ARGENTINA: WHAT WENT WRONG? Guillermo Perry and Luis Servén World Bank May 2003

Transcription

1 ARGENTINA: WHAT WENT WRONG? Guillermo Perry and Luis Servén World Bank May 2003

2 Performance in the nineties: Better than most up to 1998, worse than most afterwards Real GDP Growth Rate (Percentages) Argentina Bolivia Brazil Chile Colombia Costa Rica Ecuador Mexico Peru Venezuela Average Source: World Development Indicators Database and the Unified Survey.

3 Outline of the presentation 1. External shocks 2. Vulnerabilities The hard peg Fiscal vulnerability Financial vulnerability 3. Conclusions and lessons

4 1. External Shocks: were they more severe than elsewhere?

5 External shocks: more severe than elsewhere? Not in the case of ToT shocks Argentina Chile Mexico Terms of Trade Shocks (Percentage of GDP) Venezuela, RB Ecuador Source: World Development Indicators - World Bank.

6 External shocks: more severe than elsewhere? Not in the case of spreads at least until 2001 Sovereign Spreads Argentina Brazil Mexico Argentina's spread reached 11,983 by March 25, 02 and has remained above 7,000 since then Rusian Crisis Jan-96 May-96 Sep-96 Jan-97 May-97 Sep-97 Jan-98 May-98 Sep-98 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03

7 External shocks: more severe than elsewhere? Not capital flows at least until 2001 Gross Capital Inflows (12 month moving average, Million US$) Argentina Mexico Brazil Dec-95 Apr-96 Aug-96 Dec-96 Apr-97 Aug-97 Dec-97 Apr-98 Aug-98 Dec-98 Apr-99 Aug-99 Dec-99 Apr-00 Aug-00 Dec-00 Apr-01 Aug-01 Dec-01 Apr-02 Aug-02 Dec-02

8 2. Vulnerability: The hard peg

9 The hard peg: a suboptimal currency area Argentina's Trade Structure 2001 Why the hard peg? OCA criteria were clearly violated: trade with U.S. = 2% of GDP A shortcut to credibility and nominal stability? Sanction of de facto dollarization -- encouraging it further Great exposure to real shocks -- with adjustment hampered by nominal inflexibility Rest of the world 24% Europe (**) 20% USA 14% Brazil 25% Main LAC w/o Brazil (*) 17% Notes: (*) Bolivia, Chile, Colombia, Ecuador, Guatemala, México, Perú, Paraguay, Uruguay, and Venezuela. (**) Austria, Belgium, Switzerland, Czech Republic, Germany, Spain, Finland, France, United Kingdom, Greece, Italy, Netherlands, Norway, Poland, Portugal, Sweden, and Switzerland. Source: International Monetary Fund - Direction of Trade.

10 The hard peg and real misalignment: a model-based assessment Actual and Equilibrium REER Real Overvaluation of the Peso Overvaluation 2 standard error bands Actual REER (1995=1) Equilibrium REER Average in percent

11 The hard peg: factors behind overvaluation. Stagnant relative productivity and declining foreign assets % -15% -20% -25% -30% -35% -40% Relative Productivity Net Foreign Assets (Percentage of GDP)

12 The hard peg: factors behind overvaluation. Wrong peg or diverging fundamentals? Sources of Cumulative Peso Overvaluation, (Percentages) 50% 40% 30% Diverging fundamentals Dollar overvaluation Trade structure 20% 10% 0% -10%

13 2. Vulnerability: fiscal policy

14 Fiscal vulnerability: Deficits were on the rise after Overall Budget Balance excluding privatization revenues (Percentage of GDP) Consolidated Public Sector Federal Government Provincial Governments Source: Ministerio de Economía de la República Argentina and World Bank.

15 Fiscal vulnerability: and so were public debt indicators Consolidated Public Debt and Service (Percentages) Consolidated Public Sector Debt / GDP Interest / Tax Revenue Source: International Monetary Fund.

16 Fiscal vulnerability: Expansion in the boom forced a (partial) contraction in the recession Blanchard's Indicator of Fiscal Impulse (Percentage of GDP) Mar-95 Jul-95 Nov-95 Mar-96 Jul-96 Nov-96 Mar-97 Jul-97 Nov-97 Mar-98 Jul-98 Nov-98 Mar-99 Jul-99 Nov-99 Mar-00 Jul-00 Nov-00 Mar-01 Jul-01 Nov-01 Source: Ministerio de Economía de la República Argentina.

17 Fiscal vulnerability: Rising interest rates made things worse Argentina: Interest Payments on Consolidated Public Debt Interest Payments on Debt Percent of GDP Change in Interest Burden Percent of GDP Contribution to Change in Interest Burden Debt Volume Effect Interest Rate Effect TOTAL Source: Ministerio de Economía de la República Argentina and IMF.

18 Fiscal vulnerability: Although debt indicators did not look excessive Debt Indicators in Emerging Markets Public Debt Percentage of GDP Percentage of GDP Public Debt Interest Payments Percentage of Tax Revenue Percentage of Debt Argentina Brazil Colombia Mexico Venezuela Poland Russia Turkey Source: Goldman Sachs and IMF. Note: Data are for 2000 except for Argentina (2001).

19 Fiscal vulnerability: low growth and high interest rates increasingly threatened solvency Average Growth Rate Implicit Interest Rate on Gov. Debt Consolidated Gov. Primary Balance Sustainable Balance (a) Sustainable Balance (b) (three preceding (av. growth rate (av. growth rate year average) based on last 3 based on last 5 year observations) year observations) Pencentage Pencentage Percentage of GDP Percentage of GDP Percentage of GDP n.s.p n.s.p. n.s.p Note: n.s.p. means no sustainability problem. Argentina: Indicators of Fiscal Sustainability

20 Fiscal vulnerability: and the peg hid the true magnitude of the solvency problem Argentina: Fiscal Sustainability and Equilibrium Exchange Rate Debt Output Debt Output Consolidated Sustainable Sustainable Ratio Ratio Gov. Primary Balance Balance Adjusted Balance (av. growth rate Adjusted for RER based on last 3 for RER Misalignment year observations) Misalignment Percentage of Percentage of Percentage of GDP GDP GDP n.s.p. n.s.p n.s.p. n.s.p Note: n.s.p. means no sustainability problem. The growth rate of the economy greater than the interest rate.

21 2. Vulnerability: the financial system

22 100% 80% 60% 40% 20% 0% Financial vulnerability: A seemingly strong financial system -- with large balance sheet mismatches Private Sector Dollarization (By type of Credit) Firm's Balance Sheet Dollarization Pleadge lending Mortgage Overdrafts 83% 79% 67% 60% Tradable sector Non-tradable sector Credit in U.S. Dollars over Total Credit Jan-94 Sep-94 May-95 Jan-96 Sep-96 May-97 Jan-98 Sep-98 May-99 Jan-00 Sep-00 May-01 Average Share of U.S. Dollar Debt across Firms

23 Financial vulnerability: The fate of banks became tightly linked to that of public finances Argentina's Financial Sector: Exposure to Public Sector Billions of US Dollars Claims on the Government Total Net Assets % 16.9% 17.9% 20.0% 20.8% 26.4% 0 Dec 1996 Dec 1997 Dec 1998 Dec 1999 Dec 2000 Aug 2001 *Total net assets correct for double counting on repos. Claims on the government include public bonds in foreign and local currency and loans (net of provisions) to public sector in local and foreign currency. Source: Central Bank of Argentina.

24 3. Conclusions and lessons

25 Conclusions and lessons Vulnerability was high due to the mutually reinforcing effects of: The dollar peg against OCA criteria and without nominal flexibility. Euro and Real depreciation (plus fiscal laxity) led to massive overvaluation. The peg also hid from public view the mounting fiscal solvency problems delaying their correction. A fragile fiscal situation inherited from the expansion in the boom years forced a contraction in the recession further damaging growth expectations and solvency perceptions. A highly dollarized financial system: the required real exchange depreciation threatened the debt repayment capacity of households and firms in the non-tradable sectors weakening banks and raising large fiscal contingencies. High exposure to government risk worsened the banking problem.

26 Conclusions and lessons: What should have been done in the boom years Keeping the peg -- but reducing vulnerability: Strengthening the fiscal position (surplus) Flexibilizing labor and other markets to absorb shocks Strengthening prudential regulation: Higher capital requirements for loans to households and firms in non-tradable sectors Liquidity earmarked for demand deposits (payments system) Limits on exposure to government risk Exiting the peg: Strengthening the fiscal position to build credibility Flexibilizing markets to remove inflationary bias Encouraging gradual de-dollarization

27 Conclusions and lessons: No good options after 1999 Keep the peg and undergo a protracted recession and deflation A demanding test on Argentina s fragile institutions Eventual debtor (and bank) solvency problems from RER correction Dollarize perhaps the least-cost option in the short run Somewhat easier adjustment: no currency risk and (perhaps) lower interest rates Still eventual debtor (and bank) solvency problems from RER correction In both cases, uncertain success -- and continued exposure to the same problems in the future Devalue Immediate banking and fiscal crisis due to balance sheet mismatches Pesify and devalue Would avoid balance sheet effects But would destroy confidence in the financial sector and require a deposit freeze

28 Conclusions and lessons: What have we learned? Hard pegs against OCA criteria are high-risk they cannot survive large real shocks bound to happen. Exit can have huge cost in bad times. Pro-cyclical fiscal policy can be disastrous. Fiscal stability requires a strong institutional framework encouraging surpluses (discouraging deficits) in booms. Banks prudential regulation in dollarized economies needs to be tougher than previously thought. A hard peg is no shortcut to credibility, nor a substitute for poor institutions. It does not automatically result in price flexibility and fiscal discipline. Its institutional requirements (fiscal, financial, labor) are as stringent as those of credible floats.

29 The End