Debt Crisis

The full blown economic crisis of 2000-2001 actually started in late 1998, and eventually ended with the failure of the convertibility plan and a prolonged economic crisis. The negative economic downturn first came to the forefront because of the reversal of capital flows to emerging economies after the Russian default in August 1998. Another major contributor to the crisis was the weakening in the Brazilian real currency which caused less demand in Brazil for products imported from Argentina due to the appreciation of the Argentine peso in relative terms. Brazil was the Argentina’s biggest trading partner, so the decline of demand affected Argentina adversely. Argentina had experienced the positive externality of the depreciation of the U.S. dollar through most of the 1990s, but the strengthening of the dollar against the Euro caused a 70% devaluation in the Brazilian real compared to the dollar.

In addition, there was a general fall in the prices of commodities such as oil of which Argentina was a big exporter. Argentina’s dependence on primary product exportation added another negative effect to the economy. The real GDP fell by 3%.. The situation worsened with the advent of the presidential elections in 1999. The government increased spending without considering the possibilities of a prolonged crisis and basically pushed itself into fiscal solvency.

It is important to remember that because the monetary policy was tied under the convertibility plan government spending should have been controlled. The public sector debt grew further because of off-budget liablilities like the payments of pensions which accounted for 2% of GDP each year. These effects would not have been so bad if the growth in the economy had sustained its upward climb, but in 1999 growth declined and public sector finances deteriorated causing a rise in the debt-to-GDP ratio as shown in table 1.4.

The rapid increase in the ratio shows that there was a 10% change from 1997-1999 which is only two years and a 14.4% change and increase from 1999-2001 which is also only two years. Fiscal solvency became a big issue affecting market confidence. Adverse effects such as extended contraction of the economy as well as deposit runs and capital flight reached its peak in 2001.

The overspending in the public sector was especially dangerous because most of the financing was external debt. External debt also created problems for the government because it was used in part to cover the private sector deficit, but in essence it was actually leaving the country (capital flight) in the form of remittances, profits, debt, and dividends abroad by the multinational companies. Because of the negative balance in the private sector, the public sector should have had some reserve in spending its surpluses through the 1991-1998 time period. External debt ended up causing large problems with the balance of payments because it was not just financing the accumulation of reserves (which were spent in public sector anyway) but also causing the disaccumulation of reserves. The debt was used to fund the private sector which just used it as extra capital for investment and capital movement abroad.

The Argentine government and should have taken a number of measures before and after the introduction of the convertibility plan to prevent the likeliness of a crisis. Furthermore once the plan was introduced the government and the IMF should have anticipated the problems. Finally the government also should have exercised more restraint financially.
Before the plan was formally put into place, the government needed to reform many of the political institutions and policies that had been imposed previously. The reform would have prevented the political institutions from overspending in a time when money needed to be conserved. Tax administration should have been strengthened to make the provinces more responsible for collecting taxes rather than just enjoying their share of the federal tax.
When the Convertibility Plan was first implemented, it made some important improvements to curb the hyperinflation problem. Moreover it also began structural reforms in many institutions like tax administration and it encouraged the privatization of many state-owned enterprises. However, the inflation problem was solved in the early years 1991-94. The government and the IMF should have devised an exit strategy then because the effects of going of the plan would not have been as drastic as they became in 2002. The best time to exit would have been in 1993 when the government generated a fiscal surplus. Even though exiting the plan would have had some negative effects, on the whole the world still had optimism about the Argentinean economy. Large capital inflows and the small spreads between the peso and the U.S. dollar in the early 1990s would have prevented a big depreciation if the peg was broken. The IMF could have helped Argentina withdraw from the plan, before it was too late had it considered exit strategies, and kept quoting Argentina as the paragon of its neo-liberal policies.

The final lesson that that Argentinean government should have learned was that by generating fiscal surpluses throughout the 1990s like they did in 1993, they could have saved the economy by stopping the liquidity problems and funding crisis in 2000-2001 after the large capital outflows. If the surpluses had been present the fiscal policy could have been more flexible in crisis years.