The Argentine Crisis 2001/2002
During most of the 1990s, Argentina outperformed most other countries in Latin America in terms of growth. However, in the late 1990s, Argentina’s hard currency peg to the US Dollar, pro-cyclical fiscal policies and extensive foreign borrowing left the country unable to deal with a number of economic shocks. This eventually led to the outbreak of a severe currency, sovereign debt and banking crisis.
Author: Iris van de Wiel (intern)
Point of no return
November 30th , 2001 – As a result of rising worries among Argentines about a peso devaluation and a deposit freeze, overnight interest rates rise sharply. Moreover, spreads between US Treasury bonds and Argentine government bonds increase to 5,000 basis points. A bank run begins.
December 1st , 2001 – In order to avert an aggrevation of the bank run, the Minister of Economy Domingo Cavallo announces a freeze on bank deposits. The deposit freeze, popularly called the Corralito, proves that the existing Convertibility Plan, which had coupled the Argentine peso to the US Dollar on a one-to-one basis since 1991, is untenable. The foundation of the Convertibility Plan, the possibility of freely converting Argentine pesos into US Dollars, has become meaningless, as deposit holders can no longer access their savings. This causes unrest among the Argentine population and people start to demonstrate; similar freezes imposed in the 1980s had deprived the population of the means to protect their savings against high inflation.
December 5th , 2001 – Social unrest further grows after the IMF announces it will cut off its support, as Argentina continuously fails to meet the conditions tied to the rescue program that has been in place since September 2001. This means that Argentina loses access to its last source of foreign capital. With a total amount of almost USD 22bn in 2000 and 2001, the IMF support for Argentina is larger than its support for any other country at this time. In the protests and looting that follow, 24 people lose their lives. Both President De La Rúa and Minister of Economy Cavallo will resign soon after these events.
December 23rd , 2001 – President Rodriguez Saá, who has just been elected by the Argentine Congress, announces the default on USD 93bn of Argentina’s sovereign debt. Rodriguez Saá will have to resign a couple of days later, thereby increasing political instability even more; as much as four different presidents will try to rule Argentina in December 2001, none of them however manages to remain in office.
Figure 1: Reserves and the exchange rate
Source: World Bank
January 1st , 2002 – The Argentine Congress chooses Eduardo Duhalde as the new president.
January 6 th , 2001 –The implementation of the Law of Public Emergency and Reform of the Exchange Rate Regime marks the end of the Convertibility Plan. At first, the peso is devalued from 1 peso per Dollar to 1.4 peso per Dollar. Later on, the exchange rate will become fully floating, which allows the peso to depreciate even further (see Figure 1).
Figure 2: GDP Growth
Source: World Bank
The economic and social impact of the crisis is huge. While economic growth had already been negative in every year since 1998, the economy contracts by 11% in 2002. In absolute terms, GDP per capita in 2002 is only slightly higher than twenty years earlier (see Figure 2). Along with the fall in GDP, the unemployment rate rises from 14.8% in 1998, to a peak of 22.5% in 2001 (see Figure 3). As a result of the deteriorating economic situation, the proportion of Argentines living below the (national) poverty line rises sharply from an already high 25.9% in 1998 to 57.5% in 2002. Partially thanks to the strong depreciation of the peso, the Argentine economy starts to recover in the course of 2002.
When the IMF stops providing new loans in December 2001, Argentina fully loses its access to foreign finance. In order to regain the access to the international financial markets it lost in the run up to the crisis, the government needs to restructure the debt on which it defaulted. However, as Argentina posts large surpluses on the fiscal and current accounts after the default and large devaluation of the peso, access to foreign finance has become less urgent. Argentina takes a hardline approach against creditors, which results in protracted negotiations. By 2010, 92% of the Argentine defaulted debt has been restructured. However, ongoing litigation by holdout creditors could lead to a new Argentine default in the near future.
In the beginning of the 20th century, Argentina was one of the wealthiest countries in the world. Its GDP per capita exceeded GDP per capita of European countries such as France and Germany. After World War I, however, Argentina entered a phase of slow economic growth. The country suffered from bad policy making due to an ongoing political gridlock and was hit by adverse terms of trade. The outbreak of the oil crisis in the 1970s was the start of a long period of economic downturn, which culminated in the severe Latin American debt crisis of the 1980s. As government spending could not be matched by taxation and financial markets borrowing, the authorities became dependent on inflation to finance the rising deficits. A sharp rise in inflation was the result.
Figure 3: Inflation and Unemployment
1989 – 1997
Battle against inflation
When inflation reached an extreme annual rate of 3,080% in 1989, political support to deal once and for all with high inflation grew. Carlos Menem became the new Argentine president in the same year and introduced a set of radicial economic reforms .
First, plans for economic stabilization and liberalization were adopted in line with the Washington Consensus. Amongst other things, the reforms included the privatization of state owned enterprises, the deregulation of the economy, lower trade barriers and state reform. With the implementation of the reforms, Argentina won great commendation, especially from the IMF. Also on Wall Street, Argentina had become one of the most favorite emerging markets; the country was able to borrow relatively cheap in US Dollars and became the biggest issuer of emerging markets debt in the late nineties. This made the country increasingly dependent on foreign capital.
Second, a succesfull plan to counter the hyperinflation was implemented. The Convertibility Plan of 1991, that fixed the Argentine peso one-to-one to the US Dollar, laid the foundation for (temporary) exchange-rate stabilization. Under the currency board, Argentines could now freely convert their pesos into dollars. From then on, bank deposits and loans in dollar became widespread. Finally, expansive fiscal policy had to stimulate the economy and help restore economic growth.
After the implementation of these reforms, the Argentine economy entered a period of economic growth between 1991 and 1997. Only in 1995 output growth was negative, due to the so-called Tequila crisis in Mexico. The quick return of high economic growth in 1996 however suggested that the Argentine economy was strong enough to counter external shocks. This further strengthened the confidence in the implemented policies, including the Convertibility Plan.
1998 – 2001
Loss of competitiveness
The outbreak of currency crises in Asia, Russia and Brazil increases the borrowing costs for emerging markets, including Argentina. Furthermore, a major change in Brazil’s exchange rate policy had a great impact on the Argentine economy, as Brazil was one of the country’s main trading partners.
In 1998, Brazil ended its own peg to the US dollar, which resulted in a strong depreciation of the real. This helped the Brazilian economy to recover, but had a big impact on the Argentine economy, as it reduced the competiveness of many Argentine producers. Meanwhile, the prices of Argentina’s agricultural export products fell. All this led to a sharp reduction in exports. As a result, Argentina’s current account deficit rose and the country went into recession in the autumn of 1998.
Argentina maintained its peg, but this left it unable to respond to the growing economic problems, as it could not apply monetary or exchange rate policy. In fact, as the US dollar appreciated and reached its highest level in 15 years, the currency peg became even more of a straitjacket. Moreover, the fact that the exchange rate peg was not supported by nominal price and wage flexibility further reduced Argentina’s means to deal with the currency overvaluation and decreased the credibility of the fixed exchange rate regime.
As foreign investors lost their confidence in the Argentina economy, the country faced a strong increase in borrowing costs. This way, the country had fully lost its access to the international financial markets in July 2001.
Argentina’s fiscal policies also contributed to the crisis. For countries with a fixed exchange rate regime (in particular), it is important to follow counter-cyclical fiscal policies. However, in Argentina fiscal policy was pro-cyclical during the boom period. President De La Rúa, who succeeded Menem in 1999, wanted to tackle the resultant budget deficit of 2.5% of GDP and furthermore promised to start fight the enduring corruption. According to De La Rúa, reducing the deficit would restore confidence in government finances, reduce interest rates and thereby bring back economic growth. The effects of De La Rúa’s policy were however the opposite, as the imposed rise in tax rates only reduced domestic demand, encouraged corruption and did not lead to the necessary reduction of the fiscal deficit. Furthermore, it appeared to be difficult to implement austerity measures on a regional level, as the central government was not able to control local government expenditure. What followed were rising fears for devaluation, which eventually led to the implementation of the Corralito in December 2001.
Effects on the banking sector
In 1998, the Argentine banking sector ranked 2 nd , after Singapore, on the Camelot rating for banking system regulation, provided by the World Bank (Perry and Servén, 2003). The contraction of the economy, which started in that year, however resulted in rising non-performing loans. The January 2002 economic reforms, including the abandoning of the Convertibility Plan, the pesofication of bank deposits and loans at two different exchange rates and prize freezes for utility companies, caused a wave of defaults and liquidity problems at Argentine companies. The default rate of rated issuers was even as high as 60%. The apparent solid position of the Argentine banking sector could not prevent the sector, including both domestic and foreign banks, from being affected by the events as well. Amongst others, Argentina’s largest locally owned private-sector bank, Banco Galicia, and several foreign banks, such as the US banks Bank of America, Citigroup, FleetBoston and J.P. Morgan Chase & Co suffered heavy losses. These losses were primarily caused by:
- The bankruptcy of many of the banks’ debtors;
- The pesofication, which converted Dollar deposits to pesos at a 1.40 peso per Dollar rate and loans only at a 1 peso per Dollar rate;
- The USD 93bn sovereign default of December 23 rd , 2001.
The Argentine economic crisis was caused by the undesirable confluence of several economic events: a hard currency peg, currency overvaluation, economic rigidities, inappropriate fiscal policy, external shocks, large scale foreign currency borrowing followed by a sudden stop in capital inflows and enduring IMF support played an important role in the course of the crisis. This, together with the political and social turmoil that accompanied the events, made the Argentine crisis one of the most severe emerging market crises in history. As world economic growth in the early 2000s was strong and Argentine producers benefitted from the strong depreciation of the currency, the Argentine economy was able to recover rather quickly. Profound reforms were therefore not implemented.
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