Argentina Debt Crisis - Case Study Example

Argentina Debt Crisis

Introduction

The debt crisis of Argentina has been the result of failures in payment of many external debts. During the period of 1975, the debt recorded was near about 4 billion dollars which increased to 140 billion dollars by 2001 and the country finally announced the default in external debt. It was also regarded as one of the biggest default since the same happened to Russia in 1918. This was preceded by the default in the Mexican debt in 1982; it was the period when most of the commercial banks stopped lending new loans. It was clearly mentioned that the loans of Latin America was refused. It was well thought that the Argentinean public sector will never recover from the access to the capital market but it did. However, it has been witnessed that the external debt of the country was $145 billion and out of which $85 billion was the debt of the public sector only. However IMF concluded that Argentina’s economy outperformed than most of the countries of Latin America. Therefore, this study will focus on the further problem occurred and the solutions to the same.

Discussion

The economic performances of the Latin American countries were below average in the 1980s and the region was suffering through debt crisis as well as high inflation. Therefore, after a certain time span all the countries implemented some reforms in order to get out of such crisis. All countries freely tried to improve the international trade and were trying to control cash outflow. Therefore, after the period of hyper-inflation in the country, Argentina shaped its economic program where the focus was led on the convertibility law, external trade were also to be liberalized along with the financial flows and the public enterprises were also to be privatized.

The Convertibility law actually referred to the pegging of the Argentinean currency to the American dollar. The central bank was forced to sell the dollar to the market as it was demanded. Therefore, as it was obliged to sell the foreign currency, it also had to keep the dollar reserves to 100% of the monetary base. The 10% of the monetary base was kept aside as it was backed by the dollar-denominated by the government bonds. This clearly meant that the central bank as transferred into a currency board. This has proved to be a successful step by the government as the inflation decreased on a drastic level and the GDP began to grow by almost 40% in 1990-1994.

On the front of another reform which took place that is trade liberalization, the foreign trade has increased by huge numbers. The imports of the organization increased from $4.1 billion dollars to 21.6 billion, whereas the exports also increased from 3.7 billion to 20.1 billion dollars. However, due to huge demand of a few products, the imports increased and so the deficit in the current account also increased.

The combination of Convertibility law with that of trade liberalization made the tradable goods price stable. It is so because, the domestic price was totally dependent on the international price most of them were imported. This has also impacted the price of non-tradable goods and made it stable too.

As the result of capital inflow, the demand also increased in the country. Such a scenario increased both the imports as well as the price of the non-tradable goods. This has highly affected the industry of the tradable goods and made it weak. This again helped the current deficit increase.

Thus the capital inflow requirement began to increase in order to make up for such a huge deficit of current account of the country. Therefore, it came to such a stage where the country needed near about $10 billion per year in order to save its foreign exchange reserves. This has highly impacted the economy of the country as its GDP fell drastically along with the employment rate.

However, the International Monetary Fund played an important role in restoring the confidence of the capital market in Argentina. In order to do the same, the IMF sanctioned various financing arrangements for the country. It was not only financing but also provided assistance in the technical field which mainly included fiscal, banking as well as monetary areas. It also encouraged Argentina regarding its financial stability and good utilization of IMF support programs.

The same was the misjudgment of the IMF which ensured that the Convertibility Law plays the significant role to the access of Argentina to the capital market. The economic policies of the government regarding the issuance of the bond were also under the scrutiny of the IMF. Therefore, none of the activities in the capital market could be done without the consent and seal of the IMF.

The country lacked the access of fund on the international capital market also made it worse for the Argentine economy under the convertibility law. It has also suffered some of the external factors which included the East Asian crisis, Brazilian crisis, Russian crisis and the increase in the dollar’s value. The real effective exchange rate of Argentina also got affected by the appreciation of the US currency.

The problem with Argentina was that it assumed that fund is available from the foreign capital market and such weakness in the economic program was not taken as a serious issue. This has been a key reason for the increase in the stock of the external debt. This led to increase in the country’s risk premium and also caused rise in the country’s debt to GDP which in turn decreased the growth of the country.

With the establishment of the Convertibility Plan, various restrictions were placed on the Central Bank. It has tied the hands of the central banks regarding sanctioning loan to the government. At that moment of time, foreign players also showed reluctance in lending which led to increase in the fiscal deficit of the country. While the non-financial public sectors were reflecting no deficit then the government decided to transfer the revenues to the private sector while keeping the expenses with the public sector. This implied that the public sector budget was in a sincere deficit even during the growth period. Therefore, various debt were added to the older debt and the interest of the same increased at a fast pace which was even more than the economic growth rate.

IMF supported the Argentine economy to a great extent and also asked the policymakers to make necessary decisions at an early stage. However, there were some of the criticisms where the situation have been said to be difficult as the fixed exchange rate was rigid and lacked flexibility. This was due to the convertibility regime as it was incapable of reacting to the adverse shock.

However, after the election of Néstor Kirchner, the government led by him encouraged import substitution and also made the credit for business accessible as well as also improved the tax collection while controlling various kinds of expenses. Due to such activities, the local currency appreciated and the exports of agricultural products increased. Such a step by the government led to trade surplus and the inflow of dollar began to increase. The foreign currency reserves also increased and the debt taken from the IMF were also paid off. After such activities, the country started witnessing high GDP and also the unemployment level decreased.

Conclusion

During the period of 1989 to 1990, there were various economic reforms in the Argentina. The main crisis started with the establishment and implementation of the Convertibility regime. It actually fixed the rate of the local currency to the dollar. It was a scenario where the local bank actually worked as an exchange board and could issue the domestic currency against the dollar. Other than this, the central bank also did not have power to provide the government with any loans. The local demand of the region made the country to import more than it exported. This disturbed the balance of payment and the fiscal deficit rose. The IMF however, provided the country with loans to revive it in the international capital market but as the country’s inefficiency to utilize the resources, this measure by the IMF also failed. The country’s fiscal deficit rose to such a level where the foreign lenders were also showing reluctance to put their money and on the other hand the GDP decreased and unemployment in the country also increased drastically. Finally, with the reign of Néstor Kirchner, various improvements were made in the import and export process. The tax structure of the country also got revised so that it encouraged the exports. This has led to recovery of the fiscal deficit and also increased the foreign reserves. Such activities increased the GDP as well as the employment of the country and bought it to a stable position.