argentina crisis 2001

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ARGENTINA CRISIS 2001

Instructor: Prof. Kami RwegasiraPrepared and Presented by:Mohamed YehiaKarim Behary

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Argentina Currency Crisis (2001 – 2002)

Background Causes Impact & Effect Attempted Solutions Model Lessons Domestic Dimension

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Background

Before 1930 (the 7th on the world per capital income)Argentina enjoyed 70 years of political stability that facilitate rapid

economic development.

1940 to 1989Argentina experienced significant political instability:

military rule & internal conflictions

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How did it all go wrong with Argentina?

1989 to 1991Carlos Menem was elected president of Argentina

Tax reformation

Privatization

Trade Liberalization

Adoption of currency board (1 peso = 1 USD)Limiting the print of Pesos only to amount to purchase dollars in forex markets

1991 to 1999The government decided to peg the Peso to the US dollar (one to one fixed

rate) restore confidence and combat the hyperinflation. The new strategy worked at the time.

In 1995 the USD experienced prolonged period of real appreciation resulting in similar appreciation of the Peso relative to its trading partners.

The economic Growth Rate: 5.5% in 1996, 8.1% in 1997Then East Asian financial crisis begins in 1997, moves to Russia then to Brazil

(the big trading partner to Argentina).

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Year 2000 till 2002


30% of ARG

trading

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Products % OF COUNTRY TOTAL

Crude petroleum 10.80%Animal feed 9.20%Road vehicles 7.40%Vegetable oils 6.10%Wheat 4.60%Refined petroleum products 4.50%Oil seeds 3.80%Maize 3.80%Vegetables and fruits 3.70%Fish 3.10%∑ X 57.00%

The top 10 exports products for year 2000Products % OF COUNTRY

TOTAL Consumer goods 14.90%Food 4.60%Fuels 3.60%Industrial supplies 31.10%Machinery 29.60%Transportation 15.60%Other 0.50%∑ M 99.90%

The top 10 Import products for year 2000

The Current Account Deficit= ∑ X - ∑ M = - 42%

- Argentina’s exports became vastly expensive compared with its neighbor after Brazil crisis.-

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Impact & EffectLower export plus world price decline especially in the farm products limited Argentina’s ability to earn the foreign currency needed to repay USD foreign debts.

Peso fallen 70% against the dollar after ending the fixed link with dollar.

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Impact & Effect

-The investments values in the country became less after Peso’s huge decline.- Bad news for those borrowed in $ and are paid in Pesos.- The real value of the debts decreased.- Imported goods much more than exported goods which increase the inflation.- Brazil encountered vast drop leaving Argentina exports more expensive than neighbor countries.- The confidence in the country evaporated- Social violence widespread.

-The country went on borrowing on international market, until debt reached $140 bn.

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The problem was mainly divided in the following two factors:

Currency devaluation after breaking the link between Peso and USD.

The huge international debt that reached $140bn.

As per the old saying: “if you owe the bank $1000, it’s your problem, but if

you owe it $140bn, then it’s the bank problem” The new president desperately seeks assistance from the

IMF on December 1999.

Attempted Solutions

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Attempted Solutions

IMF agrees in year 2000 to supply three year $7.2 billion stand by arrangement with Argentina but conditioned on strict financial adjustment and assuming 3.5% GDP growth.

The government on the other hand cut $ 1 billion in budget to renew the confidence again to the economy.

The government through year 2001 was enhancing the IMF to proceed with the 2000 agreement but with 2.5% GDP growth instead of 3.5% ( supplying $7 billion as part of $40 billion) assistance package involving Inter – American Development bank, World bank, Spain, and private lenders.

The government announced a $29.5 debt to be restructured from a short term to longer maturity and higher interest rates.

Peso exchange rate for merchandise trade is priced at 50/50 dollar – Euro peg, which effectively allowed 7% devaluation for foreign trade, that should improve Argentina’s competitiveness.

These actions didn’t work due to lack of confidence still dominant in the market.

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Attempted Solutions

IMF expanded its agreement for a 2nd time after Argentina’s congress passes “Zero Deficit Law” that requiring a balanced budget by the 4th Q of 2001.

Public salary were paid by provincial bonds as federal revenue transfers decline.

The government conducted a 2nd debt for $60 billion of bonds with 7% interest rate instead of 11% - 12% interest rate for extended maturity.

The central bank reserves were falling by $2billion a day, so that the president limited dollar withdrawal to $1000 per month, which lead to more instability in the market and IMF took hold of 1.24 billion loan till Argentina’s meets its financial targets.

The disturbance spread to major cities with increasing the unemployment rate, and deep budget cut.

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Attempted Solutions A new president was appointed by the congress and suggested a new

plan that include: - Suspension of payments on public debt - New job creation program - Creation of a new currency (the Argentino). The disturbance continued leading to the president resigned after losing

party support. The congress selected a new president (Eduardo Duhalde) Jan 2002. The new president established the following economic policy: - Devaluate Peso by 29% (1.4 to the dollar) only for major foreign

commercial transactions. - Keeping floating rate for all other transactions. - Converting all debts up to $100,000 to Pesos (devaluate cost to

creditors. - New tax on oil to compensate the creditors. - All saving accounts exceeding $10,000 and $3000 will be converted

to certificates of deposit and remain frozen for one year. - Smaller deposits can withdraw by converting to Peso with 1.4

exchange rate.

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Attempted Solutions

The IMF approves request for one year extension on $926 million payment due in Jan 2002.

In 2003 a new president was elected (Nestor Kirchner) - Made bold policy move in the area of human rights - Institutional reform and economic policy The faith in democracy in Argentina restored In Jan 2006, Argentina paid off its $9.5 billion debt to international

monetary fund. Reducing poverty, controlling inflation rates. Maintain strong economy growth.

Currency Crisis Model

Rising foreign denominated debt

Exchange rate Fixed / pegged

Rising Govt deficit + monetary policy that

leads to inflation

Balance of paymentsC-Acc deficit rising

Rising public Private sector debt

Banking / financial sector fragility +

domestic borrowing constraints

Falling Forex reserves in defense of the peg

Rising expectations of a LC devaluation or

depreciation

Speculators attack

Argentina Currency Crisis Mapping April 1991, the Convertibility Plan, the exchange

rate of the a peso was fixed to 1 peso per US dollar and any individual can exchange any amount of money




leads to inflation





Falling Forex reserves in defense

of the peg

Rising expectations of a LC devaluation

or depreciation

Effect Better life style More imports Less exports

Argentina Currency Crisis Mapping Mexican and Brazilian crisis 1994,1999 led other countries to

mistrust Latin American countries moneywise In 1999 Argentina's GDP dropped 4% Limited ability of federal government to control expenditures of

provincial governments




leads to inflation






of the peg


or depreciation

Effect Capital flows out Increased deficit

Argentina Currency Crisis Mapping Mexican and Brazilian crisis 1994,1999 affected Argentina

Trade partnership Leading other countries to mistrust Latin American countries moneywise

International appreciation of the US dollar affected the international trade of Argentina




leads to inflation






of the peg


or depreciation

Effect Increasing current

account deficit

Argentina Currency Crisis Mapping During the 90s, the private debt increased by 11 times, while the public debt grew by

less than 60%. Unwilling or unable to raise taxes, public debt increased sharply from 29.5% of GDP

in 1993 to 50.3% in 1999 Associated with the increase in public debt was an increase in the debt service ratio,

which increased from 22% of exports in 1993 to 35.2% in 1999, exacerbating an increasing current account deficit




leads to inflation






of the peg


or depreciation

Effect Public dept increased

Argentina Currency Crisis Mapping December 2001, Argentina imposed a partial deposit freeze Argentina no longer in compliance with the conditions of the

expanded IMF-supported program, the IMF decided to suspend disbursements

January 2002, Argentina formally abandoned the convertibility regime




leads to inflation






of the peg


or depreciation

Effect Full blown banking

sector

Argentina Currency Crisis Mapping Argentina had old huge foreign debt inherited from earlier military

and democratic governments In 2000 and 2001, Argentina needed to borrow again from the IMF,

WB, American Development Bank, Spain, and private lenders




leads to inflation






of the peg


or depreciation

Effect International dept

increased

Argentina Currency Crisis Mapping Central bank reserves falling by $2 billion in one day 2002, restricted floating exchange rate for major foreign

commercial transactions and free floating rate for all other transactions




leads to inflation






of the peg


or depreciation

Effect Central bank

reserves falling

Argentina Currency Crisis Mapping Use of provincial bonds as “scrip” to pay public salaries Central bank reserves falling by $2 billion in one day $1,000 per month limitation on personal bank withdrawals 25% of all the money in the banks had been withdrawn December 7th 2001, Argentina announces it can no longer guarantee payment on foreign

debt December 18 IMF says Argentina can delay payment on loan of about £650m due in

January, but also says Argentina's economic policy is unsustainable




leads to inflation






of the peg


or depreciation

Effect Speculation starts Peso depreciation

Speculators attack

Lessons On the long run, pegging the local

currency to another strong currency is not in favor of the local currency

Trade partners’ crisis will magnify any local crisis

Domestic comparison




leads to inflation






of the peg


or depreciation

Exchange rated is managed floating

US$ in 5 yearsMax: 5.85Min: 5.30

Euro in 5 yearsMax: 8.60Min: 6.75

Domestic comparison




leads to inflation






of the peg


or depreciation

Inflation rated is not stable Governmental spending still high

Domestic comparison




leads to inflation






of the peg


or depreciation

Total exports is about half of the total imports

Imports about $56bn

Exports about $30bn

Domestic comparison




leads to inflation


Rising public Private sector




of the peg


or depreciation

Public dept decreased from over $100bn to$80bn

Domestic comparison




leads to inflation






of the peg


or depreciation

The CBE is independent of the government

Domestic comparison




leads to inflation






of the peg


or depreciation

The external dept is stable for the last 6 years

Domestic comparison




leads to inflation






of the peg


or depreciation

CBE reserve improved

Domestic comparison




leads to inflation






of the peg


or depreciation

Limited speculations

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