Crisis in Argentina 2003 Research Paper

Argentina shares land borders with Bolivia, Brazil, Chile, Paraguay and Uruguay, as well as it is bordered by the Atlantic and the Antarctic Oceans. The Argentine nation has been built by the fusion of diverse national and ethnic groups. Waves of European immigrants arrived in the late nineteenth and twentieth centuries. Today, descendants of Italian and Spanish immigrants predominate, but many trace their origins to East European or British and other West European ancestors.

The Argentine population has one of the lowest growth rates in Latin America (1.5%). The 80% of the population reside in urban areas of more than 2000, with more than 1/3 of the population living in the metropolitan Buenos Aries.

Argentina has impressive human and natural resources, but political conflict and uneven economic performance since World War II have impeded full realisation of its considerable potential. Nonetheless, in the past it remained one of the richest countries in Latin America.

Good farmland is Argentina’s greatest natural resource, and the crops and livestock of the fertile pampas have long provided the country with abundant food for domestic consumption, in addition to unusually plentiful exports.

Agricultural products constitute the major source of foreign exchange earnings. Grains (principally wheat, corn and sorghum) and oilseeds (soya beans and sunflowers) are the major export items. In a good years of the past, grains and oil seeds harvests totalled some 40 million metric tons. Argentina has been selling its export crops to a variety of worldwide buyers. In the early 1980s the Soviet Union became the major purchaser of grains, while later the Middle East and the European Community, as well as United States, became the major markets.

Argentina was a net energy importer in 1987. It has important reserves of petroleum and natural gas, which are the target of a more intensive exploration and exploitation effort. It also has a large electrical production capacity.

There was a military coup in March 1976 as a result of a deteriorating economy, caused by declining production and rampant inflation. The military government set out to tackle those immediate problems and in 1978 embarked on a new development strategy centering on the establishment of free-market economy. The strategy also featured the removal or reduction of restrictions in the manufacturing sector and financial markets and the search for foreign and domestic investment. Despite these efforts, by the late 1980, Argentina entered a period of recession with declining production and real wages. After a notable economic recovery in 1986, economic growth has again slowed down.

Up to the beginning of the 1990

Faced with healing a scarred society and a worsening foreign debt crisis, the government OF Raul Alfonsin was slow to tackle the root causes of the economic problems when it took office in December 1983. By mid-1985, the country was suffering from an annual inflation rate of more than 1 000%. In attempt to control inflation and set the country on a prudent fiscal base, the government introduced a shock economic plan in June 1985. The Austral Plan succeeded temporarily in reducing inflation by introducing wage and price controls. (The Austral succeeded the Peso as Argentina’s unit of currency). Annual inflation in 1986 was in double digits, 86%, for only the second time since 1972. But in 1987, with the significant increase in the public sector deficit accompanied by very large price and wage increases, inflation returned to triple digits, closing out the year at 177%. The 1988 inflation rate was in excess of 280%. The nation’s burdensome external dept grew to $59 billion and the government had to suspend interest payments.

By 1990, the Argentine economy faced serious economic crisis. Inflation has surged to an all-time high. The economy had been in a deep recession since mid-1988 and the up-turn in inflation had exacerbated the decline. Prospects for an economic turnaround were uncertain. Economic policy making was affected by events in the political arena, where the country was in the midst of the first transition between the democratically elected administrations since 1928.

Carlos Menem had won the presidential elections of 14 May 1989 and had taken office on 8 July. The new government was intent on stabilising the economy through fiscal austerity, privatisation and greater reliance on market forces. His administration sought emergency economic legislation from Congress that would provide authorisation to curtail government subsidisation of industry and to privatise many state-owned companies.

The creation of the new economic strategy (the Plan Primavera) in 1988 brought some important changes in Argentina’s economy. The programme, which relied on an overvalued austral, negotiated price controls and tight monetary policy, reduced the monthly inflation rate from 30% in August to 6% in January. A series of exchange market crises in the ensuring months produced a devaluation of over 1000% in the free exchange rate. The government responded with a series of short-term measures designed to blunt pressure on the exchange rate and to restore some price stability to the economy. However, the Alfonsian administration was unable to stabilise the economy, which led to the early transfer of power to the Menem government.

In the 90s Argentina’s external accounts were market by uncertainty. Foreign exchange reserves were low. Arrears on debt payments totalled $2.7 billion at the end of 1988 and reached almost 7 billion at the end of 1990. Prospects for substantial recovery during the 1990s were not promising for this ‘developed’ economy.

After 1990

At the core of the economic crisis is the Argentina’s currency, the peso, which was pegged to the U.S. dollar in 1991. The president Carlos Menem and the economy minister Domingo Cavallo artificially tied the peso to the dollar at one to one parity through a currency board in order to generate financial stability, restore confidence and combat hyperinflation.

Their actions effectively ended rampant inflation in the country and attracted billions in foreign investment. However, the currency board limited monetary growth by only allowing as many pesos to circulate in Argentina’s economy as dollars held in the Argentine Central Bank’s reserves. When foreign investment flowed in, as occurred during the mid-1990s, this had the effect of accelerating Argentina’s economy by increasing the monetary supply. However, the artificial peg led to an overvalued currency that eventually made Argentina’s exports uncompetitive while simultaneously encouraging high levels of imports. As long as foreign investments poured in, Argentina could cope with this situation, but once foreign investment dried up in the late 1990s, it was a recipe for disaster. Foreign debt swelled to pay for Argentina’s imports, and national debt was compounded by the free-spending habits of provincial governments, who often took on unrealistic debt loads in the expectation that they would be bailed out by the national government. As Argentina’s economy became uncompetitive, the currency board had the effect of deepening the four-year recession by shrinking the monetary supply as the country spent more on imports than it earned through exports. The slump sent unemployment spiralling to levels over 18%, creating the conditions for political unrest to reach dangerous levels.

In December 2001, the IMF signalled that it had lost confidence in the country administration’s economic program by shutting off a crucial $1.3 billion bailout when Argentina failed to meet budget-cutting targets. That prompted Argentina to announce days later that it was suspending payments on its foreign debt amounting to $141 billion dollars. The new president Fernando de la Rua, in order to halt a run on the Argentine banking system, which is largely dominated by foreign financial institutions, imposed a $250 limit on weekly withdrawals. Besides nearly freezing economic activity, this action provoked street protests around the country. Demonstrators attacked banks and looted supermarkets. In Buenos Aires, thousands marched on the presidential palace demanding food, jobs, and an end to the banking freeze. Over a dozen people died in confrontations with riot police or other demonstrators. The result was the resignation of the deeply unpopular de la Rua as president.

Argentinians were increasingly becoming used to living in a society of empty cash machines, where barter clubs begun to replace shops, and where credit cards were no longer accepted. The society and the businesses were devastated.
One of the shop owners in Buenos Aires said that time:
“I don’t know if the banks that issue the cards will still be there next week. So for the time being I am only taking cash.”

During the December 2001 holidays, it quickly became apparent that few Argentine politicians had the necessary political backing or popularity to lead their country successfully out of its economic crisis. After a false start under interim president Adolfo Rodriguez Saa, the Argentine congress appointed Eduardo Duhalde, a leader of the Peronist opposition, to serve out the remainder of de la Rua’s presidential term. Duhalde took office announcing an end to the peso’s parity with the U.S. dollar and creating a multi-tiered exchange rate to take its place. Although the rules have been shifting since the devaluation, there is now an official exchange rate of 1.4 pesos to the dollar for major international financial transactions, and a free floating exchange rate for most personal or individual needs. This devaluation could have potential explosive political implications since most salaries are paid in pesos, while most consumer debts and mortgages are valued in U.S. dollars.

Duhalde blamed the U.S. backed free-market approach for his nation’s troubles, proclaiming it a “broken model,” and warned that his government will aggressively protect Argentine industry and jobs. Duhalde and his team have since suspended government payment of debts to international creditors, introduced capital controls, and placed extraordinary taxes on oil exports. Commenting on his government’s activities, Economy Minister Jorge Remes Lenikov said:

“We have to lay bare several fallacies that we were getting used to. One is living at somebody else’s expense; the other is having deposited pesos and thinking that they are dollars or that they were converted into dollars in an accounting entry.”

Duhalde’s economic policies are largely short-term measures designed to stabilize the current economic and political situation. However, they risk turning Argentina into a pariah in global investment circles.

The United States and the IMF are taking a dim view of President Duhalde’s tactics, and it does not look as if the United States is willing, at least at this point, to support Argentina during this crisis. The Bush administration has stated that Argentina will only receive U.S. assistance through international financial organizations, and only when it has a solid economic program that includes privatization, deregulation, and fiscal discipline. In a speech in Chile, IMF First Deputy Director Anne Krueger said that:

· IMF support for Argentina is contingent upon the economic plan the Duhalde administration develops.
· Argentina should formulate a new monetary policy, a fiscal policy, and restructure the banking system.
· It would be very unlikely for the IMF to provide a solution for Argentina’s economic crisis in the near term.

Argentina’s largest regional trade partner, Brazil, has been looking for ways to reduce the risk that the economic crisis will spread. Brazilian economists have said that their country’s best protection from contagion by the Argentine crisis is for it to persevere with its own recent macroeconomic policies, including inflation targeting and a floating exchange rate. In fact, Brazil’s 1998 devaluation of its currency, the real, contributed to making the Argentine peso uncompetitive even in trade with its within Mercosur the regional trade bloc led by Brazil.

Remarkably, Argentina’s democracy appears to have survived the political turmoil associated with its economic crisis. Only two decades ago, similar levels of confrontation and popular unrest would have provoked a military coup. This time, the Argentine armed forces have wisely chosen to keep a low profile.

The crisis also has serious implications for Argentine and regional security. In the short term, the heavy strain placed on Argentine police forces by frequent riot control duty in major cities is likely to erode their capacity to deal with other threats to internal security. In particular, terrorist groups linked to Hamas and Hezbollah are strongly suspected of operating in the tri-border region where Argentina, Paraguay, and Brazil meet. These groups are thought to have carried out the bombing of the Israeli embassy in Buenos Aires in the 1990s. A weakened Argentine security presence in this already under-policed region at a time of local political turmoil may create new opportunities for these groups to prosper.

Although the U.S. war on terrorism has shifted the Bush administration’s focus away from Latin America, the Argentine economic collapse is likely to have serious implications for U.S. relations in the region for some time to come. While the Bush administration signalled a new toughness towards economically troubled debtor nations around the world by allowing Argentina to collapse, it may have sent a somewhat different message to Latin American audiences. For years, populist political leaders such as Hugo Chávez in Venezuela and Luis Inácio Lula da Silva (Lula) in Brazil have railed against IMF- and Washington-sponsored economic policies. The economic failure of Argentina, the most devoted follower of these policies during the 1990s, has been interpreted in some circles as evidence supporting the anti-IMF and anti-U.S. claims of populist leaders.

The implications of recent events in Argentina for U.S. trade policy towards Latin America are less clear. Its economic paralysis has deepened the turmoil within Mercosur. . Until now, Mercosur had been pushed by Brazil as a Latin American alternative or precursor to the Free Trade Area of the Americas (FTAA) initiative sponsored by Washington. From the Brazilian perspective, Latin American countries would have more control vis a vis the United States if they integrated into Mercosur first, then negotiated as a bloc over entry into FTAA. Until now, Argentines, deeply resentful of the Brazilian devaluation of its currency which undermined Argentine ability to export to Brazil, had rejected the Brazilian strategy of independence and opted instead to stick to their proven strategy of unabashed support for U.S. policies. On the face of it, Argentina’s crisis may place the United States in a stronger negotiating position by undermining Mercosur as an alternative. The association of the FTAA with Washington – sponsored neoliberal economic policies, however, may make the Brazilian model of greater protection for local markets, currently embodied in Mercosur, more attractive to Latin American countries in the wake of Argentina’s collapse.

After the burst of inflation followed the messy abandonment of Peso parity with the US dollar, price rises have slowed sharply since August 2002. This relative calm, together with more policy stability compared with the massive changes of rules and regulations at the start of the year 2003, has translated into indicators that show the fall in economic activity bottoming out. In spite of the government’s claims, however, it is too soon to state that the economy has started to recover. Only a few sectors, related to exports or to import – substitution, show some improvement, in spite the lack of credit.

The combination of low consumer demand, political uncertainty and an investor unfriendly policy environment caused gross fixed investment to decline sharply in 2002. This has been accompanied by a disappearance of credit and foreign direct investment, as investors continue to grapple with the way in the government reneged on its legal obligations and interfered with private contracts. Unemployment, which already stood at over 21% in May 2002, is likely to remain high and it will be several years before it again reaches single digits (Table 3). Since Argentina has an extremely limited unemployment insurance system, this means that a substantial portion of the population is experiencing great hardship. Official statistics indicate that a record high % of the population are under the poverty line and cannot even meet their basic nutritional needs. An emergency unemployment subsidy has been set up to try and limit the hardship, though the government, in default, does not have the resources to do much.

On the external front, lack of financing has made it difficult for the merchandise exports to benefit from the drastic devaluation of the Peso. In Dollar terms, they fell by about 5.5% in the first 10 months of 2002. However, plummeting imports due to low economic activity, together with the decision of the government and some corporates not to service foreign dept, has benefited the current account on a cash basis.

In the adopted new monetary policy, in 2002 the central bank expanded money supply to aid a financial system under huge pressure from depositors. To avoid excessive inflation and in the absence of other instruments, the central bank absorbed part of these Pesos through the sale of forex reserves. The absorption has been done through central bank bills, at high real interest rates.

Increased policy stability, together with tight capital controls and a relatively conservative monetary policy, made it possible for the central bank to stabilise the value of the peso after its steep depreciation in 2001. The low return offered by cash holdings of US dollars, probably the alternative most preferred by Argentine savers, made bank time deposits relatively more attractive and for the first time in many months, financial institutions benefited from an inflow of funds. Consequently, interest rates have been falling sharply over recent months. Under normal circumstances this would be pre-announcing a return of credit to the economy, as banks sought a profitable application of their funds. Unfortunately, so many fundamental problems remain unsolved, such as the regeneration of sovereign dept, the need to strengthen the financial system and so on. The table 4 presents the exchange rate levels of Peso vs US dollar.

As we could see from the latest news the Argentina’s economy has stopped collapsing – at least for now, and there are some small signs of the recovery.

After the months of negotiation, Argentina seems about to get a new loan from the International Monetary Fund (IMF). The plan is to give Argentina a temporary “transitional” loan” that will see the country through its presidential election, currently scheduled for April 27th, 2003. The fund is not offering any new money in net terms – at just under $3 billion, the loan will be just enough to let Argentina repay the IMF what it already owes up to August. No serious structural changes will be demanded in return.

It is believed that this deal is designed partly to assuage the rich countries’ guilt over the extent of Argentina’s mess, and their role in creating it. And it is partly a capitulation to highly effective Argentine pressure. January the 17th, 2003 was the day that Argentina was due to repay the IMF almost $1 billion, a payment that Buenos Aires was refusing to make without a new IMF agreement.

For some in G7, the goal of loan now should be to mitigate Argentina’s pain, which has seen living standards fall precipitously and millions drop into poverty. It will do nothing about Argentina’s fundamental problems, notably the need to overhaul its public finances and restructure the banking system. It is doubtful that this loan will even provide stability until the election.

The G7’s other motive – to avoid more Argentine defaults to multilateral financial institutions – has even less merit. Since the November 2002, when Argentina refused to honour $800mln repayment to the World Bank, the country has made clear that it would not repay any creditors unless there was a new IMF agreement. Argentina is a big borrower, not just from the IMF but also from the World Bank and the Inter – American Development Bank. A prolonged Argentine default could damage these institutions’ credit ratings. To avoid this, the G& have given out just enough money to avoid default.

An IMF agreement would be a small step towards ending Argentina’s financial isolation, but the government still has to negotiate its debt (of about $100 billion) to private creditors. Even if they accept a huge write-down on their loans, servicing these will require a budget surplus (before interest payments) far bigger than this year’s target of 2.5%. Given this to-do list, it is a little too soon to declare the worst is over for Argentina.

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