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Argentina in the boxing day New York Times

by Brad Setser
December 26, 2004

The IMF’s typical diagnosis of an emerging economies problem is “its mostly fiscal”, or so the wonky saying goes. Larry Rohter of the New York Times makes the argument that Argentina’s post 2001 success hinges on its heterorthodox economics: I am not convinced.

The number one reason for Argentina’s financial and economic stabilization is its belated conversion to fiscal discipline — or what in the old days might have been called a conservative fiscal policy. Why no hyper-inflation after Argentina’s default? The government matched revenues and expenditures, avoiding the need to print money. Hardly radical.

Rohter writes:

“Rather than moving to immediately satisfy bondholders, private banks and the I.M.F., as other developing countries have done in less severe crises, the Peronist-led government chose to stimulate internal consumption first and told creditors to get in line with everyone else.”

The first part is no doubt true. The second half, though, is a bit off: the government has not ran an expansionary fiscal policy after its default. The initial impetus for Argentina’s recovery came from the devaluation, which led to a surge in export revenues (measured in local curency terms), not government policies to spur consumption. Government spending initially had to fall to match falling revenue.

The strongest indictment of the IMF is that an Argentine government that explicitly defines its policy in opposition to the IMF has adopted a far more conservative fiscal stance than any Argentina government that embraced the IMF in the 1990s.

The world works in mysterious ways: in order to prove that it did not need the IMF, Argentina ended up adopting a more conservative fiscal policy stance in 2004 than the IMF demanded. Argentina’s primary surplus is likely to exceed 4.5% of its GDP (a primary surplus is revenues minus non-interest spending) this year …

Argentina never really was able to run a primary surplus before its default, but I don’t think Argentina could have avoided its crisis just with tighter fiscal policy from 98 on, as many have argued. Argentina’s exchange rate was overvalued before the currency board collapsed. Remember, the dollar was STRONG back then, and Argentina’s 1:1 peg to the dollar meant its currency tracked the dollar, even after Brazil let the real float.

Argentina needed to get rid of both a current account deficit and fiscal deficit back in 2000-01: without letting the exchange rate fall, fiscal tightening would only have led to a reduction in the current account deficit if it also led to a broader economic contraction. Bringing the real exchange rate down without changing the nominal exchange rate requires deflation — and much faster deflation than Argentina was able to muster in 2000 and 2001. Argentina ran a current account deficit in 2001 despite its sharp economic contraction.

Argentina’s formula for post crisis success has rested both on its tight fiscal policy, and the impetus given to exports and domestic production by a weak peso.

In my view, the IMF — and by IMF I mean both IMF management and its major shareholders, including the US — made two mistakes in Argentina. First, in 2000 and 2001 the IMF bet that Argentina could avoid both a devaluation and a debt restructuring. It financed the status quo, when it should have financed the transition to a more sustainable exchange rate regime. Second, in 2002 the IMF bet that Argentina would fail to stabilize its economy after its default and devaluation. Consequently, the IMF ended up betting wrong twice: it bet on success without a devaluation in 2001, and on failure after the devaluation in 2002. That cut into the IMF’s credibility, even if some of the steps Argentina adopted after its default — including tight fiscal policy — are hardly antithetical to the IMF.

The Times article noted one area where Argentina has disregarded the IMF’s advice: it has achieved its fiscal surplus in part by taxing exports, an IMF no-no. Over time, Argentina will want to cut its export tax, but I think the IMF has been a bit too doctrinaire here. Even with the export tax, Argentine exporters are far better off than they were with the overvalued exchange rate peso, and the IMF never objected to the currency board. Coverting dollar debt to peso debt provided exporters with a huge subsidy back in early 2002: agricultural debts taken out to finance the planting were “pesified” before the harvest, generating a huge windfall gain for some. The state giveth, the state taketh away.

The Times could have added another big point of disagreement between the IMF and Argentina: Argentina’s use of its reserves to stabilize its exchange rate, post devaluation. Here too, I think the IMF was a bit too doctrinaire. The IMF let Argentina use a ton of its reserves to defend a massively overvalued exchange rate in 2001 (net reserves fell by $20 billion), but objected to the use of $3 billion or so of Argentina’s reserves in 2002 to try to prevent an already weak peso from falling further. Using a much smaller amount of reserves to try to prevent an already depreciated exchange rate from over shooting always struck me as a more sensible use of IMF resources than defending an overvalued exchange rate.

The Times did note that Argentina put a lot lower priority on reaching agreement with its external creditors than other emerging economies, and no doubt a lower priority on concluding its debt restructuring than the IMF would have liked. However, the slow pace of Argentina’s external debt restrucutring is probably not the central component of Argentina’s post-default debt strategy. The key decision that Argentina made was not to postpone doing an external debt deal, but rather to “solve” its domestic debt problems once and for all by “pesifying” its debt (converting dollar debt to peso debt by decree, and thereby avoiding a big increase in the real debt burden). It then paid its domestic, pesified government debts while not paying its external bonds.

Argentina decided that domestic financial stabilization was more important than trying to reestablish access to international markets. That is hardly a surprise. What is more surprising is that Argentina’s strategy suceeded: continued default on its external bonds did not prevent Argentina from stabilizing its domestic financial system.

The pros and cons of pesification are too complex a topic for a simple blog post. It is well worth a whole book! The IMF has been willing to look carefully at the mistakes it made prior to Argentina’s default; it so far has not really tried to draw lessons from Argentina’s post default restructuring strategy … even if Argentina succeeds at restructuring its bonds in early 2005, that probably will remain too hot a topic for the IMF to handle.

6 Comments

  • Posted by anne

    “Argentina never really was able to run a primary surplus before its default, but I don’t think Argentina could have avoided its crisis just with tighter fiscal policy from 98 on, as many have argued. Argentina’s exchange rate was overvalued before the currency board collapsed.”

    Agreed! There was no chance Argentina could have avoided the crisis, other than dropping the currency peg. I walked the same halls with the Finance Minister, and never have had a sense of why the peg became more important than the very economy.

  • Posted by Tom DC/VA

    Moral of the story: always borrow in your own currency. Well, that’s a bit oversimplified, since its much easier to borrow in a stable currency, which Argentina never gave itself.

    Going forward, it will be interesting to see if the political culture of Argentina changes and they become more like their somewhat more thrifty neighbors to the west. If the IMF has to eat their loans to Argentina in order to help that happen, so be it.

  • Posted by IJ

    The coordination of international monetary policies! But coordination to what?

    Brad’s blog says that Argentina should have had a sustainable exchange rate long ago. The exchange rate determines the competitiveness of the country’s exports and the ability to repay its international debt. This is surely the history of all international monetary systems – individual nations want as competitive (meaning low) exchange rate as possible. The competitive devaluations in the 1930′s are said to have led to WW2, hence the discipline in Bretton Woods that was unfortunately scrapped in the 1970′s.

    Globalisation seems to need a proper Bretton Woods Mark2. The G8 might be the official forum to arrange this.

  • Posted by Billmon

    The Argentine story reads almost as a parable on the follies of monetarist fundamentalism – which, like its religious counterpart, seems to consist these days of one part snake oil to one part fire and brimestone.

    Cavallo and his Chicago School advisors insisted the economy (read: domestic prices) could and would adjust to the dollar peg – even though no country in the modern era has ever successfully deflated its way out of an overvalued exchange rate (See: Britain, 1920s). They had to insist: their doctrine demanded it and the plausibility of the peg depended on it.

    When reality made it’s usual unwelcome appearance, the Chicago boys fell back on the time-honored argument that the cure (depegging the peso) would be worse than the disease, because the ensuing crisis would destroy Argentina’s access to the international capital markets for ever and ever, making domestic stabilization impossible. (If you can’t give them the carrot, threaten them with the stick.)

    Now, less than four years later, the devaluation has reflated the economy, the banks have been recapitalized, and the external creditors are all lined up and anxious to do a deal – worried they’ll miss out on the “next Brazil.”

    Like just about every other emerging country swamped by the ’98-’01 crisis – including the good (Korea), the bad (Malaysia), and the ugly (Russia) – Argentina has discovered there is virtually no long-term penalty for default. These days, it doesn’t take long to drum up a fresh crowd of gamblers, willing to try their luck in the globalization casino. If only redemption of the soul were so easy!

    In the end, the fundamentalists were discredited by both the crisis and the cure. Their Lord of Hosts (the dollar peg) failed them, and so did their angel of retribution (the capital markets).

    But of course, the purest irony of all is the fact that stabilization was made possible by an ultra-orthodox fiscal policy – the classic remedy for a balance of payments crisis – imposed by a Peronist government that has absolutely no inhibitions about intervening in the economy (as per the export tax) to force devaluation’s winners to pay off the losers.

    The virtuous are punished while the sinners prosper. Surely, to the monetarist fundamentalists, it must seem like the end times.

  • Posted by Carlos

    I would argue that it was the “continued default on its external bonds” that allowed Argentina to “stabilize its domestic financial system”. The fiscal policy would not so conservative if they tried to pay all that bonds. It was that policy that enabled them to have their cake and eat it, too (at least for a while).

  • Posted by Guest