Finger-pointing or focussing on systemic reforms?

Will the international financial establishment take heed of the pressing need raised by Argentina’s economic troubles to reform the global financial architecture, or will it continue ignoring the lessons thrown up by a crisis which is at least in part its own handiwork?

GENEVA: The financial, political and social crisis in Argentina is focussing attention once again on the urgent need for reforming the global financial system - a focus that the powers that be, including the International Monetary Fund and the US administration and Treasury, are, however, seeking to deflect by attempting to shift the blame.

Yilmaz Akyüz, the chief author of the United Nations Conference on Trade and Development’s (UNCTAD) Trade and Development Reports (TDRs) and officer-in-charge of the UNCTAD division on Global Development Strategies, says that the Argentine crisis proves the main point in TDR 2001, namely, that any serious reform of the international financial architecture needs to provide mechanisms for the prevention and better management of such crises.

After resisting and ridiculing the idea of an international equivalent of the US Chapter 11 bankruptcy concept for sovereign debts, first put forward by UNCTAD more than a decade ago, the IMF has now recently embraced it.

However, with the IMF itself a major creditor, there will be a conflict of interest if the IMF is to judge these matters.

And a part of the solution in Argentina requires a haircut not only for foreign bondholders but also for the IMF itself, whose policy advice and prescriptions were followed by the Argentine government only to make matters worse by the day and pile up the country’s external debt, including to the IMF.

The UN conference on Financing for Development, due to take place in March at Monterrey in Mexico, provides an opportunity to set in motion a process to reform the monetary and financial system. But the prospects of this are not bright, with the US having set its face against any attempt by the UN system to interfere with the Bretton Woods institutions (the IMF and World Bank).

The situation is compounded by the corporate greed that is driving the trade policies of the major developed countries, both nationally and in writing international trade rules, thereby making the evolution of a viable trade system to support the monetary and financial system and vice versa even more difficult.

While the government and the political class and establishment in Argentina cannot escape responsibility for the crisis in that country, experts suggest that unless the opportunity is seized by the international community to reform the global financial system and hold the IMF management itself accountable, the world will continue to lurch from crisis to crisis and experience increasing social disorders.

Long foreseen

The crisis in Argentina has in fact long been foreseen, with enough warnings from other international organizations and institutions about the unviability and unsustainability of the country’s currency board system and its peso-dollar link.

However, with encouragement from the IMF, these warnings were ignored, and this has now resulted in the collapse of the Argentine financial sector and a political and social crisis that presents no easy way out for anyone.

One lesson to be drawn is that the markets can never be a substitute for the state, and any ills of governance have to be cured through political processes and not by over-reliance on the market. A well-governed state can provide an antidote to the ills of the market, but not the other way round.

As early as 1995, UNCTAD, in its Trade and Development Report, had hoisted warning flags about the likely consequences of the financial sector liberalization, capital convertibility and the Argentine currency board and link to the dollar, and the serious adjustment problems that would be posed by any sharp reversal of capital flows and the external constraints on macroeconomic stability.

Focussing on Argentina and the adjustment problems faced by it, UNCTAD posed the issue in these terms: “... the main question for Argentina is how much unemployment will be needed to improve competitiveness, given that it has excluded the possibility of using what is normally the most potent instrument of policy to that end, namely the exchange rate, and whether such a level of unemployment will be politically acceptable.”

The challenge, UNCTAD said, “is how to restore external equilibrium and a competitive exchange  while avoiding a runaway inflation that had only been overcome in the first place by sacrificing external equilibrium and a competitive exchange rate. Stabilization from a very high inflation generally requires using the nominal exchange rate as an anchor for inflationary expectations, pricing decisions and wage setting, which leads to the appreciation of the currency. The main challenge is to manage a quick and smooth transition to a stable and sustainable real exchange rate regime, so as to restore competitiveness without rekindling inflation ...”

Argentina, though, did not take heed and in fact criticized UNCTAD severely for the prognostication, which it complained was increasing the cost of its external borrowing. Encouraged and egged on by the IMF, it persisted in its course, and the whole edifice has now collapsed.

It was not merely UNCTAD that raised these questions. The issue had also figured in Fund discussions, more so after the Asian financial crisis of 1997, when at the IMF interim committee meetings, some European governments and central bankers questioned the wisdom of developing countries pegging their currencies to the dollar, pointing out that there would be no soft landing from such a policy if the currency gets overvalued and payments difficulties ensue. The Europeans urged consideration of evolving an exit strategy.

This was known to have incensed the Argentine government, which used to counter the criticism by questioning the kind of exit strategy that the Europeans envisaged for their European Monetary Union.

(The successful introduction of the euro and its acceptance by the public may appear to provide an answer of sorts to the poser, given that markets are bound to take account of the public sentiments. However, even the success of the euro and the monetary union would depend in the medium to long term on how successful the European Union and its central bank would be in ensuring employment and growth, and fostering public perceptions that there is equitable sharing of benefits and burdens among the people.)

Although they raised questions about the viability of currency pegging and the policies pursued by Argentina, the Europeans did not hesitate to take advantage.

The Argentine public sector was privatized, and Italian and Spanish corporations bought over the assets, with the inflow of foreign funds providing a cushion of sorts to Argentina. However, the takeover of the banks and financial sector by foreign banks also resulted in the tightening and then non-availability of credit to small and medium Argentine enterprises, forcing them into bankruptcy and closure. And inevitably, the foreign investments increased outflows as these foreign-owned enterprises used the peso-dollar link and convertibility to repatriate their profits annually abroad - in effect worsening Argentina’s payments and adjustment problems.

Now that Argentina has been forced to cut the peso-dollar link and has imposed controls, these governments are trying to persuade Argentina to find ways to rescue the corporations.

That the governments in Argentina and the political class would choose to take the easy way out over these several years was perhaps inevitable in the circumstances.

However, the IMF ignored the warnings from academics, other international organizations and European central banks, and encouraged Argentina to persist in its course. Now that the policy has failed, the IMF is seeking to escape responsibility by attempting to shift the blame onto Buenos Aires.

From “poster child” to “pariah”

As Prof David Felix has put it in a commentary posted on the Foreign Policy in Focus Global Affairs Commentary website, the failure in Argentina had been foretold not only by academic critics but also by bond investors, who by 1998 had come to see Argentina as over-indebted and the peso overvalued and began reducing lending and increasing the risk premia for holding Argentine paper.  Argentina, he points out, was a “poster child of the IMF and Wall Street during most of the 1990s” but has emerged now as the “pariah” of today.

It had been a poster child, Prof Felix adds, because more avidly than any other developing country, it had in the 1990s opened its financial markets and privatized its public assets. These structural reforms supported by monetary reforms - fixing the dollar/peso exchange rate and tying peso money supply to stock of hard currency reserves - were accompanied by a major foreign policy shift, from non-alignment to an all-out pro-US position, and full support to the US on a range of issues. With Argentina gaining an A+ investment rating from Wall Street and the IMF, foreign direct investment poured in to exploit privatization opportunities (with the Italians and Spanish benefiting the most).

However, he points out, the strategy to attract foreign capital proved to be a millstone, depressing the economy and repelling foreign capital.

Writing in the Straits Times of Singapore, Prof. Joseph Stiglitz, the former vice-president of the World Bank (who had to quit his post, under US Treasury pressure, because of his critique of IMF policies), has listed several lessons to be drawn from the crisis in Argentina.

In a world of volatile exchange rates, he says, pegging a currency to a hard currency like the dollar is a highly risky strategy. Globalization exposes a country to enormous shocks, and adjustment in exchange rates is part of the coping mechanism.

Any country ignores social and political contexts of its economic policies only at its peril, says Stiglitz. For, any government following policies that leave large parts of the population unemployed or underemployed is failing in its primary mission.

A single-minded focus on inflation, without concern for unemployment or growth, is risky, he warns. A country needs, for growth, financial institutions to lend to domestic firms. Selling banks to foreign owners without appropriate safeguards may impede growth and stability.

Economic strength or confidence can seldom be restored by forcing an economy into deep recession, he says.

“Argentina’s crisis,” Stiglitz adds, “should remind us of the pressing need to reform the global financial system - and thorough reform of the IMF is where we must begin.” (SUNS5037)