Argentina – a case study
During the seventies and eighties Argentina experienced high chronic inflation, and recurrent balance of payments crisis which led to a very poor macroeconomic performance resulting in low growth and small levels of investment. Chronic large budget deficits financed by money creation in an environment where money demand was falling eventually led to a hyperinflation episode where inflation was about 675 per cent for the year 1985 as a whole. The demand for money fell as confidence in the peso collapsed.
And at the same time, a number of measures reduced confidence in domestic financial instruments (Haslam, 2003). The government reacted by rescheduling domestic debt (e. g. the indexed Valores Nacionales Ajustables). In 1989, it forcefully converted some of the deposits in the banking system into government bonds. The lack of confidence in the domestic currency and the difficulties in securing confidence in the domestic capital market generated an uphill battle to attract capital back into the economy.
The convertibility plan, which fixed the exchange rate at one peso for one dollar and ensured full backing of the monetary base with international reserves, and the new charter of the central establishing its independence, set the basis for a new monetary regime. The combination of the monetary reforms, a major fiscal adjustment and far reaching structural reforms succeeded in bringing down inflation and restoring growth.
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The recurrent episodes of inflation and devaluation and the lack of financial instruments to protect savers in a credible manner from the variability in policies essentially eliminated the role of the peso as a saving instrument. By the late eighties the economy had become fully dollarized as this currency was used as unit of account, store of value and medium of exchange. The overall environment for the capital markets started to change in the nineties as the country recovered macroeconomic stability and maintained a fixed exchange rate since the convertibility plan in 1991.
The convertibility law validated the use of the dollar in the economy as it made it legal to use that currency in local contracts. This decision was particularly important as it allowed to bring on shore many financial transactions and allowed the growth of the domestic banking system and other financial institutions with instrument in pesos and dollars (Kiguel, 1998). The restructuring of foreign debt through the Brady plan was another important step in regaining access to the voluntary capital market, as it provided a long-term solution to the debt overhang.
In addition, it removed the uncertainties associated with debt that was already in default. Argentina offered three alternative bonds to pay its debts. (i) The Par and Discount bonds were thirty year bonds and had a guarantee on the principal through the purchase of zero coupons US treasuries (ii) The Floating rate note (the FRB) was shorter in duration and had no guarantees (iii) The Bocones which provided a liquid instrument to regularize the debts with pensioners, government suppliers and other creditors helped restructure the domestic debt Some additional factors also helped the development of the domestic capital market.
First, the private pension funds, that started functioning in July 1994, provided an important pool capital that invested primarily in Argentine bonds and stocks. Second, there were other institutional investors that were becoming important players in the economy, such as the mutual funds, the insurance companies and the commercial banks. The wide de-regulation of the domestic capital market, the liberalization of the financial sector and the elimination of controls on the capital account of the balance payments have also played an important role in this respect.
A third important factor was the policy response of the authorities to the balance of payment cum banking crisis following the Mexican devaluation of 1994. Earlier this would have lead to devaluations, increases in inflation and a bail out of the banking system that generated large quasifiscal deficits. But the government instead maintained convertibility and the fixed exchange rate, and the banking crisis was overcome without resorting to any massive bailouts to depositors or to the bank shareholders. This policy signaled a new commitment to rules that increased confidence in the regime and helped to develop the domestic capital market.
A key difference among Argentina’s debt instruments is based on whether they were issued on voluntary basis at market prices, or if they were part of the restructured debt and placed on a compulsive basis at a discount relative to market prices. The Brady bonds and the Bocones represented the bulk of the restructured debt and soon they were approximately 40% of total government debt. On the other hand, eurobonds and global bonds were issued voluntarily at market conditions and quickly became the standard debt instruments for the international capital markets.
The main objectives of the Argentine debt management strategy have been to reduce borrowing costs, to ensure a fluid access to the domestic and international capital markets and to minimize the vulnerability to any shocks in the international capital markets. In addition, it attempted to develop the domestic capital market and to minimize any crowding out effects on private sector borrowing. The strategy has four main elements. (i) To improve the structure of amortization to avoid excessive concentration of refinancing in any particular year.
(ii) To diversify the sources of financing and increase the number of domestic and foreign investors that hold Argentine debt in order to guarantee access to capital markets at all times and at the lowest possible cost. (iii) To secure enough liquidity at the treasury to increase flexibility in financing throughout the year and avoid the need to go to the markets in times of large volatility or high interest rates. (iv) To develop the domestic treasury market, by issuing Letes (T-bills) and Bontes (T-bonds) in pesos and dollars.
In the five-year period 2000-2004 however, per capita economic growth in Latin America will average 0. 2% per annum; which follows an unspectacular 1. 4% per annum for the decade of the 1990s (Weisbrot and Rosnik, 2003). Conclusion As Dymski (2002) points out economists have suggested five answers to the question of what causes international debt crises: perverse macroeconomic policies; problems in cross-border creditor-debtor contracts; problems in creditor/debtor relations within borrower countries; perverse interactions among cross-border creditors; problems in the global structure of cross-border financial flows.
These five causes lead to five parallel responses to the question of what should be done: fix macroeconomic policies; fix the rules governing cross-border financial contracts; fix the rules governing creditor/borrower relations within borrower countries; improve information; or fix the rules governing cross-border financial flows in the global economy. In the Latin American debt crisis, economists who were broadly sympathetic to market forces focused on the first two causes (and solutions), while those skeptical of such forces emphasized the fifth.
REFERENCES Dymski, A. G. (2002). “The International Debt Crisis. ” Department of Economics, University of California. Gillis, Malcolm, Perkins, H. Dwight, Roemer, Michael. Snodgrass, R. Donald. (1987) “Economics of Development”. 2nd Ed. W. W. Norton & Company. London. Haslam, P. (2003) “Argentina – Governance in Crisis. ” FOCAL Policy Paper 03/02. Kiguel, M. (1998) “Debt management: Some Reflections based on Argentina. ” Inter-American Development bank. Working paper. 364. The Wall Street Journal (January 23, 1981), 25.
28. Weisbrot, M. and Rosnick (2003) ‘Another Lost Decade? Latin America’s Growth Failure Continues into the 21st Century’, Center for Economic and Policy Research. Wellons, W. P. (1987). “Passing the Buck: Banks, Government and Third World Debt. ” Wertman, P. (1984). “Finance and Adjustment: The International Debt Crisis, 1982-84. ”Congressional Research Service. Report No. 84-162 E. Zupi, M. (2002). “International Financing for Development Cooperation. ” Roskilde University Centre, Denmark, 2002