Argentina: A crisis made abroad

Countering claims that the Argentine economic crisis was caused by extravagant government spending, a US think-tank has traced the roots of the Latin American country’s troubles to external shocks and wrong-headed policies backed by the international financial institutions.

by Chakravarthi Raghavan

GENEVA: The crisis in Argentina is not the result of profligate government spending but was caused by external shocks and failures of policies that were set or encouraged and promoted by the international financial institutions, including the International Monetary Fund, according to a briefing paper of the Centre for Economic and Policy Research (CEPR).

The briefing paper is by Mark Weisbrot and Dean Baker, co-directors of CEPR, a Washington-based think-tank, who warn that the IMF is playing with fire in trying to squeeze debt service out of Argentina’s collapsed economy.

In the briefing paper, Weisbrot and Baker have challenged reports in the US and international press of a profligate government that could not contain its spending and could not make the necessary hard choices to build confidence among investors and lenders.

It was higher interest payments on its debt, not increased government spending, that led to the higher deficits which in turn created doubts about the overvalued exchange rate, pushed interest rates higher and created larger deficits - in a hopeless spiral that ended in default and devaluation.

While policy failures played a role in the economic collapse in Argentina - and the most important was the fixed exchange rate tying the Argentine peso to the US dollar - the immediate cause of the crisis was a series of external shocks beyond the control of Argentina, CEPR says.

These shocks began with the US Federal Reserve’s decision to raise interest rates in February 1994 and were made much worse because of the fixed exchange rate.

The Argentine data do not support the idea that the government could not accept a sufficient dose of the austerity medicine or that it spent its way into a hole.

The total budget balance of Argentina over the period 1993-2000 suggests a significant loosening of fiscal policy, with the budget moving from a surplus of $2.7 billion or 1.2% of the GDP in 1993 to a deficit of $6.8 billion or 2.4% of GDP in 2000. But, for a country in deep recession, this deficit was modest.

However, even this deficit, and the shift from surplus at the beginning of the period, does not accurately represent government fiscal policy, the CEPR briefing paper points out.

The primary balance of the government - government spending other than interest payments, subtracted from revenues - moved from a surplus of $5.6 billion or 2.4% of GDP in 1993 to $2.9 billion or about 1% of GDP in 2000 - “a very modest deterioration”.

Even this movement did not occur on the expenditure side. Government spending, minus interest payments, was essentially flat over the period - 19.1% of GDP in 1993 and 18.9% in 2000 - despite the serious recession. All the deterioration was on the revenue side, as tax collections fell off during the recession.

It was thus difficult to argue, says CEPR, that the Argentine government contributed to the economic crisis through overspending, nor could the government have averted, even if it were politically possible, the default and devaluation through further fiscal tightening throughout the recession.

The government budget moved from surplus to deficit because of interest payments, which rose from $2.5 billion in 1991 to $9.5 billion in 2000 or from 1.2% to 3.4% of GDP.

With almost all of these payments in foreign currency, this itself was a significant drain on the economy. But the effect of rising interest rates, in the context of the fixed exchange rate, was much more damaging. The budget deficit increased uncertainty in the financial markets about the viability of the exchange-rate regime, and the uncertainty drove interest rates even higher.

Efforts to meet the deficit by cutting primary government spending even further during a period of recession made things worse: it directly cut demand and, by causing political instability and uncertainty, fed the fears of devaluation and/or default. The collapse of the economy occurred without any new borrowing by the government to finance its primary spending.

Interest rate hike

Argentina’s problems began when the US Federal Reserve hiked up interest rates in February 1994 and over the next year doubled the short-term rates from 3 to 6 percent. Argentina was hit immediately because of the uncertainty created over emerging markets: Argentina’s borrowing rate increased by the US Fed’s 3 percentage point increases, and the increasing spread.

The devaluation of the Mexican peso in December 1994 - partly triggered by the hike in US interest rates that attracted tens of billions of dollars away from Mexican bonds to the US - exacerbated the situation in Argentina, with the banking system losing 18% of its deposits within weeks.

The economy, which had been growing at an average annual 8% rate from the second half of 1990 to the second half of 1994, went into a steep recession. GDP contracted by 7.6% from the last quarter of 1994 to the first quarter of 1996, and there was a massive outflow of capital and shrinkage of reserves.

While recovery began in the second half of 1996, the Asian crisis of 1997 sent the Argentine risk premium and cost of borrowing up again. And the peso, tied to its fixed exchange rate with the dollar, became overvalued, with the dollar too becoming overvalued at that time.

The subsequent spread of the Asian financial crisis to Russia and then Brazil made things worse, and the Argentine economy went into recession in the second half of 1998 and has not recovered since. Efforts to restore confidence in the overvalued peso through spending cuts and IMF loans (including a $40 billion package in December 2000) could not reverse the downward spiral.

The IMF supported the fixed-rate policy of Argentina all the way into the abyss, though subsequently the Fund officials have claimed they did so at the request of the Argentine government.

Argentina’s debt to the international financial institutions increased from $15 billion to $33 billion, and throughout the IMF insisted that more fiscal tightening was the key to recovery, even though it was  quite clear  that  no amount of budget-cutting or tax increase could have saved Argentina from default and devaluation.

Argentina is currently trying to negotiate new agreements with the IMF and the international financial institutions, and there are renewed calls for budget austerity. Though the fixed-exchange-rate system has gone, austerity cannot help Argentine recovery, says CEPR.

At the moment, with the government of President Eduardo Duhalde lacking any public backing to be able to stand up to the IMF, the Fund officials seem to have the upper hand.

However, says Weisbrot, the IMF would be playing with fire if it tries to squeeze debt service out of the collapsed economy and push more people into poverty. (SUNS5077)

From TWE No 276 (1-15 March 2002)