economy had collapsed. It is now clear that Argentina will reverse at least some of the economic reforms introduced by president. Carlos Mennen in the early ...
Argentina’s Crisis: Causes and Consequences During the east Asian crisis of 1997, Argentina was being referred to as a model state because of its fixed exchange rate regime. However, by 2001, due to several macroeconomic reasons the economy had collapsed. It is now clear that Argentina will reverse at least some of the economic reforms introduced by president Carlos Mennen in the early 1990s to survive the crisis it is currently experiencing. That small and open economies are far more susceptible to large external shocks, such as changes in foreign interest rates, terms of trade, regional contagion effects, etc, is among the many lessons of the Argentine crisis. GEETHANJALI NATARAJ, PRAVAKAR SAHOO
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rgentina was hailed as one of the most prosperous nations in the South and Latin American continent till the onset of the crisis in late 1990s. Argentina had a growth rate of 8 per cent till 1997 but after 1997 its growth rate declined and turned negative to –3.9 per cent in 2000. In contrast, most of the other Latin American countries of the region were much steadier. For instance, Mexico had a growth rate of 7 to 8 per cent per annum in the 1990s and Brazil which performed badly in 1998 and 1999 picked up its growth after its devaluation in 1999. In 2000, Argentina’s external debt as a percentage of GDP and debt service ratio indicates that it was the worst placed as compared to its neighbours, as shown in Table 1. Argentina’s debt service ratio was 75.8 per cent whereas Mexico and Brazil (Argentina’s neighbours) had a debtservice ratio of 23.1 per cent and 64.8 per cent respectively. During the east Asian crisis of 1997, Argentina was being referred to as a model
state because of its fixed exchange rate regime devoid of all speculative tendencies. However, in the year 2001, due to several macroeconomic reasons such as the fixed exchange rate regime, high external debt and debt service ratio, etc, the economy collapsed. It is now clear that Argentina will reverse at least some of the favourable economic reforms introduced by president Carlos Mennen in the early 1990s to survive the crisis it is currently experiencing.
Overview of Economy Argentina is a country richly endowed in natural resources where agriculture and agro-industries have traditionally been important. Argentina was self-sufficient in petroleum up to the 1980s and investment following privatisation in the early 1990s turned the country into a net exporter of oil and natural gas. Manufacturing output recovered in the 1990s after two decades of stagnation. As in the case of all developing economies, the service sector in Argentina progressed and accounted for nearly 60 per cent of GDP
Table 1: Comparative Macroeconomic Indicators: 2000 Mexico GDP (US $ billions) GDP per head (US $) Consumer price inflation (ave per cent) Current account balance (per cent of GDP) Exports of goods (fob) (Per cent of GDP) Imports of goods (fob) (Per cent of GDP) External debt (Per cent of GDP) Debt-service ratio
561.2 5763 9.5 -18.2 (3.2) 166.4 (29.65) -174.5 (31.09) 171.5 (30.55) 23.1
Brazil 622.4 3751 7.0 –25.5 (4.1) 55.1 (8.85) -55.8 (8.96) 235.5 (37.83) 64.8
Argentina
Venezuela
281.7 7605 -0.9 -11.2 (4.0) 26.3 (9.34) -24.4 (9.66) 153.1 (54.35) 75.8
103.8 4293 16.2 12.9) (12.5) 34.0 (32.82) -16.1 (15.54) 34.1 (32.95) 17.4
Source: Economist Intelligence Unit country reports on Mexico, Brazil, Argentina and Venezuela, 2001.
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in 2001. Privatisation and deregulation helped the service sector to raise its efficiency in communications, electricity, distribution, finance and transport. Overall, Argentina performed very well during the 1990s before the onset of the crisis in late 1990s. Some of the macroeconomic indicators of Argentina in the decade of the 1990s (1992-2001) just prior to the onset of the crisis are presented in Table 2. Table 2 clearly indicates that real GDP growth rate in Argentina was fairly good in early 1990s (1991 to 1994) and hovered around 8 per cent. Since 1995, the GDP growth began to recede – with the exception of 1997 – and it turned negative at –3.4 per cent in 1999 and –0.3 per cent in 2000 and further deteriorated to –4.5 per cent in 2001. Consumer price inflation which was as high as 171 per cent in 1991 declined to 24.9 per cent in 1992 and has since then further reduced and turned negative in late 1990s. Similarly, Argentina’s foreign trade remained steady with exports and imports both showing a positive growth rate till 1997 but sharply declining afterwards. However, imports have consistently remained higher than exports accentuating the problem of current account deficit. However, in the year 2001, for the first time in a decade Argentina’s exports surged and imports declined reducing its current account deficit. Though Argentina’s foreign exchange reserves have also increased, its external debt and debt service ratio have spurred significantly with the debt service ratio touching 75.8 per cent of GDP in 2000 and declining marginally to 62.8 per cent in 2001. Thus, for most of the 1990s, leaving aside the external debt factor Argentina was well on the path of the economic reform process and it is only in the late 1990s (after 1997) that the signs of the crisis began to emerge. Argentina undertook the economic liberalisation programme in mid-1989 with two distinctive features in order to restructure its economy on the lines of the Washington Consensus. The first was the ‘big bang’ approach, where sequencing of reforms in several sectors such as fiscal reforms, public sector reforms and trade reforms, etc, was completely disregarded. The second was the establishment of a convertibility regime by law, which requires the Central Bank (CB) to back the whole monetary base with foreign exchange reserves. Though Argentina was flourishing for most of the years in the 1990s with continued economic reforms,
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it failed to contract government spending leading to constant increase in budgetary deficits and accumulated public debt burden (Table 3). In the external sector, a close look at Argentina’s principal exports and imports reveals that most of Argentina’s exports comprise of agricultural commodities (Table 4) which are more prone to adverse terms of trade and fluctuating market prices. On the other hand, its imports comprise of manufacturing, electrical and pharmaceutical products (Table 5) that require hefty foreign exchange. Table 4 and Table 5 list the principal exports and imports of Argentina. Coming to the major trading partners of Argentina, Brazil is followed by US, MERCOSUR and EU along with some other advanced nations. Its main importing partners are Brazil, EU and NAFTA. It’s neighbouring country, for instance Brazil follows a flexible exchange rate system and had devalued its currency in 1999 affecting exports of Argentina. The table shows that Argentina’s imports from Brazil have increased more than its exports to Brazil. Similar is the case with the most trading partners of Argentina in the 1990s. Moreover, as the peso was pegged to the dollar, it was overvalued when compared to its neighbours in the region making Argentina’s exports uncompetitive in world markets. Argentina managed to remain competitive in exports in the early 1990s since its neighbouring countries had overvalued exchange rates. However, the floating exchange rate system of all its neighbours allowed their currencies to depreciate automatically against the dollar and other major currencies. The uncompetitiveness of Argentina’s exchange resulted in falling exports, a gaping deficit on the current account and socially and politically unacceptable levels of unemployment.
An overvalued fixed exchange rate (locked at one peso per dollar since 1991) and an excessive amount of foreign debt were the two proximate causes of the Argentine crisis. Because the exchange rate was fixed at too high a level, Argentina exported too little and imported too much. This trade imbalance stood at –829 million US$ in 1999 and made it impossible for the country to earn the foreign exchange it needed to pay the interest on its foreign debt. Instead, Argentina had to borrow to meet those interest payments, causing the debt to grow even larger. The external debt as a percentage of GNP increased from 39.2 per cent in 1995 to 55.67 per cent in 2000 (Table 8). Similarly debt-service as percentage of total exports increased from 30.4 per cent to 75.8 per cent showing the burden of external debt on foreign exchange earnings. The country’s foreign debt, most of which was owned by the central and provincial governments, eventually reached 50 per cent of GDP by late 2001 and included $30 billion due in 2002. Finally it became clear that Argentina could no longer borrow to roll over those debts and pay the interest, therefore, it was forced to default and to devalue the peso almost by 29 per cent to make its exports competitive. However, whether this devaluation has helped Argentina is yet to be ascertained under a dual exchange rate regime. Although the devalued peso will eventually raise Argentine exports, in the near term the weakening of the currency will cause widespread bankruptcies since most of the borrowings were in dollars. Corporate failures will weigh heavily on the Argentine banks and may cause them to collapse too [Feldstein 2002] leading to financial chaos and high unemployment rate. The havoc that an overvalued exchange rate and excessive foreign debt caused in Argentina is certainly not unique. These
two conditions, either singly or together, have been the cause of every currency crisis (e g, south-east Asia) during last two decades. The painful effect that dollardenominated debt had on south-east Asian countries during the late 1990s was well known to Argentine economists and policymakers. Thus, allowing the peso to float down to a more competitive level would have helped Argentina to improve its trade balance and shrink its foreign debts. This could possibly have avoided the crisis in Argentina to a large extent. The reason Argentina retained its fixed exchange rate too long is fairly simple, such a peg had cured hyperinflation and brought in a decade of price stability which provided the framework for strong economic growth. Policy officials feared that breaking the link to the dollar would bring back high inflation and all of the accompanying economic problems of the 1970s and 1980s. Argentina, however, went one step ahead of other countries, when it enacted a ‘convertibility law’ which stipulated that everyone had the right to convert as many pesos to dollars as they wanted. To give credibility to that promise, the government provided that each peso in circulation would have to be backed by a dollar (or similar hard currency) at the Table 3: Government Finances of Argentina (Per Cent of GDP) 1996 1997 1998 1999 Current revenue 17.2 Capital revenue 0.3 Total revenue 17.5 Current expenditure 18.2 Capital expenditure 1.3 Total expenditure 19.5 Budget deficits 1.9
2000
18.6 18.9 0.2 0.2 18.9 19.0
19.7 20.3 1.0 0.1 20.7 20.4
19.1 19.1
21.2 21.8
1.3 1.3 20.3 20.4 1.5 1.4
1.1 1.0 22.3 22.9 1.7 2.5
Source: Economist Intelligence Unit country report for Argentina, 1996-2001.
Table 2: Argentina’s Macroeconomic Indicators: 1991-2000 Economic Indicators GDP at market prices (peso bills) GDP (US $ bills) Real GDP growth (per cent) Con- price Inflation (per cent) Exports (fob) (US $ bills) Imports (fob) (US $ bills) Cur-account (US $ bills) Reserves exclud gold (US $ bills) Tot-external debt (US $ bills) Ext-debt-ser ratio (per cent) Exch-rate (peso vs $)
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
180.9 189.6 8.9 171.7 11.97
226.6 228.6 8.7 24.9 12.24 (2.15) 14.87 (79.72) -6.55 9.99 67.8 30.1 1.00
255.3 255.5 6.0 10.6 13.12 (7.21) 16.78 (12.86) -7.45 13.79 74.5 46.0 1.00
281.6 281.9 7.4 4.2 15.84 (20.75) 21.53 (28.26) -9.27 14.33 84.7 42.9 1.00
279.6 279.7 -3.9 3.3 20.83 (31.51) 19.91 (-7.56) -1.33 10.55 86.8 38.9 1.00
272.2 272.2 5.5 0.2 24.04 (15.42) 22.28 (11.97) -6.84 18.10 111.4 39.4 1.00
292.9 293.0 8.1 0.5 26.43 (9.93) 28.55 (28.14) -12.50 23.32 128.4 50.0 1.00
298.9 299.1 3.9 0.9 26.44 (0.04) 29.56 (3.52) -14.60 24.75 141.5 57.5 1.00
283.3 283.4 -3.4 -1.2 23.33 (-11.75) 24.11 (-18.46) -12.31 26.25 147.9 75.8 1.00
282.3 282.5 -0.3 -0.9 26.25 (12.51) 24.01 (-0.42) -11.12 25.15 156.3 76.2 1.00
266.7 266.7 -4.5 -0.9 26.61 (1.38) 19.19 (-20.03) -4.54 14.55 114.8 62.8 1.00
8.28 -6.47 6.01 63.4 34.4 1.00
Source: Economist Intelligence Unit country report for Argentina, 1991 to 2001. Figures in parenthesis refer to yearwise percentage change.
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central bank, the so-called Currency Board System. The fixed exchange rate could have succeeded, however, only if the peso became competitive enough to generate more trade surplus and foreign exchange earnings that could have been used to pay interest on the outstanding international debt. Although the one-to-one exchange rate made Argentine products and hence uncompetitive, expensive this could still have been remedied if productivity had risen faster lowering costs of production than wages permitting Argentine prices to decline. Argentina’s economists correctly foresaw that the combination of low inflation and market liberalisation would lead to a rapid growth of productivity. Although this was sufficient at first to lead to both rising real wages and increased international competitiveness, eventually rigid labour laws and strong union pressures prevented the further reduction in production costs that Argentina needed to become competitive [South American Political and Economic Affairs, August 2001].
The ‘Crisis’ Even when the peso was pegged to the dollar, many speculated as to what would happen if investors on seeing Argentina’s rising current-account deficit and its increasing foreign debt became nervous and began to convert their pesos to dollars. Although the government had enough dollars at the central bank to back the currency in circulation, it didn’t have nearly enough to cover the total amount in checking and savings accounts that individuals might want to convert. The currency board rules ensured that as individuals began to convert their pesos into dollars, the central bank would shrink the money supply causing interest rates to rise sharply. Long before the central bank ran out of dollars, the interest rates on peso deposits would get so high that people would be encouraged to keep their funds in pesos. In that way, the central bank would never exhaust its supply of dollars. Moreover, the high interest rates would weaken domestic demand, causing wages and prices to fall until the peso became competitive again, eliminating the reason for the original nervousness. Although all this sounded logical, a problem remained. If the government was not willing to push interest rates high enough because of the damage it would do to the economy, and if wages
did not fall sufficiently in response to economic weakness, the current-account deficit would remain and investors would lose confidence in the exchange rate’s longterm viability. This is exactly what happened. Once the external debt started to mount with Argentina not being able to control its spending, exports became uncompetitive and were unable to keep pace with the US dollar. As a result, investors began to lose faith in the economy and people became nervous and there was a run on the banks in Argentina. Wage increases kept the cost of production in Argentina high, depressing exports and encouraging imports simply because of the appreciation of the US dollar against other currencies and also because of depreciation (and devaluation in case of
Brazil) of some of the neighbouring countries’ currencies. Argentina’s competitiveness worsened as the dollar strengthened relative to most of the other currencies, pulling the peso up with it. The dollar rose sharply against the Japanese yen after 1995, against the currencies of south-east Asia after their crises of 1997 and 1998, and against the European currencies in 1999 and 2000. The terms of trade also moved against Argentina, with world prices for its exports declining relative to the prices of its imports. But the biggest blow to Argentine competitiveness came when Brazil’s currency, the real, fell sharply in 1999. To keep the peso-dollar peg intact as the economy became less competitive, Buenos Aires tightened macroeconomic policy,
Table 4: Major Exports of Argentina (US million dollar) Exports Mineral oils and fuels Vegetable oils Cereals Food industry residues Vehicles Oil seeds and fruits Boilers, machines and mechanical equipment Fish, crustaceans and molluscs Skins and leather Meat and edible residues
1996
1997
1998
1999
2000
3089 1890 2560 2367 1519 964 765 945 829 781
3094 2225 3007 2404 2658 339 895 961 937 763
2277 2734 3042 2006 3028 1052 819 859 785 601
2829 2332 2063 2049 1628 869 787 781 752 653
4678 1677 NA 2432 1949 1013 807 822 809 619
Source: Economist Intelligence Unit country report for Argentina, 1996-2001.
Table 5: Major Imports of Argentina (US million dollar)
Boilers, machines and mechanical equipment Electrical machinery Vehicles Organic chemicals Plastic materials Paper and cardboard Optical, photographic and medical equipment Mineral oils and fuels Pharmaceutical products Iron and steel
1996
1997
1998
1999
2000
4576 2976 3095 1387 1106 727 642 864 401 424
5841 4112 4513 1563 1391 871 797 906 478 668
5955 4288 5049 1530 1350 927 795 799 600 587
4793 3342 2959 1343 1133 812 725 676 647 565
4173 3985 2715 1430 1220 811 721 927 648 423
Source: Economist Intelligence Unit country report for Argentina, 2001.
Table 6: Major Export Destinations Argentina (US million dollar) Exports to Brazil US Chile Netherlands Spain Mercosur EU NAFTA Total exports
1996
1997
1998
1999
2000
6615 (27.78) 1973 (8.28) 1766 (7.41) 1225 (5.14) 724 (3.04) 7918 (33.25) 4562 (19.15) 2326 (9.77) 23811
8133 (30.77) 2204 (8.33) 1932 (7.31) 880 (3.33) 623 (2.36) 9597 (36.30) 3985 (15.07) 2523 (9.54) 26431
7949 (30.07) 2212 (8.37) 1857 (7.03) 1100 (4.16) 842 (3.19) 9415 (35.61) 4602 (17.41) 2699 (10.21) 26434
5690 (24.39) 2653 (11.37) 1869 (8.01) 1013 (34.34) 962 (4.12) 7071 (31.34) 4713 (20.19) 3174 (13.60) 23333
6990 (26.47) 3110 (11.78) 2670 (10.11) 746 (2.82) 913 (3.46) 8401 (31.81) 4691 (17.76) 3764 (14.25) 26409
Source: Economist Intelligence Unit country report for Argentina, 1996-2001. The figures in the parenthesis indicated the percentage share of different countries in total exports of Argentina.
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raising interest rates by almost 36 per cent and pushing the economy into recession. But despite unemployment rates of close to 15 per cent, wages did not decline due to rigid labour laws. The fixed exchange rate made it impossible to increase competitiveness by a traditional currency devaluation (as a variety of countries did, ranging from the UK in 1992 to South Korea in 1998 and Brazil in 1999) and the resistance of unions to lower wages prevented a fall in production costs that could have achieved the same real devaluation without a change in the exchange rate. The inevitable result was increasing current-account deficits, which reached nearly 5 per cent of GDP, and therefore mounting foreign debt. The growth of foreign debt also reflected the combination of low private savings rates, which reduced the domestic pool of investment, and substantial deficits in the budgets of the central and provincial governments. As the debt grew, the interest rate that Argentina had to pay foreign creditors also rose, further increasing the annual imbalance and accelerating the growth of the foreign debt. Default became unavoidable. When Argentina finally defaulted on $155 billion of central and provincial government debt in December 2001, it was the largest sovereign debt default ever in history. Sophisticated Argentines and foreign investors knew that the peso had to be devalued if future current-account deficits were to be reduced without a continued massive recession. The convertibility law allowed them to shift pesos into dollars and then to take the dollars out of the
country. Although a loan from the International Monetary Fund (IMF) in 2001 gave a temporary boost to confidence that stemmed the run on the central bank, this lasted only a few months and the peso was devalued sharply in January 2002 [Feldstein 2002]. The question that comes to mind foremost is that if Argentina was not able to cope with the fixed exchange rate system why did it not devalue its currency sooner in 1997,1998 or in 1999. One can site three possible reasons for the same. First, there was a fear that breaking the peg and devaluing the peso would bring back the high rates of inflation that had plagued the economy before the two currencies were tied. Second, Argentine households, businesses and government had so much dollardenominated debt, the government feared that devaluation would prompt widespread bankruptcies and personal defaults by raising the peso value of outstanding debts. Finally, there was always the hope that the situation would improve over time. The large US trade deficit suggested that the dollar might experience a sharp decline relative to the yen and the European currencies. If that happened, Argentine products would become much more competitive internationally. But that did not happen. Infact, the dollar (and therefore the peso) continued to strengthen in 2000 and 2001.
Conclusion The Argentine crisis has clearly showed the dangers of a large external debt and the disadvantages of a fixed exchange rate
Table 7: Major Importing Countries from Argentina (US million dollar)
Brazil US France Germany Italy EU Mercosur NAFTA Total imports
1996
1997
1998
1999
2000
5326 (22.41) 4749 (19.99) 1181 (4.97) 1427 (6.01) 1503 (6.33) 6900 (29.03) 5801 (24.41) 5562 (23.40) 23762
6914 (22.71) 6095 (20.01) 1375 (4.52) 1655 (5.44) 1747 (5.73) 8321 (27.33) 7605 (27.98) 7155 (23.49) 30450
7055 (22.48) 6227 (19.85) 1584 (5.05) 1876 (5.98) 1605 (5.12) 8594 (27.39) 7931 (25.28) 7216 (22.99) 31378
5596 (21.94) 4996 (19.59) 1504 (5.89) 1409 (5.52) 1355 (5.31) 7119 (27.91) 6290 (24.65) 5777 (24.66) 25508
6443 (25.52) 4732 (18.75) 993 (3.93) 1261 (5.00) 1013 (4.01) 5783 (22.90) 7199 (28.52) 5675 (22.48) 25243
Source: Economist Intelligence Unit country report for Argentina, 1996-2001.
Table 8: External Debt Indicators from 1995 to 1999 (US billion dollars) 1995
1996
1997
1998
1999
2000
Total external debt 86.83 Total debt service 7.49 Total external debt as per cent of GDP 39.2 Total debt service as per cent exports 30.4
111.93 11.11 42.0 39.5
130.82 16.22 45.7 50.2
141.54 18.99 48.6 57.5
147.88 23.14 53.7 75.8
156.31 22.15 55.67 84.39
Source: EIU country profile, Argentina, 1995-2001.
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regime. There are a few important lessons that the Argentine crisis brings to the fore: (i) first, a fixed exchange-rate system, even one based on a currency board or other ‘hard’ fix, is a bad idea that is likely to lead to an overvalued exchange rate, a currency crisis, and widespread defaults. A market-determined floating exchange rate is the only way to avoid these problems; (ii) second, substantial foreign borrowing in dollars is a very risky strategy, particularly true of not only short-term debt and (iii) third, the opening of the economy to trade, the encouragement of foreign direct investment, and the privatising of state-owned firms are desirable policies. These policies did not cause or contribute to Argentina’s crisis, and it would be a serious mistake to reverse them now in Argentina or any other emerging market. The Argentine experience also proves that small and open economies are far more susceptible to large external shocks, such as changes in foreign interest rates, terms of trade, regional contagion effects, etc. In this context, flexible exchange rates provide a less costly adjustment mechanism by which relative prices can be altered in response to such shocks as opposed to fixed rates. Though Argentina’s hard US dollar peg was important in helping the country realise financial and monetary stability, recent large devaluations in emerging market economies required exchange rate adjustments that were not forthcoming. The current crisis will weaken the trading arrangements between Argentina and its neighbours (Brazil, Paraguay and Uruguay) and also with MERCOSUR. A closer look at Argentine economy would definitely go a long way in helping other countries make cautious policy decisions with respect to external debt and exchange rates. EPW
References Economists Intelligence Unit Country Report (2000): Argentina, London. – (2000): Brazil, London. – (2000): Mexico, London. – (2000): Paraguay, London. Feldstein, Martin S (2002): ‘Argentina’s Fall, Lessons from the Latest Argentina’s Crisis’, Foreign Affairs, March-April. South American Political and Economic Affairs (2001): ‘Effects of Argentina’s Economic Crisis Remain’, August 10. Various issues of the Economists Intelligence Unit Country Report on Argentina, London.
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