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