TOPICS > Economy

Argentina on the Brink

December 21, 2001 at 12:00 AM EDT


RAY SUAREZ: There was relative calm in Buenos Aires and elsewhere today, in contrast to the riots and looting of the past four days, it was quiet. For Fernado de la Rua, who resigned as president yesterday, the public’s message was clear, fuera: Get out. This morning as the Argentine parliament formally accepted his resignation, de la Rua offered no apologies for his country’s economic ruin.

FERNANDO DE LA RUA, Former President, Argentina (Translated): I leave for history the message that I have with loyalty and honesty and with the most profound conviction that I have done what is necessary, what is correct, and what I understood to be the most important for this country.

RAY SUAREZ: On Wednesday two, weeks of scattered protests escalated as Argentine’s condemned the government’s belt tightening programs, cuts in spending to with the massive debt. They targeted banks to protest the latest austerity measure, a limit to bank withdrawals, right before Christmas. Another target: McDonald’s, a symbol of the free-market policies that many on the street blame for the country’s four- year recession.

MAN (Translated): All social classes are in the same boat here. All social classes are victims to the economic interests here.

WOMAN (Translated): We have no way out. We have no way out, and we are desperate.

RAY SUAREZ: The most deadly violence followed the widespread store looting. Shopkeepers fired on the crowds taking their goods. More than 20 people have died in street violence.

Many store owners, like this man, lost everything. Two merchants committed suicide. Much of the chaos came Wednesday night, despite the emergency state of siege declared by the president and the resignation of the unpopular economic minister, Domingo Cavallo, once celebrated for his inflation-busting reforms.

Today Argentina’s economy is in free fall: Four in ten Argentines live in poverty, unemployment is near 20 percent, the country owes $132 billion to foreign lenders, and exports are down– they’re relatively expensive overseas because the Argentine peso is tied to the strong U.S. Dollar. Yesterday in Buenos Aires, as the president’s helicopter lifted off from the Casa Rosada, the presidential palace, demonstrators cheered the end of de la Rua’s two years in office.

One of de la Rua’s final acts was to lift the state of siege. The opposition Peronist Party is in charge, and plans to hold elections within three months. Today the interim president reinstated what he called a partial state of siege on the streets

RAY SUAREZ: And joining me now are Miguel Diaz, the director of the South America Project at the Center for Strategic and International Studies, and Carol Graham, senior fellow in economic studies at the Brookings Institution. Well, let’s try to break it down. What happened to bring this crisis now to Argentina, Carol Graham?

CAROL GRAHAM: Well, I think it hasn’t been a question of whether. It’s been a question of when. I think people have been expecting something to happen for several months. It was very clear that the combination of public expenditure policies and an exchange rate policy were unsustainable.

In particular, having the peso tied to the dollar has meant that Argentine exports have been relatively expensive compared to others. The currency is overvalued. And it has been a drag on growth. This was a policy that in the early 1990s was sort of the pinnacle of the inflation fighting, the inflation stopping policies implemented by the same finance minister that just resigned, Domingo Cavallo.

In the early 90s, it was controversial but proved to be very effective. By the late ’90s, it was widely seen to be something no longer sustainable and had to be changed. The problems are or the problems still are but particularly were a reason for not changing the policy in time was that the alternatives are very costly. One is dollarization. And the second is devaluation. The first has a number of costs, including —

RAY SUAREZ: And by dollarization, you mean basically using the US Dollar as –

CAROL GRAHAM: Giving up the peso.

RAY SUAREZ: — the currency of Argentina.

CAROL GRAHAM: That means that the Argentines then give up their ability to make monetary policy at all because their currency becomes a dollar and all monetary policy becomes subject to what the US Treasury is doing for the US.

In terms of devaluation, the other alternative, the problem with that is that a lot of Argentina’s debt — all the external debt, but the internal debt, a lot of pensions, mortgages, whatever, are dominated in dollars. So if you devalue, the amount that people owe is going to increase dramatically. And the risk is that a lot of banks and businesses and individual consumers go out of business.

RAY SUAREZ: So Miguel — if you’re paying a mortgage, if you’re buying goods overseas to stock the shelves of your stores, devaluation means suddenly if it’s big enough, you could be wiped out?

MIGUEL DIAZ: Argentines are already suffering. And a devaluation would make things worse. The big risk of devaluation is that it could spark hyperinflation. It has happened in Argentina. It is something everybody has been trying to avoid for a long time.

And that is the risk. If I could just backtrack and add to what Carol was saying, there is a substantial political component to what happened yesterday. The president hasn’t been able to exert any leadership. The public hasn’t been able to see a way out, a light at the end of the tunnel. And with the week before Christmas, I think the Argentine public just got tired decided to take to the streets to get rid of de la Rua.

RAY SUAREZ: Help me understand this a little more because in the recent past Argentina was considered a pretty — pretty, becoming a pretty stable place. It had democracy, governments that succeeded each other through the ballot. They had sold off a lot of state industries, which they had been encouraged do by international lending agencies, low inflation, decent growth, people were making a little money. How did all this collapse?

CAROL GRAHAM: Well, even by the mid-1990s, even when Argentina’s economy was growing quite rapidly and it was seen to be a success story, the warning signs were out there about two things, possibly three.

The first was the fact that this convertibility policy of tying the peso to the dollar was resulting in an overvalued exchange rate, and that that was having a cost on the country’s ability to export and grow and therefore even at the height of the high growth unemployment was quite high. This was as a result of this. So there were warning signs as much as six or seven years ago that this was probably not a sustain sustainable policy.

RAY SUAREZ: So creating any new job in Argentina was becoming more expensive than it had to be.

CAROL GRAHAM: Right. That was one problem. The other problem is what was going on on the public expenditure side, which is both municipal governments indebted to the federal government and the government basically spending more than it had.

And the third is the external debt burden. Argentina’s external debt burden is about six times its export earnings. Take Peru as a counter example. Its burden is only twice its export earnings. So its external debt burden is very high.

And one has to think about what kind of debt is sustainable, particularly when a country is not growing quickly. In other words, what was sustainable in the mid 90s when the country was growing with debt service became unsustainable by the late 90s as the country went into recession.

RAY SUAREZ: So, Miguel if you are an Argentine who’s still in work, go off to whatever job you’re doing, the government decides to default and and… pushes off the payments of its debts far into the future, how does that affect you in your shop or in your office or in your home?

MIGUEL DIAZ: Well, it affects you in a number of ways. For one, default is a sign of failure for the entire country. Nobody is going to invest in the country, especially foreign investors, if there’s a perception that the country cannot meet its obligations.

If a country cannot meet its obligations, the corporations in those countries and individuals in those countries are also not going to be — are going to be deemed as incapable of meeting their obligations.

There is a panic that started actually a long time ago but the default just kind of seals it that’s led to capital exodus. Argentines are taking their money to Miami, they’re not investing in the country. And that impacts the worker, the average worker on the street as well.

CAROL GRAHAM: Just on this topic of default this, I think this highlights a need for something the international community is already thinking of but should move more quickly on and that is a mechanism for sovereign countries to negotiate — renegotiate unsustainable debt burdens. There has been.. There is a proposal that was floated by Ann Kreiger, who’s the number two person at the IMF, several weeks ago that proposes a mechanism for doing this, similar to the way firms declare bankruptcy.

It really is just a proposal that would require a lot of agreement by a lot of different — by many, many countries. But the point is that if countries had a structured and orderly way to renegotiate their debt, a mechanism that brings creditors and debtors to the table, that you can avoid this kind of messy, messy crisis and default kind of scenario, which is really the worst possible outcome for people in the country and Argentina. And it is not a great outcome for creditors.

RAY SUAREZ: Does this have the possibility of pulling down the country’s neighbors so if you’re sitting next door in Chile or Brazil and your country has been not doing some of these things that got Argentina into trouble, you might suffer as well?

MIGUEL DIAZ: Right. All signs point that it won’t impact its neighbors. The markets have reacted that way over the last couple of days. Brazilian debt, for example, hasn’t been impacted. Fundamentally, Brazil imports very little to Argentina anyway.

So it’s not going to be impacted in terms of its exports. Now, the concern is if there is a further meltdown of the Argentine situation — and things could get worse in Argentina — that investors will be scared away from investing in countries like Brazil, which have substantial capital financing needs next year. That is a concern.

But for the time being, it doesn’t seem like it is going to have much of an impact. The markets have seen this train wreck coming for a very long time and they have been preparing themselves for it. So a lot of those institutional investors, for example, who will be purchasing Brazilian debt or potentially will be purchasing Brazilian debt have been positioning themselves and should be in a good position to still be involved in the markets for next year.

CAROL GRAHAM: But I think it’s quite important that this is quite distinct from say the Asia crash or the Russia crisis, which were big surprises to the market and therefore you got this panic or herd behavior. As I mentioned earlier with Argentina, it was a question of when not whether that some kind of crisis was going to occur.

And so investors have been prepared for it. Argentina is distinct from its neighbors in that it was the only country that had this kind of exchange rate policy that was very clearly a red flag in terms of something that wasn’t going to last.

RAY SUAREZ: So, short-term, what does the prognosis look like for everyday Argentines, for the leadership of the country?

MIGUEL DIAZ: Well, this play has yet to be played out completely, the story has yet to be played out completely. You still have to make very important decisions on the exchange rate regime in Argentina — whether to dollarize or whether to devalue — those are very important decisions that the new president is going to have to be making at some point.

There are very serious risks in neither of those approaches; the devaluation, as I said before, entails the risk of a hyperinflationary-type scenario. Dollarization is also a very difficult option, especially considering the fact that they don’t have sufficient foreign exchange research to carry it out, which will require, in turn then, for the US to take a very supportive role for any dollarization effort to

RAY SUAREZ: Miguel Diaz, Carol Graham, thank you both.