|The Argentine Financial System in Crisis, by Raúl Fratantoni, Avvocato in New York
I. Brief Political and Economic Outline Before the Crisis
After years of four-digit inflation, the decade of the 90’s began with a growth and frenzied consumption fueled by the Dollar and, as a result, induced a GDP growth of approximately 56% in Argentina. The principal reason for this growth rate is attributable to, what was then, a new effective monetary regime, the Convertibility. The Convertibility Law established that for each Argentine Peso in circulation, a corresponding US Dollar would be held in reserve in the Argentine Central Bank. In addition, the federal and provincial governments made substantial reforms in the area of utilities and public works, mainly by the sale of the public entities or assets to privately owned domestic and foreign groups. Although it is clear that many of such processes were not done as they should have been done, because of lack of expertise (clearly at the beginning), and a substantial corruption at all levels, the immediate results were positive; the states received a large injection of funds and stopped losing money from the stated-owned deficit companies, all ineffectively managed before being privatized. Furthermore, the federal and provincial states started collecting important tax revenues from the activities of such new companies.
However, the development of the country seen for almost 8 years since 1991 stopped in the second quarter of 1998, when the total GDP sank by more that 8%. This same figure was seen in the next three years, and it is expected that the GDP shall sink by more than 15% for this year. The GDP is declining to approximately 1/3 of the figure in late 1990 (from 290 billion to around 100 billion), and the GDP per capita declined from about 8.5 thousand in the early 1998 to around 3 thousand this year.
Having the country in the midst of a recession, Mr. Fernando de la Rúa, the candidate of the opposition alliance (Alianza) was elected President of Argentina. Although his supporters consider that Mr. de la Rúa received the country in a critical condition from his predecessor Mr. Carlos Menem, as publicly stated by his first Economy Minister, Mr. José Luis Macchinea, in December of 1999, Mr. de la Rúa demonstrated that he was not the right person to govern Argentina.
Followed the resignation of his Economy Minister, Mr. Doming F. Cavallo, Mr. de la Rúa had to resign on December 20, 2001 in the midst of a social turmoil, after two years in the government, and two years in advance of the end of his presidential term. After his resignation an interim president was appointed in a stormed session by the House of Representatives and Senate. The elected one was Mr. Adolfo Rodríguez Saá, a peronist governor of the small Province of San Luis. After six days in power, from December 24 to December 30, 2001, Mr. Rodríguez Saá resigned after a new round of demonstrations triggered by the appointment of officials believed to have been involved in illegal activities in the past, as well as other worrisome economic and political signs. The worst signal from his 6-day presidency was certainly given the same day he was appointed when, in his inaugural speech, stated as a “success” that the payments on the Argentine external debt were to be suspended. This statement was followed by an applause by the General Assembly. The default of the Argentine external debt was on approximately 141 billion US Dollars. On January 2, 2002 Mr. Eduardo Duhalde, the current President, was appointed. His term is scheduled to end in December 2003.
In the last few months, the Argentine crisis has proved to be cumbersome and difficult to follow, given the numerous conflicts, measures, countermeasures, announcements, denials, ambiguous regulations, conflict among the state powers, etc. Last week Mr. Duhalde’s key man, his Economy Minister, Mr. Jorge Remes Lenicov, resigned after the lack of support for his new plan to give public bonds to the depositors.
After detailing a brief description of the event and facts involving the crisis in Argentina, we focus now on the causes of the crisis as well as the measures taken.
II. The Causes of the Crisis and the Measures Taken
While the causes of Argentina’s financial and economic problems are many, such as excessive external indebtedness, persistent fiscal deficits, decline in the price of the world commodities, corruption and political instability, among others, Argentina’s immediate problem is the insufficiency of funds, derived from its strict monetary policy, the Convertibility.
In order to prevent a massive collapse of the banking system, after the intent of the government to carry out a debt swap, and a bank deposit run that resulted in a decrease of the deposits in banks of $1.8 billion (2.7%) on November 20, 2001, the government was compelled to create the so-called “corralito” (i.e. a bank deposit freeze). This measure imposed restrictions on deposit withdrawals, limiting the cash withdrawals from savings and checking accounts to $1,000 per month, although the funds could be used as a means of payment. Together with this bank deposit freeze, foreign exchange controls were established by restricting cross-border transfers, subjecting the majority of them to the previous authorization of the Argentine Central Bank. These unpopular measures generated riots, looting, and demonstrations and were the ones that ended with the resignation of Mr. Cavallo and Mr. de la Rúa in December 2001.
With the coming of Mr. Duhalde, the relevant economic measures taken were the following:
First, the Argentine Congress enacted the Law on Public Emergency declaring that because the country is in a public emergency in relation to economic, administrative, financial and exchange matters, certain legislative powers shall be delegated to the Executive Branch until December 10, 2003, date in which the current President Mr. Eduardo Duhalde shall leave the Presidency.
Consequently, the Executive Branch was given, among others, the powers to (i) set forth the exchange rate between the Argentine Peso and the US Dollar, or other foreign currencies, thereby ending the Convertibility Regime of 1 Argentine Peso to 1 US Dollar; (ii) minimize the economic impact of the devaluation on individuals and entities indebted to the financial system in US Dollars, by restructuring such debts; (iii) regulate the exchange regime, authorizing the Argentine Central Bank to determine which transactions shall be included in the official exchange market; (iv) provide compensatory measures in favor of financial entities and to issue any measures necessary to preserve the funds of savings holders in relation to their deposits in Argentine financial entities; (v) renegotiate concession agreements corresponding to public utilities signed by the National Government; and (vi) issue any necessary provisions for the exchange of national and provincial securities.
These powers granted to the Executive Branch were effected by several decrees dictated days after. The most important measures included were:
· The conversion of all US Dollar debts in Argentine Pesos debts (i.e. “pesification”) at the parity 1 US Dollar = 1 Argentine Peso, regardless of the original amount or nature, within or outside the financial system. These debts are to be indexed according to inflation and a maximum interest rate will be established by the Argentine Central Bank;
· The pesification of US Dollar deposits at the parity 1 US Dollar = 1.4 Argentine Pesos, also to be indexed according to inflation;
· The issuance of a public bond to compensate banks for the difference between the rate of conversion into pesos of assets and deposits;
· The suspension of all legal actions against the deposit restrictions for 180 days;
· The establishment of only one foreign exchange market, in which the price of the US Dollar will result from the free interaction of supply and demand; and
· The control by the Argentine Central Bank on every transfer of funds abroad, with the exception of payments related to the promotion of exports, trade-related transactions, among others.
With all these foreign exchange and deposit controls, more than a month of bank holidays, and restrictions on the repayment of foreign currency debt, the Argentine banks has been essentially reduced to instruments of monetary policy. This is hindering their ability to conduct normal operations as commercial, moneymaking entities. Currently, Argentina has a segmented financial system where 60% are sight deposits, and the rest are just frozen. In this scenario, the financial system is falling and it is expected that the new financial system emerging from the crisis will maybe be even one tenth of the previous one.
Although these measures are trying to bring some respite to the Argentine economy, after more than four months of being almost paralyzed, the key issues on the agenda of the recently elected Economy Minister, Mr. Roberto Lavagna, are still pending definition.
The bank deposits freeze, though necessary when the Argentine system was illiquid, and probably the only alternative that the authorities had back in November of 2001 in order to prevent a total financial collapse, will certainly be difficult to end, because the rational response to an unfreezing is a run on the financial system.
But the true fact is that there is not enough money to redeem the system’s $65 billion in US Dollars/Argentine Pesos liabilities with real US Dollars, that a total unfreezing is not an alternative, and, that sooner or later the “corralito” will have to end. At that point, depositors will be ultimately forced to accept something other than US Dollars in exchange for their deposits, and this could take the form of a new currency, US Dollars at a devalued exchange rate, or US Dollar bonds (as in 1991).
III. What’s Next?
Although it is not clear how and when Argentina will recover from this economic chaos, which has been accompanied by a loss of confidence in the political and social institutions, what it is sure is that the current crisis requires commitment and immediate effective measures by the Government.
As a preliminary measure it would be necessary to reform in depth the political system in order to have the population able to control the acts of the its representatives. Indeed, the central issues of this crisis are not in essence economic or financial ones, but a lack of trust in a corrupted political system with corrupted institutions, where the legal representatives of the country have no moral authority to do any single act of government.
Together with this systematical reform of the political system, the government will have to:
· Stop with its “begging policy” based on a bailout request to the International Monetary Fund, as the sole alternative to end the crisis. To make a successful restructuring of the foreign currency sovereign debt, it would be necessary first to focus on the innumerable resources that Argentina has, and afterwards promote a capital injection.
· Draft a reasonable budget, making it compatible with the limited growth of the Argentine economy.
· Promote a substantial reform in all the branches of the government eliminating political expenses which are unjustifiable, and reshaping and closing the unnecessary public agencies and offices.
· Make a substantial reform of the current perverse co-participation tax regime, in which the federal government collects the money for undisciplined provinces that do not care in developing their own sources of income, and which promotes excessive expenditures with inexistent control.
In conclusion, it would also be important to have the pressure of the whole Argentine community in order to reduce the excesses of the government, and assure that the necessary reforms are made, and that the essential public duties of the government (security, health, justice, honest and efficient social welfare policies) are provided to the citizenry. Therefore, there is no more time to chatter in the cafés, but, rather, a time to unity, compromise and act.
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- Brief of the presentation for the Council of America’s, New York, April 5, 2002. The Legacy of the 90s by Juan Luis Bour. Chief Economist and Director of FIEL, Buenos Aires, Argentina.
- The Argentine Crisis: A Chronology of Events After The Sovereign Default by Carina López. April, 2002. Standard & Poor’s, Buenos Aires, Argentina.
- Moody’s Special Comments on Argentina. Argentina: The End of Convertibility, December, 2001; Argentina: The Money Problem, January 2002; and, Argentine Banks face Insolvency.