The Financial Crisis in Argentina

CRS Report for Congress
The Financial Crisis in Argentina
J. F. Hornbeck
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
After nearly four years of recession, Argentina plunged into a severe political and
financial crisis that ended the presidency of Fernando de la Rua on December 20, 2001.
On January 1, 2002, the Argentine Congress selected Peronist Party leader Eduardo
Duhalde to complete his term of office. For over a year, President Duhalde struggled
with Congress to define an economic strategy that would unify the country and solidify
support for a new round of international financial assistance. Unable to come to terms
with the IMF over a medium-term package, on January 24, 2003 the Fund approved,
with some reservations, a new transitional $6.8 billion arrangement that provided
enough financial resources to “roll over” Argentina’s current IMF commitments only
through August 2003. This helped provide stability during the presidential election
cycle, which resulted in Governor Néstor Kirchner’s victory. Although Argentina’s
economy has stabilized, it remains fragile, the country is deeply in debt, and the new
administration faces difficult political choices if it is to define a long-term economic
recovery strategy. This report concludes with the May 25, 2003 inauguration of
President Kirchner and will not be updated.
Background to the Crisis
The seeds of Argentina’s financial and political crisis were planted with adoption of
its currency board in 1991, a strategy conceived to fight hyperinflation by constraining
long-term undisciplined monetary and fiscal governance. Prior to 1991, economic and
political turmoil defined Argentine history, punctuated at times by attempts at
stabilization. It was widely hoped that the election of Peronist candidate Carlos Menem
to President in 1990 (and his selection of Domingo Cavallo as Minister of Economy)
would inaugurate a period of lasting change. They began a major structural adjustment
program that included tax reform, privatization, trade liberalization, deregulation, and the
currency board.1 Congress approved the currency board with passage of the Convertibility
Law, which legally guaranteed the convertibility of peso currency to dollars at a one-to-

1 More on the reforms of this time can be found in Wise, Carol. Argentina’s Currency Board:
The Ties That Bind? In: Wise, Carol and Riordan Roett, eds. Exchange Rate Politics in Latin
America. Washington, D.C. The Brookings Institution. 2000. pp. 96-99.
Congressional Research Service ˜ The Library of Congress

one fixed rate, and which limited the printing of additional currency only to an amount
necessary to purchase dollars in the foreign exchange market. Effectively, each peso in
circulation was backed by a U.S. dollar and monetary policy was forcibly constrained to
uphold that promise. By tying its currency and monetary policy to the United States,
Argentina was able to achieve its goal of a similarly low inflation rate.
The currency board’s monetary restriction, however, effectively required a fiscal
constraint as well because a government deficit had to be covered by debt rather than by
printing money (monetized).2 Therefore, the currency board raised hopes for a credible
economic stabilization based on a compulsory monetary restraint and implied fiscal
discipline, both long absent in Argentina. The economy performed well in the early

1990s. Stabilization brought low inflation and interest rates, attracted new investment,

and spurred economic growth. But its success hinged on continuing economic growth and
disciplined macroeconomic policies, particularly if it were to weather the inevitable
external shock. Three major “areas of vulnerability” were clear from the outset: the fiscal
deficit, which would threaten the financial stability of the currency board; the high level
of external debt, which would compound budgetary pressures and leave Argentina
vulnerable to the vagaries of external capital; and a real (inflation-adjusted) appreciation
of the peso, which would cause international competitiveness (current account) problems.3
Economic Challenges
Despite these concerns being well known, Argentina failed to heed them. First, and
foremost, Argentina’s convertibility regime required fiscal control. This was no small
task given weak tax compliance, recession-induced revenue shortfalls, and overspending
by provincial and national governments. As fiscal deficits continued, debt rose to become
the key vulnerability. As may be seen in Table 1, since 1995, the consolidated primary
fiscal balance, which excludes interest payments, was slightly negative or positive, but the
overall balance, with interest, grew to become a serious deficit by 1999. The difference
between the two deficit measures shows how between 1995 and 2001 the portion of the
budget spent on servicing public debt (interest payments) grew from less than 2% to over

5% of GDP. The debt service ratio, a measure of the foreign component of public debt,

was equally dismal, more than doubling from 29.5% in 1995 to 65.7% in 2001.
Importantly, budget deficits and debt plagued both provincial and national
governments, eventually undermining credibility in the country’s overall fiscal policy (and
by extension the convertibility regime).4 Fiscal sharing guaranteed federal payments to
provincial governments that served as a significant portion of their revenue, an
arrangement that discouraged discipline at the local level and proved difficult to alter.
Neither was there sufficient external pressure on Argentina to change fiscal course given
continuing lending by the International Monetary Fund (IMF) and private creditors who

2 See CRS Report RL31169, Argentina: Economic Problems and Solutions, by Gail Makinen.
3 Dornbusch, Rudiger. Progress Report on Argentina. In: Dornbusch, Rudiger and Sebastian
Edwards. Reform, Recovery, and Growth: Latin America and the Middle East. Chicago,
University of Chicago Press. 1995. pp. 224-29.
4 See Wise, Carol and Manuel Pastor. From Poster Child to Basket Case. Foreign Affairs,
November/December 2001, p. 6.

did so relying on promises of future policy changes and assumptions of strong economic
growth. These assumptions proved to be excessively optimistic, which should have
become increasingly clear as Argentina’s recession dragged on.
Table 1. Argentina: Selected Economic and Financial Indicators
1995 1996 1997 1998 1999 2000 2001 2002
GDP Growth (%)-
Inflation - CPI (%)
Unemployment (%)18.417.
Consolidated Overall-2.3-3.2-2.1-2.0-4.1-3.6-6.8-9.9
Fiscal Balance (% ofa
Consolidated Primary-0.4-
Fiscal Balance (% ofb
Current Acct. Bal.(%-1.9-2.4-4.1-4.8-4.2-3.1-1.78.2
of GDP)
Debt Service c29.533.840.138.149.654.865.747.4
Terms of Trade0.37.8-1.2-5.5-5.910.2-0.6-1.1
Source: IMF.
a. Includes federal and provincial government budgets, trust funds, and capitalization of interest.
b. Primary balance excludes interest payments.
c. Public sector debt as a percent of exports of goods and nonfactor services.
External factors also threatened the currency board, beginning with a real
appreciation of the peso. It started in 1991 with Argentina’s higher inflation rate relative
to the United States, but became a serious issue when the U.S. dollar appreciated from
1995 to 1999, meaning that the dollar-linked peso also appreciated relative to the
currencies of Argentina’s trading partners. Argentine exports became less competitive,
and imports a bargain, as seen in the deteriorating current account deficit. Argentina’s
competitiveness was further eroded by the Brazilian devaluation in January 1999,
diminished terms of trade due to falling commodity prices, and rising interest rates. By
the late 1990s, these inhospitable external factors, along with the global downturn in
2001, compounded the effects of poor domestic policy decisions to compromise
Argentina’s current account, budget deficit, and debt position (see Table 1).
By 2000, Argentina faced a major adjustment problem, creating a policy conundrum
that was centered on the inherent constraints of the currency board. In countries with
flexible exchange rates, a persistent current account deficit that is not financed by capital
inflows would force the exchange rate lower, correcting the currency overvaluation,
improving competitiveness, and in time, restoring balance. Given weak productivity
growth and Argentina’s inability to devalue its nominal exchange rate, the only way to
become more competitive was to allow dollars to leave the country, thereby reducing the5
money supply, and causing domestic prices to fall (a de facto policy of deflation). This
process could take years to restore competitiveness and find a new growth equilibrium,
and at a severe social cost; Argentina’s deepening recession and growing unemployment.

5 Makinen, Argentina: Economic Problems and Solutions, p. 3

The constraints of the currency board also kept Argentina from fighting its lingering
recession with either a strong fiscal stimulus or expansionary monetary policy, as the
United States did in 2001. In fact, the consensus policy recommendation was to do just
the opposite and tighten the budget to address concerns over mounting debt and overall
fiscal credibility. In short, Argentina had no way to address both problems of debt and
economic growth simultaneously and still maintain its currency board.
Unable to address basic economic imbalances, President de la Rua, again guided by
Minister of Economy Domingo Cavallo, opted for increasingly novel and desperate
measures to meet pressing short-term financial needs. In June 2001, $29.5 billion of
short-term debt was exchanged for new debt with longer maturities and higher interest
rates. It was assumed that the return of strong economic growth would allow Argentina
to cover the higher debt service. Argentina then engineered an effective 7% devaluation
of the peso for foreign trading, expecting to improve its competitiveness, but which also
further compromised confidence in the currency board. As perceptions of risk rose,
interest rates followed, so liquidity became tighter and both the federal and provincial
governments issued bonds in the form of scrip to pay public salaries. This quasi-money
was allowed to circulate as currency, further undermining the monetary system.
Argentina’s last hope for financial recovery rested on the debt swap announced in
November 2001. The federal government had $132 billion dollars in debt ($95 billion in
bonds). Some $60 billion of bonds were refinanced as a tax-receipt guaranteed loan,
lowering the average interest rate from between 11-12% to 7% and extending the maturity
of the notes by three years. The November debt swap strained credibility with private
lenders, who labeled it a “distressed exchange” and treated it effectively as a default. In
addition, the interest savings proved to be much smaller than anticipated and Argentina
failed again to meet the fiscal targets promised in its IMF program. This led to the IMF’s
refusal to extend a $1.3 billion draw scheduled for December 2001. By then, Argentina
found itself cut off from international financial markets, both public (official) and private.
As confidence in the peso waned, the flight to dollars accelerated and international
reserves fell by over $4 billion in November. President de la Rua responded with a decree
limiting individual cash withdrawals to $1,000 per month, setting off the violent protests
that culminated in a full blown crisis, and soon thereafter, his resignation.
The Role of the International Monetary Fund
Argentina’s attempts to deal with its financial difficulties included an ongoing
relationship with the IMF. As Table 2 suggests, Argentina is no stranger to the IMF;
since the Latin American debt crisis in the 1980s, it has tapped the IMF repeatedly, and
in general, for increasingly large amounts of money. Argentina’s current $6.8 billion
“transitional” (eight-month) IMF stand-by arrangement was approved on January 24,

2003. It replaced the March 20, 2000 arrangement requested by President de la Rua,

which in turn had replaced the extended arrangement of February 4, 1998. Argentina’s
growing indebtedness to the Fund has been conditioned on repeated promises of fiscal
adjustment, including reducing transfers to provincial governments and obtaining their
commitments to cut local budgets as part of a broader revenue-sharing reform effort.
Previous arrangements also assumed that Argentina’s economy would grow by 3.5% in
2000, and 4.0% in later years, which clearly did not happen. The Argentine government
projects the economy to grow by 3% in 2003.

Table 2. Argentina: History of IMF Lending
(in millions of SDRsa)
Date ofDate ofFacilityAmountAmountAmountb
Arrangement Expi r a t i on Agreed Draw n O ut s t a ndi ng
Dec. 28, 1984June 30, 1986Stand-by1,182.51,182.50
July 23, 1987Sept. 30, 1988Stand-by947.5616.50
Nov. 10, 1989March 31, 1991Stand-by736.0506.00
July 29, 1991March 30, 1992Extended780.0438.80
March 31, 1992March 30, 1996Stand-by4,020.34,020.3731.4
April 12, 1996Jan. 11, 1998Stand-by720.0613.0 0
Feb. 4, 1998March 10, 2000Extended2,080.000
March 10, 2000March 9, 2003Stand-by16,936.8 9,756.39,015.3
Jan. 12, 2001Jan. 11, 2002(of which6,086.65,875.05,134.0
Jan. 24, 2003Aug. 31, 2003Stand-by2,174.5747.0747.0
Tot a l 29,577.6 17,880.4 10,493.7
Source: IMF Web site at [].
a. The Special Drawing Right (SDR) is the unit of account at the IMF, its value is based on a basket of
currencies and fluctuates over time. On March 18, 2003 it was equal to approximately $1.36.
b. Amount still owed to the IMF as of February 28, 2003. # Supplemental Reserve Facility provides funds
at higher rates and shorter maturities to countries that have experienced a sudden loss of market
confidence, but have corrective reform measures in place.
Argentina’s continued weak economic performance during the crisis prompted the
IMF on January 12, 2001 to augment the original agreement by $7.0 billion (SDR 5.2
billion). This was part of a larger package that included $5.0 billion in loan commitments
from the Inter-American Development Bank (IDB) and the World Bank, $1.0 billion from
Spain, and voluntary refinancing from the private sector of $20 billion. The IMF
advanced these funds with an expectation that the Argentine economy would grow by
2.5% in 2001, which also proved unattainable, leading to a third augmentation of $7.4
billion (SDR 5.6 billion) on September 7, 2001. This increase was also based on
promises of strong fiscal reform, as defined by the “Zero Deficit Law” passed on July 29,
2001, and revenue sharing reform with the provinces. Despite IMF funding, it became
increasingly clear that the high cost of debt combined with recession and doubt over
Argentina’s ability to make needed adjustments led the country to default.
President Duhalde was given broad emergency powers by the congress to keep
Argentina’s financial crisis from mushrooming into economic and social collapse. He
initially attempted to restore Argentina to financial competitiveness and credibility by
abandoning the currency board and the peso’s 1-to-1 peg with the dollar in favor of a dual
exchange rate system based on an official rate for foreign trade transactions of 1.4 pesos
to the dollar and a floating rate for domestic transactions. Dollar denominated bank loans
up to $100,000 were converted to pesos at the 1-to-1 rate, passing on the cost of
devaluation disproportionally to creditors (mostly banks). Duhalde also “guaranteed”
dollar deposits, but to avoid bank runs, retained the policy of limiting monthly
withdrawals begun under President de la Rua.

From the beginning, this plan faced opposition from both international creditors and
domestic interest groups. To complicate matters further, on February 1, 2002, the
Argentine Supreme Court ruled that the freeze on bank deposits was unconstitutional. To
avoid a run on the banking system, Duhalde responded by easing limitations on
withdrawals, but decreed a moratorium on enforcement of the Supreme Court order. On
February 3, 2002, Duhalde announced a new economic plan, adopting a single floating
exchange rate system and a changing array of capital controls. The foreign exchange
market was unstable for months before the peso settled, losing over 70% of its value.
Duhalde also gave up on his earlier promise to guarantee dollar deposits, which were
converted to pesos at the previous official rate of 1.4 to the dollar. The mismatch in the
conversion rate between bank loans (assets) and deposits (liabilities) left banks
undercapitalized and relying on government assurances for financial assistance.
Argentina was also unable to move quickly to resolve a host of other structural problems
that impeded development of a credible plan to rebuild the financial system and work out
a new IMF assistance package.
The Argentine economy resumed growth in late 2002, much sooner than many had
predicted. Resolving severe economic and social problems, including high rates of
unemployment and poverty, will require more time. In addition, Argentina remains in
default of its private debt and is subsisting on a short-term transitional $6.8 billion
arrangement put in place on January 16, 2003, which was supported by the United states
and other G-7 countries as necessary for Argentina to avoid defaulting on the IMF. The
Fund provided sufficient financial resources only to “roll over” Argentina’s IMF
repayments through August 2003 under the assumption that a medium-term arrangement
could be put in place by September 9, 2003, when a $2.7 billion payment comes due. The
interim agreement helped provide the stability Argentina needed to complete the
presidential election cycle that resulted in Governor Néstor Kirchner’s victory in what was
widely reported as a fair election with near record voter turnout (80%).
As the Kirchner administration takes over, Argentina has already begun a reform
process that will have to continue if it is to achieve long-term economic growth and
stability. The freeze on bank deposits has been lifted, following a Supreme Court ruling,
various scrips are being replaced with pesos, and fiscal control is being re-exerted.
Although Argentina’s economy has stabilized, it remains fragile and deeper structural
reforms await action. These will make for difficult political decisions on such issues as
the sovereign debt workout, banking sector reform, public utility contract negotiations,
and tax reform, just to name a few in addition to dealing with the IMF. Therefore,
although this chapter of Argentina’s financial crisis appears to be over, returning to a path
of growth and prosperity presents a long-term challenge to the country.