Argentina: Life After Default

By 02 August, 2010

The emergence of the Greek sovereign debt crisis in recent months serves as a powerful reminder of how far Argentina has come this decade. Argentina defaulted on sovereign debt (bonds issued by the Government) in 2002, which was followed by a period of intense economic, political and social turmoil. Argentina’s government debt was the largest default in international finance history at $132 billion US dollars. Its central bank currency was nearly wiped out during the crisis.

Argentina has largely overcome this decade and the problems that are currently facing the Greek Government and its people. Social unrest has erupted in Greece. The latest round of demonstrations attracted over 50,000 protesters who vented their anger at the Government’s proposals to increase taxes, cut public sector pay and pensions while decimating public spending – many demanding that tax cheats and corrupt politicians be put on trial. A small group of protestors turned violent, throwing bottles at the police who responded by firing tear gas in what turned out to be the biggest protests since George Papandreou, Prime Minister, took office in October last year.

The trade-off for these brutal austerity measures is to receive backing from the European Union (EU) and the International Monetary Fund (IMF) which seems to have choked off Greek default for now, but question marks remain over the longevity of the euro.

Argentina saw four years of economic recession which led to the economic crisis of 2001/02. Argentina’s then-President, Fernando de la Rua, presided over the depegging of the peso to the U.S. dollar, draconian spending cuts and social unrest. Unemployment soared to over 19% and inflation rocketed as economic collapse poured millions of citizens into unexpected poverty. Domingo Cavallo, the economy minister of the time, introduced a raft of austerity measures that sparked widespread rioting which swept through the country as the people took to the streets to protest against the apparent collapse of the economy. As many as 20,000 people started looting shops in the capital, Buenos Aires, with many banks and restaurants being destroyed.

Fearing the worst, much of the population began a run on banks, trying to empty savings accounts, retirement accounts and liquidating assets in an attempt to salvage capital. Fernando de la Rua responded by freezing withdrawals from bank accounts with a series of measures called the “corralito” resulting in more civil unrest.

The number of people under the poverty line more than doubled in 2002 compared with pre-default levels and violent protests that year unseated five presidents. In nominal terms, it took over seven years for the economy to recover to pre-default levels and even now GDP per capita is still below 1998 peaks. Investment in Argentina dried up over night and essentially the country lost access to international capital markets as investors fled in fear. They deemed the risk of investment too high.

After eight long years, Argentina is proof that investors usually do forgive a country for defaulting. It will provide a valuable lesson on the immediate results of default if Greece does go down this road. The obvious benefit is the saving on the debt, but judging by Argentine experience, it will be followed by swift and horrifying economic collapse, accompanied by political chaos.

So for Greece, which runs a primary deficit of 8 percent of gross domestic product (GDP), a default would quickly lead to even more savage fiscal austerity. Moreover, a default will hit not only foreigners but also Greek banks, which holds around €45 billion of their government’s bonds – 10 percent of their assets. So far, the rescue package offered to Greece is in the region of €110 billion, which seems to have restored calm to the financial markets for now.

However, Argentina’s President, Cristina Fernandez, has criticised the bailout as repeating “the same recipes” applied to Argentina. Austerity imposed on Greece will have “terrible consequences on the economy … what they are trying to do is rescue the financial system”. There is a fundamental difference between the current Greek crisis and the past economic turmoil of Argentina – the single European currency. Whereas in Argentina when default was followed by a devaluation in the peso of around 70% which acted to boost exports, Greece lacks that option.

Like Greece, which is a weak economy stuck to a strong currency, one root of the Argentine debt crisis lay in its currency board which tied the peso to the dollar at parity. Once the peg was ditched the peso fell dramatically. Luckily for Argentina, it coincided with the global economic upturn that fuelled a boom in oil, metals and food prices, all of which helped Argentine exports. From 2003 to 2008, exports grew by 15-17% per year and contributed to GDP growth of, on average, 8% a year.

As Greece can not devalue its currency, the burden of adjustments can only fall on the fiscal side. There are very limited options available – savage tax rises and spending cuts, leave the euro or both.

Many argue that Greece would not benefit much by reverting to its old drachma currency as its exports are negligible. Tourism will gain to some extent but must still compete with cheap regional rivals such as Spain, Portugal and Turkey.

Argentina had a currency issue. Greece has been living off EU handouts, borrowing for two decades and concealing the true extent of its fiscal imbalances.

Argentina’s Recovery and Beyond

Following Argentina’s restructuring of outstanding defaulted debt in June 2010, it is set to finally emerge from “pariah” status in international capital markets. Fitch, a ratings agency, was the first to lift Argentina’s sovereign foreign-currency debt out of the “default” category. The upgrade in the ratings will make it easier for the government to issue new and external debt. Such issuance may still be tricky given the current environment in the eurozone and Argentina’s government is likely to continue to rely on domestic sources of finance for now.

Fitch’s decision on July 12th to remove the “RD” rating from Argentina’s long-term foreign-currency debt and to upgrade it to “B”, moving it out of the default category, reflects the completion in June of the swap of US$12.1bn in foreign debt for new securities. This represented 67% of the US$18.3bn in eligible outstanding defaulted debt. The acceptance rate was above the government’s target of 60% but below the initial market projection of 70-75%.

With the second restructuring out of the way, and with economic growth expected to be robust this year Argentina is believed to be in relatively good shape to meet both its financing requirement and its debt obligations over the next two years.

Argentina’s public debt has increased over the years to around 50% of GDP in 2009 from around 48% of GDP in 2008 and it still faces debt obligations of about $15 billion in 2010, most of which is due in the second half of the year. To avoid the crisis of the early 2000s, the government will need to find new financing to roll over their debt obligations if President Fernandez is to avoid using foreign currency reserves to pay debt. However, the continued usage of foreign exchange reserves is yet another risk.

Clearly, Argentina has come a long way since the economic crisis but there are still a number of risks to sustainable economic growth in the coming years. Political and economic stability will play a crucial role in delivering this success as the country draws closer to closing this chapter of its economic history.

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