Passing
judgment in a landmark case the Supreme Court of Argentina
recently declared that the deposit of US $247 million
that the province of San Luis has with the state-owned
Banco de la NaciAon has to be returned to the province
in dollars. This has led to the fear that the Court
has in effect declared as unconstitutional a one-year-old
decree issued by the Argentine President that led
to the conversion of billions of dollar-denominated
bank deposits into pesos. The Court ruled 5–3
in favour of redollarization. The ruling however has
run into controversy with accusations of biasedness
against two of the judges who have ruled in favour.
Of the two, one has a dollar-denominated account,
while the other had made his opinion public even before
the ruling was announced.
While many have blamed Argentina's political class
for the debacle, the fact is that the country's policies
during the 1990s were being advocated as exemplary
by neoliberal economists all around the world. Argentina's
'growth' during this decade after years of stagnation
was hailed as a success of the IMF–World Bank
guided economic reforms. And in the early 1990s the
reforms did seem to work. But a series of external
shocks, starting with the Mexican peso crisis of 1994
and 1995, the Asian crisis in 1997 and 1998, and most
importantly the Brazilian devaluation in January 1999,
left the country in the midst of an economic collapse.
Economic growth turned negative, and interest rates
rose amidst fears that Argentina might default on
its debt. The higher rates of interest virtually hastened
Argentina's debt default.
In order to maintain investor confidence the Argentine
government focused all its efforts on just attaining
investment-grade rating in the credit markets. Virtually
all commitments to domestic constituencies, public
employees and pensioners were abrogated by the government
in order to exhibit its commitment to serve Argentina's
external debt. But nothing that Argentina did helped
it regain the confidence of its investors. The more
regressive measures the Argentine government took—retrenchment,
cuts in government salaries, sharp fiscal cutbacks—the
more jittery did the investors and creditors become.
Nothing seemed to work for the government in Argentina.
It seemed apparent that the one-to-one fixed rate
on exchange of peso–US dollar that was in place
since 1991 had become unsustainable, not only in respect
to the US dollar, but also vis-à-vis other
currencies. Anticipation of devaluation triggered
fears about the peso losing its value and hence led
to eagerness on the part of all Argentineans to convert
their deposits into US dollars. The government also
planned a freeze on the prices charged by the foreign-owned
companies providing public utility services like electricity,
gas and telephone services. Exports of foreign-owned
oil companies were also to be brought under the tax
net.
Even then Argentina had to devalue its currency, and
when the pesofication was carried out, for every dollar
held, an account holder in a dollar-denominated account
was given 1.4 pesos. However, the devaluation did
not help Argentina much in shoring its exports. Primary
among the causes behind this failure is the recession
in major industrial countries, the shift of the United
States to selective protectionism, and competition
from other developing countries, most of them in a
position similar to that of Argentina, with each trying
desperately to grab a share of the world's primary
products market to rev up its foreign-exchange earnings.
It is under this situation that Argentina decided
to first freeze fixed-term dollar current and savings
accounts, initially for a year, and later decided
to convert dollar-denominated bank deposits worth
billions of dollars into pesos. Holders of current
accounts of less than US $10,000 were allowed to convert
dollar savings into pesos at 1.4 pesos for each dollar,
or withdraw US $500 every month.
It is a fact that the recent ruling by the Argentine
Supreme Court has been a 'narrow' one in the sense
that this ruling in favour of 'redollarization' will
apply only on the amount deposited by San Luis province
in the Banco de la NaciAon. However, policy makers
fear that this judgment will open a can of worms,
as it will encourage numerous other depositors, many
of whose dollar deposits had been similarly pesofied
under the Presidential decree. Many Argentineans are
seeking to 'redollarize' their accounts and are fighting
against the government in the court to achieve the
same.
The Argentine government as well as the country's
banks that are holding these deposits have warned
that there are not enough dollars with them to oblige
depositors if the Supreme Court instructs the banks
to redollarize all dollar-denominated bank deposits
that have been converted into pesos. If all such claims
have to be converted back into US dollars, the banks
will need an estimated US $10–20 billion to
meet such demands. Argentina currently has just about
US $10 billion in foreign-currency reserves.
In fact the economy might run into greater trouble
if the decision of the Argentine Supreme Court is
extended to include all depositors who had dollar-denominated
deposits in December 2001. The amount in such deposits
with Argentine banks was then about US $50 billion.
Most of this money has since been withdrawn in pesos
and now the amount remaining with these banks in dollar-denominated
accounts is worth around US $10 billion.
While the depositors who deposited their savings in
dollars have welcomed the decision, and are hoping
for a similar verdict when their lawsuits come up
for discussion in the court, the nation will be thrown
into further financial chaos if the ruling has to
be implemented. Senior advisers to Mr Eduardo Duhalde,
the interim President of Argentina, have suggested
that issuing bonds would be the only means of repayment
if the Supreme Court passes a similar ruling in favour
of other depositors. The advisers have suggested that
the bonds would be denominated in dollars, complying
with the court ruling. However, these would be repayable
over a period of ten years to enable the recovery
of the Argentine economy instead of leading it to
an abyss.
The proposal of the advisers is not likely to find
acceptance among the depositors. It might be no more
acceptable to them than the decree ordering pesofication
of their deposits. And with the Presidential Election
being just round the corner, slated to take place
in late April, the chances of retaining power by the
ruling Peronist Party might take a beating in that
case.
For more than a decade, till January 2002, one peso
was valued at one dollar. The two currencies were
used almost interchangeably in ordinary transactions
and banks accepted deposits in either currency. However,
the people of Argentina considered the American currency
to be stronger, and most preferred to maintain dollar-denominated
accounts in Argentine banks. In January 2002 Duhalde
abolished the system when the country faced an economic
collapse. All dollar accounts were transformed into
peso deposits, and the peso was delinked from its
one-to-one convertibility with the US dollar. The
peso was floated on the currency market and has lost
about 70 per cent of its value vis-à-vis the
dollar since then. On 5 March 2003, the day the Argentine
Supreme Court delivered its judgment on the San Luis
province's appeal against pesofication, the peso was
quoting at 3.175 pesos to an American dollar.
Redollarization will result in problems galore for
the banks. Not only the deposits, but loans were also
pesofied when the decree for pesofication was passed.
Banks will lose a lot of money if the loans they have
given out are not redollarized along with the dollar-denominated
deposits.
The Supreme Court order will also jeopardize Argentina's
relationship with the IMF. In January this year the
government promised to keep the nation's money supply
under tight control in return for the IMF's allowing
the nation to roll over nearly US $7 billion in debts
with the Fund. The country does not have access to
any credit since December 2001, when it declared the
world's biggest sovereign debt default. Redollarization
may drain whatever resources the country has in its
hands, and might further impede economic recovery.
It is going to put further pressure on the country's
fragile banking system. Argentina's public debt today
is about one-and-a-half times the GDP of the country.
If the Argentine government is forced to redollarize,
it will make the economy vulnerable to external pressures
as the country will then have to agree to whatever
conditionalities the international financial institutions
impose on the country in lieu of the extra dollars
that Argentina might need. The government's capacity
to print money, go for deficit financing, and create
employment and generate domestic demand will be nullified.
And this is definitely not going to help Argentina
come out of the economic ruins that the country is
now in.
Nearly 60 per cent of Argentines currently have no
savings and many have to do odd jobs or even scavenge
for a living. Whatever chances remain of addressing
their needs by the government would vanish once the
meagre resources left with the government go to pay
the deposits in dollar-denominated accounts in Argentina's
banks. The government now hopes that this ruling is
an exception, that it doesn't become a precedent,
and doesn't translate into similar rulings in all
pending cases in which Argentine depositors have challenged
the 'pesofication' decree.
Even as Argentine depositors in dollar-denominated
accounts expect a ruling in their favour, the only
way out of the mess with relatively less damage to
the national economy seems to be the issuance of the
ten-year bonds suggested above. In fact on 31 May
2002 the government had signed a decree to that effect.
Standard and Poors has listed the important measures
spelt out by the Argentine government in that decree.[1]
The measures are as listed below:
- Depositors with special needs (above 75 years
old, in need of medical treatment) will be entitled
to choose a dollar-denominated bond with a five-year
maturity.
- In exchange for the reduction of deposits that
will result from depositors choosing government
bonds, banks will provide the government with sufficient
guarantees to access the Central Bank's financing
to purchase the government bonds. Only if these
new government bonds default, or after the external
debt restructuring takes place, will banks be entitled
to use their pledged assets to cancel the loans
granted by the Central Bank to finance this deposit-bond
swap, which would finally allow financial institutions
to reduce their exposure and their balance sheet
to the Argentine government.
- The period to choose government bonds in exchange
for rescheduled deposits expires thirty working
days after the signature of the present decree.
- Those rescheduled deposits not exchanged by government
bonds will be converted into securities and listed
in local markets. These new securities will be accepted
to acquire new stocks and new CP placements. Depositors
will also be entitled to use these certificates
to cancel loans granted by the same bank that issued
the deposit.
- The government bonds can be used to cancel mortgage
and personal loans.
- The government will prepay the bonds if the holder
wishes to use them to acquire government assets,
new cars, finance the construction of new buildings,
and the like, within certain limitations.
- Depositors with funds in sight accounts will
be entitled to bid for acquiring the new ten-year
dollar bond.
- Banks will be allowed to create new savings and
current accounts that will not be subject to the
restrictions of cash withdrawals imposed on 'old'
accounts, both in pesos and dollars.
- New loans and deposits can be indexed to inflation,
despite this measure's contribution to the continuous
increase in most of the economy's prices.
- Banks will receive government bonds in compensation
for the asymmetric pesofication of assets and deposits,
as well as the reduction in equity caused by the
banks' dollar-denominated cross-border debt, which
was no longer backed by dollar assets after the
pesofication of the economy. Banks will be compensated
by a peso bond for the difference of 0.4 that resulted
from the conversion of dollar assets into pesos
at the 1:1 parity, while dollar deposits were converted
at the 1:1.4 parity. Banks will be entitled to receive
a dollar bond to compensate the loss in equity caused
by the dollar liabilities that were not subject
to pesofication (mainly cross-border debt).
- Investors whose government bond holdings had
been converted into pesos may request the redollarization
of their holdings if they accept the government's
invitation to participate in an eventual external
debt restructuring.
Argentine banks and the IMF are pushing the government
to convert deposits into obligatory bonds. And this
seems to be the only way out of the situation that
the Supreme Court ruling has landed the country in.
However, with the Presidential elections slated for
27 April, the present government might just try to
pass the onus of this unpopular but unavoidable decision
to the next government.
It is true that no country, more so if it is pursues
an open-economy approach, can for long maintain a
fixed-currency regime if its economy does not grow
compatibly with the rest of the world. The move might
be able to provide short-run stability to a country
whose currency blows in whatever direction speculative
traders decide it should. However, if the country
performs poorly, people are bound to lose confidence
in the local currency, and will want to convert their
deposits into international currency. This will lead
to an increased demand for international currencies
(like the American dollar), and hence to a further
weakening of the domestic currency. Trying to maintain
a fixed-currency regime or a forcible conversion of
all foreign-currency denominated accounts into domestic
currency will lead to protest from both domestic and
foreign investors, and loss of investor confidence,
particularly that of foreign investors. Dollarization
will definitely lead to reduced control of countries
over their economies. The move would also require
countries to match domestic currency creation with
dollar inflows. This will hamper the efforts of national
governments at generating additional demand, and would
be costly in terms of growth and jobs.
Countries like Ecuador and Turkey are today in a similar
situation after pegging their national currencies
to the American dollar. The Turkish lira's crawling
peg against the dollar collapsed in February 2001
after a row between Bulent Ecevit, the Prime Minister,
and the President Necdet Sezer. Since then, the IMF-backed
reform efforts have concentrated on trying to rebuild
a shattered banking system damaged by holding large
unhedged dollar liabilities, suddenly made more expensive
by the collapse of the crawling peg.[2] Shifting expectations
about the performance of the US economy might affect
economies of nations that have pegged their currencies
to the US dollar. A lot of these expectations might
be merely speculative in nature. Further dollarization
could spell trouble for nations whose economic cycles
are not in sync with those of the US. For example,
the Fed's decision to notch up interest rates to reduce
growth in the United States would have a negative
impact on a dollarized foreign country that needs
to stimulate growth.[3]
MORE
ON ARGENTINA CRISIS
1. http://www.standardandpoors.com/europe/francais/Fr_news/The-Argentine-Crisis-Chronology2_07-06-02.html
2. http://specials.ft.com/worldeconomy2001/FT3DIMMVJUC.html
3. http://www.businessweek.com/2000/00_11/b3672178.htm
April 8, 2003.
Sources
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