With or without the imf? Economic Recovery after Devaluation in Argentina and Brazil



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With or without the IMF? Economic Recovery after Devaluation in Argentina and Brazil

Andres Gallo

University of North Florida
Abstract

The recent economic experiences of Argentina and Brazil are quite similar and different at the same time. Both countries had to devalue (Brazil in 1999 and Argentina in 2002), a party, or coalition, from the center-left came into power, social conditions were deteriorating, and foreign debt problems were mounting. Nonetheless, the policy choices in the aftermath of the devaluation were different. While Brazil opted for a market friendly approach to reestablish confidence in the economy, Argentina declared default and contradicted IMF’s recommendations. This paper compares the experience of both countries in regards of which had the best strategy for recovery. The economic performances show that both countries recovered in a similar fashion, underscoring the need of the IMF to help on the recovery.




Introduction

The recent experience of the IMF in Latin America is far for promising. The failure of Argentina’s economic program in 2001 represented a hard blow to the effectiveness of the International Monetary Fund’s (IMF) rescue policies and diminished the institution’s support among both developing and developed countries. In many instances, Dr.Baer analyzed the relationship of Brazil and other Latin American countries with the IMF and other international institutions (Amann and Baer, 2005; Baer, et. al., 2002, Baer, 2001, Amann and Baer, 2000). One of his main concerns is how countries deal with IMF’s proposed policies and how many degrees of freedom governments have. This paper is an attempt to evaluate how much a country needs the IMF. The recent experience of devaluation and recovery of Argentina and Brazil offers an interesting case of analysis. After the devaluation in 1999 Brazil pursued an economic policy closely monitored and supported by the IMF, while Argentina, after the crisis of 2001-2002 pursued a more independent policy that, in many cases, opposed the IMF’s recommendation. This paper compares the performance of both countries and compares the benefits of whether or not to pursue an IMF recipe to get out of a balance of payment crisis. As it shows, following the IMF recipe is not guarantee for either success or failure.


Crisis and Recovery in Argentina and Brazil

In the late 1990s and early 2000s Brazil and Argentina went through economic crises and devaluation. Both countries came from fixed exchange rate regimes, although the Convertibility program implied a higher degree of economic, and political, compromise to the fixed exchange rate (Baer, et. al., 2002). In the end, the inconsistencies of these regimes, the contagion from the Russian and Korean crises, and the inability to generate economic growth forced a devaluation and abandonment of such policies. Even though the economic crisis was severe in both countries, the Brazilian economy was able to react in a better fashion to the devaluation, while the Argentine economy underwent the most serious economic depression of its history (Table 1). In Brazil the economy came to a stop in 1998 and 1999 (close to zero GDP growth) but quickly recovered after the devaluation (Amann and Baer, 2003). On the Other hand, Argentina went through a deep recession from 1999 to 2001, but the devaluation could not stop the economic debacle. As a result, the economy dropped by 18.4% from 1999 to 2002 (Gallo, et. al., 2006). Brazil transitioned to a floating exchange rate without major shocks on the economy, but Argentina went through rough times, which involved the default of government debt, the pesification of all contracts in the economy, bankruptcy of the banking system, and borderline maxi-devaluation cum hyperinflation before the government was able to restore some macroeconomic stability (Gallo, et. al., 2006). As the data show, the impact of the economic crisis and the devaluation was stronger in Argentina than Brazil.



Many studies addressed the reasons for the economic crisis and weaknesses of the economic models in each country (Corrales, 2002; Fraga, 2000, Amann and Baer, 2002; Manzaetti, 2002; Boinet, et. al., 2005; Dominguez and Tesar, 2005; Calvo and Talvi, 2005; Alvarez Plata and Schrooten, 2004; Goretti, 2005; Buscaglia, 2004). Even though the debate is far from closed, this paper concentrates on the aftermath of the crisis and which strategies both countries followed to be able to restart economic growth.

Table 1

Brazil Economic Indicators




GDP Real Growth

GDP per Capita

Inflation Rate

Exchange Rate

Investment

Debt

Exports

Imports

Trade







ppp 2000 US Dollars







% GDP

% GDP

% GDP

% GDP

% GDP

1990

-4.2

6,497.2

2947.7




20.1

25.9

8.2

6.9

15.2

1991

1

6,447.2

432.7




19.7

29.7

8.7

7.9

16.6

1992

-0.5

6,292.5

951.6




18.9

33.0

10.9

8.3

19.2

1993

4.9

6,537.9

1927.9

0.03

20.8

32.8

10.5

9.1

19.6

1994

5.9

6,767.5

2075.8

0.64

22.1

27.9

9.5

9.2

18.7

1995

4.2

6,940.1

66.0

0.92

22.2

22.8

7.7

9.5

17.2

1996

2.7

7,021.1

15.7

1.01

20.9

23.4

7.1

9.2

16.3

1997

3.3

7,176.1

6.9

1.08

21.4

24.5

7.5

10.1

17.7

1998

0.1

7,099.7

3.2

1.16

21.1

30.7

7.3

9.9

17.2

1999

0.8

7,137.2

4.9

1.81

20.1

45.7

10.3

11.8

22.1

2000

4.4

7,300.8

7.0

1.83

21.5

40.4

10.7

12.2

22.8

2001

1.3

7,350.6

6.8

2.36

21.2

45.4

13.2

14.2

27.4

2002

1.9

7,393.9

8.4

2.92

19.7

50.6

15.5

13.4

28.9

2003

0.5

7,305.5

14.7

3.08

19.7

46.8

16.4

12.8

29.1

2004

4.9

7,531.3

6.6

2.93

21.3

36.8

18.0

13.4

31.4

2005

2.3




6.9

2.43
















2006

3.5




4.6

2.18
















Source: World Development Indicators (WDI), World Bank, at www.worldbank.org and Euromonitor, 2006.

Table 1 (Continuation)

Argentina Economic indicators




GDP Real Growth

GDP per Capita

Inflation Rate

Exchange Rate

Investment

Debt

Exports

Imports

Trade







ppp 2000 US Dollars







% GDP

% GDP

% GDP

% GDP

% GDP

1990

-1.3

8,998.5

2313.9

0.49

14.0

44.0

10.4

4.6

15.0

1991

10.5

9,864.3

171.6

0.95

14.6

34.5

7.7

6.1

13.7

1992

10.3

10,755.3

24.9

0.99

16.7

29.9

6.6

8.1

14.7

1993

6.3

11,174.3

10.6

1

19.1

27.2

6.9

9.3

16.2

1994

5.8

11,682.7

4.1

1

19.9

29.1

7.5

10.6

18.1

1995

-2.8

11,254.4

3.3

1

17.9

38.2

9.6

10.1

19.7

1996

5.5

11,756.6

0.2

1

18.1

40.8

10.4

11.1

21.5

1997

8.1

12,571.2

0.5

1

19.4

43.8

10.5

12.8

23.3

1998

3.9

12,955.8

0.9

1

19.9

47.3

10.4

12.9

23.3

1999

-3.4

12,400.2

-1.1

1

18.0

51.4

9.8

11.5

21.3

2000

-0.8

12,173.6

-0.9

1

16.2

51.9

10.9

11.5

22.4

2001

-4.4

11,523.2

-1.1

1

14.2

57.3

11.5

10.2

21.7

2002

-10.9

10,676.7

25.8

3.06

12.0

146.9

27.7

12.8

40.5

2003

8.8

11,363.9

13.4

2.9

15.1

128.2

25.0

14.2

39.2

2004

9

12,221.6

4.4

2.92

19.1

110.6

25.3

18.1

43.4

2005

9.2




9.6

2.9
















2006

7.3




10.1

3
















Source: World Development Indicators (WDI), World Bank, at www.worldbank.org and Euromonitor, 2006.

Post Crisis Economic Model in Brazil

In the aftermath of the crisis, the Brazilian economy faced an economic policy dilemma (Amann and Baer, 2003; Goretti, 2005). Many commentators believed that the government was going to revert to old policies of irresponsible monetary emission to finance budget deficits1. However, the management of the devaluation allowed the economy to show a quick economic recovery with a low inflation rate and a smooth transition to a flexible exchange rate (Amann and Baer, 2003). The monetary and fiscal restrain helped the economy to make the transition and stabilize just a year after the devaluation2. Nonetheless, the Argentine crisis and the upcoming presidential election in 2002, with the growing possibility of Lula being elected president, increased the uncertainty on the economic performance (Boschi, 2005; Goretti, 2005)3. While Cardozo’s party offered a continuation of a policy of open markets and orthodox policies, Lula’s candidacy rode on the back of a political coalition with deep roots on social and welfare policies. Lula’s campaign tried to emphasize that his government will not promote a strong departure from orthodox policies. Financial markets reflected this nervousness on their performance and lack of interest on Brazilian assets4. Nonetheless, Lula’s victory did not bring chaos but a continuation of the policies that enabled the economy an ordered way out of the crisis5. The government pursued a policy of dialogue and collaboration with the IMF, while at the same time tried to adjust to the social demands from their constituencies. Economic policy followed an orthodox pattern of floating exchange rate and consistent monetary and fiscal policies, which quickly restored confidence on the path of the economy6. The result was economic growth and a higher degree of predictability of government’s policy (Table 1). Investors changed their pre-electoral view of Lula, and realized that his government was not going to change the economic model for the Brazilian economy.

Social policies were more difficult to implement, since the orthodox economic model limited the ability to pursue dramatic changes on social resources or income distribution7 (Figure 1). Total expenditure as percentage of GDP did not change from the levels reached by the previous government. There was not significant change on the percentage of total government expenditure devoted to social welfare programs. As a result, the government focused on the redesign of social programs within the budget limits. Nonetheless, corruption scandals and lack of speed on the reforms undermined the success of such policies and hurt Lula’s support from its political base.

Figure 1

Source: Own elaboration based on Euromonitor 2006.


This year, the government faces the challenge of a new presidential election and the need for Lula to improve his chances of being reelected8. The flexible exchange rate led to an appreciation of the Real with respect to the US dollar, which reduced the competitiveness of Brazilian exports. The economy has slowed down and the uncertainty of the election creates some uneasiness among investors. On the political front, Lula’s government tried to boost popularity by cancelling all debt with the IMF, a decision that Argentina quickly followed9.
Post Crisis Economic Model in Argentina

Argentina’s recession was much more severe than in Brazil (Table 1). The collapse of the financial and banking system in late 2001 led to a political crisis without precedent, in which five presidents were named and resigned in a span of ten days (Corrales, 2002; Manzetti, 2002). In early 2002, the provisional government declared the default of all foreign debt, the devaluation of the peso and the modification of all contracts in the economy according to the new reality of the country (Gallo, et. al., 2006). The management of the crisis was far from ordered and in many cases represented desperate attempts to maintain some kind of stability amid the general economic chaos (Corrales, 2002). Economic activity came to a halt and GDP plunge in a recession that seemed to never end (Table 1). The government was very close to hyperinflation in its attempt to control fiscal and monetary policies, and the IMF decided not to help the country in the solution of the crisis10. After one year of effort the economy stabilized and economic activity started to show signs of recovery. The deep devaluation promoted import substitution industries and the favorable international prices fostered agricultural exports, the only bright spot during the recession years11. A new government was elected in early 2003 to deal with a difficult economic situation12. The government was in default of its debt, the banking system was bankrupt, the contracts with privatized companies were suspended and the economy was just showing some signs of recovery (Gallo, et. al., 2006). The Government followed a monetary policy focused on sustaining the exchange rate at three pesos per US dollar, in order to maintain the competitiveness of the domestic industry and agricultural exports (Table 1). The income from exports was quickly monetized by the Central Bank leading to an increase in domestic demand13. As a result, the economy started to recover and quickly showed signs of improvement (Table 1). Inflationary pressures were too low, given the low level of utilization of industrial capacity and high unemployment rates14. On the fiscal side, economic activity increased resources and the default allowed the government to save resources and run fiscal surpluses15. This economic model continued throughout 2005 and 2006, while the IMF recommended a more flexible exchange rate and an immediate agreement with debt holders. Because of the opposed points of view, the government decided to close all channels of communication with the IMF and pursue a more independent economic policy16.

In early 2005 the government gave debtors a “take it or leave it” offer for the defaulted debt, leading to the highest cut on sovereign debt in history17. The IMF did not support this program, but debtors, faced with no other choice, accepted the deal (Sturzenegger and Zettelmeyer, 2005). The restructuring of the debt allowed the government to go back to financial markets, although the initial premium was high (Figure 2). The fiscal situation continued under control and the favorable international conditions, high prices for exports and low interest rates, allowed for a sustained economic growth (Table 1).

By late 2005 the economic expansion was straining the industrial installed capacity and employment had dropped dramatically18. As a result, inflationary pressures appeared19. The government resorted to exert political pressure on different industries and later to directly control prices, set prohibitions to export meat and increases on taxes on exports20. To minimize the criticisms and opposition from the IMF, the government followed Brazil’s example and cancelled the debt with the IMF using Central Bank reserves. The Central Bank continued to sterilize the inflow of US dollars in the economy, allowing the country to maintain an exchange rate close to three pesos per US dollar and containing the domestic demand. Nonetheless, the interest rate on short term notes have increased due to both, the volume of the debt and the increase on the US interest rates. This policy is generating a cost in terms of short-term bonds the Central Bank has to issue to pursue this policy21. Investment has remained the Achilles’ heel for this economic model, as price controls, contract and judiciary uncertainty and heterodox policies do not promote much investment beyond the real state boom and public works. Nonetheless, the policy of confrontation with the IMF has given political and economic payoffs to the government, despite the challenges ahead.


Comparing economic performance in the aftermath of the crisis
In order to assess the benefits of counting wit the support of the IMF, while undergoing an economic crisis, this section compares the performance of the main economic indicators for Argentina and Brazil. According to the policies described previously, Brazil followed an IMF friendly policy pattern, with a floating exchange rate, fulfillment of its debt payments, adequate fiscal and monetary policies while Argentina followed policies in direct opposition to the IMF and the international financial community, i.e. defaulting its debt, controlling the exchange rate through monetary emission and market controls, sterilizing the inflow of foreign exchange, using controls to stop inflation but maintaining a surplus on fiscal accounts.

International markets reacted to the differences on the economic crises in both countries (Figure 2). While the high jump on country risk in Brazil, due to the devaluation of 1999 implied a jump of more than 500 basis points, it seems small compared with the jump of more than 6000 thousands of basis points in Argentina from June 2001 to June 2002. The Brazilian economy followed with a high jump on risk in 2002 fueled by the fear of contagion from Argentina and the possible election of Lula. Nonetheless, the country risk strongly declined by the end of 2002 and beginning of 2003 as markets realized that Lula’s policies were consistent with the sustainability of the economy and the Argentine crisis was limited to the domestic market. Finally, in 2005, Argentina returned to international markets and the country risk dropped substantially, as the government moved out of default and started to pay interests on the new bonds.



Figure 2

Source: Own elaboration from Ministry of Economy, Argentina, www.mecon.gov.ar


In terms of economic growth, the performance has been quite different. The effect of the devaluation on the Brazilian economy meant a slowdown for the economy, while the Argentine crisis produced a decline on real GDP of 18.4% (from 1998 to 2002). However, the recovery in Argentina has been strong, with a growth of 38.9% from 2002 to 2006, while Brazil grew 11.6% in the same period. As a whole, the Brazilian economy grew 21.2% from 1997 to 2006, while the Argentine economy reached a growth rate of 13.4%. As a result, part of the explanation for the amazing performance of the Argentine economy in the last few years can be explained by the strong negative effect of the crisis on the economy. This negative effect is seen on the loss of GDP per capita measured on constant US Dollars. In Argentina, GDP per capita fell by 2.8% from 1997 to 2004, while in Brazil it increased by 4.9% in the same period (Figure 3).

The devaluation produced an adjustment of the nominal exchange rate in Brazil, while it drastically changed relative prices in Argentina (Figure 4). This difference on the effects of the devaluation is reflected on the abrupt change on trade balance in Argentina (Figure 5). The devaluation cum recession increased the trade surplus from 1.3% of GDP in 2001 to 14.9% in 2002. This surplus declined in the last few years because of the economic growth, but it is still higher than in Brazil, due in part to the differences on exchange rate policies each country applied.



Figure 3

Source: Own Elaboration from World Development Indicators (WDI), World Bank, at www.worldbank.org



Figure 4

Source: Own elaboration from IMF Financial and Monetary Statistics, at www.imf.org


Figure 5

Source: Own Elaboration from World Development Indicators (WDI), World Bank, at www.worldbank.org


Argentina had a similar effect in total debt as percentage of GDP, which abruptly increased to 147% in 2002, and declined in 2005 as a consequence of the default. In Brazil the debt burden increased in 1999, as a result of the devaluation, but it did not go out of control, fluctuating with the changes on exchange rate.

In the case of investment, Argentina suffered a strong setback, with low levels of investment from 2000 to 2003. This deficit on real investment has not been complemented by foreign flows of direct investment, which drained in 2001. While Argentina had higher inflow of capital as percentage of GDP during the 1990s, Brazil surpassed that levels from 2000 to 2004 (Figure 6). Moreover, the decline on the inflow of capital to Argentina is more noticeable when we take into account the value of investment in US Dollars (Figure 7).



Figure 6

Source: Own Elaboration from World Development Indicators (WDI), World Bank, at www.worldbank.org


Figure 7

Source: Own Elaboration from World Development Indicators (WDI), World Bank, at www.worldbank.org

Inflation and exchange rate has been under control in both countries, although Argentina is having problems because its monetary policy is devoted to the control of the exchange rate. Total inflation after the devaluation of 1999 to 2006 was 78% for Brazil, and 59% in Argentina during the same period. Nonetheless, Argentina had an inflation rate of 63% from 2002 to 2006, which has increased in the last quarters. As a consequence, the government introduced price controls and other measures in order to sustain prices at low levels. In the short run price controls proved useful on maintaining inflation, but the result in the medium term, when controls are to be lifted, are uncertain (Figure 8).

Budget surplus changed drastically after the devaluation. Both countries switched from deficits to surplus, improving their fiscal situation. In the case of Argentina, the debt default, which allowed the government to avoid payment of interests for more than three years, helped to sustain a budget surplus (Figure 9).

With respect to unemployment, there was no change in Brazil, while in Argentina the crisis sharply increased unemployment rate (Figure 10). Nonetheless, the fast economic recovery helped to lower unemployment rates to similar levels than in Brazil.

Figure 8

Source: Own elaboration from IMF Financial and Monetary Statistics, at www.imf.org


Figure 9

Source: Own elaboration from IMF Financial and Monetary Statistics, at www.imf.org


Figure 10

Source: Own elaboration from IMF Financial and Monetary Statistics, at www.imf.org



Looking Ahead, Challenges and Opportunities

As this paper showed, both countries faced challenges to their fixed exchange policies and devaluation was the path to change the situation. Nonetheless, the economic program after the devaluation was different. While Brazil moved to a flexible exchange rate policy and focused monetary policy on inflation, with a fiscal policy consistent with the macroeconomic equilibrium, Argentina chose a higher exchange rate level and designed a monetary policy to sustain that exchange rate. As the demand increased, and the economy reached higher levels of production, the Central Bank started to sterilize the incoming reserves, as a way to stop excessive inflationary pressures. Nonetheless, the government is attempting to control inflation by using strict price controls, limits on exports and taxes. The fiscal policy and the default helped to sustain the macroeconomic situation, and the booming economy is pushing down the unemployment rate. The situation in Argentina, however, looks weaker than in Brazil.

Despite the perceived weaknesses in the Argentine economic program, the aftermath of the crisis has not produced much difference on the current performance of both countries. Economic growth resumed, inflation and exchange rates are under control and the debt seems to be between manageable ranges. Nonetheless, the IMF supported Brazilian policies, while at the same time opposed many of the Argentine policies. Did it matter to follow the IMF advice? The answer seems to be no.

One of the main objectives of the IMF is helping countries to go through economic crises and help them grow. From the comparison drawn in this paper, the economic recovery has been as successful in Brazil as it was in Argentina. It is also true that the positive conditions on international markets, high prices for agricultural exports and low interest rates, eased the situation. As a result, the question that remains is whether the economic model can be sustained in both countries and what the rate of success will be in the medium run.


References
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1 “Brazil’s tradition of inflation and indexation will make it difficult for the government to keep inflationary expectations in check in the wake of the devaluation, despite the relatively closed nature of the economy (in 1998 imports accounted for 7.9% of GDP) and despite the depressed state of domestic demand and deflationary forces in the world economy. Producers and retailers alike have been quick to raise prices in the wake of the devaluation. But the government has clamped down on abusive pricing, and it will be helped by a reluctance on the part of the public, particularly the poor, to accept a return to inflation after past four years of price stability. The EIU expects the devaluation to have a greater pass-through impact on prices than is likely to be assumed in the redrafted IMF agreement. But we expect inflation to be contained to around 25%. Under these assumptions, a return to widespread indexation of prices and salaries will not occur, and the conditions would be created for a slow reduction in inflation in 2000.” The Economist Intelligence Unit, Brazil Country Report, 1st Quarter 1999, at 10.

2 Having consolidated the fiscal adjustment in recent months with the approval of the DRU, the LRF, a minimum wage of R151, and a fiscally conservative budget, the government will wait until after the October municipal elections to seek approval for reform of the tax system and social security, which are crucial for competitiveness and the long-term health of the public finances respectively. The government is on course to meet its target of a primary surplus of 3.25% of GDP. Monetary policy will remain cautious and dependent on the degree of US monetary loosening. The economy is set to recover in 2000-01. The inflation target will be achieved. The trade balance will swing into surplus but the overall external financing requirement will remain large.” The Economist Intelligence Unit, Brazil Country Report, June 2000, at 3.

3 “Financial markets have become volatile at the prospect of a Lula victory, adding to interest charges on the public debt. The termination of all cooperation by the Partido da Frente Liberal (PFL) with the government has also hampered the passage of legislation needed to meet primary fiscal targets and to move ahead with reform. Investors remain nervous of the Partido dos Trabalhadores (PT), despite the moderation of its stance on economic policy.” The Economist Intelligence Unit, Brazil Country Report, June 2002, at 16.

4 “…the PT has been keen to emphasize its commitment to the responsible management of the economy and has abandoned its radical stance on fiscal spending and relation with the IMF. Lula has also made significant efforts to improve its own image as a statesman, by engaging in high profile international visits. Drawing on the lessons of previous campaigns, the PT’s television spots have been crafted carefully to underline the message of responsible government. But despite these efforts, Lula’s strong showing in the polls has generated a degree of anxiety among investors that has already been reflected in currency jitters and the widening of spreads on Brazilian debt, adding to the burden of public debt servicing. This development has underlined the urgency of Lula’s efforts to win over sections of the business community.” The Economist Intelligence Unit, Brazil Country Report, June 2002, at 12.

5 “The government is maintaining the orthodox macroeconomic framework inherited from the previous administration, of Fernando Henrique Cardoso in 1995-2002, which encompasses fiscal discipline, a floating exchange rate and inflation targeting.” The Economist Intelligence Unit, Brazil Country Report, September 2003, at 8.

6 Since coming to power in January, the Partido dos Trabalhadores (PT, the Workers Party) government has been remarkably successful at building consensus and maintaining the confidence of the markets. As a result, it has been congratulated by the IMF while managing to retain a relatively high level of public support despite very tight economic management” The Economist Intelligence Unit, Brazil Country Report, September 2003, at 12.

7 Tight fiscal restraint has limited the government’s scope for initiation or expansion of social welfare programmes, but a series of announcements have been made in an attempt to demonstrate its commitment to social reform. These include the approval of a targeted employment programme for those who have never worked before; the imposition on banks of a requirement to increase the volume of small loans (see Economic policy); affirmation that the government is preparing legislation criminalising “illicit enrichment, citing diversion of resources from social programmes; and a literacy programme which aims to harness voluntary effort.” The Economist Intelligence Unit, Brazil Country Report, September 2003, at 17.

8 “Corruption investigations that erupted in mid-2005 drag on, but the political environment is increasingly dominated by the October 2006 presidential and legislative elections. The president, Luiz Inácio Lula da Silva of the leftist Partido dos Trabalhadores (PT), is expected to seek re-election. Following a steep decline in his approval ratings in the second half of 2005, Mr da Silva’s popularity has rebounded in 2006. Provided that no new corruption scandals emerge, an improved public relations campaign, higher public investment spending, the impact of social assistance programmes and an increase in the minimum wage will help consolidate the recovery of his support among the poor majority of the population.” The Economist Intelligence Unit, Brazil Country Report, June 2006, at 7.

9 “Whatever the economics involved, wriggling free from the tutelage of the IMF is always good politics, in Latin America in particular. That is why Brazil's finance ministry announced on December 13th that it would repay early its entire debt of $15.5 billion falling due to the IMF over the next two years. The immediate effect was to rush Néstor Kirchner, Argentina's president, into an identical declaration just two days later. He said his government would repay $9.8 billion to the Fund, before the end of this month. In both cases, the motivations were similar. More telling was the difference in market reaction and policy implications.

Both governments claimed they would make financial gains from the move—a saving of over $900m in interest payments for Brazil and of $842m for Argentina. In both cases, the more powerful motive was political. Brazil's president, Luiz Inácio Lula da Silva, is burdened with a corruption scandal and a below-par economy as he prepares for a tough fight to win a second term in an election next October. Paying off the IMF will please his left-wing supporters without ruffling financial markets. Mr Kirchner runs the risk that by the time he seeks a second term at an election in April 2007, Argentina's economic recovery may have run out of steam. Paying off the Fund will “generate freedom for national decisions”, he said. Even La Nación, a habitually Kirchner-sceptic newspaper, hailed this as an “historic” move. The Economics, December 20th 2005, at http://www.economist.com/World/la/displayStory.cfm?story_id=5327790



10 “Our growth forecast for Argentina is based on the assumption that the current situation will not develop into a spiral of high inflation or hyperinflation and, eventually, dollarisation. However, if the current programme fails or if negotiations with the IMF do not move forward sufficiently rapidly, this risk will increase. The economy will remain depressed during 2002, but should start to stabilise in 2003.”

“After three years of deflation, the devaluation of the peso has fuelled price increases. Although inflation will accelerate in the near future, our primary forecast is that hyperinflation will be avoided. The ability of the authorities to control the growing pressures for indexation will be crucial—Argentina has a deep-rooted tradition of indexation to the US dollar. In our view, indexation is unlikely in the current context of a severely depressed economy. However, popular demands for the reinstatement of real purchasing power through wage increases are likely to re-emerge before mid-year.” The Economist Intelligence Unit, Argentina Country Report, April 2002, at 6-7



11 “During the first half of 2002 real agricultural output increased by 1%, while the production of fisheries rose by 1.4%. These were the only two sectors that recorded positive output growth rates during the period. The record soybean harvest was the main factor behind growth in agriculture..” .” The Economist Intelligence Unit, Argentina Country Report, December 2002, at 26

12 “The new president, Nestor Kirchner, who was sworn on May 25th, was elected with a relatively weak mandate and lacks a strong base within the ruling but divided Partido Justicialista. The Economist Intelligence Unit, Argentina Country Report, June 2003, at 3.

13 After pursuing an expansionary monetary policy during the second quarter of the year, the authorities subsequently adopted a more conservative stance. While during the second quarter of the year the monetary base increased at a monthly rate of 7.1%, during the third quarter the rate of expansion slowed to 2.4% per month. This was facilitated by a fall in the supply of dollars, which reduced pressures for the authorities to intervene in the foreign-exchange market to maintain the competitiveness of the peso. The smaller dollar surplus in the third quarter stemmed from a lower trade surplus and higher capital outflows. However, this pattern was reversed in October, and official intervention in the foreign-exchange market increased again, causing the expansion of the monetary base to accelerate as the Central Bank sought to prevent the price of the dollar from falling below Ps2.8:US$1. To partly sterilise the resulting monetary expansion, the authorities issued new Letras del Banco Central (Lebacs, Central Bank paper), the stock of which reached Ps8.7bn at the end of October (compared with Ps3.4bn at the beginning of the year).” The Economist Intelligence Unit, Argentina Country Report, December 2003, at 24.

14 Utilization of industrial capacity was at 55.5% on June 2002, while unemployment was close to 20%. Source, National Ministry of Economy of Argentina, at www.mecon.gov.ar

15 “During the third quarter of 2004 the public-sector finances recorded a strong surplus, continuing the trend established in the first half. Primary government spending rose"pushed up by higher transfers to the provinces, the increase in public-sector wages and higher infrastructure spending # but at a lower rate than revenue. The overall non-financial public sector surplus (NFPS) for the third quarter (on a cash basis, and including transfers to the provinces) was Ps5.0bn. The cumulative primary surplus for the first nine months was Ps16.8bn, equivalent to 5% of GDP.” The Economist Intelligence Unit, Argentina Country Report, December 2004, at 16.

16 “The government repaid the SDR6.7bn (US$9.5bn) it owed to the IMF at the beginning of January from Central Bank reserves. We do not expect it to seek another deal with the Fund to replace the stand-by arrangement it suspended in the third quarter of 2004. The government will make use of heterodox measures (including price controls and export taxes) to meet its macroeconomic and fiscal targets, an approach it regards as vindicated by three years of strong economic growth and increased stability, but it will try to dodge the politically costly structural reforms advocated by the Fund. These reforms include a comprehensive overhaul of fiscal relations between the federal government and the provinces, one of the causes of the unmanageable build-up of debt in the 1990s.” The Economist Intelligence Unit, Argentina Country Report, February 2006, at 2.

17 “In recent statements, the Fund has indicated that it wants to see a “realistic strategy” to deal with holders of the 24% of the defaulted external debt (US$19.5bn) who refused to enter the debt swap. Argentina has agreed in principle to address the issue of holdouts at some time in the future, although what kind of deal they will be offered is as yet unclear. So far, the Argentinean government has insisted that those bondholders who failed to enter the swap would receive nothing.” .” The Economist Intelligence Unit, Argentina Country Report, April 2005, at 2.

18 “Rapid output growth has taken the level of capacity utilisation in industry to 75.1%, close to its 1998 peak. Capacity utilisation rose by 2 percentage points in September, the largest monthly rise since February. The industrial sectors where capacity is most stretched are petroleum refining, where it is running at 94.3%, basic metal industries (87.3%) and textiles (88.2%).” The Economist Intelligence Unit, Argentina Country Report, December 2005, at 32.

19 “During the third quarter of 2005 the consumer price index (CPI) increased by 2.6% quarter on quarter, picking up compared with the 2% rise in the second quarter, but lower than the 4% experienced in the first three months of the year. On a monthly basis, the CPI rose by 1% in July, by 0.4% in August and by 1.2% in September, the highest monthly rise in prices since March.” The Economist Intelligence Unit, Argentina Country Report, December 2005, at 25.

20 “The government will concentrate on maintaining large fiscal surpluses, keeping the economy growing strongly, and combating resurgent inflation. It will also try to redistribute income to poor households following the recovery from a severe economic crisis in 2001-02. Keeping the economy growing without generating higher inflation hinges on increasing investment, which has now exceeded the pre-crisis peak of 1998 in real terms. Investment will be encouraged by targeted incentives, with the aim of removing bottlenecks in sectors, such as energy and industrial inputs, which have arisen as a result of strong domestic and export demand. The government will use so-called price agreements (under which moral persuasion will be applied to leading producers and retailers to lower prices in the expectation that competitors will follow suit) and export taxes to stem price rises on the domestic market.” The Economist Intelligence Unit, Argentina Country Report, June 2006, at 8.

21 “The Central Bank will target a level of monetary aggregates consistent with a gradual lowering of inflation, which rose sharply in 2005. But it will also be guided by the conflicting goal of maintaining exchange-rate competitiveness. The Central Bank will continue to intervene in the currency market, accumulating foreign-exchange reserves while issuing Central Bank paper to sterilise the impact on the money supply. The government will also combat inflation directly by seeking price agreements. There was little effective tightening of monetary policy in 2005, with real interest rates still negative, but interest rates have risen in 2006 and we expect this trend to continue if the Central Bank is to adhere to money supply targets and roll over its increasing stock of paper. Greater government borrowing on the domestic market to repay debt issued in the wake of the crisis in 2001-02, and higher US interest rates, will add to upward pressure on local interest rates.” The Economist Intelligence Unit, Argentina Country Report, June 2006, at 9.


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