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S. Sethuraman

THE FINANCIAL implosion in Argentina had been in the making for months as the third largest economy of Latin America desperately clung to its peso-dollar one-to-one exchange rate and sought to restructure its $155-billion foreign debt without default and devaluation, along with a zero-deficit budget target. The denouement, for a country on a path guided and aided by the IMF, was tragic.

For an economy severely contracting for the third year in succession and unemployment rising at 18-20 per cent, the belt-tightening policies of the Economy Minister, Mr Domingo Cavallo, and the draconian controls on banking and foreign exchange transactions after large outflows of deposits dried up liquidity and pushed up interest rates, strained the limits of patience for the hungry and unemployed on the streets. The country's sovereign credit rating had been lowered earlier, shattering investor and creditor confidence.

The last straw was a further cut in the budget by $9.2 billion, by Mr Cavallo, after he was egged on by the IMF to come up with a more credible fiscal programme before it could release the much-sought-after tranche of $1.3 billion, and this triggered food riots, looting of supermarkets and clashes with police, resulting in the killing of 29 persons.

The IMF said on December 6 that it could not recommend the completion of its review of the loan programme, in view of the slippage in fiscal performance but that it would be willing to work with Argentina to develop a sustainable economic programme.

In the face of public wrath and damage, Mr Cavallo had to resign but escalating civil disturbances ultimately forced the President, Mr Fernando de la Rua, also to step down and Argentina began to pick up the pieces with a new leadership.

With a bang, the acting President, Mr Adolfo Rodriguez Saa, announced in the Congress on December 23, to the cheering of the Peronists, who returned to the House in majority in the 2001 elections, the suspension of repayments on $132-billion national debt and the use of the funds earmarked for debt servicing to feed the hungry and create one million jobs. This seems to have pacified the people, at any rate for now. (Mr Saa has since resigned.)

Argentina's default is the largest in history though in recent years, Russia, Ukraine and Ecuador did default on their outstanding bonds. The caretaker Argentinean President, who would hand over to an elected successor in March, declared that the situation left no alternative but for them "to take the bull by the horns". He did not, however, move to change the exchange rate system (Currency Board) which would mean a devaluation with damaging consequences for banks, businesses and individuals, but proposed the issue of a third currency to be used to pay for public works and salaries of employees.

Out of the total debt of $l55 billion, the Government owed $132 billion to foreign lenders, banks, pension funds and multilateral institutions (the IMF/World Bank). The outgoing government had cut interest rate payments on domestically held bonds to use the savings to finance part of the budget deficit, which was one of Mr Cavallo's desperate remedies and intended as an attempt to change the high-cost debt structure.

But Argentina would still need external help to overcome its current recession, and Mr Rodrigeuz Saa has appealed to the US and Spain for economic assistance. Two IMF bail-out packages, since early 2000, totalling $48 billion had not proved adequate to mitigate Argentina's woes. The Bush Administration and the IMF had taken the stand at the height of the crisis in Buenos Aires that without specific reforms more external aid would not be forthcoming. The new regime has not ruled out eventual renegotiation of the outstanding debt.

The rulers of Argentina, past and present, remain wedded to the dollarisation of the economy introduced in 1991 as the one-to-one exchange rate for the peso had helped reduce inflation and generated GDP growth of 4.3 per cent on average during the l990s. But the strengthening of the dollar, the devaluation of the Brazilian real, increases in international interest rates and terms of trade losses pushed Argentina into a deep recession since l999. With the slump in revenues, the zero-deficit was becoming a mirage.

Argentina's unilateral declaration of default brings a serious challenge to the IMF in the New Year in its search for mechanisms to bring about a more orderly resolution of the recurring financial crises. The international financial community has not been able to find the right answers since the Asian financial crisis of l997, with the IMF continuing with its highly-conditioned assistance packages that help to bail out private creditors, leaving the debtors in no better condition. It is in this context that the proposal of the IMF's First Deputy Managing Director, Ms Anne Krueger, for an international workout mechanism with `standstills' on sovereign debts assumes importance. The IMF Executive Board has given a preliminary nod to it and the plan is to be etched out.

Ms Kruger's proposal for standstill gives debtors legal protection from their creditors while they negotiate an orderly way of restructuring their debt. It would involve the imposition of temporary exchange controls to prevent capital outflow. Ms Kruger feels it might take two-three years for such a proposal to be put in place as it has go get the support of IMF's member-countries.

Financial experts agree that official financing should no longer help to bail out private investors and creditors and that they should bear the consequences of their decisions. They caution that the mechanism to help debtor countries in distress should not exacerbate populist sentiment in solvent countries to use it even when they are fully servicing their obligations. An alternative would be for authorities in countries in need of standstill to directly approach their creditors and the private sector response, with persuasion from official sector, can be evoked without legal procedure.

Economists and market analysts have blamed the US Government, the IMF and the leading industrial nations for contributing to Argentina's misery. They point out that the IMF went on to rescue Argentina on more than one occasion and when it was in dire distress, it turned its back. The US Treasury Secretary, Mr Paul O'Neill, had a few months ago, ruled out any more help to Argentina, favouring a bankruptcy procedure similar to the one applicable to corporate undertakings.

There is considerable anger against the Bush Administration for its "hands-off" attitude and financial analysts attribute the IMF's latterly lukewarm approach to Argentina's plight after having encouraged its `zero-deficit' policy, which was no doubt proving difficult to implement, especially when the country was in recession. The IMF, for its part, takes the stand that whatever programme was laid out for its assistance was `owned' by Argentina. Yet, the IMF's Economic Counsellor, Mr Kenneth Rogoff, noted on December 18 that "the mix of policy, debt and the exchange rate regime was not sustainable".

IMF officials say that they are prepared to work with the new Government to help develop sustainable programmes. They contend that the IMF has trying been to help Argentina develop its own programmes that can be sustained, both economically and politically. The Fund's inability to complete its review in December was a consequence of Argentina's inability to meet the targets under the zero-deficit programme, they add.

There is, no doubt, a palpable difference in the manner in which in recent times the IMF has dealt with Pakistan and Turkey on the one hand, and Argentina on the other. In its September review of the Pakistan standby facility, the IMF waived the shortfall in fiscal deficit and approved the release of the last instalment with a commendation of the way Pakistan had implemented the economic and reform programme. On this basis, the IMF subsequently approved a $1.3-billion soft loan to Pakistan under the Poverty Reduction and Growth Facility (PRGF). Turkey received $3.1 billion as part of a $l9- billion loan package on November 28, with the Fund's appreciation of its strong implementation of economic reform programme, especially its fiscal performance. The Bush Administration has been going all out to help Pakistan as a frontline state cooperating in the war against terrorism in adjoining Afghanistan, while Turkey is also a key ally in the US- led coalition against terrorism. Even Argentina, in the midst of its troubles, had committed to send about 600 troops as part of a peace-keeping force in Afghanistan. An inter-American think-tank spokesman thinks the perception of letdown by Washington would not be conducive to the ambitious goal of the Bush Administration of promoting a Free Trade Area of the hemisphere.

Since developments in Argentina were predictable for some time, there has been no contagion effect of the debt default in the Latin American market so far. To the extent its action denies it access to international capital market, Argentina will be under compulsion to seek assistance — bilateral and multilateral — till it can stabilise its economy. It is bound to reopen dialogue with the IMF at some stage though the present caretaker government would not like to make commitments that would bind the Government in March when a new President will be elected for a two-year term.

Meanwhile, the proposed introduction of a third currency, Argentino, from January, alongside the peso and the dollar will be a risky novel experiment amidst fears that there could be a currency devaluation some time.

With its 37 million people and a GNP of $285 billion, Argentina is one of the upper middle-income countries in per capita terms ($7,440). The country had been attracting significant flows of private capital, especially FDI, till 1999.

It overcame hyper-inflation of the l980s with its currency board system for exchange rate and free market reforms that seemed to work well for years until the recession brought on by external and internal factors pushed Argentina to the brink of financial collapse.

(The author, a former Chief News Editor, PTI, now writes from Washington.)

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