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Argentina/International Debt

In this essay, the causes of economic recession in Argentina in 2001 will be studied. Fernando De la Rúa became President of Argentina in December 1999. The government was worried about the Federal budget deficit, which was 2.5 percent GDP in 1999. It was difficult to reduce spending in order to diminish the deficit. Tax rates had risen  three times: in January 2000, April 2001, and August 2001. The combined level of Federal payroll tax became even higher than in the USA.

The cause of crisis was also high governmental debt. Provincial governments had large debts, so central government financed them.

There were also external events that caused crisis. From 1998 foreign investment to emerging market, countries fell due to some major currency crises. The peso prime rate rose highly, as well as interest rates. However, the main causes of crisis were internal. The Argentinian government did not cope with all financial issues (Saxton).

In 2002, economic activity and poverty rates have shot up. The new government and the new economic team managed to reach to a degree of financial stabilization without the IMF. Central bank intervention was of $3 billion, capital and exchange controls, and, in addition, responsible fiscal policy stopped the free fall of peso. Government revenues were falling, but the government in fact spent only what it took in, refusing to print money.

The real economy started to grow in mid-2002. To stabilize the banking system took more time (Setser & Gelpern).

A new stage of crisis started. It was marked both by a strong national recovery and by deliberations to allocate losses.

In 2001 Argentina made three main decisions to cope with the crisis. The first one meant seeking for IMF’s help in currency management and accommodation of fiscal policy. The second one was seeking more money and issuing new bond. The third decision was  restructuring of public and private national debts through pesification.

Appeal to IMF was not a surprise. Argentina had long relationships with IMF. IMF financed the initial reforms. Stabilization caused an economic boom. Revenues were supported by privatization.

However, there were some issues conducted with implementing reforms. Many members of IMF and G7 finance community doubted about giving additional financing to Argentina. It was provided in 2001 due to decisions of optimists in IMF.

Argentina was unable to avoid devaluation of peso and external debt. There were not enough dollar reserves. Nevertheless, Argentina did not have to pesify in order to convert deposits and loans into pesos at different rates (asymmetrically), or to index interest payments on loans to increase in peso wages,  the consumer price index and interest payments on deposits will be increased. After considerable pressure and litigation, the government eventually issued new low-coupon bonds to compensate banks for the 40 percent difference in conversion rates (Setser & Gelpern).

Pesification was successful: national contacts were restructured and deposits were unfreezed quite quickly. It was a basis of currency recovery.

However, pesification had many disadvantages. People who benefited most from the initial pesification decision paid down their debts quickly; those who lost their money often got compensation (Setser & Gelpern).

Peso was overvaluated. Correction of it required the decrease of Argentinians’ real income. Most assets were in dollars, and the borrowers were unable to earn enough dollars to repay their debts. Argentinian taxpayers lost a lot: they were going to pay off national debts for a long period.

Only exporters and importers benefited from Argentina’s monetary policy. The external bondholders suffered losses. The face value of claims reduced to 50 percent.

Urban poverty increased a lot during the recession. It was 38 percent before the devaluation. In 2002, it increased to 58 percent, and in 2005 fell up to 34 percent. People also suffered from unemployment and price increasing. Caused by devaluation, government financing of the poor people fell.

In fact, Argentina used all potential sources go out of the recession. They included banking system’s liquid reserves, free cash flow of pension system, borrowings from the IMF, and relationship with USA government.

The government of Argentina made all decisions. However, they all would have been impossible without IMF’s financing and advices. The IMF’s financing helped to avoid the most difficult consequences. Only after the stop of financing, Argentina started to reduce debts.

Such steps were painful for the economy and society. It was difficult to escape from extensive dollar debts and overvaluated currency rate. IMF seemed to avoid responsibility for those decisions (Setser & Gelpern).

Argentina’s debts were very large. In 2001, the sovereign debt was about $81.8 billion, and it was the largest in the history. In 2012, Argentina still owed $15 million to foreign creditors, including $3-5 million owed to the USA. Having more than $45 billion in reserves, Argentina had the money to pay, but simply refused to pay. It is no surprise that foreign investment in Argentina stayed far lower than its regional peers, even at that time when Argentina used international oil companies to cooperate with. The government of Argentine has recently nationalized the explorations of private oil fields.(Shapiro).

Argentina’s Ambassador of the United States, Jorge Arguello, stated that Argentina had already paid all its debt off. However, it refers only to the debts to IMF. He failed to mention that there were still $15 million owed to private creditors in 2012, as well as debts to government, including the USA (Shapiro).

Could Argentina afford to pay more? It had a government budget surplus, which before interest payments, was about 4% of GDP last year, and its foreign-exchange reserves increased to more than $19 billion. With such resources, it could have paid its debts, perhaps by as much as 3 or 4 cents on the dollar, reckoned Vladimir Werning of J.P. Morgan. It would be unreasonable for the government to pay more debts because it was unknown how much money it would have in the future. (“Argentina’s Debt Restructuring: A Victory by Default?”).

Moreover, half of Argentina’s foreign creditors, representing one-quarter of its loans, refused to accept restructuring offer in 2005. “The government of Argentine issued a unilateral take-it-or-leave-it exchange offer of 27 cents on the dollar, as compared to a typical restructuring offer of at least 40 to 50 cents on the dollar. In June 2010, nine years after the default, Argentina came back and offered the equivalent of 35cents on the dollar” (Shapiro). The creditors used their legal rights to refuse from such offer.

Argentinians held half of the debts. They had no choice and accepted government’s offer. Many small foreign lenders, including pensioners, had no reasons to wait. Many investors were unable to wait for a better proposal due to the financial crisis in 2008-2009 (Shapiro).

“Argentina has refused to comply with the findings of the World Bank’s arbitral body for disputes between government and foreign investors, the International Center for Settlement of Investment Disputes (ICSID)” (Shapiro).

Argentina is said to be a good example of a country, which successfully restructured its debts. In fact, its policy reduced a lot direct foreign investments. Argentina expanded bank reserves, and the banks began to finance while the Government continued borrowing. As a result, Argentina had the largest inflation rate in the world. Argentina has a high possibility of default. Many countries want to exclude Argentina from G20 community (Shapiro).

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