The default on sovereign debt in December 2001

I - INTRODUCTION

The default on sovereign debt in December 2001 and the abandonment of

the fixed exchange rate in January 2002 provoked, as it is very well known, a

full-blown financial crisis in Argentina. The peso depreciated more than 350%

in the nine first months of the year and the inflation rate reached 25.9% in 2002,

after three years (1999-2001) of deflation. The recession deepened: after having

fallen 4.4% in 2001, GDP collapsed 11% in 2002. Therefore, in 2002 GDP was

20% lower than in 1998 and the unemployment rate reached 18%. The current

account balance, after displaying a deficit in 2001 (-1.7% of GDP), turned into a

large surplus in 2002 (8.3% of GDP). Poverty and inequality increased and the

wounded productive sector will surely take several years to recover.

The causes of the Argentinean crisis have been extensively debated. In

short, three main interpretations could be listed.

• The first one emphasizes the incompatibility between the rigid exchange-rate regime and the imprudent fiscal policies (Mussa, 2002), so that the crisis was, in fact, a first generation type of crisis.

• The second explanation stresses the “sudden stop” in international

capital markets after the Russian crisis in August 1998 .

• The third explanation blames the inappropriate character of the exchange-rate

regime .

II- The Argentinean crisis (2001-02)

Primary public expenditures remained virtually constant (around 23-24% of GDP) between 1993 and 2001. The public deficit did not reach relatively high levels until 1999 (4.2% of GDP) and as a consequence, rather than as a cause, of the recession. The public primary balance was even positive in 1997 and 1998. In short, “the fiscal imbalance that emerged was related to the recession and hence is best understood as a consequence rather as a cause of the crisis.

Moreover, the reduction in Argentina’s net capital inflow in 1999 respective to 1998 was mild (it only decreased from 23.3 US$ billion in 1998 to 21.0 billion in 1999), mainly because inward foreign direct investment triplicated its value.

Origin of the Argentinean crisis

The origin of the Argentinean crisis has to be tracked to the exchange rate-based stabilization program adopted in April 1991, with the creation of a currency board. Argentina’s currency board was not actually “orthodox”, but it consisted mainly in establishing a fixed peso-dollar exchange rate and in backing the bulk of circulating pesos with reserves in US dollars.

For analytical purposes, the period which has to be observed is 1992-98, as

in 1999 the economy already entered recession. From 1999 onwards, data are

misleading, because, for instance, the relatively low level of the current account

deficit (4.2% of GDP in 1999 and 3.1% of GDP in 2000) was a consequence of an

abrupt fall in imports, induced by the recession.

Public debt increased from 29.5% of GDP in 1993 to 43.3% in 1998 and to 51.3% in

2000 .

Argentina’s currency board could hold a maximum of one third of its

assets in government bonds and it acted temporarily (in the aftermath of the Mexican

crisis) as a lender of last resort. Moreover, the central bank kept a certain amount of

regulatory power over commercial banks, as it established their reserve ratios.

The hard peg had indeed some positive results in the case of Argentina.

First, it allowed for a substantial reduction in inflation, whose annual rate

decreased from 3,080% in 1989 and 2,314% in 1990 to 17.5% in 1992. The

inflation rate was lower than 4% since 1994 and lower than 1% since 1996.

Therefore, interest rates could decrease and the investment rate grew

significantly (gross domestic investment increased from 14% of GDP in 1990 to

17% in 1992 and to 21% in 1998).

Second, the peg made possible an increase in productivity, mainly in the

tradable goods sector, which contributed also to the growing external

competitiveness. The annual rate of change in total factor productivity, which

had been negative in the 1980s (-1%), reached 2.1% in 1991-98 (

The main reason is that the imports of capital goods grew substantially in the

early 1990s.

Third, it regenerated financial intermediation, as both bank deposits and

loans increased their share in GDP: between 1991 and 1998, deposits increased

from 8% of GDP to 26%, while loans grew from 14% to 30%.

Finally, the disappearance of the exchange risk contributed to a sharp

growth in capital inflows in the form of foreign direct investment, which was

also a result of widespread privatizations of public firms and banks. Gross

foreign direct investment increased from US$ 1.8 billion in 1990 to 4.2 billion in

1996 and to 8.1 billion in 1997.

All the above factors contributed to a substantial growth of GDP (an annual

rate of 6.7% in 1991-97), although the expansion was erratic,

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