Boris Lvin (bbb) wrote,
Boris Lvin

Q&A: Argentina's economic crisis

Monday, 4 February, 2002, 09:14 GMT
Q&A: Argentina's economic crisis

In the mid-1990s Argentina was lauded as an economic miracle. Today, after three years of stagnation, it represents one of the world's most intractable economic trouble spots. Why? BBC News Online maps the country's fall from grace.

How did it all go wrong for Argentina?

In 1991, during Domingo Cavallo's first spell as economy minister, the government decided to peg the peso to the US dollar to restore confidence and combat hyperinflation.

At the time, the strategy worked, but in time Argentina suffered the disadvantages of such a fixed peg.

By linking the peso to the dollar, Argentines adopted a currency whose exchange rate bore little relation to their own economic conditions.

This was a boon in times of hyperinflation.

But when stability returned to Argentina, the inability of its currency to respond proved more of a burden than a benefit.

Argentina had, in effect, ceded control over monetary policy - consider how important cutting interest rates has been to the US and UK this year.

Buenos Aires was left dancing disco when the tango would have been wholly more appropriate.

How did the 1997-99 currency crisis affect Argentina?

While Argentina was able to sidestep the fallout from the Mexican currency collapse of 1995, the so-called Asian currency crisis, which began two years later, provided a more troublesome beat.

When the Brazilian real plummeted in 1999, the peso was unable to follow suit, leaving Argentine exports vastly more expensive than those of its neighbour.

A decline in world prices for farm products, and the global economic slowdown of recent months, only worsened Argentina's problems.

Lower export takings have limited the country's ability to earn the foreign currency needed to repay dollar-denominated debts.

Decling industrial activity has denied the government the cash to balance budgets, while levels of unemployment and "underemployment" top 30%.

How will devaluation help?

The new Argentinean government has now devalued its currency by at least 30% and ended the fixed link with the dollar.

This will boost exports and help restore Argentina's foreign currency earnings which may ultimately be needed to pay off its huge foreign debts.

That is because exports will become cheaper in comparison to the Argentinean peso.

But it will hurt businesses which have invested in Argentina by making their investments in the country less valuable, and their profits smaller.

And it will be bad news for those people in Argentina who have borrowed money in dollars and are paid in pesos - for example, some small businesses and many with mortgages.

They would then have to pay back their debts in a currency that was worth less than before, so the real value of their debts will increase.

But that could be expensive for the government.

And devaluing the peso could boost inflation, as imported goods will become much more expensive.

What about Argentina's debt?

In the meantime, Argentina's huge debt problems had not gone away.

The country went on borrowing on international financial markets, until debt reached some $140bn.

Now the government has said it will default on these payments.

The default may bring the country some breathing space, but it is sure to make negotiating a final deal with its creditors that much harder.

And it will make it much harder for Argentina if it tries to borrow money again on international financial markets.

However, the sums Argentina owes are so massive that it is very much in its creditors' own interest to eventually come to an arrangement.

To paraphrase the old adage, if you owe the bank $1,000, it's your problem, but if you owe it $140bn, it's the bank's.

How did Argentina lose its way after being a former economic power?

In the 1930s Argentina was, thanks largely to beef exports, a global power, boasting income per capita similar to that of France.

But from the 1940s the country tumbled from the international stage, weakened first by isolationism, then military rule and internal conflict.

With the crisis-stricken government printing cash wholesale, inflation soared to 200% a month by the end of the 1980s.

Shoppers would pay more for goods in the afternoon than they had in the morning.

How did the country escape that particular crisis?

Carlos Menem, on gaining presidency in 1989, liberalised trade, privatised many state businesses and cut red tape in a bid to foster industrial growth.

The programme initially failed, undermined by concerns over levels of state deficits.

But the decision in 1991 to peg the peso to the US dollar boosted confidence - investors deemed dealing in greenbacks a safer bet.

The move also fostered financial stability - prices denominated in dollars could hardly be adjusted so quickly.

With world economic conditions fair, and seeds of recovery sown, Argentina became locked in a virtuous circle of foreign investment fostering growth which attracted further cash.

From 1991-94, Argentina's economic output expanded by an average of 7.7% a year.

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