Dollarization or Convertibilty Plan

Under the leadership of Domingo Cavallo as economy minister and Carlos Menem as president, Argentina decided to implement strong policies to curb inflation. The plans adopted in the 1980s under the previous administration had been largely ineffective usually working in the first few weeks but then the Argentine economy would revert back to the previous inflationary problems. Inflation was largely caused by the Central bank accommodating for the deficit by printing money and increasing the money supply.

Cavallo introduced the convertibility plan at the beginning in April 1991, which pegged peso to U.S. dollar in one-to-one ratio. This was commonly referred to as convertibilidad or convertibility. Argentina adopted U.S. dollar as its sole medium of exchange. This policy is known as dollarization.This plan was implemented in response to the inflation and economic stagnation in Argentina in the 1980s, which reached their peak to hyperinflation and near economic collapse by 1989.

The creation of quasi-currency board was to tie up monetary policy, so the central bank would have at all times have to keep a certain reserve of U.S. dollars without just printing non-backed pesos. The IMF was skeptical of the convertibility plan just like the other plans because Argentina would need a much disciplined fiscal policy to make the plan work. However, the plan seemed to show more success in curbing inflation every year after 1991.

Due to the large decrease in the inflation rate, confidence in the peso grew and people started to increase their bank deposits because the likelihood of the value of their money decreasing fell. Overall fiscal balance increased with a budget deficit of less than 1% from 1991-1998. Argentina became an investment attraction with main capital inflows in the form of portfolio or direct investments; it received more than $100 billion in net capital inflows and over $60 billion in gross foreign direct investments.

The new change in the economy also contributed to GDP growth. GDP grew steadily except for the 2.8% drop that occurred from the negative effects of the Mexican “Tequila Crisis” in late 1994, but Argentina bounced back because of the government’s strong stance with the convertibility plan and IMF financial support of structural reform. The government decided to let interest rates rise and they raised taxes but did not allow easy money to be available through the Central Bank.

Also because of the rise in confidence of the country’s economy because of convertibility, Argentina was able to get an agreement with the U.S. government that reduced it’s debt by $10 billion (approx. 29% of GDP) under the debt-reduction plan. Policies aimed to resemble the likes of the Washington Consensus and the IMF goals were implemented under Carlos Menem’s administration. Menem wanted to put Argentina in the forefront of Washington Consensus followers after the fall of the Soviet Union in 1991. Many of the policies he advocated created a favorable atmosphere for Argentina in the IMF even though they were against his party platform which supported strong trade barriers and a lot of leverage for working unions. Menem’s government ended all price controls by 1992.