How Argentina challenged Austerity Politics – crosspost

“Markets may not bear a grudge but they know their enemies.” – Financial Times Columnist on the market’s reaction to the death of Kirchner. [1]

On Wednesday, October 27th 2010, the former President of Argentina, Nestor Kirchner, died suddenly. A Reuter’s article, published on the 28th, accurately described business reaction:
“Argentine bonds and stocks rose on Thursday, spurred by investor confidence that the death of former President Nestor Kirchner could herald an era of more market-friendly economic policies.” Investors disliked the economic policies of Kirchner, who was a key power broker in the current government of his wife, President Cristina Fernandez. He had been expected to run for a second term in the October 2011 election. [2]

The Financial Times spoke as follows: “The sudden death of Néstor Kirchner, Argentina’s pugnacious former president, sparked a rally on international financial markets at the prospect of a more investor-friendly regime in one of the world’s top commodities producers.” [3]
Kirchner became President of Argentina after the General election of 2003, held in the midst of a major economic crisis. Argentina’s recession from 1998-2002 was comparable to the U.S. Great Depression in terms of unemployment, which peaked at more than 21%, and lost output of about 20%of GDP. [4]

In December of 2001 and January 2002, the country underwent a massive devaluation, a world-historical record sovereign default on $95 billion of debt, and a collapse of the financial system.
The IMF was instrumental in bringing about the collapse by supporting an overvalued exchange rate with increasing debt levels and rising interest rates. But when Argentina’s economy collapsed, it offered loans, with a series of conditions that in the event would hamper the economy’s recovery. In this process, the IMF was negotiating on behalf of the foreign creditors. Kirchner refused the Fund’s conditions, and the IMF refused to roll over Argentina’s debt.

During the Menem administration, Argentina was the poster-child for the free market policies pushed by the IMF. The Buenos Aires government privatised state enterprises, liberalised foreign trade and investment, and tightened government fiscal and monetary policy. During the 1990’s the Argentinean economy seemed to do well. [5]
However, its foundations proved to be weak. Economic growth in that period, while substantial, appears to have been in large part the result of an increasing accumulation of international debt, fortuitous expansion of foreign markets, and short term injections of government revenues from the sales of state enterprises.
The first most important cause of the country’s economic troubles was the government’s decision to maintain the fixed rate of one peso (the Argentinean unit of currency), for one U.S. dollar. This ensured that the Peso was overvalued.

The IMF’s role here was crucial: It arranged massive amounts of loans, including $40 billion in 2001, to support the Argentine peso. It did not take long for Argentina to pile up a foreign debt that was literally impossible to pay back. If all that weren’t enough, the Fund made its loans conditional on a “zero-deficit” policy for the Argentinean government.

Elsewhere, in 1998, the IMF supported overvalued currencies in Russia and Brazil, with massive loans and sky-high interest rates. In both cases the currencies collapsed anyway, and both countries were better off for the devaluation: Russia’s growth in 2000 was its highest in two decades. [6]
However, in Argentina, these economic policies had substantial support among the country’s business elite, particularly those whose incomes derived from the financial sector and primary product exports. [7]
The IMF provided Argentina with ‘small’ loans when the country’s economic difficulties surfaced. As the Argentine crisis intensified, the IMF increased its support. The IMF coupled the funds provided with the condition that the Argentine government maintain its severe monetary policy and continue to tighten its fiscal policy, in other words, intensify economic austerity measures. [8]

Deficit reduction, which according to the IMF is supposed to be the key to economic growth, was undertaken with a vengeance. In early July 2001, on the eve of a major government bond offering, Argentine officials announced budget cuts of $1.6 billion (about 3% of the federal budget), hoping that these cuts would reassure investors and allow interest rates to fall.

Apparently, however, investors saw the cuts as another sign that the country’s crisis was worsening, and the bonds could only be sold at much higher interest rates (14% as compared to the 9% that similar bonds had commanded in mid-June). By December, the effort to balance the budget required far more severe expenditure cuts, and the government announced a huge reduction of $9.2 billion in its spending, about 18% of its entire budget.

IMF policies often succeed in curtailing inflation; sharp cuts in government spending and restrictions of the money supply will usually stabilize price increases. However, nowhere has the IMF policy package led to stable, sustained economic expansion, and, as in Argentina, it often generates growing and sustained inequality. [9]
It seems that the IMF did nothing to help Argentina avoid the breakdown of economic activity, instead it played the opposite role of attempting to ensure that credit from all sources was denied until an overall agreement, sufficiently favorable to foreign creditors, could be reached.

The IMF itself had about $15 billion of loans outstanding to Argentina. It deferred payments on these loans three times so far in 2002: $933 million in January, $136 million in May, and $985 million in July. [10]
The battle came to a head in September of 2003, when Kirchner temporarily defaulted to the IMF rather than accept its conditions. No middle-income country had ever done this. No one knew for sure what would happen. But the IMF backed down and rolled over the on the loans. The Argentinean economy went on to grow at an average of more than 8 percent annually between 2003 and 2009, pulling more than 11 million people out of poverty (in a population of 40 million).[11]

Kirchner took an even harder line against Argentina’s foreign creditors, forcing most to accept a bond exchange at 35 cents (or less) on the dollar. The vast majority of the holdouts finally capitulated on similar terms in early 2010 with 92.4% of the debt now restructured. [12]

Kirchner forced the bondholders by this means to take a two-thirds loss on about $82 billion in bonds, meaning that Argentina only paid $25 for every $100 it defaulted on. According to one source, this was the largest bond restructure in history.
Argentina’s high growth rates have also brought difficulties, such as high inflation; however, it is apparent that Argentina’s difficulties would have been rather more serious had it acceded to the IMF’s demands and honoured the bondholders in full. [13]

Ireland is about to implement sweeping austerity measures of a kind similar to those imposed on Latin America in the 1990’s. However, the evidence that economic programs of this kind produce economic growth in their aftermath appears to be lacking. It seems that the opposite is the case: the IMF’s own research indicates that of 170 historical examples studied fiscal austerity produced a consistent pattern of failure. The IMF study indicated that 1% of GDP adjustment would produce a 0.5% fall in economic growth.
This suggests that a €4bn adjustment in the December budget will probably cut economic growth by €2bn. The proposed overall €15 billion cut could lock the Irish economy into a prolonged, near-permanent recession. [14]

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Article source: It is the first in an Austerity series.


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