The expansion of the Argentine crisis

When the Argentinian crisis erupted last year, both the IMF and the US Treasury were confident that there was little danger of contagion. Now, however, the crisis has spread to neighbouring Uruguay and Brazil, forcing the IMF to rush emergency financial aid to these beleaguered nations. While there is no denying that there are internal factors behind the crises in both these countries, it is clear that the failure of the IMF to respond promptly to the Argentinian crisis has been a critical factor in the extension of this crisis.

Ariela Ruiz-Caro

THE recent economic convulsions in various Latin American countries, especially in Uruguay and Brazil, have managed to banish the idea, held by the IMF and sectors of the United States government, that the apocalyptic crisis in Argentina would be circumscribed to the country alone.

Over the past few days, Brazil has experienced capital flight of substantial magnitude, which has caused a sharp increase in the dollar exchange rate; while in Uruguay, the drain on deposits in the order of 45% over the first six months of the year could not be contained - international reserves dropped from a level of over $3,000 million to less than $600 million.  The reasons behind the Brazilian crisis are many, but the enormous pressure of repaying the maturing foreign and domestic debt - making it necessary to obtain resources amounting to $50,000 million during the forthcoming year - is a decisive element.  This factor will affect any government taking over after the October elections.  In the case of Uruguay, the phenomenon is directly related to the lack of confidence of Argentine investors, many of whom had placed a considerable portion of their investments in the Uruguayan market.

It was therefore understandable why a few weeks ago, the Secretary General of the Organisation of American States (OAS) qualified the position of the United States government as ‘not very constructive and quite dangerous’ vis-a-vis the Argentine crisis, due to the fact that, if an orderly solution were not found, the contagion to the other Latin American countries would be widespread.

In fact, contagion took a little while to reach the banking systems because it started with a reduction in direct investment in the region.  The UN Economic Commission for Latin America and the Caribbean (ECLAC) announced that the Argentine crisis would lead to a global recession in the whole zone, which would record a growth of barely 0.8%.  Countries such as Brazil and Chile have had to adjust by half their expectations of growth for this year.

In this respect, the extension of the crisis to neighbouring countries and the reiteration by the IMF that it would not provide immediate assistance to Argentina mark a further worsening of the situation.

A new ‘lost decade’ in the making?

The present crisis in Latin America is the third in less than a decade. The previous collapses took place in 1995 and 1998-1999.  In this crisis and in the two previous ones, unexpected drops occurred in the region’s growth. But the factors which triggered the three episodes were very different.  The Tequila crisis in 1995 did not have a global character, but was focused on Mexico and extended by means of financial contagion to Argentina, which in turn involved Uruguay. The crisis which originated in Asia in the second half of 1997 caused financial uncertainty that has since never really abated and that hit South America more forcefully.

According to ECLAC economists, in contrast to the previous crises, this is a real global crisis, launched by a world economic slowdown and sharpened in Latin America by the Argentine default.  Given such a development, there is no doubt that a regional crisis warranting concern does exist and could lead to a new ‘lost decade’.

However, the IMF does not have a response to address the problem on a regional level. And, although the United States Treasury has backed Uruguay - the only case it has recognised of the danger of contagion in the region - it does not seem particularly interested in any approach other than addressing it on a case-by-case basis.  Within this framework, the United States government has decided to help Uruguay to avoid an even greater collapse of the banking system.  The $1,500 million granted to Uruguay represents in this case a change in the United States’ ‘anti-bailout’ policy in facing financial crises in emerging countries.

In fact, the United States Treasury Secretary, Paul O’Neill, has repeatedly stated that the US will not participate in bailouts because ‘it is not right to use the money of US carpenters and plumbers to salvage banks and companies that have mis-invested in high-risk countries seeking higher and quicker profitability.’

The agreement signed recently by Brazil with the IMF that involves a $30,000 million credit suggests that, in spite of the prevailing discourse, the Latin American region is beginning to represent a problem for North America.  Nevertheless, this agreement cannot ensure a resolution of the difficulties faced by Brazil due to the enormous debt-servicing burden it bears. Testament to this is the fact that its country risk and the exchange rate of its currency, the real, remain at levels similar to the ones registered before the agreement.

According to a study by the Economist Intelligence Unit, the short-term risk for investment in Latin America rose in July to its highest level since 1997. In July the mean country risk for Latin America reached 56 points, just one point above sub-Saharan Africa, which is the highest-risk region. Investor confidence, already greatly weakened by the Argentine crash, is also affected by the increase in political uncertainty in the five Andean countries (Bolivia, Colombia, Ecuador, Peru and Venezuela), by the impact of the Argentine crisis on Uruguay and by uncertainty arising from the elections in Brazil and, to a lesser degree, in Ecuador.

Difficulties in the neighbouring countries will have a decisive impact on Argentina, in both the short and long term.  Depreciation of the Brazilian real may reduce the competitiveness that, with the sharp peso devaluation, had been enjoyed by certain productive sectors in Argentina.  Also a foreseeable contraction of the domestic market will lead Brazil to increase its placing of surplus products in neighbouring-country markets.  This could have an impact on the import-substitution policy that the government has lately been attempting, and adversely affect the trade balance.  Regionalisation of the crisis will also strengthen international investors’ reticence vis-a-vis Latin America, particularly regarding the more critical areas of the region. 

Policy pitfalls

Right from taking up office, the current Argentine government has expended considerable effort to fulfil the demands of the IMF, alleging that this is the only alternative available and that it is the only way of attracting capital once again and reinserting the country into the international financial system.

However, experience shows that contractionary policies such as those recommended by the IMF, far from stimulating the entry of foreign currency, can lead to a vicious circle of stagnation and loss of capital.  Entry into agreements with the IMF is often justified on the grounds that it generates investor confidence.  However, the fiscal deficit is not the only, or even the most important, determinant of this confidence: a stagnant economy, even one that maintains a balanced budget, does not attract long-term capital. 

The situation inherited by the present government has been worsened by devaluation and by the scant efforts made, particularly at the beginning of its term, to collect taxes from those directly benefiting from the increase in the exchange rate and to guarantee the due liquidation of currency obtained from exports. Furthermore, devaluation did nothing to improve foreign sales which, far from increasing, dropped, even as it placed at risk many companies, both big and small, that had taken up loans to expand their activities.

It also quickly and substantially made the price of local assets cheaper, stimulating a new wave of foreign takeovers.  One critical manifestation of this phenomenon has been the sale of the Argentine oil company Perez Comanc to Brazil’s Petrobras, whereby almost the entire local energy market has now come under the control of foreign companies, generating understandable concern on the part of both the government and the private sector. 

Dilemma of debt

The worsening of the crisis has also paralysed the financial system, which in turn has set back recovery of the economy and even hindered exports. Another major part of the problem is the public debt.  So long as this is not solved, there will be no credit and no savings, and people will continue to buy dollars.  The government’s liabilities include not only the claims of owners of debt bonds issued by the Argentine state but also the claims of public companies that were privatised, such as Metrogas, Aguas Argentinas and the telephone companies.  If no agreement is reached with these debtholders, Argentina will be liable to a series of legal actions in foreign courts.

Within this framework of difficulties, the government’s effective deadline to reach an agreement with the IMF is September.  That month a debt of $2,880 million with the multilateral body will fall due.  If by then it has not managed to sign another agreement - making it possible to reschedule all the pending payments - the government will be obliged to draw down its reserves to pay the IMF or otherwise postpone maturity until 2003, thereby losing the possibility of reaching an agreement this year. In either case, the situation is complicated.  If it pays with Central Bank reserves, the remaining reserves will drop to a level that is too low for market standards and this will run the risk of encouraging a strong rise in the dollar exchange rate.  In the worst-case scenario, the ghost of hyperinflation will return to haunt the nation.

On the other hand, if, faced with the lack of an agreement with the IMF, the government decides not to pay, another equally feared problem will arise: that of defaulting on payments to international bodies. The consequences of this are less clear, particularly at a time when access to foreign credit is nil.

Obviously, this scenario makes negotiations for foreign assistance very difficult. The situation is further complicated by the position of the IMF and the United States government which, in return for granting assistance, demand the design of a sustainable economic plan, a practically impossible task if financial relief is not forthcoming or if unsustainable adjustment measures, in economic and political terms, must be instituted.

The power vacuum in Argentina generated by the vain attempts of the authorities to reinsert the country into the international financial system has finally obliged President Eduardo Duhalde to bring forward the elections to March next year. The new president and vice president and half the Chamber of Deputies will take up office on 25 May, the date on which the 1810 May Revolution, which consolidated the first national government, is commemorated.                      

Ariela Ruiz-Caro, a Peruvian economist, is a consultant for the UN Economic Commission for Latin America and the Caribbean (ECLAC). She was formerly an official with the Andean Community of Nations and has participated in the Latin American and Caribbean Information Exchange Programme on External Debt at the Latin American Economic System (SELA). The views reflected in the above article are the sole responsibility of the author.