Argentina, South America’s second largest economy is presently in an economic depression that started in year 1999. The tension in Argentina was building until it all collapsed like a deck of cards in December 2001 when Argentina defaulted on $95 billion USD of debt, making it the largest sovereign debt default in history. Now, the nation remains in a much weakened state with social disruptions, labour strikes, hunger, violence, poverty and rampant unemployment at 25 percent. It is Argentina’s worst economic crisis in its almost 200 year history. Argentina has experienced the threat and reality of economic crises for decades. This nation of 38 million people has been governed from one unstable government to another. Today the middle class have been decimated over the last 4 years where now approximately 58 percent of the population live in poverty of which 28 percent live in extreme poverty. Real estate prices in Buenos Aires are down 75 percent in direct correlation to the collapse of the Argentinian peso. Previously, the 1970’s witnessed military dictatorships leading to the Falklands War with Great Britain and hyperinflation in the 1980’s. This is indeed a very ironic outcome for Argentina reflecting the national mismanagment that has taken place as the economy has been stagnant from 1940 to 1992 considering that earlier in the 20th century, Argentina was one of the wealthiest countries in the world.
How did it all go wrong?
After the distrastrous hyperinflation of the 1980’s and early 1990’s, Argentina implemented a new currency regime, the “convertibility” system in 1991. From year 1989 to 1991, the economy was at hyperinflation levels with inflation near the 3,000 percent level. With the leadership of a new centre-right President, Carlos Menem, the economy began to boom in the 1990’s as it grew by 40 percent. Massive levels of foreign investment, tax relief, industry privatizations brought a sense of economic renewal and strong GDP growth to Argentina. The government at the time financed budget deficits by issuing international bonds. In fact, Argentina accounted for 25 percent of the emerging bond market. This new so-called economic security was in large financed with borrowed money, as debt levels increased, so did the interest rates on the debt. Former President Menem during the 1990’s had the correct policies of lower taxes, higher levels of foreign investment, industry privatization and increased freedoms to its citizens.
However, President Menem’s government with well documented extensive corruption and greed was one of several causes that collapsed the economy into its prolonged economic downturn. This outright corruption that took place within President Menem’s administration was noticed with former finance minister Cavallo resigning from then President Menem’s Peronist government in disgust. Argentina is now experiencing this economic hangover that in now endures partly from these blatant abuses of elected office. If President Menem’s government were more responsible, Argentina today would perhaps have experienced a milder recession rather than the deep depression that prevails. In response, former President Menem states that he inherited an economy when he took power that was loaded in debt at approximately $120 billion USD although much of this was disguised in voodoo accounting. As the good times endured during the 1990’s, Argentina’s debt load accumulated as stated to a massive level until it crippled the economy by 1999. The Argentinian economy with rigid labour laws became unproductive mixed in with low commodity prices and new tax increases under former President de la Rua.
Bad Luck and Failed Currency Policy
The devaluation of the Brazilian Real in January 1999 coupled with the Real’s steady depreciation during year 2001 greatly impacted Argentine exports aiding to Argentina’s five year recession. The IMF in December 2000 provided Argentina with a $13.7 billion USD loan coupled with an international rescue package of $39.7 billion USD. The IMF is currently owed in excess of $14 billion USD, a new IMF deal is a necessity in order for Argentina to regain access to global capital markets. This relief package turned out to be a short term solution as Argentina defaulted on its debt in December 2002 making it the largest sovereign debt default in history. Since 1999, Argentina’s economy got caught in a currency jam as Argentina’s peso is pegged to the USD in a 1 to 1 ratio in a currency board arrangement. The prolong bull market in the USD that began in 1995 over time made Argentina’s exports uncompetitive pariticularly when neighbouring economies currencies were depreciating versus the USD by the late 1990’s. Argentina under President Menem was correct to anchor against the USD to reign in inflation and bring stability and growth to Argentina. Where they went wrong is that they stayed on the currency anchor far too long, they should have abandoned it in the mid 1990’s to a floating exchange rate regime rather than hanging on.
POLITICS: Argentina’s new President, Nestor Kirchner representing the centre-left of the Peronist Party won the May 18, 2003 election over former President Menem who bowed out a couple of days before in a second round run-off election. The initial policy for President Kirchner suggests that his government will not make drastic policy change from the interim caretaking tenure of President Duhalde. Negotiations with the IMF will continue as is it his policy to seek a debt restructuring deal with multinational lenders in order to tap the global capital markets again. President Kirchner will seek to levy more state control & regulation in certain industry groups, quickly implement a $1 billion USD spending program into a public works & infrastructure and invest monies into social housing. Argentina’s volatile political history more recently in December 2001 includes 5 Presidents taking office after former President Fernando de La Rua was forced to resign after social protests and violence resulting in 30 dead. Since the the debt default in late 2001, former President Duhalde did successfully stabilize the economy after months of chaos with new signs of economic recovery on the horizon. Now finally, a course of political stability may take hold but political surprises have been popular in Argentina including military rule which ended in 1983. The country is in need of political reform and transparency to root out the remaining elements of political corruption.
ECONOMY: by mid 2002, the Argentine economy has stabilized somewhat after the massive currency devaluation at the beginning of the year. However, foreign investor confidence remains shattered as personal & corporate bankruptcies has resulted in Argentina struggling to escape a five year depression as it is in the process of liquidating its debts. The root of the economic malaise was an inappropriate currency regime that crippled the economy. The currency peg during the 1990’s was supported by the IMF as they are partly to blame for this disaster as well. In March 2003, the IMF did provide Argentina with a $3 billion USD temporary loan. Provincial debt alone is at $25 billion USD. The national debt is in the process of being renegotiated with international lenders in an attempt to bring the debt to GDP ratio down towards the 65 percent level from the current 120 percent. Similar to Russia in 1998, Argentina will have to restructure and refinance payment terms on the debt, this will be a multi-year process where some investors may only receive 20 cents on the dollar. The debt default is a complex arrangement including both domestic and international debt issued in several currencies. Accordingly, Argentina is engaged in a total economic reorganization to closing the budget deficit, cutting public spending and revamping the pension and social security agencies. Argentina now with a massive currency devaluation and minimal access to capital markets will be forced to run surpluses on its balance of payments account of which it is doing presently.
The Argentine economy is not at all productive, many industries remain inefficient resulting in real wages declining 40 percent over the last 5 years. Argentina for the most part is a protectionist economy collecting huge tariffs on imports. Rising global commodity prices will help the economy grow especially in metals & mineral mining. Argentina does have modern first class mining laws as they do encourage foreign investment into mineral exploration, particularly gold and silver mining. The economy for the most part is dependent upon agricultural (beef, soybean, wool, grain) and energy resource exports for foreign exchange earnings. Brazil is the largest trading partner followed by Chile and the United States. Argentina is also actively involved with the success of ‘Free Trade of the America’s’ by year 2005.
Economic Statistics
GDP as measured by purchasing power parity is at $390 billion USD (2002) or GDP/Capita at $10,000 USD (2002). GDP growth in 2002 collapsed by 14.7 percent with year 2003 forecasting stabilization rebounding by 2.5 pecent and 2004 estimated at 3.8 percent. Inflation for year 2003 is projected at 15 percent with a goal of under 5 percent for 2004. Year 2002 inflation came in at 40 pecent , inflation for year 2001 came in at 4 percent after a deflationary 2000 at 0.7 percent at a time when the peso was pegged to the USD. Inflation had peaks in year 1976 at 444 percent and in 1989 at 3080 percent. The current account deficit had year 2000 at 3.3 percent of GDP, 2001 at 3 percent primarily due to capital outlays in debt payments to foreigners. After the devaluation, the current account is forced to swing into a surplus position projecting a strong positive balance of 7.5 percent of GDP for 2003 and projected at 6 percent for 2004. The trade account has turned into a surplus now with year 2003 looking at $15 billion USD. The fiscal deficit has now turned to a primary surplus estimated at 2 percent of GDP for 2003 due to minimal debt payments being made. Total external debt is at $141 billion USD. Composition of the economy includes agriculutre at 5 percent of GDP, industry at 28 percent and services at 66 percent. Official unemployment is at 18 percent but the real rate is higher.
POSITIVE: rich in natural resources, well educated nation, advancement with electronic banking and clearing systems, current account controls removed in January 2003, legal reform implemented. CONCERN: minimal foreign confidence shown for Argentina’s economy, weak consumer demand, rigid labour laws and proliferation of crime (kidnappings, robbery, murder).
PROBLEM: the attitude in Argentina is not positive from government to business to labour. Infrastructure difficulties exist in highways & roads, and the telecommunications industry is in disarray. The federal and provincial governments are a bloated bureaucracy, not at all efficient. All levels of Argentina’s governments are providing for payrolls to support this artificial make-work employment. There are far too many on public payroll for the current wealth creation capacity of the economy. Argentina is in a private sector wealth production deficit position with a lack of entrepreneurs. Government spending on the whole is out of control. A currency devalaution for Argentina has had serious consequences: most Agentine corporate debt is issued in US-dollars, this has caused a large number of bankruptices. Many Argentine assets have and may continue to sell for pennies on the dollar as the debt gets liquidated over time. The country’s massive present foreign debt load is unsustainable with debt servicing accounting for 70 percent of exports. Former President de la Rua’s tax increases were the wrong policies. Argentina has some of the highest tax rates in Latin America particularly top tax rates and a regressive 21 percent value added sales tax which is far too high. No wonder tax evasion is at the levels it is and why smart young Argentine entrepreneurs are in other parts of the world building businesses.
ECONOMIC SOLUTION: debt and economic growth are the key problems within Argentina, actually, growth is indeed the number one crisis. A revival in economic growth is taking place due to the peso devaluation and decline of the USD which is helping Argentina’s export competitiveness. Argentina must revive GDP growth, must change the current attitude and implement policies to attract foreign investment similar to Chile. Reverse the capital flows with cash flowing back into the Argentine banking system, lower taxes, implement measures to lower tax evasion that has been as high as $25 billion USD/year. Provide an environment for entrepreneurs to support long term economic growth - the wealth creators. A renegotiation of the debt level to a reduced level of 65 percent of GDP will be required as this level is manageable providing the economy grows and the debt is restructured at reasonable interest rates and maturities. Argentina must lower tax rates and respect property rights. Hopefully Argentina will learn from the costly lessons learned during the 1990’s, an honest government with the correct policies will revive Argentina with strong economic GDP growth. Until then, it is going to be a long nasty hangover.
BANKING SYSTEM: needs to be restructured from the the liquidity crisis and banking freeze as a result of the debt default in 2001. During the financial panic leading up to the debt default, Argentina’s banks experienced bank runs exceeding $20 billion USD with much of it now in mattress money reflecting low confidence in the banking system. At the time, former President Duhalde implemented banking restrictions in December 2001 including a bank account freeze and ruled USD deposits to be converted to pesos. As a result, social protests and violence came to fruition while thousands of lawsuits against the ruling have been forwarded. Meanwhile, insolvent banks have been closed over the last two years coupled with many international banks writing off their Argentine banking investments. At present, the banking system is slowly regaining confidence but remains vulnerable. In addition, the banking freeze has been removed as capital controls have been dismantled with economic stability returning. Banking system crisis dates include: 1980-82, 1989-90, 1995 Tequila Crisis, year 2001. It is believed that with fairly high domestic interest rates that many Agentines maybe lured to re-deposit money back into the banking system. Total foreign currency debt is at $110 billion USD, mostly dominated in dollars, yen and euros. Year 2000 reserves were at a respectable $28.5 billion USD although they have been depleted to a net level of $10.5 billion USD for March 2003 after the currency crash.
REGIONAL: Brazil, Uruguary, Chile
The region is experiecing growing confidence particularly with Brazil’s relatively new President, Lula de Silva a centre-left leader. It is vital to restore international confidence and the investment climate within Argentina and the region to avoid a historical challenge with financial contagion. The Brazilian Real has been appreciating recently off its low levels since the real was floated in early 1999. Now with the Argentine peso devaluation, Argentina is now benefitting from international tourism visits in cities like Buenos Aires including many visitors from Japan interested in Tango dancing lessons.
KNOWLEDGE: rich in natural resources including fertile agricultural farmland. Mining investment is an important source of capital inflows representing $7 billion USD during the 1990’s and up until 2010 Argentina is projecting to attract another $8 billion USD. Mining reserve wealth alone for Argentina is estimated at $50 billion USD in the areas of silver, zinc, copper and gold production. In the energy sector, Argentina is the 4th largest producer in Latin America including advanced nuclear production facilities with 3 nuclear plants. The nuclear industry is Latin America’s most advanced. In oil, Argentina’s offshore ocean shelf is said to be larger than the North Sea as minimal offshore oil exploration to date has been implemented in the southern Atlantic. Tremendous oil wealth lies ahead for Argentina. Net oil exports in 1999 were measured at 372,000 b/p/d. In addition, Argentina’s natural gas reserves are the 2nd largest in South America at 24 trillion cubic feet with Chile being an important consumption market. Finally, great energy wealth also exists in hydropower as with new dams Argentina has the capability to increase hydropower output for electricity production. Giant Brazil with its huge market will be an important energy export market for Argentina.
CURRENCY: ISO symbol ‘ARS’, Argentinian peso. At time of review on May 26, 2003, the Argentinian peso had an exchange value of 2.88 ARS to 1 USD. The peso is now under that of a floating exchange rate regime as of February 2002 when the currency board arrangement was abandoned in January 2002. Before convertibility law in 1991, Argentina has had a long history of peso devaluations. Argentina’s floating exchange rate is the appropriate currency regime in BI.C’s view. For decades, Argentina has basically operated with 2 currencies, the peso and the USD. Since 1935 when the Central Bank of Argentina was established, the peso has been decimated in value and holds a terrible record reflecting the competence of its politicians. In comparison to purchasing power parity, as of April 2003, the ARS was approximately 40 percent undervalued in relation to the USD.
CURRENCY HISTORY: historical valuations include convertibility implemented in 1991 where the Argentinian peso was pegged at par to the USD (1.0), January 1, 2002 at 1 ARS to 1 USD, January 9, 2002 at 1.21, January 16, 2002 at 1.88, March 20, 2002 at 2.54, March 27, 2002 at 3.25, June 26, 2002 at 3.88, November 20, 2002 at 3.55, January 1, 2003 at 3.36, March 19, 2003 at 3.06. Low came in at 3.9 ARS to 1 USD in March 2002.
Alternative Currencies
When economies enter depressions and confidence is lost in the national currency, citizens often look to alternative forms of currencies to facilitate transactions. Argentina is no exception. Speudo currencies have included Patacons, provinces have issued paper promises with their own currency versions including federales, petroms, independencias as ‘quasi-currency’. Other currencies including barter have become very popular including creditos. At present, there are one million members in Argentina who belong to ‘Barter Solidarity Network’ with up to 5 million Argentines using various barter clubs. Shopping malls in Buenos Aires issued its own currency for shopping ‘pacificos’. These forms of alternative currencies are not a healthy sign to an economy and once the faith is returned to the peso, these alternative currencies will lose their appeal.
USD Dollarization Possibility
There is an opinion that ‘dollarization’ may take place as this will lower Argentina’s cost of trade, provide Argentina with a larger export market, lowering of interest rates and also provide for an increase in access to capital both through borrowing and direct investment. Argentina has adopted an unofficial ‘dollarization’ since 1991 with the USD exchange peg as approximately 80 percent of Argentine bank loans during the 1990s were in US-dollars. Argentina then was in a stronger position to ‘dollarize’ then it is now. Outright dollarization is a possible option, but not likely in the medium term. By dollarizing the peso, asset prices will soar such as stocks and interest rates will fall. A continuation of Argentina being one of the freest economies in the world as it was under former President Menem’s rule in the mid 1990’s. The big problem with dollarization today is not perhaps the Argentine peso, but the US-dollar itself. It is currently in a controlled crash against many of the world’s currencies. A more likely scenario is a currency union amongst MERCOSUR countries as Brazil and Argentina’s economy become more interdependent on trade rather than the Argentina’s small trade with the United States which finds itself in a precarious economic situation itself. The US-dollar may no longer be the world’s reserve currency, gold may take over this role again.
CURRENCY OUTLOOK: fluctuate in a trading range of 2.6 to 3.2 ARS to the USD over the next 12 months. Long term purchasing power parity is at an approximate level of 1.9 to 2.2 to the current falling USD. A return to convertibility is very unlikely for Argentina again. Immediate potential risk includes Argentina unsuccessfully concluding a constructive debt agreement with creditors resulting in its inability to raise monies in the global markets. Other risks include its domestic political risk and its horrific history of currency management but the population is fed up and politicians are now on notice particularly with globalization. The regional situation has much improved with increasing commodity prices giving a boost to Chile and Brazil is finally rebounding with new political leadership. The stock market is up 15 percent so far n 2003, confidence with Argentina’s new leader is helping to stabilize and foster confidence reflecting in the peso’s appreciation over the short term. Argentina does indeed have much better days ahead for its people. Inevitably, Argentina will realize a higher standard of living as this well educated nation has a similar resource and population base to the highly industrialized wealthy nation of Canada.
UPDATED: May 26, 2003
