No More Rabbits for Argentina

By Scott B. MacDonald

By mid-December 2001 Argentina had completely run out rabbits to be pulled from its magic hat. The wizard of high finance Domingo Cavallo resigned on December 20, following President de la Rua’s fateful decision to order a state of siege following wide-scale riots against austerity measures. It is reported that over 20 people died in the riots and looting. De la Rua was to shortly follow his economy minister out of government, resigning and leaving the presidential palace by helicopter. The long expected, but painfully arrived at, last days of the currency board appear on hand. With the government in crisis and riots in the street, the country is done with attempting to pay its foreign debt and must contend with a new reality — falling off the map to international investors for a period as it renegotiates what it can pay.

For Argentina to adhere to its promises of living within its means on its budget, there must be political will. That is going to be difficult to find. After four years of recession and unemployment heading toward 20%, debt fatigue has clearly set in. The public no longer has much faith in the leadership elite. There is considerable frustration that painful austerity measures were undertaken without any tangible result at breathing life back into the economy. De la Rua and his administration were totally discredited and Carlos Menem, who is seeking to set the stage for re-election under the Peronista banner, is regarded as one of those responsible for the huge build up of $132 billion in external debt. The bottom line for many Argentines is where did all that money go? Corruption is clearly suspected, leaving a bad taste for many in the unemployment lines. At the end of day whoever assumes the mantle of leadership in Argentina has few choices. The International Monetary Fund has turned its back on its once model student and left it to fend for itself.

Argentina must now live with a formal default and go through the process of rescheduling its debt. Moreover, it is likely to devalue the peso, hence dismantling the currency board. Dollarization is not an option considering the fall in foreign exchange reserves. The banks sit on the edge of a major systemic crisis. In the short-term this is going to hurt Argentina more. The population of 37 million will face a harsher environment and no doubt more radical voices will be raised calling for an end of the market-oriented economic policies that got the country into its current mess. Populism could become a danger to the country.

Although conditions are grim for Argentina, there are some silver linings in the dark clouds. As the country makes the shift from a currency board to a floating peso it will be able to gain a higher degree of competitiveness for exports. This is important if the country is going to return to growth. Moreover, an agreement to move ahead with an official default and rescheduling removes the Argentine crisis from the headlines, begins to normalize its credit conditions, and allows the country to start the process of moving beyond what had appeared to be a perpetual crisis mode. However, none of this is to be easily achieved. There are definitely questions over political will to deal with the painful decisions that need to be made. De la Rua lasted only two years into his term.

Argentina is likely to have a grand coalition or unity government take the place of the departed de la Rua or a Peronista administration, operating with the support of at least part of the opposition. In the short-term, Adolfo Rodriquez Saa, Governor of San Luis Province has been appointed as an interim president. One of his first official acts has been to declare a default on the country’s $132 billion debt, promising to use the money to saved to create jobss and fortify social programs. He will serve for only three months until an election is held on March 3, 2002.

A new economic team must be formed and calm restored to the streets. The whiff of tear gas is not the sweet smell of an economy and society working in harmony. Moreover, support for basic human needs must be made available for the poorer segments of Argentine society. Then and only then can Argentina return to the bargaining table with its creditors to discuss what can be done.

Argentina’s slow motion wreck has been sad to watch, but the very gradualistic nature of its demise has been a blessing to the rest of Latin America. Although the move to default and eventually devaluation will send tremors throughout the region, this time around it should not push Latin America into a major crisis, such as the one that occurred in 1994 with Mexico’s abortive devaluation. Mexico has benefited from NAFTA, making closer ties to the United States and moving its economy along a more stable business cycle as opposed to boom bust cycles. For Brazil, the Argentine situation has forced the major government political parties to close ranks, pass important legislation and push for a single presidential candidate in the elections in October 2002. In addition, there has been a gradual de-coupling of regional currencies and securities values from Argentina’s.

Foreign banks have a little over $64 billion of loans, bonds and deposits in Argentina. Most of the major international banks have some exposure, including Citigroup, Banco Santander, and J.P. Morgan Chase. FleetBoston, the 7th largest bank in the United States, has already indicated that Argentina is hurting its bottom line, noting that Q4 earnings are down by $750 million, partially due to a write-down on loans to the South American country. Although this hurts a number of bank’s bottom lines, the default is not expected to send any major bank into a crisis. There has been a lot of time to prepare what has happened. Santander has already stated that it plans to set aside $900 million and inject as much as $500 million into its Argentine unit to cover potential losses. BBVA, Spain’s second largest bank and another major player in Argentina, plans to set aside 400 million euros.

2002 will be another testing year for Argentina. A new government will have to tackle how to return the country to growth and normalize relations with the international creditor community. None of this will be easy. However, the magicians are now gone. The wizard’s hat has been put away. The time for rabbits is over. The time for material changes is now.

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Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editor: Dr. Jonathan Lemco, Director and Sr. Consultant

Associate Editors: Robert Windorf, Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin, Uwe Bott, Jonathan Lemco, Jim Johnson, Andrew Novo, Joe Moroney, Russell Smith, and Jon Hartzell

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