11

Managing the Financial Managing the Financial Crisis: Argentina (2002) Crisis: Argentina (2002)

Mario I. BlejerMario I. Blejer

22

Managing the crisis:Managing the crisis: Assess the Nature and the Root

Causes of the Crisis

Define the Tradeoffs

Define and Operational Strategy

Persevere in the Implementation

Learn some Lessons

33

The Nature of the Argentina CrisisThe Nature of the Argentina Crisis

The Argentine crisis is The Argentine crisis is bothboth a a CURRENCYCURRENCY and a and a BANKBANK crisis – Inter- crisis – Inter-related but caused by a number and related but caused by a number and combination of different factorscombination of different factors

Analytically, better to distinguish Analytically, better to distinguish between them in an explicit mannerbetween them in an explicit manner

44

THE CURRENCY CRISISTHE CURRENCY CRISIS

The Currency Crisis reached its peak with the January 2002 devaluation. It is usually analyzed in the context of the ARGENTINE CURRENCY BOARD SYSTEM, ARGENTINE CURRENCY BOARD SYSTEM, established in 1991 as an anti-inflationary devise.

The question to be analyzed is: The question to be analyzed is: What were the weaknesses and the main causes for the demise of the convertibility regime?

55

THREE APPROACHES:THREE APPROACHES:

1. The loss of competitiveness of 1. The loss of competitiveness of the Argentine economythe Argentine economy

2. Macroeconomic policy 2. Macroeconomic policy inconsistencies inconsistencies

3. The 3. The “Sudden Stop”“Sudden Stop” argument argument

66

Tradables/non tradables (WPI/CPI)

Convertibility average101

224220

148

70

90

110

130

150

170

190

210

230

25019

80

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Ene

-02

Mar

-02

May

-02

Jul-

02

Sep

-02

Nov

-02

Ene

-03

ind

ex 2

001=

100

77

-4,0%

-3,0%

-2,0%

-1,0%

As percentage of GDP

0,0%

1,0%

2,0%

3,0%

1993 1994 1995 1996 1997 1998 1999 2000 2001

0%

10%

20%

30%

40%

50%

60%

Overall Result Primary Surplus

Total Debt (2° axis) EMBI Spread (2° axis)

Fiscal misalignement turned the burden of Fiscal misalignement turned the burden of the debt unsusutainablethe debt unsusutainable

88

-4,0%

-3,0%

-2,0%

-1,0%

As percentage of GDP

0,0%

1,0%

2,0%

3,0%

1993 1994 1995 1996 1997 1998 1999 2000 2001

0%

10%

20%

30%

40%

50%

60%

Overall Result Primary Surplus

Total Debt (2° axis) EMBI Spread (2° axis)

Fiscal misalignement turned the burden of Fiscal misalignement turned the burden of the debt unsusutainablethe debt unsusutainable

Public Debt

99

-4,0%

-3,0%

-2,0%

-1,0%

As percentage of GDP

0,0%

1,0%

2,0%

3,0%

1993 1994 1995 1996 1997 1998 1999 2000 2001

0%

10%

20%

30%

40%

50%

60%

Overall Result Primary Surplus

Total Debt (2° axis) EMBI Spread (2° axis)

Fiscal misalignement turned the burden of Fiscal misalignement turned the burden of the debt unsusutainablethe debt unsusutainable

CountryRisk

1010

Primary Expenditures as % of GDP(cumulative 12 months)

17,0%

17,5%

18,0%

18,5%

19,0%

19,5%

Dic

-97

Ma

r-9

8

Ju

n-9

8

Se

p-9

8

Dic

-98

Ma

r-9

9

Ju

n-9

9

Se

p-9

9

Dic

-99

Ma

r-0

0

Ju

n-0

0

Se

p-0

0

Dic

-00

Ma

r-0

1

Ju

n-0

1

Se

p-0

1

Dic

-01

Ma

r-0

2

Ju

n-0

2

Se

p-0

2

Dic

-02

1111

Primary Expenditures as % of GDP(cumulative 12 months)

17,0%

17,5%

18,0%

18,5%

19,0%

19,5%

Dic

-97

Ma

r-9

8

Ju

n-9

8

Se

p-9

8

Dic

-98

Ma

r-9

9

Ju

n-9

9

Se

p-9

9

Dic

-99

Ma

r-0

0

Ju

n-0

0

Se

p-0

0

Dic

-00

Ma

r-0

1

Ju

n-0

1

Se

p-0

1

Dic

-01

Ma

r-0

2

Ju

n-0

2

Se

p-0

2

Dic

-02

1212

Monthly Gross Domestic Productseasonally adjusted (Jan 98 = 100)

98,3Dec 00

82.2Nov 02

94,6Jul 99

99,0Dec 99

102,3Jun 98

75.0

80.0

85.0

90.0

95.0

100.0

105.0

Jan-

98

Mar

-98

May

-98

Jul-9

8

Sep

-98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-9

9

Sep

-99

Nov

-99

Jan-

00

Mar

-00

May

-00

Jul-0

0

Sep

-00

Nov

-00

Jan-

01

Mar

-01

May

-01

Jul-0

1

Sep

-01

Nov

-01

Jan-

02

Mar

-02

May

-02

Jul-0

2

Sep

-02

Nov

-02

Source: CEA-UCEMA en base a datos del INDEC.

1313

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

IV 9

4

IV 9

5

IV 9

6

IV 9

7

IV 9

8

IV.

99

IV.

00

IV 0

1

-35.000

-30.000

-25.000

-20.000

-15.000

-10.000

-5.000

0

5.000

10.000

15.000

Capital Flow s and Economic Activity Capital Flow s and Economic Activity (Accumulated 4 quarters - U$Sm. GDP Cyclical Component)(Accumulated 4 quarters - U$Sm. GDP Cyclical Component)

Capital Flows Private Sector

GDP Growth Russian Crisis

1414

-2%

-1%

0%

1%

2%

3%

4%

1998

-I

1998

-II

1998

-III

1998

-IV

1999

-I

1999

-II

1999

-III

1999

-V

2000

-I

2000

-II

2000

-III

2000

-IV

2001

-I

2001

-II

Arg

entin

a

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

Chile

Argentina

Chile

Sudden Stops in Argentina and Chile(Private Capital Flows, Percentage of GDP

1515

THE BANKING CRISISTHE BANKING CRISIS

While the problems of convertibility and the While the problems of convertibility and the

consequent exchange rate uncertainty consequent exchange rate uncertainty

played a role, the played a role, the bankingbanking crisis was crisis was

largely caused by the largely caused by the government government

“abuse” of the banking sector“abuse” of the banking sector, given , given

its inability its inability to to adjust the budget deficitto adjust the budget deficit

1616

50

55

60

65

70

75

80

Sep 00 Dec 00 Mar 01 Jun 01 Ago 01 Nov 01 Feb 02 Apr 02 Jul 02

Finance Minister

Resignation

"

“Corralito”

Interest

rate

ceilings

Devaluation

Private Sector Deposits (in bn Arg. Private Sector Deposits (in bn Arg. Pesos)Pesos)

1717

Credit to Private SectorCredit to Private Sector

Loans to Private Sector Evolution

20

25

30

35

40

45

50

1-Feb-02 15-Mar-02 8-May-02 20-Jun-02 2-Aug-02 16-Sep-02 29-Oct-0211-Dec-02 24-Jan-03 7-Mar-03

Billion ARG $

Nominal Stock Real Stock

1818

The main cause for the banking crisis The main cause for the banking crisis was the fear was that banks would be was the fear was that banks would be rendered insolvent by government rendered insolvent by government policy and that deposits would be policy and that deposits would be confiscated.confiscated.

An important reason behind this fear was the fact that privateprivate sector assets sector assets were being displaced by were being displaced by public public sector assets in bank’s balance sector assets in bank’s balance sheets.sheets.

1919

0%

20%

40%

60%

80%

100%

Dec-99 May-00 Oct-00 Mar-01 Aug-01 Jan-02 Jun-02

Public Sector Private Sector

Private Sector assets have been displaced by Private Sector assets have been displaced by Public Sector assets in bank’s balance sheetsPublic Sector assets in bank’s balance sheets

$ 76 MM

$ 43 MM

2020

The increasing banking exposure to the public The increasing banking exposure to the public sector was accompanied bysector was accompanied by

1. a 1. a rapid decrease in depositsrapid decrease in deposits and and

2. a 2. a sharp increase in country risksharp increase in country risk

2121

Exposición del Sistema Financiero al Riesgo del Sector Público

71

151

104

216

80

100

60

100

140

180

220

dic-98 jun-99 dic-99 jun-00 dic-00 jun-01 dic-01

70

80

90

100

110

Indice EMBI Argentina

Crédito al Sector Público / Patrimonio Neto (en %)

Depósitos Sector Privado - Base dic2000 = 100 (2º eje)

EMBI Index

Public Sector Loans / Net Worth (%) Private Deposists - Index Dec 00 = 100 (2nd axis)

2222

November 2001:withdrawal restrictions November 2001:withdrawal restrictions on bank deposits on bank deposits (“corralito”). (“corralito”).

December 2001: Riots the De la Rua December 2001: Riots the De la Rua and Cavallo government.and Cavallo government.

First two weeks of January 2002: First two weeks of January 2002: --public debt default --public debt default --currency board is abandoned and --currency board is abandoned and the currency devalued the currency devalued --bank assets and liabilities are --bank assets and liabilities are pesifiedpesified asymmetrically - i.e. asymmetrically - i.e. at at different ratesdifferent rates

2323

The abandonment of the currency The abandonment of the currency board was traumatic:board was traumatic:

-- Complete -- Complete loss of confidenceloss of confidence in the banks, the in the banks, the currency, and the governmentcurrency, and the government

-- Continuous -- Continuous bank runbank run

-- A -- A run on the pesorun on the peso that pressured strongly the that pressured strongly the exchange rateexchange rate

-- -- No money market or debt instrumentsNo money market or debt instruments for for open market operationsopen market operations

2424

The Tradeoffs and The dilemma for The Tradeoffs and The dilemma for the central bankthe central bank

Having regained the LOLR function Having regained the LOLR function the CB could provide the liquidity the CB could provide the liquidity needed to finance the bank run. needed to finance the bank run. Pesos would fly to the exchange Pesos would fly to the exchange market – risk of hyperdevaluation market – risk of hyperdevaluation and and hyperinflationhyperinflation..

OROR

2525

The CB could restrain the rediscount The CB could restrain the rediscount facility and let banks deal with the facility and let banks deal with the deposit run. May prevent deposit run. May prevent hyperinflation, at the risk of the hyperinflation, at the risk of the total total collapse of the banking sector.collapse of the banking sector.

2626

Only feasible intermediate Only feasible intermediate solution:solution:

slow the pace of the bank run slow the pace of the bank run

and, at the same time, try to and, at the same time, try to avoid excessive liquidity avoid excessive liquidity expansion. expansion.

2727

The Strategy FollowedThe Strategy Followed

-- -- Provide liquidity support to banks to prevent massive bank closures.

-- Develop -- Develop sterilization instrumentssterilization instruments at the at the Central Bank --the Central Bank --the LEBACLEBAC-- to mop up -- to mop up liquidity and to compete with the U$S.liquidity and to compete with the U$S.

-- -- Utilize part of CB reserves to intervene in the foreign exchange market to slow the pace of depreciation and to avoid chaotic conditions.

2828

Choice of Foreign Exchange Market Choice of Foreign Exchange Market Strategy:Strategy:

high interest rates high interest rates

vs.vs.

FE market intervention:FE market intervention:

substitutes or complements?substitutes or complements?

2929

persevere to the point where persevere to the point where

greedgreed > panic> panic

3030

Accumulated evolution (31-Jan-02 al 24-Jul-02)

-In billion of pesos-

0

5

10

15

20

25

31-Ene 17-Feb 6-Mar 23-Mar 9-Abr 26-Abr 13-May 30-May 16-Jun 3-Jul 20-Jul

Loans Assistance Bank Reserves fall Deposits fall

The central bank provided rediscounts to The central bank provided rediscounts to illiquid banks and financed about 1/3 of the illiquid banks and financed about 1/3 of the

deposit dropdeposit drop

3131

The market for The market for Central Bank Central Bank

ST BillsST Bills (LEBAC) was actively (LEBAC) was actively

developed, initially with 7 developed, initially with 7

days maturities and then with days maturities and then with

14 and 28 days, in Pesos and 14 and 28 days, in Pesos and

U$S. Interest rates reached U$S. Interest rates reached

140% initially.140% initially.

3232

Intervention in the foreign Intervention in the foreign exchange market prevented exchange market prevented disorderly behavior but did disorderly behavior but did not peg the rate, that not peg the rate, that devalued from 1 to 3.6 Pesos devalued from 1 to 3.6 Pesos per Dollar. Intervention in the per Dollar. Intervention in the first five months was about first five months was about U$S 2 bn.U$S 2 bn.

3333

Initially deposit withdrawals Initially deposit withdrawals continuedcontinued

Private Sector Deposits - Year 2002

-2609

-4335 -4378 -4526

-998

160

-235 -340

-823 -810-1274 -1230

-5000

-4000

-3000

-2000

-1000

0

1000

Feb Mar Abr May Jun JulIn million of pesos

Deposits minus preventive measures Preventive measures

3434

However, the trend reversed after However, the trend reversed after four monthsfour months

Private Sector Deposits - Year 2002

-2609

-4335 -4378 -4526

-998

160

-235 -340

-823 -810-1274 -1230

-5000

-4000

-3000

-2000

-1000

0

1000

Feb Mar Abr May Jun JulIn million of pesos

Deposits minus preventive measures Preventive measures

3535

Private Sector Deposits(in billion pesos)

40

45

50

55

60

65

70

75

80

01-Oct-01 27-Nov-01 23-Jan-02 21-Mar-02 17-May-02 13-Jul-02 18-Oct-02 04-Nov-02 31-Dec-02

Devaluation

Withdrawal

Restrictions

"Corralito"

Recovery

Reprogramming

Pesification

3636

The need for the provision The need for the provision of liquidity from the of liquidity from the Central Bank where largely Central Bank where largely reducedreduced

3737

Flujos Mensuales de Asistencia del BCRA

29%29%

61%52%

31%29%

-500

0

500

1,000

1,500

Ene Feb Mar Abr May Jun Jul Ago Sep Oct Nov

Millones de Pesos

-30%

0%

30%

60%

90%

Asistencia Neta Mensual Asistencia/Salida de Depósitos

3838

The demand for LEBACs grew strongly. The demand for LEBACs grew strongly.

-- LEBACs with up to one year maturities -- LEBACs with up to one year maturities were introduced successfully.were introduced successfully.

-- By October interest rate has fallen to -- By October interest rate has fallen to 8-45% range, according to maturities. 8-45% range, according to maturities.

3939

Average duration and cost of LEBACs in pesos

0

20

40

60

80

100

120

140

15-mar 14-apr 14-may 13-jun 13-jul 12-aug 11-sep 11-oct 10-nov 10-dec 9-jan

Days

0

20

40

60

80

100

120

140

ANR 14d %

Average Cost

AverageDuration

Decrease of average cost and duration of LEBACs

4040

The exchange rate stabilized and started to The exchange rate stabilized and started to appreciate. The CB has stopped selling appreciate. The CB has stopped selling and is actively buying reserves to prevent and is actively buying reserves to prevent a large appreciation in the exchange rate.a large appreciation in the exchange rate.

In total the CB has regained more than the In total the CB has regained more than the initial stock of interventioninitial stock of intervention

4141

Accumulated intervention and exchange rate evolution

-2500

-2000

-1500

-1000

-500

0

500

1000

4-Mar 23-Apr 12-Jun 1-Aug 20-Sep 9-Nov 29-Dec

Millions of USD

2.0

2.5

3.0

3.5

4.0

$/USD

Net accumulated intervention - since Mar 4 Exchange rate

4242

0%

3%

6%

9%

12%

Jn Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

CPI Nominal Exchange Rate – monthly average (2° axis)

The stabilization of the exchange rate has also resulted in a sharp decline

in level of inflation

4343

Indeed, as always, Indeed, as always,

greedgreed > panic> panic

4444

The Financial System needs restructuringThe Financial System needs restructuringFinancial statements situation - Dec2001/Dec2002

Loans to the Public Sector

21% 54%

17% 45%

0

20

40

60

80

100

120

140

160

180

Dec 01

Dec 02

Loans to Private Sector

4545

LESSONSLESSONS

1. The Potential Fragility of 1. The Potential Fragility of Financial InstitutionsFinancial Institutions

Solid and solvent financial structures could Solid and solvent financial structures could deteriorate quickly in the face of deteriorate quickly in the face of inadequate interventions and policies.inadequate interventions and policies.

The fact is that weak financial sectors are The fact is that weak financial sectors are not necessarily crisis prone. Crises are not necessarily crisis prone. Crises are generated by inconsistent policies and an generated by inconsistent policies and an unstable macroeconomic environmentunstable macroeconomic environment

4646

2. Financing the Public 2. Financing the Public Sector and the Sector and the

“Crowding Out” Effect“Crowding Out” Effect

4747

3. The Importance of 3. The Importance of Proper Liquidity Proper Liquidity

ManagementManagement

Availability of liquidity is a crucial Availability of liquidity is a crucial element in the prevention and the element in the prevention and the management of financial crisesmanagement of financial crises

LOLR does not guarantee stability LOLR does not guarantee stability but its absence accelerates the but its absence accelerates the erosion of confidenceerosion of confidence

4848

4. The Role of Foreign Banks

-- Do they reduce financial -- Do they reduce financial vulnerability?vulnerability?

-- Can they provide, implicitly, -- Can they provide, implicitly, LOLR function? LOLR function?

4949

5. 5. Capital ControlsCapital Controls

Does capital account integration Does capital account integration reduce financial vulnerability?reduce financial vulnerability?

Long run desirability vs. short run, Long run desirability vs. short run, transitional, riskstransitional, risks

Capital controls and crisis Capital controls and crisis managementmanagement