[stop-imf] CEPR: Argentina Since Default

Fri, 06 Sep 2002 17:06:03 -0700

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The Center for Economic and Policy Research (http://www.cepr.net) has
released a new paper titled "Argentina Since Default: The IMF and the
Depression" by Alan Cibils, Mark Weisbrot, and Debayani Kar. Please see
the executive summary below.

For the PDF version:
http://www.cepr.net/Argentina.%20PDF.PDF

For the HTML version:
http://www.cepr.net/argentina_since_default.htm

EXECUTIVE SUMMARY:

It is now more than eight months since the economic crisis led to
demonstrations and riots that toppled the government of President
Fernando de la Rúa in Argentina, and the country defaulted on its public
debt. Argentina's economy has continued to decline, with the recession
now having lasted more than four years. At this moment it is not yet
clear when this downward spiral will end.

This paper looks at Argentina's crisis since the default in an attempt
to find a way out of the depression. After more than half a year of
negotiations, there has been no loan agreement with the IMF, nor is it
clear when there may be one. Furthermore, it is not clear if a loan
agreement will provide new resourcesóas opposed to simply providing
money for multilateral debt payment. In addition, the costs to the
Argentine economy of conditions attached to IMF loans may exceed the
benefits. For these reasons, and others detailed below, it is important
to consider the prospects for reviving the economy, whether or not an
agreement with the IMF is reached.

Background and Origins of the Crisis

The IMF is still insisting that "failures in fiscal policy constitute
the root cause of the current crisis,"  and recommending fiscal and
monetary austerity as a means of reviving investor confidence and
thereby stimulating economic recovery. But this approach has failed for
more than four years, as the economy remains mired in a depression, with
a loss of more than 20 percent of GDP since the last business cycle peak
in 1998.

Furthermore, the crisis was not caused by fiscal profligacy: the
worsening of the central government's fiscal balance from 1993 to 2002
was not a result of increased government spending (other than interest
payments). Rather, there was a decline in government revenue due to the
recession, which began in the third quarter of 1998. More importantly,
Argentina got stuck in a debt spiral in which higher interest rates
increased the debt and the country's risk premium, which led to ever
higher interest rates and debt service until its default in December of
2001. The interest rate shocks came from outside, starting with the US
Federal Reserve's decision to raise short-term rates in February of
1994, and on through the Mexican, Asian, Russian, and Brazilian
financial crises (1995-1999).

Argentina's currency board system contributed significantly to the
depression, because economic activity was directly reduced by the large
capital outflows during various episodes international financial
turbulence.

It is also worth noting that the government's decision to privatize its
social security system in 1994 had a major impact on the central
government budget deficit: in fact, the lost revenue, plus accumulated
interest costs, amounted to nearly the entire government budget deficit
in 2001.  In spite of all these things, the central government's deficit
was never very large, peaking at 3.2 percent of GDP in 2001 (all
attributable to interest payments). Much has been made of provincial
spending, but the provincial deficits totaled 1.1 percent of GDP in 2000
and peaked at 1.9 percent in 2001. All told, none of this deficit
spending is very large in the face of such a deep depression.

This was a truly unviable system. It is difficult to imagine any fiscal
policyóassuming it were even politically possible to cut enormous
amounts of government spendingóthat could have avoided the fate of
December 2001, given the overvalued currency, the size and growth of
Argentina's debt (mostly denominated in foreign currency) relative to
export earnings, and the free mobility of capital. Deficit spending did
not cause the current crisis, and attempts to bring about an economic
recovery through continued fiscal and monetary austerity are not likely
to be more successful in the near future than they have been in the
past.

The Current Situation

GDP has declined at a record 16.3 percent annual rate in the first
quarter of 2002. Unemployment stands at 21.5 percent of the labor force,
and real monthly wages have declined by 18 percent over the course of
the year. Official poverty and indigence rates have reached record
levels: 53% of Argentines now live below the official poverty line,
while 25% are indigent (basic needs unmet). Since October 2001, 5.2
million Argentines have fallen below the poverty line, while seven out
of ten Argentine children are poor today.

While this is the worst economic crisis in Argentine history, there are
a number of reasons to view the economy as poised for a rapid recovery,
and one that can take place without external financing. Most
importantly, Argentina is running a large current account and trade
surplus. Primarily a result of the devaluation, the export sector has
vastly expanded as a share of the economy (see below), and is
considerably more competitive internationally.

The Road Ahead

Even if the IMF eventually proves willing to reach a new loan agreement
with the government of Argentina, it is still an open question whether
the country would be better off with an economic recovery program of its
own. While there are risks to both paths, it seems that Argentina would
be better off declaring a moratorium on its debt and using its available
resources to put the economy on a sustainable growth path.

One risk of going the IMF route is that the policy conditions imposed by
the Fund would themselves prolong and/or worsen the depression. As noted
above, the recommended fiscal and monetary policies would almost
certainly have that effect.  Even assuming that the economy recovers, an
IMF agreement might well put Argentina into a type of receivership in
which slow growth, permanently high interest rates, and a continued
unsustainable debt burden cause the country to limp along from one
crisis to the next.

What is the alternative to an IMF agreement? Most importantly, the
government would have to begin to revive economic activity directly,
instead of waiting for foreign or even domestic investment to resume on
its own. Once the economy begins to recover, and investors no longer
fear a worsening breakdown, private investment would return. (This is
not so unusual as it may seem from looking at IMF packages in these
situations: in the United States, the most recent (mild) recession and
continued economic weakness has been countered by a shift from a Federal
budget surplus of about 2 percent of GDP to a deficit of 1.5 percent, or
about $350 billion dollars. Business investment has yet to recover).

Demand could be stimulated through public works programs, along with
income support for the families of the unemployed and the poor. A
subsidy for unemployed workers or at the very least a food stamp program
of some sort would be particularly important, due to the lack of access
that many poor families now have to adequate food.

The export sector can potentially play an even bigger role in
jump-starting a recovery. First, the export sector has gone from a
relatively small to a sizeable part of the Argentine economy. Before the
devaluation, exports of goods and services were only 11.5 percent of
GDP. Now they are about 37 percent of GDP. This is not only because of
the contraction of GDP, but mostly because the devaluation makes each
dollar of export earnings worth (currently) about 3.6 pesos. Of course
the devaluation also makes Argentine exports much more competitive.

The government could work directly with private banks in major export
markets (e.g. Brazil) to arrange for letters of credit and allow exports
to expand more rapidly.

One of the great advantages that Argentina has over other countries in
such situations, in terms of recovering on its own, is that the country
is running large surpluses on both its trade and current accounts. For
the first quarter of 2002, the current account surplus was $1.5 billion,
or 7.1 percent of GDP on an annual basis. The merchandise trade surplus
is 3.75 billion dollars, or 17.8 percent of GDP on an annual basis. The
current account surplus is not a result of debt default: net foreign
interest payments in the first quarter of 2002 actually exceeded those
of a year ago.

What has happened is that imports have collapsed -- for the first
quarter of 2002, imports of goods and services are down 60 percent from
a year ago, and even more from their level during the 1998 business
cycle peak. The importance of this change cannot be over-emphasized. It
means that the Argentine economy has already gone through an enormous
"structural adjustment," as a result of the depression. In other words,
as a result of a steep and painful shrinking of the economy (which
automatically reduces imports), Argentina has already accomplished the
adjustment that is necessary to set the stage for sustainable and even
rapid growth. Furthermore, the current account surplus is not likely to
disappear any time soon, since the full effect of the devaluationóin
terms of increasing exports and reducing importsóhas not yet been felt.

The country is therefore capable of paying for the imports that it
needs, for the foreseeable future, without any need for foreign
financing. This means that the Argentine economy is ready to recover
without new loans from the IMF or other international institutions.

The details of an economic recovery program remain to be worked out, but
it is certainly feasible. Aside from meeting the most basic needs of the
poor, the most important thing is to come up with a plan that revives
production and consumer demand, and allows exports to grow without
unnecessary constraints. Even if an IMF agreement is reached it cannot
be assured that such an agreement will provide net new resources to the
economy, or lead to increased private investment. Moreover, any new
credits will almost certainly be disbursed in tranches (installments),
with conditions that might hinder or even abort an economic recovery.
Therefore, regardless of when IMF and US Treasury officials decide that
they are ready to sign an agreement, Argentina must have a viable
economic recovery plan of its own. The alternative is to leave the
economy at the mercy of the IMF/US Treasury and the forces of economic
contraction.

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&nbsp;
 The Center for Economic and Policy Research (<a href="http://www.cepr.net/" eudora="autourl">http://www.cepr.net</a>)
has released a new paper titled "Argentina Since Default: The IMF and the
Depression" by Alan Cibils, Mark Weisbrot, and Debayani Kar. Please see
the executive summary below.
For the PDF version:
 <a href="http://www.cepr.net/Argentina.%20PDF.PDF" eudora="autourl">http://www.cepr.net/Argentina.%20PDF.PDF</a>
For the HTML version:
 <a href="http://www.cepr.net/argentina_since_default.htm" eudora="autourl">http://www.cepr.net/argentina_since_default.htm</a>
EXECUTIVE SUMMARY:
It is now more than eight months since the economic crisis led to demonstrations
and riots that toppled the government of President Fernando de la R&uacute;a
in Argentina, and the country defaulted on its public debt. Argentina's
economy has continued to decline, with the recession now having lasted
more than four years. At this moment it is not yet clear when this downward
spiral will end.
This paper looks at Argentina's crisis since the default in an attempt
to find a way out of the depression. After more than half a year of negotiations,
there has been no loan agreement with the IMF, nor is it clear when there
may be one. Furthermore, it is not clear if a loan agreement will provide
new resources—as opposed to simply providing money for multilateral debt
payment. In addition, the costs to the Argentine economy of conditions
attached to IMF loans may exceed the benefits. For these reasons, and others
detailed below, it is important to consider the prospects for reviving
the economy, whether or not an agreement with the IMF is reached.
Background and Origins of the Crisis
The IMF is still insisting that "failures in fiscal policy constitute
the root cause of the current crisis,"&nbsp; and recommending fiscal and
monetary austerity as a means of reviving investor confidence and thereby
stimulating economic recovery. But this approach has failed for more than
four years, as the economy remains mired in a depression, with a loss of
more than 20 percent of GDP since the last business cycle peak in 1998.
Furthermore, the crisis was not caused by fiscal profligacy: the worsening
of the central government's fiscal balance from 1993 to 2002 was not a
result of increased government spending (other than interest payments).
Rather, there was a decline in government revenue due to the recession,
which began in the third quarter of 1998. More importantly, Argentina got
stuck in a debt spiral in which higher interest rates increased the debt
and the country's risk premium, which led to ever higher interest rates
and debt service until its default in December of 2001. The interest rate
shocks came from outside, starting with the US Federal Reserve's decision
to raise short-term rates in February of 1994, and on through the Mexican,
Asian, Russian, and Brazilian financial crises (1995-1999).
Argentina's currency board system contributed significantly to the depression,
because economic activity was directly reduced by the large capital outflows
during various episodes international financial turbulence.
It is also worth noting that the government's decision to privatize
its social security system in 1994 had a major impact on the central government
budget deficit: in fact, the lost revenue, plus accumulated interest costs,
amounted to nearly the entire government budget deficit in 2001.&nbsp;
In spite of all these things, the central government's deficit was never
very large, peaking at 3.2 percent of GDP in 2001 (all attributable to
interest payments). Much has been made of provincial spending, but the
provincial deficits totaled 1.1 percent of GDP in 2000 and peaked at 1.9
percent in 2001. All told, none of this deficit spending is very large
in the face of such a deep depression.
This was a truly unviable system. It is difficult to imagine any fiscal
policy—assuming it were even politically possible to cut enormous amounts
of government spending—that could have avoided the fate of December 2001,
given the overvalued currency, the size and growth of Argentina's debt
(mostly denominated in foreign currency) relative to export earnings, and
the free mobility of capital. Deficit spending did not cause the current
crisis, and attempts to bring about an economic recovery through continued
fiscal and monetary austerity are not likely to be more successful in the
near future than they have been in the past.
The Current Situation
GDP has declined at a record 16.3 percent annual rate in the first quarter
of 2002. Unemployment stands at 21.5 percent of the labor force, and real
monthly wages have declined by 18 percent over the course of the year.
Official poverty and indigence rates have reached record levels: 53% of
Argentines now live below the official poverty line, while 25% are indigent
(basic needs unmet). Since October 2001, 5.2 million Argentines have fallen
below the poverty line, while seven out of ten Argentine children are poor
today.
While this is the worst economic crisis in Argentine history, there
are a number of reasons to view the economy as poised for a rapid recovery,
and one that can take place without external financing. Most importantly,
Argentina is running a large current account and trade surplus. Primarily
a result of the devaluation, the export sector has vastly expanded as a
share of the economy (see below), and is considerably more competitive
internationally.
The Road Ahead
Even if the IMF eventually proves willing to reach a new loan agreement
with the government of Argentina, it is still an open question whether
the country would be better off with an economic recovery program of its
own. While there are risks to both paths, it seems that Argentina would
be better off declaring a moratorium on its debt and using its available
resources to put the economy on a sustainable growth path.
One risk of going the IMF route is that the policy conditions imposed
by the Fund would themselves prolong and/or worsen the depression. As noted
above, the recommended fiscal and monetary policies would almost certainly
have that effect.&nbsp; Even assuming that the economy recovers, an IMF
agreement might well put Argentina into a type of receivership in which
slow growth, permanently high interest rates, and a continued unsustainable
debt burden cause the country to limp along from one crisis to the next.
What is the alternative to an IMF agreement? Most importantly, the government
would have to begin to revive economic activity directly, instead of waiting
for foreign or even domestic investment to resume on its own. Once the
economy begins to recover, and investors no longer fear a worsening breakdown,
private investment would return. (This is not so unusual as it may seem
from looking at IMF packages in these situations: in the United States,
the most recent (mild) recession and continued economic weakness has been
countered by a shift from a Federal budget surplus of about 2 percent of
GDP to a deficit of 1.5 percent, or about $350 billion dollars. Business
investment has yet to recover).
Demand could be stimulated through public works programs, along with
income support for the families of the unemployed and the poor. A subsidy
for unemployed workers or at the very least a food stamp program of some
sort would be particularly important, due to the lack of access that many
poor families now have to adequate food.
The export sector can potentially play an even bigger role in jump-starting
a recovery. First, the export sector has gone from a relatively small to
a sizeable part of the Argentine economy. Before the devaluation, exports
of goods and services were only 11.5 percent of GDP. Now they are about
37 percent of GDP. This is not only because of the contraction of GDP,
but mostly because the devaluation makes each dollar of export earnings
worth (currently) about 3.6 pesos. Of course the devaluation also makes
Argentine exports much more competitive.
The government could work directly with private banks in major export
markets (e.g. Brazil) to arrange for letters of credit and allow exports
to expand more rapidly.
One of the great advantages that Argentina has over other countries
in such situations, in terms of recovering on its own, is that the country
is running large surpluses on both its trade and current accounts. For
the first quarter of 2002, the current account surplus was $1.5 billion,
or 7.1 percent of GDP on an annual basis. The merchandise trade surplus
is 3.75 billion dollars, or 17.8 percent of GDP on an annual basis. The
current account surplus is not a result of debt default: net foreign interest
payments in the first quarter of 2002 actually exceeded those of a year
ago.
What has happened is that imports have collapsed -- for the first quarter
of 2002, imports of goods and services are down 60 percent from a year
ago, and even more from their level during the 1998 business cycle peak.
The importance of this change cannot be over-emphasized. It means that
the Argentine economy has already gone through an enormous "structural
adjustment," as a result of the depression. In other words, as a result
of a steep and painful shrinking of the economy (which automatically reduces
imports), Argentina has already accomplished the adjustment that is necessary
to set the stage for sustainable and even rapid growth. Furthermore, the
current account surplus is not likely to disappear any time soon, since
the full effect of the devaluation—in terms of increasing exports and reducing
imports—has not yet been felt.
The country is therefore capable of paying for the imports that it needs,
for the foreseeable future, without any need for foreign financing. This
means that the Argentine economy is ready to recover without new loans
from the IMF or other international institutions.
The details of an economic recovery program remain to be worked out,
but it is certainly feasible. Aside from meeting the most basic needs of
the poor, the most important thing is to come up with a plan that revives
production and consumer demand, and allows exports to grow without unnecessary
constraints. Even if an IMF agreement is reached it cannot be assured that
such an agreement will provide net new resources to the economy, or lead
to increased private investment. Moreover, any new credits will almost
certainly be disbursed in tranches (installments), with conditions that
might hinder or even abort an economic recovery. Therefore, regardless
of when IMF and US Treasury officials decide that they are ready to sign
an agreement, Argentina must have a viable economic recovery plan of its
own. The alternative is to leave the economy at the mercy of the IMF/US
Treasury and the forces of economic contraction.
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