1. Argentina crisis 2001 Instructor: Prof. KamiRwegasiraPrepared and Presented by:Mohamed YehiaKarimBehary 1

2. Argentina Currency Crisis (2001 – 2002) Background Causes Impact & Effect Attempted Solutions Model Lessons Domestic Dimension 2

3. Background Before 1930 (the 7th on the world per capital income) Argentina enjoyed 70 years of political stability that facilitate rapid economic development. 1940 to 1989 Argentina experienced significant political instability: military rule & internal conflictions 3

4. How did it all go wrong with Argentina? 1989 to 1991 Carlos Menem was elected president of Argentina Tax reformation Privatization Trade Liberalization Adoption of currency board (1 peso = 1 USD) Limiting the print of Pesos only to amount to purchase dollars in forex markets 1991 to 1999 The government decided to peg the Peso to the US dollar (one to one fixed rate) restore confidence and combat the hyperinflation. The new strategy worked at the time. In 1995 the USD experienced prolonged period of real appreciation resulting in similar appreciation of the Peso relative to its trading partners. The economic Growth Rate: 5.5% in 1996, 8.1% in 1997 Then East Asian financial crisis begins in 1997, moves to Russia then to Brazil (the big trading partner to Argentina). 4

5. Year 2000 till 2002 5 How did it all go wrong with Argentina? 30% of ARG trading

6. How did it all go wrong with Argentina? 6 The Current Account Deficit= ∑ X - ∑ M = - 42% - Argentina’s exports became vastly expensive compared with its neighbor after Brazil crisis. -

7. Impact & Effect 7 Lower export plus world price decline especially in the farm products limited Argentina’s ability to earn the foreign currency needed to repay USD foreign debts. Peso fallen 70% against the dollar after ending the fixed link with dollar.

9. Bad news for those borrowed in $ and are paid in Pesos.

10. The real value of the debts decreased.

11. Imported goods much more than exported goods which increase the inflation.

12. Brazil encountered vast drop leaving Argentina exports more expensive than neighbor countries.

13. The confidence in the country evaporated

14. Social violence widespread.

16. Attempted Solutions IMF agrees in year 2000 to supply three year $7.2 billion stand by arrangement with Argentina but conditioned on strict financial adjustment and assuming 3.5% GDP growth. The government on the other hand cut $ 1 billion in budget to renew the confidence again to the economy. The government through year 2001 was enhancing the IMF to proceed with the 2000 agreement but with 2.5% GDP growth instead of 3.5% ( supplying $7 billion as part of $40 billion) assistance package involving Inter – American Development bank, World bank, Spain, and private lenders. The government announced a $29.5 debt to be restructured from a short term to longer maturity and higher interest rates. Peso exchange rate for merchandise trade is priced at 50/50 dollar – Euro peg, which effectively allowed 7% devaluation for foreign trade, that should improve Argentina’s competitiveness. These actions didn’t work due to lack of confidence still dominant in the market. 10

17. Attempted Solutions IMF expanded its agreement for a 2nd time after Argentina’s congress passes “Zero Deficit Law” that requiring a balanced budget by the 4th Q of 2001. Public salary were paid by provincial bonds as federal revenue transfers decline. The government conducted a 2nd debt for $60 billion of bonds with 7% interest rate instead of 11% - 12% interest rate for extended maturity. The central bank reserves were falling by $2billion a day, so that the president limited dollar withdrawal to $1000 per month, which lead to more instability in the market and IMF took hold of 1.24 billion loan till Argentina’s meets its financial targets. The disturbance spread to major cities with increasing the unemployment rate, and deep budget cut. 11

18. Attempted Solutions A new president was appointed by the congress and suggested a new plan that include: - Suspension of payments on public debt - New job creation program - Creation of a new currency (the Argentino). The disturbance continued leading to the president resigned after losing party support. The congress selected a new president (Eduardo Duhalde) Jan 2002. The new president established the following economic policy: -Devaluate Peso by 29% (1.4 to the dollar) only for major foreign commercial transactions. - Keeping floating rate for all other transactions. - Converting all debts up to $100,000 to Pesos (devaluate cost to creditors. - New tax on oil to compensate the creditors. - All saving accounts exceeding $10,000 and $3000 will be converted to certificates of deposit and remain frozen for one year. - Smaller deposits can withdraw by converting to Peso with 1.4 exchange rate. 12

19. Attempted Solutions The IMF approves request for one year extension on $926 million payment due in Jan 2002. In 2003 a new president was elected (Nestor Kirchner) - Made bold policy move in the area of human rights - Institutional reform and economic policy The faith in democracy in Argentina restored In Jan 2006, Argentina paid off its $9.5 billion debt to international monetary fund. Reducing poverty, controlling inflation rates. Maintain strong economy growth. 13

20. Currency Crisis Model Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Balance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Speculators attack Rising expectations of a LC devaluation or depreciation

22. More imports

23. Less exports Balance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

25. In 1999 Argentina's GDP dropped 4%

27. Increased deficitBalance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

30. Unwilling or unable to raise taxes, public debt increased sharply from 29.5% of GDP in 1993 to 50.3% in 1999

37. Central bank reserves falling by $2 billion in one day

38. $1,000 per month limitation on personal bank withdrawals

39. 25% of all the money in the banks had been withdrawn

40. December 7th 2001, Argentina announces it can no longer guarantee payment on foreign debt

42. Peso depreciationBalance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints Speculators attack Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

43. Lessons On the long run, pegging the local currency to another strong currency is not in favor of the local currency Trade partners’ crisis will magnify any local crisis

44. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Exchange rated is managed floating Balance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints US$ in 5 years Max: 5.85 Min: 5.30 Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation Euro in 5 years Max: 8.60 Min: 6.75

45. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Inflation rated is not stable Governmental spending still high Balance of payments C-Acc deficit rising Rising public Private sector debt Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

46. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Total exports is about half of the total imports Balance of payments C-Acc deficit rising Rising public Private sector debt Imports about $56bn Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Exports about $30bn Rising expectations of a LC devaluation or depreciation

47. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Public dept decreased from over $100bn to$80bn Balance of payments C-Acc deficit rising Rising public Private sector Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

48. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation The CBE is independent of the government Balance of payments C-Acc deficit rising Rising public Private sector Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

49. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation The external dept is stable for the last 6 years Balance of payments C-Acc deficit rising Rising public Private sector Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

50. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation CBE reserve improved Balance of payments C-Acc deficit rising Rising public Private sector Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation

51. Domestic comparison Exchange rate Fixed / pegged Rising Govt deficit + monetary policy that leads to inflation Limited speculations Balance of payments C-Acc deficit rising Rising public Private sector Banking / financial sector fragility + domestic borrowing constraints Rising foreign denominated debt Falling Forex reserves in defense of the peg Rising expectations of a LC devaluation or depreciation