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Group 7
Abhilash K. (01)
Anant Bibhore (08)
LamzoulianVaiphei (30)
Prasanna Nakka (41)
Ranjit Ram (49)
Supratik Saha (61)
Problems that the Argentinean economy will face in the next 3 years......................................................................8
1) High Inflation:....................................................................................................................................................8
Remedies to the problems that the Argentinean economy will face in the next 3 years..........................................12
1) High Inflation:..................................................................................................................................................12
Bibilography.............................................................................................................................................................15
Argentina -- A socio-political-economic Overview
Pre – Independence: Argentina is the eight largest country of the world
spread over an area of almost 28 lakh square Km. Inhabited from almost 11,000
BC the country was relatively sparsely populated until the arrival of the
Europeans in the 16th century. Juan Diaz de Solis is credited to have been the first
European to visit the area presently known as Argentina. The Spanish established
a colony in Argentina around 1580. Napoleon’s Spanish conquest triggered a
revolution in Argentina in May 1810, popularly known as the May revolution.
Argentina made a formal declaration of independence in the year 1816. 85% of
modern Argentina is inhabited by the descendants of immigrants from Europe,
the remaining being Mestizos, indigenous Americans and others.
Golden Age: Soon after the declaration of independence, a civil war wrecked
the country and Paraguay, Bolivia and Uruguay seceded to form separate
nations. Political instability continued till the formation of the constitution in
1853. A national unified government was established in 1861. Post-unification,
Argentina witnessed a developmental spree and emerged as one of the ten
wealthiest countries of the world by 1929. This period in the twentieth century is
referred to as the ‘Golden Age’ of the Argentine economy. GDP growth averaged
around 5% during this period. This economic prosperity of the country could be
attributed to the following key reasons:
Dirty War in the 1970’s: During the 1970’s the country witnessed the ‘Dirty
War’ after the military seized power from the widow of Juan Peron, who had
started the Partido Unico de la Revolucion popularly known as the Peronist. From
1976 to 1983 Argentina remained under a military dictatorship and in attempt to
curb the extremists the military took very harsh measures. Large numbers of
deaths and disappearances were reported during this period and the economy
remained in chaos. Serious economic problems, mounting charges of corruption,
public revulsion in the face of human rights abuses and, finally, the country's
1982 defeat by the United Kingdom in an unsuccessful attempt to seize the
Falklands/Malvinas Islands all combined to discredit the Argentine military
regime.
The Menem Magic in the 90’s: Menem along with noted economist of the
period, Domingo Cavallo initiated imposed peso-dollar parity in 1992. This meant
that the peso was fixed vis-à-vis the US dollar on a one-to-one basis and this
convertibility was backed by codified law and a promise by the central
government to furnish dollars to anyone who wanted to exchange pesos. This
created an atmosphere of credibility in the steps taken by the government to
curb inflation. In addition to this the government took steps to promote
liberalisation, deregulation and privatization of the Argentinean economy. Soon,
inflation came down to single digit figures and in the period from 1990 to 1997,
the GDP of Argentina grew on average by 6% per year. By the end of the decade
The Argentinean Default: But, this peso dollar parity meant that the
monetary base had to be completely backed by foreign currency reserves. This
effectively disabled Argentina’s monetary policy. Also, the exports became less
competitive and vis-a-vis important trading competitors. As a result, Argentina’s
ability to earn hard currency was damaged. Argentina started borrowing heavily
to finance deficits. The global slowdown in 2001 hit the country and market
confidence deteriorated. The government was starved of foreign reserves and
despite IMF’s bailout attempts the Argentinean economy collapsed into default in
2001. The political situation was thrown into turmoil as one president after
another assumed office and stepped down. The one-to-one pegging with the US
dollar had to end and 60% of the Argentines were left below poverty line.
Chart: GDP Growth Rate 1980-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)
Chart: Unemployment Rate 2003-2010 (Data Source: International Monetary Fund, World
Economic Outlook Database)
Inflation: Official Inflation figures are very unreliable as the government has
tried to supress inflationary data. Officially customer prices have increased by
6.3% in 2009. Unofficial figures however have put the inflation of last year at
15%. Coupled with the recessionary pressures of the past year this is an
extremely high figure. Officially 2010 was an even more difficult year for
consumers as officially inflation was supposed to rise at 10%. Unofficial
calculations report the price increase to be at a whooping rate of 25% in 2010.
High inflation will have a toll on the real GDP increase in the coming years.
Chart: Inflation 2008-2011 (Data Source: International Monetary Fund, World Economic Outlook
Database)
Chart: Current Account Balance 2008-2011 (Data Source: International Monetary Fund, World
Economic Outlook Database)
Exchange Rate: The Central Bank of the country intervenes in the exchange
rate even now though peso is no longer pegged at one-to-one to dollar and the
exchange rates are supposed to be floating. But, in reality the exchange rate is
determined by a managed float system. Average exchange rate in 2009 was 3.73
pesos per dollar. In September 2010 the rate was 3.94 pesos per dollar. The
peso's real exchange rate had been undervalued in earlier years, which, along
with historically high global commodity prices, helped lift export volumes and
values to record levels.
Debt Levels: The economic crisis of 2001-02 is still haunting the country in the
form of huge debts which are yet to be paid back. Debts in Argentinean Peso
have increased from 615 billion in 2008 to 675 billion in 2009. Estimated value of
debts in 2010 was a high 774 billion peso. It owes about 8 billion USD to official
creditors. International Capital Markets have been closed for Argentina since its
debt crisis. From May to June 2010, the Government of Argentina offered a debt
restructuring for private holders of defaulted bonds. Two-thirds of the private
bondholders participated. This has resulted in about USD 6 billion in private
default claims which is yet to be paid back.
Chart: General government gross debt 2008-2011 (Data Source: International Monetary
Fund, World Economic Outlook Database)
Fiscal and Monetary Policy: The Central Bank governor Martín Redrado was
removed by the government on his refused to transfer USD 6.6billion of foreign
exchange-reserves for public debt payments. The new Governor, Mercedes Marcó
del Pont, is a close ally of the government. So, it is expected that the Central
Bank will continue with it’s lose monetary policy instead of moves to tighten
liquidity. Also, the Central Bank might continue financing the fiscal deficit of the
government as and when necessary.
The government is following an expansionary fiscal policy with heavy
government spending. The expenditures are targeted at keeping the growth
rates high and close the average of 9%. The combined effect of expansionary
fiscal and monetary policies is bearing down on the prices which are on an ever
increasing trend.
1) High Inflation:
High inflation is a problem that the Argentine economy has been troubled
with from a long time and is likely to be a big problem for the economy in the
coming years. The central government has been reporting inflation rates at
around 9% on an average since 2006. But, private estimates put this number at
around 20%. So, it is a well-known fact in the global financial markets that the
government is underreporting the inflationary figures.
The steps taken by the government to control inflation have clearly not
been enough. Neither the fiscal policy undertaken by the government, nor the
monetary nor the managed float policy for exchange rates have done anything to
instil belief in the consumers and the industries that inflation is going to come
down in the coming future. On the contrary, inflation is following an increasing
trend and seems to growing at a year-on-year basis.
These demands put forward by the official unions are indicative of the
following problems:
1. Purchasing power of the Peso is reducing fast as the wage increments are
not being able to keep up with the price rise
This huge burden of debt has been a cause of concern on the Argentine
government ever since. The debt restructuring policy followed by the
government in the recent years has resulted in paying back of USD 100 billion of
debt. But, there a long way to go before the problem can be alleviated. The debt
in terms of domestic currency is on a rising trend even now. The country ows
about USD 6.3 billion to official creditors in different nations who are collectively
called the Paris club. The international capital markets are also closed to
Argentina before it can repay back a substantial amount of these debt
obligations.
But, as the government has rescheduled debt with the official creditors this
normally means that the government has to register for an economic program
with the international Monetary Fund. But, this will again prove to be a major
setback for the government which had recently in 2006 succeeded in paying
back USD 9.8 billion of IMF credit. If the government has to enter into a renewed
agreement with the IMF it has to go back on its previously announced victory
against the IMF. The Argentine government had only succeeded in repaying IMF’s
money as the Venezuelan president Hugo Chavez had stepped in to help.
Venezuela poured in the money earned from oil exports in bailing out Argentina
against the IMF. Venezuela also assisted Argentina to access the foreign financial
markets by underwriting USD 4 billion for Argentina through bonds. But, it would
be able to continue doing so if the oil prices fall in the near future.
Due to this very reason Argentina needs to improve its image with its
creditors. The country needs more funds than Venezuela has underwritten it for.
This can only be received once investor confidence is rejuvenated. But, the
history of default and consequent devaluation of the domestic currency is still
fresh in the memories of Wall Street and the other investors. This has severely
deteriorated the credit rating of the country and increased country risk. As a
result, Argentina has to pay much higher interest rates in international markets
and is expected to do so in the near future.
Also, the country has a recurrent problem in the form that many creditors
had held out against the debt restructuring scheme of the government. This is
because these creditors felt that the terms of the negotiation were tilted against
them. These creditors are constantly demanding that the government negotiate
a restructuring with better terms. So, all in all the debt crisis is harming the GDP
of the country as the investment required cannot be generated. So, it is in
Argentina’s interest to come to terms with all of its creditors and repay the
mounting debt as soon as possible.
1) High Inflation:
The contractionary monetary policy would ensure that there is less supply
of money in the market. This will result in higher interest rates, which will be
reflected in lower investment over times. As, the investment component will fall,
so would the aggregate demand. With the fall in aggregate demand prices should
fall bringing down inflation.
r LM2
LM1
r3
r2
r1 IS2
IS1
Y1 Y2 Y
Graph: Using IS-LM Curve to depict the fiscal and monetary policy outcomes
The two bigger economies of Latin America viz. Brazil and Argentina have
both experienced an average increase in GDP in the past 5 years barring the two
year period of recession in 2008-2009. Both of these economies have exports as
a key part of their GDP. But, the differentiating factor in Brazil’s success and
Argentina’s dubious financial situation has been in the exchange rate policy
followed by the central Banks of the two countries.
Brazil has not tinkered much with the exchange rate of its domestic
currency and has let it float relatively freely. This has resulted in the Brazilian
currency, the Real appreciating against other major currencies in the last 5 years.
But, Argentina had taken the just opposite approach.
So, taking a cue from Brazil, the Central Bank of Argentina should stop
interfering aggressively with the exchange rate of the Peso. This would be
beneficial in three ways:
Firstly, it would release the pressure on imports. As, the currency appreciates
imports would be less costly and the import intensive industries would do better.
Secondly, such a policy would lower inflation and even more importantly when
the Central bank announces such a policy the expectation of the people
regarding inflation is going to come down. This would be beneficial in bringing
down the price levels which are astronomically high and are ever increasing at a
fast pace.
Argentina has a huge burden of debt and it is high time that the
Government to allocates a higher part of its budget in paying back the
accumulated credits from foreign investors. The debt restructuring had helped
but as a lot of creditors had not accepted the terms, the government has to
renegotiate with these creditors to include them in the debt restructuring
scheme. This would ease the burden somewhat. But, the essence in doing so is
time as the accumulated debt is increasing every year.
The credit rating of Argentina had gone down hugely after the default in
2001-2002. The debt pay back would help in recovering that tarnished image and
open up the global capital markets for Argentina which at present is quite closed
for them.
Though Argentina seems to have learnt its lesson against huge borrowings
but, the recent borrowings from Venezuela is an area where it should tread more
carefully. Argentina would better not repeat the mistake it made in the start of
the last decade.
1. Wikipedia - http://en.wikipedia.org/wiki/Argentina
2. World Economic Outlook Database, October 2010
3. Argentina Country Report 2006 by The Economist Intelligence United Ltd
4. U.S. Department of State Background Note on Argentina
-http://www.state.gov/r/pa/ei/bgn/26516.htm
5. Central Intelligence Agency - The World Fact book -
https://www.cia.gov/library/publications/the-world-factbook/geos/ar.html
6. Argentine Financial Crisis: Lessons Learned - INTERNATIONAL JOURNAL OF
BUSINESS RESEARCH, Volume 9, Number 5, 2009
7. Radobank Country Report Argentina -
http://overons.rabobank.com/content/images/Argentina-201004_tcm64-
85825.pdf
8. Argentina - Macroeconomic issues -
http://globotrends.pbworks.com/w/page/14807636/Argentina%20-
%20Macroeconomic%20issues