Lessons from the Crisis in Argentina

Christina Daseking, Atish Ghosh, Timothy Lane, and Alun Thomas

• Publisher: INTERNATIONAL MONETARY FUND
• eBook ISBN:
  9781589063594
• Year: 2005

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Contents

Preface

I. Overview

II. Boom Years and Buildup of Vulnerabilities: 1992–98

Public Finances

The Structural Setting

Summary

III. Downturn and Deepening Depression: 1998–2000

Initial Downturn—1998

Deepening Depression and Policy Dilemma: 1999–2000

Summary

IV. Crisis: 2001

V. Aftermath: 2002

VI. Role of the IMF

VII. Conclusions

Lessons for Crisis Prevention and Management

Lessons for the IMF

Appendix I. Argentina’s Potential Output Growth

Appendix II. Chronology of Key Developments in 2001–2002

References

Tables

1. Fiscal Indicators

2. Public Sector Debt Dynamics

3. Ratings of Institutional Strength and Corruption

4. Programmed and Actual Fiscal Balances and Impulses, 1999–2001

Boxes

1. The Argentine Crisis: A Brief Review of the Academic Literature

2. Argentina’s Intergovernmental Relations

3. Trade Liberalization and Real Exchange Rate Dynamics—Evidence from Other Countries

4. Labor Market Reforms: How Much Was Done?

5. Fiscal Discipline and the Viability of the Exchange Rate Regime

6. Did the Currency Board Contribute to Dollarization?

7. Factors Contributing to the 1998 Downturn

8. Deflation and Depression

9. Could Expansionary Fiscal Policy Have Stabilized the Debt Dynamics?

10. Monetary Conditions Indices for Argentina, Chile, and Mexico

11. Was There a Credit Crunch?

12. Empirical Estimates of the Effects of a Depreciation

Figures

1. Argentina: Key Macroeconomic Indicators

2. Revenue Performance in Selected Emerging Market Countries, Averages 1996–2000

3. External Debt Ratios in Selected Countries, 1998

4. Exports, Imports, Terms of Trade, and Real Exchange Rate

5. Export Performance

6. Indicators of Financial Market Development in Selected Countries, Averages 1997–99

7. Productivity and Wages

8. Labor Market Characteristics

9. Contributions to Output Growth

10. Capital Market Indicators

11. Evolution of Forecasts for Real GDP Growth and Consumer Price Inflation: Program Projections and Consensus Forecasts

12. Monetary Aggregates

13. Fiscal Performance Under IMF-Supported Programs

14. Potential Output and Output Gap

II Boom Years and Buildup of Vulnerabilities: 1992–98

Argentina’s 1991 Convertibility Plan seemed to herald a new era of high growth and low inflation, to be founded on disciplined macroeconomic policies and market-oriented structural reform. Real GDP growth, which, on average, had been negative during the 1980s (falling by about ½ percent per year), rebounded sharply to more than 10 percent during the first two years of the stabilization program and more than 5 percent during 1993–94 (Figure 1). After reaching hyperinflationary levels in the late 1980s, inflation fell to single digits by 1993. Capital inflows also began to surge, reflecting newfound confidence in the economy, until the 1995 Tequila crisis interrupted this impressive macroeconomic performance through a sharp reversal of capital flows and a slump in economic activity. However, when Argentina’s monetary conditions eased considerably soon after the crisis, and growth rebounded rapidly to 5 percent in 1996 and 8 percent in 1997, many observers only felt the robustness of Argentina’s economy confirmed.

Figure 1. Argentina: Key Macroeconomic Indicators

Source: IMF, World Economic Outlook.

¹ Derived from the financial account of the balance of payments.

Yet underlying this performance were both existing weaknesses and growing vulnerabilities, particularly in the fiscal area, the external and financial sectors, and the labor market. Fiscal performance, while not conspicuously profligate in terms of headline deficit measures, was repeatedly undermined by off-budget expenditures and was too weak throughout the 1990s to prevent a growing reliance on private capital flows to meet the public sector’s steadily rising borrowing needs. Exports, though growing at a solid 8 percent per year between 1990 and 1998, did not keep pace with sharply rising import demand, which grew at an average rate of 25 percent per year over the same period. The relatively small domestic financial sector fostered dependence on foreign debt-creating flows to finance both private and public spending. Finally, despite a good start on structural reforms, by mid-decade these were petering out and were, in some cases, even reversed, leaving important rigidities.

These vulnerabilities took on particular importance in the context of Argentina’s exchange rate regime. While the currency board brought significant benefits, ending decades of high or hyperinflation, it also implied restrictions on the use of monetary policy and the exchange rate as an adjustment tool, putting much of the onus of macroeconomic stabilization on fiscal policy, and requiring greater nominal flexibility of the economy, especially in the labor market, to absorb external shocks. The logic of a currency board is that the institutional and economic costs of abandoning the regime lend credibility to the peg. But this also means that in cases where persistent external and/or public sector deficits have resulted in the buildup of large exposures, a country is trapped in a regime that, by design, constrains the policy choices available to the authorities. At the time of the introduction of the currency board, IMF staff in its analyses expressed misgivings about the viability of the regime in light of concerns about price and wage competitiveness and the conduct of fiscal policy. Over time, despite the vulnerabilities exposed during the Tequila crisis, the IMF staff’s assessment of the currency board regime became more positive.

Public Finances

Despite a booming economy, Argentina’s public finances deteriorated during the 1990s (Table 1). The deterioration was the result of moderate headline deficits, averaging some 1½ percent of GDP over 1992–98, combined with persistent off-budget spending. The latter consisted mainly of court-ordered compensation payments after the social security reform of the early 1990s and arrears to suppliers, and raised average new borrowing requirements above 3 percent of GDP per year over this period. While off-budget expenditures tapered off over time, on-balance primary spending grew strongly, accompanied by rising interest payments. As a result, and with the revenue ratio broadly stable, Argentina’s estimated structural fiscal position deteriorated from approximate balance in 1992 and 1993 to a deficit of 2¾ percent of GDP by 1998.⁵ While it was not obvious that deficits of this magnitude were a problem, provided that growth rates remained at 5 percent or above, they spelled vulnerability in the event of much slower growth. This was the case because Argentina, instead of building up fiscal cushions during the boom period, had accumulated considerable amounts of new debt.

Table 1. Fiscal Indicators

(In percent of GDP, unless otherwise indicated)

¹ Consolidated fiscal accounts of federal and provincial governments.

² Actual balance corrected for the economic cycle (i.e., the difference between actual and potential GDP).

³ The impulse identifies the changes in the fiscal balance that are not due to cyclical fluctuations or changes in interest payments. A positive impulse defines an expansionary policy stance.

⁴ Includes various court-ordered compensation payments, including to pensioners and former victims of political prosecution.

⁵ For the purpose of deriving the structural balance and the fiscal impulse by the two subsectors of government, revenue and expenditure of the federal government are adjusted to exclude transfers to provinces.

⁶ Derived on the basis of a Hodrick-Prescott filter using quarterly GDP data from 1995 onward.

⁷ Positive figure indicates GDP above potential.

Spending—both on- and off-budget—was the main driving force behind the deteriorating public debt dynamics during this period. The federal government’s off-budget expenditures explain nearly 9 percentage points of the 10 percentage point increase in the public debt ratio from 31 percent of GDP in 1992 to 41 percent in 1998 (Table 2).⁶ Capitalized interest and valuation changes were roughly offset by privatization receipts, and both the primary deficit (excluding off-budget activities) as well as the endogenous debt dynamics—arising from the differential between growth and interest rates—had a roughly neutral impact on the debt ratio. This does not mean that budgetary performance was prudent, though: real primary spending (deflated by the GDP deflator) was allowed to grow by a cumulative 35 percent, or 5½ percent a year, during 1993–98.

Table 2. Public Sector Debt Dynamics

(In percent of GDP, unless otherwise indicated)

¹ Endogenous debt dynamics result from the interest rate/growth differential and are derived as [(i–π)–g (1 + π)]/(1 + g + π + g π) times previous period debt ratio, with i = nominal effective interest rate; π = growth rate of GDP deflator; and g = real GDP growth rate.

² Including valuation changes, capitalized interest, and other debt-creating transactions of provincial governments which added an estimated 0.2 to 0.4 percent of GDP annually to the public debt ratio during 1996–2001.

³ Defined as fiscal deficit, plus amortization of medium- and long-term debt, plus short-term debt at end of previous period. The federal government has accounted for about 90 percent of public debt over this period.

⁴ Derived as nominal interest expenditure divided by previous period debt stock.

⁵ Nominal rate minus change in GDP deflator.

⁶ Assumes that the effective interest rate on public debt remains unchanged.

⁷ Assumes unchanged average maturity of medium- and long-term debt and unchanged share of short-term in total debt.

A more cautious fiscal stance during this period could have greatly improved the public debt dynamics and likely prevented Argentina’s eventual default. This can be illustrated by contrasting the actual debt dynamics with a hypothetical alternative fiscal scenario. For example, if real on-budget spending increases had been limited to 3 percent a year, given the estimated average growth rate of potential GDP during the 1993–2001 period, the public debt ratio would have decreased to 26½ percent of GDP in 1998 even with unchanged off-budget activitie...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Preface
• I. Overview
• II. Boom Years and Buildup of Vulnerabilities: 1992–98
• III. Downturn and Deepening Depression: 1998–2000
• IV. Crisis: 2001
• V. Aftermath: 2002
• VI. Role of the IMF
• VII. Conclusions
• References
• Tables
• Footnotes