To a striking degree, Argentina’s crisis involved vulnerabilities that were already present or indeed were building up during the boom years of the 1990s—when the country was widely viewed as a star performer. The key elements of vulnerability were the public debt dynamics, the constraint on monetary policy imposed by the currency board, and weaknesses on the structural side. There was little sense of urgency to address these vulnerabilities at that time, given the widespread eagerness to interpret the boom as the onset of an era of permanently higher growth founded on structural reforms and sound macroeconomic policies.
Once the economic slump set in, the vulnerabilities surfaced. As the economy remained depressed, the debt dynamics became explosive. The fiscal adjustment necessary to stabilize the debt ratio was not forthcoming and eventually the required primary surplus became implausibly large, particularly in relation to the political system’s ability to deliver. On the other hand, the debt dynamics constrained the authorities’ ability to stimulate the economy, and the potential for export-led growth was limited by structural weaknesses and unfavorable external conditions. By 2001, almost no strategy would have succeeded without a sovereign debt restructuring that reduced the present value of Argentina’s public debt burden.
The currency board turned from being a source of policy credibility to a handicap. On the one hand, the currency board was relatively successful in containing the adverse effects of financial market contagion from the Russian default. In addition, while Argentina lost competitiveness under the currency board following the Brazilian devaluation and the appreciation of the U.S. dollar, the direct impact on the economy was muted by exports’ limited role in the economy. On the other hand, the currency board may have suppressed a more rapid expansion of exports after trade was liberalized and did constrain monetary policy when the economy slid into recession. In addition, competitiveness was one of the concerns behind the widening spreads on Argentina’s sovereign bonds, particularly since under the fixed exchange rate regime, real exchange rate adjustments required deflation of nominal wages and prices, which was not only difficult to achieve but also contributed to weakening economic activity. Finally, by lending credibility to the exchange rate peg, the currency board arrangement allowed Argentina’s public sector to continue borrowing excessively in international capital markets, thereby raising the cost of the eventual collapse. Indeed, within the above concerns, the public sector’s excessive debt creation—and thus, the inconsistency of fiscal policy with the requirements of a “money dominant” regime—was arguably the single most important factor behind Argentina’s demise.
While the crisis itself was the result of economic forces that were difficult to reverse in the context of Argentina’s existing vulnerabilities, it was exacerbated by a series of policy mistakes. Some key steps during 2001 included actions to tinker with the currency board, which undermined confidence but provided no additional room for maneuver, while voluntary debt swaps substantially increased the present value of debt service. The measures surrounding the collapse of the currency board and public debt default—notably the capital controls, the corralito and corralon, and the asymmetrical pesoization and indexation—exacerbated the macroeconomic consequences of the crisis and complicated its resolution.
Looking forward, the country faces enormous challenges not only in restoring macroeconomic stability but also in re-establishing the pre-eminence of contracts, property rights, and economic security that has been damaged by the government’s default on its debt and abandonment of its convertibility commitment. Damage both to the balance sheets and to the credibility of the banking system also needs to be repaired. While the devaluation has addressed immediate concerns about competitiveness, one troubling aspect of the performance of the Argentine economy was that, even during its boom years, 1991–98, unemployment remained persistently high, underscoring the need for reforms of the labor market and for other improvements in economic institutions and structures that foster a more dynamic private sector. On the macroeconomic policy front, Argentina will first need to develop and implement a coherent monetary policy framework. In terms of the public finances, even with a major debt restructuring, substantial primary surpluses will be required to service the massive increase in public sector liabilities (including those related to the recapitalization of the banking system). More generally, there needs to be a fundamental re-thinking of the role of the state—not least, in the relations between the federal government and the provinces and in the size and cost of the civil service—if expenditure is to be commensurate with revenues.
Lessons for Crisis Prevention and Management
Argentina’s story underscores many of the lessons that we have learned from previous crises. It serves as another illustration of the complex dynamic interactions among various sources of vulnerability that crises frequently involve, and, in view of these interactions, of how difficult it is to resolve a crisis once it starts. Argentina is also a reminder that very severe vulnerabilities can build up in countries that are widely viewed as “star performers.” The fact that most of the usual indicators of impending difficulties did not look alarming until the situation had deteriorated to the point that there was no good exit is indeed disconcerting. These considerations emphasize that there remains considerable work to do on crisis anticipation and prevention.
Growth projections were a central symptom of the failure of most actors—including the authorities, the IMF, and market participants—to identify the vulnerabilities that were building up during the boom years of the 1990s. During that period, Argentina’s growth projections were based on what was, in hindsight, an overly favorable reading of the benefits of the structural reforms that had taken place and prospects that further reforms would be implemented. This experience calls for a careful and critical assessment of the links between structural reforms and growth, both in the context of work on individual countries and in cross-country analysis. But at the same time, projecting growth after a structural change inevitably involves an element of judgment, and in view of the irreducible uncertainties, it is essential to stress-test projections with regard to plausible alternatives.
The Argentine crisis calls for a new focus on sovereign debt and the debt dynamics, both with regard to crisis prevention and resolution. It is striking that, when Argentina’s debt started on the path of no return, its level (as a share of GDP) was in a range not previously viewed as alarming. This experience clearly calls for a more cautious assessment of debt levels, in view of a careful consideration of the scope for adjustment in the event of adverse circumstances. In Argentina’s case, the “danger level” of debt needed to be viewed, in particular, in the light of the exchange rate regime, the comparatively small share of exports and their concentration, the political and administrative factors that limited the room for maneuver on the fiscal side, the country’s large size in emerging markets worldwide, and the relative lack of flexibility of its labor and product markets. The need for a systematic and disciplined analysis of debt sustainability, illustrated by the Argentine experience, has motivated recent IMF work in this area,40 and has influenced decisions on exceptional access and prolonged use of IMF resources, in an attempt to strike the right balance between supporting a member experiencing difficulties and safeguarding IMF resources.41
With regard to crisis resolution, the Argentine crisis illustrates the importance of timely debt restructuring in cases in which the debt dynamics have become irreversible. Once a debt restructuring has become unavoidable, measures to delay it are likely to raise the costs of the crisis and further complicate its resolution. At the same time, the crisis also illustrates the pervasive effects of a default on the financial system and macroeconomic policies—making the exchange rate regime unviable and compromising an otherwise healthy financial system. The experience suggests that it would be desirable, if it is possible, to find a more orderly approach to debt restructuring. This was an important initial motivation for the IMF’s work on the Sovereign Debt Restructuring Mechanism (SDRM). The underlying problem remains: the Argentine experience highlights the need to find better ways of anticipating and resolving debt crises.
The Argentine crisis also entails important lessons for exchange rate regimes. We would not conclude that Argentina’s currency board was a mistake from the start: on the contrary, the currency board was critical in taming hyperinflation when many other approaches had failed. Particularly given this early success, it would have been an extremely difficult political decision to exit without a crisis. But a currency board puts much more stringent demands than other regimes on fiscal and financial policies, as well as on the flexibility of trade and the labor market. Given the structure of the Argentine economy, a peg to the U.S. dollar was arguably not an ideal arrangement once inflation was successfully reduced to single digits. Indeed, to the extent that the currency board arrangement encouraged the buildup of balance sheet mismatches, an earlier exit (e.g., in 1992–94 or in 1996–97) would have been preferable. Such an exit, had it been undertaken sooner, would not have been painless, but it would likely have been less painful than what actually occurred. This illustrates the importance of an appropriate macroeconomic policy mix and, more specifically, an exchange-rate regime that fits a country’s economic and political realities. A currency board can have specific temporary advantages, irrespective of a country’s economic structures—such as achieving disinflation—but if its long-term benefits are questionable, it is important to exit the arrangement in time before market pressures make it untenable.
More generally, the Argentine experience points to the limits in the ability of an exchange rate arrangement—even when strongly endorsed by the authorities and the public—to discipline other aspects of economic policy in a way that ensures stability. This experience is also a reminder that “hard pegs” are not as hard as is often supposed: in extremis, a government can unwind a currency board, albeit at considerable cost to the country. The forced redenomi-nation of bank assets and liabilities also serves as a reminder that there are limits to the extent to which a peg can be durably hardened through formal dollarization. Moreover, to the extent that a hard peg does secure credibility, this can be a mixed blessing: the high credibility of Argentina’s currency board through 2000 helped enable the country to borrow from the capital markets at spreads that did not fully reflect the risks. This temporarily insulated the country from adverse market reactions to unsustainable policies, and thus ultimately allowed a much bigger disaster to materialize.
Lessons for the IMF
The occurrence and severity of the Argentine crisis have been particularly disturbing to the IMF given its extensive engagement for many years beforehand. Of course, key policy decisions on the exchange rate regime and the lack of supportive fiscal and structural policies were the authorities’, and the IMF expressed concerns over the vulnerability of the situation, as early as 1998. Moreover, in the run-up to the crisis, the authorities took damaging steps, either without consulting the IMF or against the IMF’s advice. But the IMF’s experience in Argentina does call for some fresh thinking about its role, both in normal times and in the context of a crisis. Several of these lessons—like the more general lessons on the economics of crises just summarized—are starting to be reflected in the IMF’s work.42
The Argentine crisis reflects shortcomings in IMF surveillance to identify early on the vulnerabilities that emerged during the boom period, and in bringing about needed changes once these vulnerabilities became apparent. The experience highlights the risk that, in a program country, where attention is focused on implementation of the program, it is easy to lose sight of the need for a fresh and critical assessment of the overall direction of policies. In particular, the IMF’s macroeconomic projections, like those of the authorities and market participants, extrapolated the favorable growth results of the 1990s and did not adequately scrutinize the basis for this growth. There was not sufficient attention paid to the fact that the structural reforms that were seen as critical to growth had largely stalled. Fiscal policy assessments were not based on an adequate appraisal of the risks to debt sustainability in the event of a slowdown in growth. Moreover, the exchange rate assessments in Argentina did not stress the need for a timely exit; instead, the IMF accepted the authorities’ refusal to discuss a possible change in the status quo until a change was forced by the markets. Such assessments should be more proactive, asking the tough questions and recommending needed changes in noncrisis times. This experience is a significant motivation for recent initiatives to strengthen the IMF’s surveillance in program countries by ensuring a fresh look at the economic issues.43
A second area in which the Argentine experience has had an important impact is with regard to the decision to commit IMF resources. During the years of deepening depression, as it became increasingly clear that the situation was deteriorating in several dimensions, the IMF nonetheless endeavored to help the country by providing financing and its accompanying “seal of approval.” This pattern continued through September 2001, when the IMF approved one last significant tranche of financing despite considerable doubts about the prospects for success, and despite the authorities’ steps taken against the IMF’s advice in the preceding months. The IMF’s decision was understandable in light of the high and immediate costs of withdrawing support, but the low probability of success should have outweighed these concerns. This experience raises difficult questions about how the IMF—and the international community more generally—can strike the right balance between supporting a member country experiencing difficulties without financing and implicitly perpetuating policies that are doomed to fail. Following the collapse of the currency board, the IMF took a more cautious approach by waiting for the authorities to assemble a viable policy package rather than rushing to provide new financing.
The experience raises more general questions about the IMF’s use of its “seal of approval.” If the IMF had chosen to withdraw its financial support, the direct financing effects would have been limited, as the institution’s financial exposure—at least until September 2001—covered a relatively small portion of Argentina’s total borrowing requirements. The main consequences would have been the adverse impact on market sentiment and negative political repercussions that would have likely been felt far beyond Argentina. In balancing these considerations, the IMF decided to continue providing its support, despite serious concerns over fiscal and external sustainability. Such attempts to make strategic use of the “seal of approval” ultimately devalue that signal and compromise the IMF’s credibility more generally. The limits to the IMF’s involvement should be based on the underlying quality of policies, not on the perceived cost of withdrawing support. That said, the IMF’s decision to continue or withdraw its support to a member country in particular circumstances is always made under uncertainty, and more likely than not the IMF will continue to make occasional judgment errors and take decisions that will prove wrong ex post.
An important consideration that has to guide the IMF’s decision-making process and that was clearly underscored by the Argentine experience is that, in a situation in which the debt dynamics are clearly unsustainable, the IMF should not provide its financing. To the extent that such financing helps stave off a needed debt restructuring, it only compounds the ultimate cost of such a restructuring. This consideration has led the IMF to search for better ways of facilitating debt restructuring in cases in which it is a necessary element in the policy package. The initial proposal for an SDRM, which was intended to tackle this problem, has not been implemented due to insufficient international support, although there has been progress with other approaches, including the promotion of collective action clauses (CACs) in sovereign bonds and a code of conduct. The problem the SDRM was meant to address has not gone away, and there remains a need for further work to strengthen the capacity for sovereign debt restructuring within the present legal framework.
The Argentine experience also provides lessons for conditionality and ownership. First, it is a reminder that the injunction in the IMF’s 2002 Conditionality Guidelines to focus on what is critical to achieve macroeconomic objectives is a positive as well as a negative one. In Argentina, the programs did not include certain structural reforms—notably involving trade and labor markets—that, at least in hindsight, were indeed critical to achieving sustainability and addressing key vulnerabilities. Moreover, even those structural measures that were included were often not implemented.
The Argentine experience also highlights the fact that, while ownership of policies is important, it is not sufficient to guarantee their viability. Arguably, in Argentina there was strong ownership for an inconsistent set of policies—with wide popular support in particular for the currency board but not for the fiscal policies needed to support it. Ensuring that policies are both nationally owned and viable is a very complex challenge that the IMF and the country authorities need to face.