Argentine Peso Devaluation
Recurring financial crisis in Argentina
Written in 2015
The theories of economic growth, introduced in the early post-Keynesian model of economic growth, have proved to be a powerful way of thinking about economic development. Many governments of developed and emerging economies praise them as their guiding star; so do many economists and policymakers at international organizations and intergovernmental organizations, including the United Nations and the International Monetary Fund.
Although many economic growth theories like the Harrod-Domar model are in danger of becoming victims of their own success, with broad dissemination, due to the complex and elusive nature of the quest for growth, debt policy has not failed everywhere, and Mexico is a good example of a success story. Post the Debt Crisis of the 1980s, banks in Mexico were stabilized, reducing their exposures to risk and a rescheduling agreement with foreign banks were implemented to reduce the debt burden.
Surely, Latin American economies have been drowning in recurring financial crises for the past thirty-five years. Today, the future of the Argentine economy is unclear. Instead of keeping an eye on aggregate demand, policymakers have been heavily relying on the exchange rate as the main cornerstone to restrain inflation. Evidence of such policies were notable about five years ago (2010 to 2011), where domestic prices rose about 54 percent, whereas the nominal exchange rate was only 12 percent, causing the real exchange rate to appreciate substantially.
It’s worth noting that high inflation coupled with an appreciating real exchange rate could spill disaster for a developing country. Argentina’s case was no different — growth in GDP, real wages, and investment dwindled. In fact, since the end of 2011, the economy has been trapped in a stagflation.
Argentina’s economic problems seem to derive from the imbalances that are being amassed.
Before the 2011 election, investors were already in a febrile state of mind about the Argentine peso. Widespread pessimistic views about the economy’s performance caused an anticipation of a currency devaluation. Many people were betting it would happen post-election; and in pursuit of profits, Argentine investors rushed to buy US dollars and other foreign deposits. Unfortunately, President Kitchener won the race, and the government changed course. The peso was not going to be devalued. The demand for US dollars however persisted; consequently, reserves in the central bank dried up.
Policymakers could have sustained the high demand for foreign currencies by devaluing the peso, thereby fine-tuning economic variables like real wages to stabilize. This was a nasty pill for the government to swallow; instead they opted to implement policies that included controls on imports and acquisition of foreign exchange in order to increase domestic savings.
Though this strategy may sound somewhat appealing, the real question is, are such structural solutions fit for a country like Argentina? In contrary, Mexico catered to the liberalization of foreign exchange and import restrictions during its disarray, which opened other doors to help stimulate their economy.
Controls can be very helpful if channeled in the right direction, that is, being built on a solid foundation, where for example, fiscal balances in a country are sustainable. In March 2015, Argentina ran a 17.4 billion pesos ($1.93 billion) deficit, just a year after running a budget surplus of 3.6 billion pesos. That’s too volatile. And besides, controls tend to backfire–instead of unwiring macroeconomic imbalances, they aggravate them.
It doesn’t take a genius to tell you implementing controls on the forex market to prevent the devaluation of a currency, while the real exchange rate is overvalued, that the economy will be subject to market failure. Investors and other business agents who use the forex market to do business will be forced to leave, for they won’t break-even on their investments. Few businessmen would operate in such circumstances, and many would opt for unregulated markets (i.e. black markets).
The market is destroyed almost by then. Black markets tend to negatively affect market outcomes, putting pressure on forex demand and supply variables (upward pressure on demand and the opposite for supply). For example, business agents are encouraged to delay orders and over-voice (increase fraudulently the price of a good or service) or under-invoice (the opposite) when exporting and importing goods and services. Furthermore, financial institutions and companies trying to participate in the regulated market, to void their foreign debts, leads to a feedback loop which eventually eats up the central bank’s reserves.
Indeed, initiates like the Baker Plan, which Mexico adopted, could help Argentina in debt restructuring. In Mexico, the Baker Plan allowed banks to reschedule their debts and give out billions of dollars in loans to citizens (of course in exchange for a half-a-billion-dollar bailout from the World Bank). However, for such reforms to fully work, banks must “keep true to their word,” otherwise giving away mere fractions in loans to the public would lead to inefficiency. That is why the Baker scheme eventually failed in Mexico. Suffice to say, it was a good plan. In fact, other countries reduced their debt burden under the Brady Plan.
In 1992, progress in debt deduction, coupled with reforms and the zeal of NAFTA, generated positive capital flows in Mexico, an astounding accomplishment — recorded at 8.5 percent of GDP. Current account deficits were about 6 percent, and the economy was basically reinvigorated.
Argentina’s Central bank’s reserves have been dwindling relentlessly for the past few years. However, starting on Thursday, the country’s exchange rate will be allowed to float after years of fixed exchange regime, prompting what is expected to be a 30% devaluation of the peso. Whether this new regime would help stimulate economic growth in the country in unknown; however, what’s necessary is for Argentina to ensure that its borrowing is matched by viable investments.
SOURCES: INTERNATIONAL DEBT STATISTICS 2015 — THE WORLD BANK
