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Argentina in Crisis: What Went Wrong?

Last weekend’s Latin America Conference featured a surprise luminary speaker, Professor Ricardo Hausmann, Harvard Kennedy School of Government Professor of the Practice of Economic Development, who outlined events leading to the recent Argentina debt crisis that led to street riots and a revolving door to the presidency.

Prof. Hausmann cited a decline in commodity prices and rising domestic costs as initially unsettling the region. In the first quarter of 1999, he said, as emerging market investors turned to other markets such as Asia and Russia, “capital flows reversed and then essentially died.” By the second quarter, “Argentina got hit” and the economy was declining by 5.2%. Most startling, however, was that by the first quarter of 2000, other nations in the region such as Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela began to recover, but Argentina continued its decline.

The “dominant diagnostic,” said Prof. Hausmann, who served as the first Chief Economist of the Inter-American Development Bank (1994-2000) where he created the Research Department, were “self-fulfilling bad expectations about a weak public debt position,” a pessimism that led to rising interest rates and lower output.

Prof. Hausmann pointed his finger initially at government policy-makers for worsening what he saw as a manageable situation. First, he said Argentine leaders wanted to calm bond holders and therefore mistakenly raised taxes in early 2000 and in August 2001 adopted a zero-deficit policy, which meant the nation’s pensioners would get variable amounts of money in line with the country’s financial position.

When this approach began failing, the government became afraid about its ability to rollover its short-term bonds and therefore adopted a debt exchange program and accepted IFI support packages “full of lies,” said Prof. Hausmann. “The Argentine government,” he said, “has made many, many stupid announcements” to try and reverse declining confidence. When Argentina’s short-term debts came due, the government had to accept new, higher-priced bonds, which only further undermined confidence and the country’s financial position.

In 1997, said Prof. Hausmann, there were no fiscal problems in Argentina. There was 36% public debt as a percentage of GDP, interest rates were at 6%, and their growth rate was at a brisk 5%. Economists predicted a .3% budget surplus was necessary with these figures, and Argentina was producing a .4% surplus.

The problem came when analysts didn’t believe Argentina could sustain a 5% growth rate in the face of worldwide weakening emerging markets. With new projections of an assumed 2.5% growth rate, economists predicted a need for a 3.5% surplus and projected 46% debt to GDP ratio, which led to higher public debt servicing costs. “It was not about a bad government regime that did them in,” said Prof. Hausmann, though he faulted some of their reactions to the crisis.

Argentina had a dollar peg initially (followed by a dollar-euro mix) and in order to remain competitive in a weakening environment, the government needed to devalue the currency. However, because of the dollar peg, most companies held debts in U.S. dollars. If the government chose to devalue the currency, “then all balance sheets would go to hell,” said Prof. Hausmann.

The government eventually devalued the currency, and “revenues are 40% now what they were last year” in dollar terms, and neither the public nor the private sector can service its debt. The government, in order to alleviate some of these pressures, de-dollarized some debts and enacted a “savings freeze” to prevent capital flight. However, warned Prof. Hausmann, this has caused a virtual collapse of the payment system in Argentina.

“This is really big stuff,” he said. “We haven’t seen something like this since the major depression of the 1930’s.”

Prof. Hausmann, who served as Minister of Planning of Venezuela (1992-1993), as a member of the Board of the Central Bank of Venezuela, and as Chairman of the IMF World Bank Development Committee, recommended that the government still needs to control fiscal policy and instill confidence in the financial system by ensuring people it won’t “print too many pesos.”

He recommends de-freezing savings accounts and devaluing the currency by partially converting deposits into long-term bonds. He also suggests rebuilding trust in the banking sector by ensuring that at least a select group of banks survive with strength, and he says the government should articulate a clear monetary policy that is fiscally prudent. As time passes, he fears international willingness to intervene will wane, but that support from abroad could be critical to a successful recovery.
“The government is broke,” he concluded. “It cannot pay its current employees. It cannot pay its pensioners. The only thing it can do is turn the situation around. There is no alternative channel.”

March 11, 2002
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