Question

Financial Crisis Argentina

10. Briefly discuss crisis and response.

11. What are the new and old lessons?

Answer 1

Solution)

10) Argentina was in a race against time on Wednesday to cut a deal by the end of the day with holdout investors who are suing it and to avert its second debt default in a little over a decade.

It was the latest crisis in Latin America’s No. 3 economy, which has suffered a series of economic and political meltdowns going back to the 1930s.

In the early 20th century, the South American country was one of the world’s richest, thanks to its production of beef, wheat and other farm goods, plus an educated workforce made up mostly of European immigrants and their descendants.

But the constant crises, often attributable to government mismanagement and fluctuating commodities prices, have plunged millions into poverty and put the country off-limits to all but the most daring investors today.

Here are some of Argentina’s crises through history:

1930

The Great Depression hit Argentina especially hard, as demand in Europe and United States for its farm exports suddenly dried up. As customs revenues plunged, the government had trouble paying public workers, causing unrest to grow.

Fed up with the crisis, the military staged a coup in 1930 against democratically elected President Hipolito Yrigoyen, setting a precedent for throwing out governments in times of economic trouble. For the remainder of the 20th century, more generals (14) than civilians (11) would run the country.

1955

President Juan Peron, a populist who drew his support from Argentina’s poor and working class, oversaw a period of relative prosperity following World War Two. Factory workers received paid vacations and unions gained unprecedented power as the economy grew at an annual pace of nearly 6 percent.

However, by the early 1950s, the good times came to an end as commodity prices fell once again. Peron’s nationalizations of British-owned railroads and other property antagonized business leaders and caused investment to dry up.

Inflation soared to 40 percent, and real wages plunged. The death in 1952 of Peron’s wildly popular first lady, Eva, known as “Evita,” weakened him further. Three years later, as labor strikes paralyzed the country, Argentina’s military intervened again and sent Peron into exile.

1976

Argentina’s economy failed to stabilize under a succession of military and democratic governments that implemented wildly different policies. Between 1930 and 1983, presidents averaged only two years in office, while the lead minister for economic affairs was replaced at a pace of once a year.

By the 1970s, many Argentines with warm memories of postwar prosperity were clamoring for the military to allow Peron to return home. The generals relented, and Peron assumed the presidency once again. But he was unable to heal either the economy or the increasingly violent fissures in Argentine society, and Peron died of heart failure just a year later.

Various armed factions struggled for control under Peron’s successor: his third wife, a former nightclub dancer he had met in Panama. In early 1976, as annual inflation surpassed 600 percent, the generals staged yet another coup.

Ensuing years would see rising inequality and an explosion in Argentina’s foreign debt, as well as the deaths of up to 30,000 suspected leftists as the military tried to snuff out dissent in the so-called “Dirty War.” In 1982, the military launched an invasion of the Falkland Islands, a British colony claimed by Argentina and called the Malvinas by the South American country. Britain retaliated, and Argentina lost the ensuing brief, but bitter war. Many believed the military was using the conflict to distract from economic woes fueling political discontent.

1989

Democracy returned to Argentina in 1983 - this time to stay. With the armed forces disgraced by widespread human rights abuses, the loss of the Falklands War and poor economic management, a vast majority of Argentines deemed the armed forces unfit for power, an opinion that still prevails today.

However, that did not mean stability.

Under President Raul Alfonsin, public payrolls swelled while government revenues remained stagnant. In 1989, only 30,000 out of 30 million Argentines paid any income taxes.

That year, inflation reached an unprecedented 5,000 percent, rising so fast that some supermarkets read prices out over intercoms rather than bothering to update price tags.

As strikes swept the country and rioters looted supermarkets for food, Alfonsin decided to hand over power five months early to his elected successor, Carlos Menem.

2001

Menem spent the 1990s cultivating foreign investment, slashing import tariffs, and privatizing money-losing state enterprises. Inflation fell to single digits, and Argentina was for a time hailed as a poster child for free-market reforms by the International Monetary Fund and others.

By the time Menem left office in 1999, however, rampant corruption was scaring off many investors. Contagion from financial crises in East Asia and Russia caused capital to rush out of Argentina almost as quickly as it had come in. The currency peg that Menem used to tame inflation became untenable as the government, unable to print money, borrowed it instead.

In 2001, unemployment soared beyond 20 percent, and reports surfaced of widespread hunger and malnutrition in a country that had long prided itself as being one of the world’s breadbaskets.

When another wave of riots and looting reached the capital, Menem’s successor, Fernando de la Rua, resigned. It was a period that would see five presidents in just two weeks.

Before the crisis ended, the economy had shrunk by a fifth and thousands of young, educated Argentines had emigrated to their grandparents’ ancestral homes in Europe. The government also stopped payment on more than $100 billion in debt, the world’s biggest-ever sovereign default.

2014

Since the default, Argentina has remained cut off from foreign capital markets and is considered a pariah by most investors. But the economy has also defied doomsday predictions by Wall Street analysts and others, and has by some measures experienced its best run of growth since the 1940s.

Most economists credit high prices for Argentina’s soy and other commodities, due largely to demand from China.

However, the economy is now paying the price for President Cristina Fernandez’s populist and interventionist policies, economists say, and is set to contract for the first time on an annual basis since 2002.

High government spending on social welfare programs, printing of new money and an ailing currency have fueled one of the world’s highest inflation rates. In January, the government was forced to devalue the peso.

If Argentina defaults once again, economists forecast an outflow of dollars that will pile more pressure on dwindling central bank reserves if it cannot extricate itself from the mess swiftly. So far, no one expects a recession anywhere near as deep as in 2002.

Other hallmarks of past Argentine crises, such as social unrest and a fortified political opposition, remain absent.
11) In the 1980s, Argentina built up substantial debt and also suffered from periods of very high inflation. To stabilise inflation, Argentina set a peg of the Argentina Peso against the dollar – the peg was one Peso to one dollar (this was enshrined in law).

The aim of this fixed exchange rate was to give people greater confidence in the Argentinian currency after periods of inflation.

• The fixed exchange rate meant that inflation was stabilised and encouraged capital flows into Argentina. These capital flows led to a rise in wages and living standards
• It also made imports cheaper, so the value of imports increased,
• Exports became less competitive, leading to lower demand for exports.
• This fall in exports and rise in imports lead to a current account deficit which was initially financed by these international capital flows.
• However, the over-valuation of the currency contributed to a fall in domestic demand, and from 1998, Argentina experienced fall in GDP.
• Also from 2001, international capital flows to Argentina dried up as investors were worried about the state of the global economy and the state of Argentina finances.

In particular, Argentina was adversely affected when the dollar rose against the Brazilian Real in 1999. This meant that the Argentina currency experienced a strong appreciation against its main trading partner – Brazil. This appreciation led to rapid fall in exports.This appreciation in the Argentina currency was a key factor in pushing Argentina economy into a deep recession. Domestic demand fell. Unemployment rose to a socially crippling level of over 15%.

Government Debt

During 1999-2002, the Argentina government debt became unmanageable. This was because:

• Legacy of debt from 1980s
• Poor tax collection and corruption
• Rise in government spending
• Fall in tax revenues from recession.

International investors lost confidence in Argentinian bonds and interest rates rose to over 30%. Argentina relied on loans from the IMF to meet its shortfall.

Austerity

In response to the debt crisis, the Argentinian government implemented many austerity measures, such as spending cuts and wage cuts to try and meet IMF deficit reduction targets.

The austerity measures led to a bigger fall in GDP, but did not solve the debt crisis because the austerity measures created even lower economic growth.

In 2001, Argentina was in real crisis. The economy was in meltdown, there were protests on the streets and it couldn’t meet its external debt commitment. It was at this point Argentina defaulted on its external debts and left the currency peg.

Leaving the Fixed Exchange Rate

Argentina left the fixed exchange rate and stopped trying to keep the currency pegged against the dollar. The government also tried to prevent capital outflows by freezing bank accounts for 12 months. Leaving the currency peg, led to a huge devaluation in the Argentinian currency.

From 1 Argentina Peso = 1 US Dollar. By 2002, the currency fell to 4 Peso to 1 Dollar. Inflation was running at 80%. This led to imported inflation and a large reduction in living standards.