Role of IMF

Argentina tried to recover market confidence by getting a stand-by agreement from the IMF, which supported it financially all the way through to late 2001. Much of the IMF support in the 2000-2001 came because of a feeling of obligation rather than for strict economic reasons. It was partially the IMF’s fault for failing to see the possible negative implications of the convertibility and for not encouraging the Argentine government to back out of it while there was still a chance.

Backing out of the convertibility plan during the crisis would have disastrous effects especially on the middle class because the value of their entire life savings would be worth almost nothing compared to before. Argentina lost IMF support in 2001 because of the implementation of policies the IMF did not support such as changing the currency peg to an equally weighted basket of the dollar and the euro, engaging in some protectionist policies in desperately weakened sectors, and calling for a deposit freeze in late 2001.

All these measures however failed to pick up the economy and also caused the loss of IMF support. Not only that, but the conditions of the urban poor became drastic and many took to searching for food out of garbage bins in a country where food was abundant. The public was angered by the effects of the plan after they could not withdraw money from their accounts. Massive riots and public demonstrations took place resulting in the resignation of President De la Rua. In 2002 Argentina officially went off the convertibility plan.
Despite the promising effects of the convertibility plan on the surface in the beginning years, there were many underlying vulnerabilities which required consideration, but they were largely ignored by the Argentine government and main aid lenders like the IMF. Looking at these vulnerabilities may explain why the crisis occurred and how it could have been deterred. Before the peg was imposed the Argentinean government should have considered it’s current account deficit and if the real exchange rate could be flexible. Some of Argentina’s characteristics did not match the conditions for an ideal peg to the U.S. dollar. Argentina exported primarily homogenous goods which were very dependent on global shocks. These products were mainly primary products like agricultural products, livestock, and natural minerals or resources like gold or petroleum. “Argentina also had a small total trade-to-GDP ratio at 16% which required a large real exchange rate change to generate a given size of external adjustment.” Moreover the trade with the U.S. was a small percentage of total Argentine trade at 15%. Finally Argentina and the U.S. did not share the same business cycles which could cause further problems. Counting all these differences between the Argentina and the U.S., Argentina would have to be able to respond well to changes in the real exchange rate and that was dependent on its markets and institutions. In Argentina the product and labor markets demonstrated institutional rigidity because of bad policy. Though many of the IMF promoted structural reforms helped to decrease the rigidity, the labor market still remained rigid. However it was not just the trade mismatch with the U.S. and the institutional rigidities that did not give the convertibility plan a viable future, it was also the need for a good disciplined fiscal policy.
Fiscal policy discipline was very important under the convertibility plan because the hands of the Central Bank were tied as far as increasing the money supply in recessions. However, because Argentina had a tax sharing system between the federal government and the provincial governments, the collection and usage of taxes was inefficient. First, the provinces did take much tax responsibility because they acquired much of their tax share from the federal fund. In some provinces people were taxed 5% of what they should have been taxed. Furthermore, because the provincial governments did not take responsibility for federal tax collection yet shared in the benefits, they squandered a lot of the tax money on huge public projects or other bad investments that were especially aimed at winning votes right before elections putting the public sector into deficit. Another example of institutional rigidity came to surface in the government because it was hard for the national government to decrease the share of tax that the provinces got since the provincial governors were involved in the selection process for representatives to the national government.