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Business
Root causes for crisis
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The economy had become vulnerable to external shocks viewed against adverse terms of trade and the basket of products it could offer in the world market.
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WHEN EDUARDO Duhalde took over as the fifth President of Argentina in two weeks, not many were hopeful that he would usher in a new era. He has since sent an emergency economic plan to the Congress seeking special powers to end the peso-dollar peg, reform the banking system, control prices and protect local industry and jobs. He has devalued the peso and introduced a dual exchange rate to reduce the adverse impact on domestic depositors. Thus ends a decade of dalliance with free market and peso's link with dollar. The U.S. Treasury and the International Monetary Fund (IMF) may be disturbed over these, though Koehler has expressed support for the new policies and added, "But one also must recognise that without pain, it won't get out of this crisis, and the crisis — at its root — is home-made". Was it wholly home made?
Strictly speaking, it was not necessary for Argentina to have kept the link with the dollar for such a long time; it was not also related to the adoption of free market policies. It was an accident of history and, to be fair, it was effective in the initial years of its adoption. Fear of inflation runs deep in the Latin American psyche. In Argentina, peso-dollar peg became a totem which could not be easily disregarded. If, over the years, peso-dollar rate created high costs, it was also assessed that the severance costs could be more. What was the background to the dollar link? Troubled monetary conditions are not new to Argentina. It has a long history of unstable policies dating back to the 19th century. It has also a record of defaults rocking the London Exchange on occasions. Inflation raged for years. High inflation rates were observed in 1975, from 1982 to 1985 and from 1987 to 1990. In 1989 the consumer price change was 3079.4 per cent and in 1990 it was 2314 per cent.
Carlos Menem was first elected President in May 1989 and was determined to end inflation. The Congress passed the `Convertibility Law' in March 1991 establishing the convertibility of the currency and a currency board. In January 1992, the currency — austral — was renamed as peso and the rate was fixed at par.
Basically, it was an attempt to curb the issue of paper currency and set limits on the central bank's policies. Under the law, the bank must sell dollars for pesos at par. Free reserves, consisting of gold, foreign currency or deposits and bonds payable in foreign currency, had to be maintained at a level equal to 100 per cent of the monetary base. The bank was not allowed to lend to the government. A textbook currency board has to back its currency with foreign reserves only. However, in Argentina it was allowed to hold government bonds within limits — a total of 33 per cent with an annual ceiling of 10 per cent — to be purchased at the market price. These were deflationary measures and were effective as inflation came down to 25 per cent in 1995 and to negligible levels in the years ending 1998 and 1999. Currency board measures were tagged on to other reforms like reduction in government spending and taxation, elimination of budget deficits, privatisation, liberalisation of foreign trade, removal of restrictions on direct foreign investment, permission for capital flows including portfolio investment and deregulation of banking industry.
In the early years, growth did pick up. After years of stagnation, the growth rate went up from minus one per cent annual average between 1980 and 1990 to 4.3 per cent in the years from 1991 through 1998. These were the years when Argentina was held as a model for other developing countries.
The currency board and the dollar peg could not shield the economy from adverse winds blowing from abroad. Rather, they restricted the freedom for adoption of flexible policies in a changed global context, which neighbours like Mexico, and Brazil had. Privatisation programmes did not improve the industrial and manufacturing capability of the country. There were allegations of corruption in the sale of government companies, utilities especially, to chosen parties. A Governor of the central bank had to face criminal charges when a U.S. Senate Committee disclosed money laundering of sale proceeds. Another feature was that, in most cases, foreign companies capitalised Latin American loans (Brady bonds) bought at discounted prices. Privatisation did help the government to fill budgetary deficits and the IMF encouraged these attempts. Though the country was open for foreign investment, growth was confined to primary production like oil, gas and mining.
Much of the investment was from Spanish companies, especially in petroleum. The economy had become vulnerable to external shocks viewed against adverse terms of trade and the basket of products it could offer in the world market. The regional grouping, Mercousur, promoted growth of the auto sector and exports (28 per cent) were confined to Brazil and became uncompetitive when Brazil devalued. Though the peso was pegged to the dollar, it was not immune to speculative attacks since the credibility of the peg was always in doubt. When the Tequila crisis struck in 1995 and later, when the Russian and Brazilian crises boiled over in 1998-99, there were rumours of peso devaluation.
One trend in international capital flows was that after the eruption of East Asian crisis in July 1997, there was a temporary relief to Argentina. Foreign deposits with Argentine banks increased by about 40 per cent. The Convertibility Act had independently encouraged a disproportionate increase in the operations of foreign banks in dollars in Argentina. Loans were denominated in dollar as also interest payments. Total debt liability is estimated at $155 billion and about 80 per cent of it is in dollars and estimated at 30 per cent of its GDP. Economists and other analysts were unanimous that the situation was unsustainable and drastic measures were necessary. It needed time and also financial assistance to meet the transitional needs. The Bush administration and the IMF were unwilling for both.
The Bush administration's approach to fund assistance is, in theory, market oriented though in practice it is contradictory. The Clinton administration had committed to an assistance of $40 billion in December 2000 and this had not been disbursed. When it was finally agreed, it was made out to be one of the early attempts to involve private sector in bailouts. It was a disaster and the Argentine government could not complete bond sales and the private market did not bite.
What many economists suggested around this time was the so-called `Quadruple D': devaluation, dollarisation, deposit write-down and debt restructuring. The IMF would continue to pursue its standard prescriptions and press for deficit reduction, and could not encounter introduction of exchange control and removal of convertibility.
There was also contradiction in the U.S. policies. In August 2001, Brazil was favoured with a standby credit of $15 billion and Turkey with $1.51 billion. When it came to Argentina, they argued, "Unless Argentina set its house in order, further aid would not be forthcoming". This refrain continued as late as December 2001 when by then unemployment and misery had reached unbearable levels and there were riots on the streets. Argentina has contributed a good deal to create the crisis. But it may not be wholly honest to suggest that Argentina's difficulties are `home grown'. As Krugman put it, "Argentina's economic policies had `made in Washington' stamped all over them".
K. Subramanian
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