Argentina Economic Update (6 Feb 02)

8/2/2019 Argentina Economic Update (6 Feb 02)

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Will Argentina be able to maintain its competitiveness in international markets?

As a consequence of one of its prior economic and political crises and after a decade of having the peso

pegged to the US dollar, Argentina completely abandoned the currency board in 2002 and allowed its

currency to float freely. With the possibility of exercising monetary policies plus favourable internal as well

as external factors, the country experienced one of its most illustrious periods of growth in history. Today,

after almost a decade of walking through this new paradigm, one crucial question starts to pop up withstrength: Can Argentina maintain its competitiveness in international markets? What policies should be

implemented to sustain or even foster growth? What are the potential challenges on this front, in the next 5

to 10 years?

Argentina Economic Update

John B. Taylor,Under Secretary of the Treasury for International Affairs

Testimony before the Subcommittee on International Monetary Policy and Trade of the

House Financial Services Committee

February 6, 2002

Thank you Chairman Bereuter, Ranking Member Sanders and members of theSubcommittee for inviting me to participate in this hearing on the current economicsituation in Argentina.

The people of Argentina are facing extremely trying times. Throughout this difficultperiod, President Bush has made it clear that Argentina is an important friend and ally of

the United States of America. We want our allies to be strong leaders of free democraciesand free markets. Argentina should be an engine of economic growth in our hemisphere. Itis important that Argentina succeeds.

In order to understand the current situation in Argentina, I think it is helpful to begin byreviewing some of the key economic developments in Argentina during the last decade.

The Economy of Argentina in the 1990s

In the early 1990s, the government of Argentina undertook a series of important reforms ineconomic policy, including monetary policy, fiscal policy, structural policy, and

international trade policy. Perhaps most dramatic and immediately noticeable was thechange in monetary policy. A highly inflationary monetary policy was replaced by a new"convertibility law," which pegged the peso one-to-one with the dollar and largelyprevented the central bank from financing the government's budget deficit by printingmoney. Fiscal policy was also brought into better control with a decline in deficits. On thestructural side, a comprehensive privatization program was implemented through which anumber of inefficient state-owned enterprises were privatized. Moreover, barriers to


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international trade and investment were reduced and Argentina's financial sector wasopened to foreign investors.

These market-oriented reforms produced very impressive results. Hyperinflation-which hadrisen to over 3000 percent-was brought to a quick end by the convertibility law. Economic

growth turned around sharply: after falling during the 1980s, real GDP began growing atover 4 percent per year. Investment and exports grew particularly rapidly. The sharpincrease in economic growth was even more remarkable given the very rapid disinflationthat was occurring at the same time.

However, starting in the late 1990s there were a number of policy setbacks and externalshocks which sharply reduced economic growth in Argentina and ultimately led to thefinancial crises in 2000-2001 and the current halt to economic activity.

First, government budget deficits began to increase, an indication that fiscal discipline hadbegun to wane. Government spending at the federal and provincial level increased faster

than tax revenues. These deficits could not be financed by money creation because of theconvertibility law. Instead, they were financed by borrowing in both the domestic and theinternational capital markets; however, as the government's debt began to rise and raisequestions about sustainability of the debt, risk premia rose and increased interest rates.Eventually the higher interest rates put additional pressure on the budget deficit and heldback economic growth.

Second, the low inflation of the early-to-mid 1990s turned into persistent deflation whichalso had negative effects on economic growth. In addition, the currencies of Argentina'smajor trading partners in Europe and Brazil depreciated relative to the dollar, and thereforerelative to the Argentine peso. This effective appreciation of the peso led to a deteriorationin Argentina's competitiveness which, along with the higher interest rates, further held backeconomic growth.

Third, persistent expectations of depreciation of the peso caused interest rates on peso loansto be higher than dollar interest rates. Whenever policy actions were taken that raisedquestions about central bank independence or about the convertibility law, marketexpectations of depreciation increased causing domestic interest rates to rise further.

As low economic growth persisted into 2000, concerns began to grow that a vicious cycleof low tax revenues and continued government spending increases would lead to risinginterest rates, which would further slow the economy. Following the political turmoil inOctober 2000 when Vice President Alvarez resigned, Argentina's borrowing costs soaredand rolling over government debt became more and more difficult. Renewed plans toreduce the budget deficit brought interest rates down temporarily, but by February 2001 itwas clear that further actions needed to take place. The Argentine government introduced anumber of policy changes and finally decided to create a rule - the zero deficit law - in thesummer of 2001 to try to provide confidence about the government's seriousness in gettingits fiscal house in order.


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Eventually, however, it became clear that these changes to the budget were not working.Many market participants considered the government's economic plan to be unsustainable,and interest rates on government debt began to increase sharply. By November, it wasapparent that the government's debt would have to be restructured and, indeed, President dela Rua took the step of announcing that such a restructuring would take place.

As the restructuring effort was underway, the uncertainty about its impact on the bankingsystem led to increasingly large deposit withdrawals from banks and international reservesbegan to fall. In order to stop the withdrawals and the decline in reserves, the governmentimposed severe restrictions on such withdrawals in December. Soon after the restrictionswere imposed, social and political protests turned violent, leading to the resignation ofPresident de la Rua and his Ministers.

Economic circumstances in Argentina deteriorated after the imposition of the restrictionson deposit withdrawals. The lack of a functioning payments system led to a virtual halt ofmuch economic activity. The shortage of liquidity is hindering economic growth and

underlies much of the social frustration. The Duhalde government, which took over inJanuary, is in the process of gradually removing these restrictions and at the same timemoving to a flexible exchange rate system.

It is of course up to the government of Argentina to work out the details of a set ofeconomic policies that will increase economic growth in a sustainable way. Indeed, it hasbegun to lay out the broad outlines of such a policy strategy in the last few days, and, asSecretary O'Neill said on Monday, we are encouraged that the Argentine Government istaking substantive steps to address its economic problems. In terms of economic policy, thegovernment must still develop a growth-oriented tax system and a lasting budgetarrangement with the provinces that is based on realistic assumptions about availablesources of non-inflationary financing. The central bank must establish a transparent, rules-based monetary regime that will keep inflation from rising as the convertibility law did inthe 1990s. The government must begin discussions to restructure its debt. And banks mustbe recapitalized so that lending to the private sector can resume, which in turn willstrengthen growth, investment, and job creation.

Summary of IMF Programs

During the period of time discussed above, the government of Argentina had severalprograms with the International Monetary Fund (IMF). In March 2000, Argentina obtaineda $7.4 billion IMF program. The Argentine government treated the program as"precautionary," meaning that the government did not intend to draw upon it. However,starting in the summer of 2000, the growing concern in financial markets was that thepersistent Argentine recession was setting up the potential for a financial crisis.

In December 2000, Argentina drew on $2 billion from its IMF program, and the nextmonth the IMF approved an additional $6.3 billion for Argentina's program, bringing thetotal program size to $13.7 billion. As a condition for the January package, the Argentinegovernment agreed to a series of structural measures in the area of fiscal, pension and


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health care reforms to help develop a sustainable fiscal position in the medium-term and tobuild investor confidence.

In August 2001, the IMF provided Argentina with a further augmentation of $8 billion. Ofthis amount, $5 billion was to bolster reserves in the central bank to counter a substantial

fall in deposits during the summer.

The remaining $3 billion could be used to support a voluntary, market-based debt operationand thereby begin to address Argentina's debt sustainability problem. However, when taxrevenues continued to fall short and the government failed to reach an agreement ontransfers to the provinces, it became increasingly clear that the government was not goingto be able to meet its fiscal targets and had no other sources of financing. This fueledconcerns about the government's ability to service its debt, particularly to domestic banks,and eventually prompted an accelerated run on the banking system.

In December, IMF staff determined that Argentina was not going to make its fiscal targets

for the fourth quarter that were agreed upon in August and that its program was no longersustainable. Thus, the IMF could not complete its review and consequently did not disbursea loan tranche in December 2001.

U.S. Policy

Since the Bush Administration took office, we have remained in close engagement with theIMF, the G-7, and other leaders in the region about the financial and political problems thatArgentina faces. Moreover, we have and will remain fully engaged with Argentina -- ourneighbor, friend, and strong ally. As President Bush has stated and Secretary O'Neill hasreiterated, once Argentina has designed a sustainable economic program, we are preparedto support it through the international financial institutions.

Our engagement with the International Monetary Fund and the government of Argentinaduring the last year should be viewed in the context of our overall approach to emergingmarkets. During the last four years the flows of capital to the emerging markets havedeclined sharply, and it has been the intent of the Bush Administration to reverse this trendby reducing the frequency of financial crises of the kind that we have seen in Argentina.

Of course the ideal would be to prevent crises such as the one in Argentina from occurring.This requires not only early detection of policies or of external shocks that could causecrises, but also the resolve to take actions to reverse such policies or counter such shocks.The Bush Administration has encouraged the IMF to strengthen its capacity to detectpotential troubles on the horizon, and to be willing to warn countries that are heading downa dangerous path to take appropriate action. Effective communication with markets is alsokey. And the IMF can be more effective and credible in undertaking these tasks if itfocuses on issues that are central to its expertise - notably strengthening monetary, fiscal,exchange rate, financial sector, and debt management policies. In the last decade, the IMFbecame too involved in matters outside of these core areas.


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I hope the emerging market asset class grows much more in the future as the rates ofeconomic growth in developing and emerging market countries rise. But we have torecognize that official sector resources cannot possibly grow at such a high rate that we cancontinue with very large official finance packages to deal with emerging market debt crises

as in recent years. There will inevitably be limitations on the use of official sectorresources.

Moreover, in order to reduce bailouts of private investors it is necessary to limit the use ofofficial resources, especially in cases where debt sustainability is in question. We musttherefore gradually move in the direction of less reliance on large official finance packages.

An important change has been occurring in emerging markets and we have encouraged thischange as part of our approach to emerging markets. Investors are increasinglydifferentiating between countries and markets based on fundamental economic assessments-- judgments that are facilitated by better information. This differentiation is reducing

contagion from one country to another, as exemplified most recently by the relativestability in other emerging markets over the past few months despite the crisis inArgentina. Emphasis on the risk of contagion by the official sector in the past led to theexpectation on the part of investors and emerging market governments that the officialsector would bail them out. That encouraged excessive risk-taking and gave rise to the veryconditions that made financial crises more likely. Changing this mindset has been animportant priority, and, I think, an area where we have made some progress.

One important challenge that remains is to explore options to promote more orderlysovereign debt restructurings. The official sector should not encourage countries to defaulton their debts, but we recognize that restructuring can and will happen in certain cases. Atthe moment, there is a great deal of uncertainty about the process involved in suchrestructurings. It is important to find a way such that when a sovereign debt restructuringoccurs, it does so in a more orderly manner that treats debtors and creditors fairly andreduces the scope for arbitrary, unpredictable official action.

Thank you again for this opportunity to speak with you. I look forward to hearing yourviews and answering your questions.


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New Challenges for Argentinas Monetary Policy

Author: Miguel A. Kiguel July 28th, 2011 Comments (1)Share ThisPrint

These days the interest rates on 30 day-time deposits have reached 12.2%, the highest level in the past

21 months, while the interbank rate rose from 9.8% to 12.6% in a matter of days (reaching 14% at its

peak), only to return to previous levels.

The big question is whether this rise was simply due to a temporary liquidity problem in the financial

system, which can be explained by the smaller supply of funds in the interbank market by public sector

banks (which was later partly reversed), or if instead it reflects a change in the monetary and financial

conditions which would indicate that this is the beginning of a process of rising interest rates, as has

been predicted.

In our opinion, everything indicates that we are reaching the end of a cycle and that from now on the

Central Bank will encounter monetary policy dilemmas in most decisions. These decisions will involve

important tradeoffs between different policy objectives. For example, if they opt for high levels of

liquidity to maintain low interest rates, the risk is losing international reserves and hence facing

exchange rate pressures, or a rise in inflation. If instead they choose to tighten monetary policy to

dissuade the purchase of dollars and to maintain the stock of international reserves, the cost will be

accepting an increase in interest rates. Within these dilemmas we do not include the fulfillment of the

monetary program, as we do not believe that the Central Bank has it as one of its priorities.

This type of tradeoff among monetary policy objectives tends to be the rule throughout the world ratherthan the exception, although this dilemma has only recently begun to emerge in Argentina. In this

context, it is worth asking what the potential problems might be, why they have not appeared until now,

and what the risks to monetary and exchange policies are.
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One problem facing the Central Bank is that individuals no longer want to keep so many pesos unless

interest rates offset the risk of devaluation. This puts rising pressure on interest rates.

A second problem generated by this situation is that if the Central Bank prints money and increases the

levels of liquidity to prevent a rise in interest rates, it generates a surplus of money that will eventually

be used for the purchase of dollars (thus the Central Bank would lose reserves) or the purchase of goods

(with which there would be a pressure on prices).

In recent weeks, this seems to have been the choice of the Central Bank. In recent auctions of Nobacs

and Lebacs the maturities were only partially renewed, which injected pesos into the market to avoid

pressures on interest rates. In the last three weeks, the base expanded by almost AR$ 3 billion this way.

The movement of interest rates also shifted the market preference towards Nobacs (which are at floating

interest rates) over the fixed interest rate Lebacs, a move that indicates that banks are concerned about

increases in the Badlar rate. Furthermore, the allocation of Lebacs and Nobacs in the Central Bank

auctions in recent weeks is among the lowest in the past year, indicating that banks have smaller

amounts of excess liquidity as loans are growing faster than deposits.
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In our opinion, the economy is going to converge to a new equilibrium in the coming months in which

the interest rate will be slightly higher than in the first months of this year (between 12.5 and 13.0%), as

banks will not have significant excess liquidity (as was the case in recent years). This balance may

change after the elections, when we anticipate two possible scenarios, though both include increases in

interest rates.

The first option is that there is no change in economic and monetary policies, in which case increasing

capital flight is possible, along with expectations of a further depreciation of the currency and hence a

rise in interest rates. In this case, the increases in interest rates would be a result of market pressures.

The second option is one in which there is a change in monetary policy with the objective of reducinginflation. In this scenario, there would be a rise in interest rates driven by a change in monetary policy;

however, the impact on the exchange rate is not clear; if it coincides with an increase in investor

confidence in the Argentine economy and a sharp increase in capital inflows, it is possible that the

country will experience a strengthening of the peso ( la Brazil).

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Down, down, down (a peso devaluation thread) - Baexpats - Community of Expatriates in

Buenos Aires, Argentina

[...] Brazil is changing the landscape too. http://www.economonitor.com/blog/201...netary-policy/ [...]
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1/20/10Today, we visited Argentinas Chief Economist, Pedro Labasa, who resides as the second incommand at the Central Bank of Argentina. Labasa oversees monetary policy and research for

Argentinas unique and complex financial system. After entering through a side entrance as asecurity precaution to the recent political situation concerning Redrado, Labasa and hisadvisors sat down with Chapmans MBAs to present a contemporaneous analysis of

Argentinas fiscal. During the 1980s, tariff and trade shocks on commodities and hyperinflationof more than 200% every month at its worst created a financial crash unlike any that Argentinahad ever seen before. Argentinean citizens, accustomed to their European cosmopolitanlifestyles, watched in horror as their purchasing power slipped to unmanageable levels. In aneffort to address the problem, the entering president in the 1990s established a currency bowlwith no monetary policy but a fixed currency to that of another country, the United States Dollarin this case, in an effort to immediately curb inflation. While hyperinflation fell, new problemsemerged in its wake of economic crisis. In an effort to provide a sturdy monetary base, the newpressures on the financial system could not support the financial system, despite theirstructured

The Outside

framework of regulation that required high liquidity ratios in order to put public debt on theirbooks. Furthermore, the new fiscal policy was limited in its ability to address changes in the

market and could not release new pesos into the market as they were tied to the dollar andwould create a rapid change in valuation of the peso. Therefore, the central bank issued publicdebt in the form of bonds in lue of more traditional forms of fiscal policy. With hyperinflationsolved, Argentina now faced an economic issue similar to that of the United States: an evergrowing public debt.So where is Argentina at this point? Theyre still in default of their international loans, aconsistently instable political system, and a feeble economy; a financial, economic, and socialnightmare. Strong leadership and an effort to fight the Argentinean populist movement mayhelp Argentina prevail in the long run but as the rest of the world weathers through therecession, Argentina finds no help abroad with limited access to traditional credit channels.

Argentineans will need full confidence before they start investing again.
http://www.travelblog.org/Photos/4683209http://www.travelblog.org/Photos/4683209http://www.travelblog.org/Photos/4683209


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Economic Research and Data

FRBSF Economic Letter

2002-25; August 23, 2002

Argentina's Currency Crisis: Lessons for Asia

Argentina's currency board regime

Asian currency arrangements

Lessons from the Argentine experience

Conclusion

References

Download and Print PDF Version (52KB)

This Economic Letter is based on a presentation Mark Spiegel prepared for a panel on "Optimal

Currency Arrangements for Emerging Market Economies: The Experience of Latin America andAsia," organized by the Latin American and Asian Economics and Business Association on July

15, 2002, in Tokyo, Japan.

Before Argentina's currency crisis erupted this year, renewed interest in pegged exchange rateregimes had been gaining momentum, especially in Asia. That region's 1997 financial crisis ledmany of its nations to explore whether formal currency arrangements might forestall a repeat

of such crises. The initial efforts concentrated on developing institutions to raise liquidityregionally, and since then the feasibility of greater monetary policy coordination also has beenconsidered.

Asian countries found particular inspiration from the successful launch of the European

Monetary Union (EMU). The EMU consists of 11 European nations that adopted a singlecurrency, the euro, and ceded monetary policy to a single central bank authority; at the same

time, however, these countries retain a large amount of other policy independence, particularlyconcerning domestic public finance. As such, the EMU provides a model of a viable currencyunion that closely matches a potential ASEAN arrangement (the ASEAN nations are Brunei,Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and

Vietnam). The launch of the EMU was followed by the Chiang Mai Initiative in June 2000, inwhich the ASEAN nations plus Japan, China, and Korea agreed to adopt a system of swaparrangements. There was some speculation that the successful launch of these swaparrangements would lay the foundation for more intensive regional monetary policy

coordination.

However, the difficulties experienced by Argentina this year have slowed much of the

momentum for the adoption of formal fixed currency arrangements. The shock of seeingArgentina's currency board regime, which had been perceived as strong and credible despite

some misgivings about the appropriateness of its currency peg, appears to have renewed

doubts about the sustainability of any formal exchange rate arrangements.

In this Economic Letter, I review the circumstances surrounding the collapse of Argentina'smonetary regime and describe some lessons these circumstances may provide for proposedAsian currency arrangements.

Argentina's currency board regime

Argentina maintained a currency board regime from April 1, 1991, through January 6, 2002,under which the Argentine peso was pegged one for one to the U.S. dollar. In several respects,

the regime did not meet the criteria of an "orthodox" currency board, as defined by Hanke and
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Argentina Economic Update (6 Feb 02)

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