new debt with longer maturities and higher interest rates, caused the international markets to react negatively since it was considered as a signal of difficulties. In May, as a consequence of persisting hard budget difficulties, Standard & Poor’s lowered Argentina’s long-term sovereign rating further from B+ to B and in the following couple of months to B-. And when finally, later in November, a second debt swap was conducted whereby $60 billion of bonds with an average interest rate of 11-12% were exchanged for extended maturity notes carrying only 7% interest rate, international bond rating agencies considered it an effective default and lowered Argentina’s long-term sovereign rating from CC to SD (selective default)13. From mid-October 2001 onwards, a sense of inevitability surrounded the prospect of a default. The added pressure of capital outflows, first by international investors and then the withdrawals of deposits from the Argentine banking system, eventually tipped the scales. In the early days of December, the IMF decided to withhold a $1.24 billion loan instalment, pointing to the failure to meet fiscal target outlined in the loan agreement. By then, Argentina found itself cut off from international financial markets, both public and private. At that point, the government first declared a bank holiday (the “Corralito” and then “Corralón”) and then announced it could no longer guarantee payment on foreign debt. At that point, the whole system crumbled in utter chaos. Neither of the various steps undertaken to reassure the markets and re-establish confidence – IMF lending packages, tight fiscal policies, debt swaps – had had the expected effects. On the contrary, they worsened the situation since foreign investors perceived them as increasingly desperate measures to meet pressing short-term financial needs, and thus signals of an imminent crash14. When Argentina entered into recession, it was clear that it required some sort of stimulus – either a fiscal stimulus or an expansionary monetary policy. But either way spelled disaster. As for the first option, as we have seen, several steps were repeatedly taken in the opposite direction, according to the view of those – the IMF in primis – who argued that the problem had a fiscal origin and required a fiscal response. The argument was that a fiscal contraction could be expansionary, since it would eliminate fears of insolvency and make capital markets more forthcoming15. Such an argument was adopted by the government and led to a series of fiscal adjustment efforts that, in fact, increased the nonsocial security national primary fiscal surplus by over 2 percentage points of GDP in spite of the recession16. But as seen above, they ended up deepening recession, while failing to treat the real underlying disease, which was lack of growth. 13 Lyons 2001. 14 Hausmann and Velasco (2002), Roubini and Setser (2004), Mussa (2002). 15 Tejeiro 2001, Mussa 2002. 16 Hausmann and Velasco 2002. 28
As for the second option, i.e. a looser monetary policy, in spite of the various warnings launched by several analysts calling for a real devaluation17, at no point in time was there in Argentina political or popular consensus to incur the costs of exiting Convertibility18 immediately in order to avoid a bigger, deeper and more costly exit further down the road. Indeed, given the open currency exposures in the balance sheets of both the public and the private sectors, and the large degree of overvaluation of the currency19, exiting the peg would have precipitated a latent corporate, banking and fiscal crisis. In the face of a deteriorating economic and financial position, Argentina preferred to hope that its difficulties were temporary, drawing on IMF financing, spending its own remaining reserves to defend the status quo and then resorting to increasingly desperate attempts at clever financial engineering to postpone a payments crisis. Unable (and unwilling) to devalue or to lower interest rates, the ruling class hoped that deflation would eventually improve its competitiveness20 and it chose to go through a painful and protracted deflationary adjustment while keeping the Currency Board and attempting to retain market confidence in the meantime. But as Roubini21 and Krugman22 point out, the real exchange rate adjustment brought about by deflation increases the real burden of foreign currency denominated debts in the same way as a nominal depreciation: both reduce “peso” revenues (one through falling peso prices, one through changes in the peso/dollar) while leaving dollar debts unchanged. The only difference is that deflation occurs more slowly. The search for a new equilibrium through deflation entailed a severe social cost, thus hampering the fragile Argentine institutions. De la Rúa’s government was already weak and divided and, after 4 years of recession, it suffered a heavy defeat at the Congress election of October 2001. His last attempt to handle the turmoil by bringing back Cavallo, with his costly efforts to stave off devaluation, precipitated financial collapse. But to fully understand Argentina’s unquestioning support of the 1-to-1 peg to the end, it is necessary to look back to the Argentine economic history.
17 Krugman (1999, 2001, November 8, and 2001, December and 2001, December 28), Velasco (2001), De la Torre, Levy Yeyati and Schmukler (2002) 18 Cavallo 2002, Mussa 2005 (in Weisbrot and Mussa, 2005); Setser and Gelpern 2005. 19 The World Bank estimated that the peso was overvalued by around 40%, with roughly half the overvaluation due to the dollar’s appreciation (See paragraph 1.2). 20 Given weak productivity growth and inability to devalue the nominal exchange rate, the only way to become more competitive was to allow dollars to leave the country, thereby reducing the money supply, and causing domestic prices to fall – a de facto policy of deflation (Perry and Servén 2003). 21 2001. 22 2001. 29
1.1 Internal causes. A retrospective of the Argentine economic history: an unparalleled decline The collapse of 2001 was exceptional in its severity, but wild economic fluctuations and crises had been the norm for decades in Argentina, whose history is defined by economic and political turmoil, punctuated at times by attempts at stabilization. This was hardly the development anticipated in the early 1900s. At that time, Argentina was among the richest countries in the world, and its favourable economic climate attracted both immigrants and capital. In 1913, Argentina ranked among the top 15 nations in terms of wealth: the country’s income per head was on par with that of France and Germany, and far ahead of Italy and Spain23. The large, fertile Pampas gave the agricultural sector good conditions and were the basis for strong, export-oriented growth within primary produce (mainly wool, wheat, corn, and beef). The standard of living was high: GDP per capita was 80% of the average for 16 present OECD countries (see Table 5). Since then though, Argentina has lost ground against Western economies almost continuously and experienced a consistent declining trend which had dire consequences for the real economy and for economic policy making. In the second half of the century the country’s decline accelerated and in the 1980s Argentina’s standard of living reached an all-time low in relation to the OECD countries (see Chart 4 and Chart 5). Table 5 - Argentina’s GDP per capita relative to 16 OECD countries1
Argentina’s relative GDP per capita (%) 1
Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway, Sweden, Switzerland,
United Kingdom and USA. Unweighted average. Note: Adjusted for differences in purchasing power. The 2000 figure relates to GNP per capita.
Source: Maddison (1989) and World Development Report 2002 for the year 2000
23 Sørensen 2001. 30