Public Information Notice: IMF Executive Board Discusses Lessons from the Crisis in Argentina
IMF News, March 24, 2004
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- Published: March 24, 2004
Background
- On November 17, 2003, the Executive Board of the International Monetary Fund (IMF) discussed a staff report on the lessons from the crisis in Argentina.
- Crisis chronology and key facts:
- 2001-02: Argentina experienced one of the worst economic crises in its history.
- Output, which had begun to contract in 1999, fell by about 20 percent in the three years ending December 2002.
- Inflation reignited; the government defaulted on its debt; the banking system became largely paralyzed.
- The Argentine peso, then pegged at par to the U.S. dollar, reached lows of Arg$3.90 per U.S. dollar (in mid-2002).
- In the course of 2003, the economy began to recover, though the road to sustained growth and stability remained long.
- The staff paper examines origins and evolution of the crisis up until early 2002 to draw lessons for crisis prevention and the Fund’s surveillance and use of resources.
- The report will be complemented by an evaluation by the IMF's Independent Evaluation Office, scheduled to be discussed by the Executive Board in May 2004.
Executive Board Assessment — overarching messages
- Directors welcomed the opportunity to consider lessons, underscoring importance of learning to prevent future crises and alleviate consequences.
- Directors welcomed the staff paper as an important contribution and looked forward to the Independent Evaluation Office report to further enhance the Fund's learning culture.
- Some Directors requested a more in-depth analysis of past discussions between staff and Argentine authorities and of the Fund's internal decision-making process.
Key findings on sources of vulnerability
- Crisis reflected interaction of several sources of vulnerability present during the 1990s boom years:
- Deteriorating public debt dynamics—driven to a sizable extent by off-budget spending.
- Constraint on monetary policy imposed by the currency board.
- Structural and institutional weaknesses that had long plagued Argentina.
- Continued willingness of the private financial community to finance growing borrowing requirements facilitated vulnerability buildup.
- Contextual amplifiers:
- Onset of economic slump in 1998, heightened political uncertainty, and exogenous financial shocks made vulnerabilities critical.
- Vulnerabilities limited room for fiscal stimulus and the currency board limited scope for supportive monetary policy.
- Authorities were unable to garner support for the large fiscal adjustment needed to arrest adverse debt dynamics, ultimately abandoning the exchange rate peg and defaulting on debt service obligations.
Public debt dynamics — central role and assessment implications
- Directors viewed Argentina's public debt dynamics as playing a central role.
- Notable observations:
- Prior to the downturn, the level of debt relative to the size of the economy was not in a range considered alarming, and fiscal policies were viewed as sustainable.
- Reasons the outcome was worse than expected included:
- Failure to take account of the exchange rate regime when assessing the "danger level" of debt.
- Comparatively small share of exports and their concentration.
- Political and administrative factors limiting fiscal maneuver, including constraints imposed by fiscal federalism.
- Large share of public debt denominated in foreign currency.
- Relative lack of flexibility in labor and product markets.
- Policy implication:
- Need for rigorous implementation of the framework for assessing debt sustainability—along with strengthened analysis of balance-sheet weaknesses, notably currency mismatches—to make careful assessments of sustainable debt levels given country-specific constraints, including foreign currency constraints.
Growth projections, stress testing, and realism in forecasts
- Directors noted that growth projections for Argentina during the 1990s—by the authorities, the Fund, and market participants—were, in hindsight, too optimistic.
- Consequences:
- Overly optimistic projections led to complacency regarding fiscal performance.
- Projections reflected overly sanguine readings of reform impacts and prospects for future reform.
- Recommendations:
- Stress test assumptions on economic growth and other key variables underlying sustainability assessments.
- Staff to reflect further on approaches to strengthen realism of macroeconomic projections, particularly in a program context.
- Careful and critical assessment of links between structural reforms and growth is required.
Currency board and exchange rate regime lessons
- The currency board initially reduced inflation and maintained credibility but later became a liability:
- It became a handicap to adjustment facing late-1990s shocks.
- Credibility lent to the exchange rate peg allowed excessive public sector borrowing in international capital markets, increasing cost of eventual collapse.
- Directors’ emphases:
- Ensure chosen exchange rate regime is supported by fully consistent macroeconomic and structural policies.
- Timely consideration of a clear exit strategy is needed, though finding the best exit is difficult.
- Some Directors supported that emerging market economies with significant access to international financial markets are likely best served by more flexible exchange rate arrangements.
Structural weaknesses and institutional failures
- Structural weaknesses aggravated vulnerabilities:
- Weak fiscal institutions, including intergovernmental fiscal arrangements, tax administration, and expenditure management, complicated adjustment efforts.
- Trade regime contributed to a narrow export base relatively unresponsive to market signals.
- Labor market reforms in the early 1990s fell short of providing sufficient flexibility for shock adjustment.
- Policy recommendations:
- Develop domestic financial markets to reduce reliance on external borrowing.
- Implement sound debt management policies.
- Promote structural reforms—via close cooperation with multilateral development banks—to underpin sustained output and employment growth.
Surveillance, candor, and medium-term perspective
- Argentina's experience underscores need for strong and effective Fund surveillance in all countries.
- Directors called for:
- Moving beyond monitoring program implementation to a fresh, critical assessment of policies from a medium-term perspective.
- Candor and clarity in surveillance, including a more proactive stance when exchange rate regimes are inconsistent with other policy constraints.
- Implementation of recent policy changes that strengthen surveillance in program countries, including Article IV consultations in program countries and ex post assessments for long engagements.
- Exploration of more confidential ways to discuss and communicate serious concerns about emerging vulnerabilities.
- Greater attention in surveillance to regional context and global conditions affecting a country's policy outlook.
- Directors looked forward to a stocktaking in the context of the biennial surveillance review.
Exceptional access, resource commitment, and Fund credibility
- Directors discussed consequences for decisions on committing Fund resources where debt sustainability is in question.
- Views diverged:
- Many Directors urged caution, stressing safeguarding Fund resources and the credibility risks of implicitly supporting policies likely to fail.
- Other Directors noted difficulty of judging prospects and argued the Fund must weigh risks of failure against high and immediate costs of withdrawing support.
- Future work:
- Directors looked forward to discussing these issues further in the forthcoming review of experience with the new framework for exceptional access, including consideration of exit strategies from exceptional access.
Sovereign debt restructuring
- Many Directors believed costs of the crisis could have been attenuated if Argentina had restructured debt in an orderly way earlier, though early restructuring would still have entailed significant economic dislocation costs.
- Directors noted the need for continued efforts toward a more orderly approach to sovereign debt restructuring.
Conditionality, ownership, and program design
- Lessons:
- Strong support for the currency board in Argentina was not matched by support for other policies needed to make it work, illustrating that ownership alone does not guarantee viability.
- Both the authorities and the Fund must build domestic ownership for viable, implementable policies.
- Past programs failed to tackle some key structural issues affecting macroeconomic vulnerability.
- Recommendation:
- Rigorous application of the Fund's Conditionality Guidelines should help ensure structural reforms critical to macroeconomic objectives are effectively covered.
Next steps and the Independent Evaluation Office
- Directors will discuss the Independent Evaluation Office review on the role of the Fund in Argentina following the Spring 2004 meetings.
- The Independent Evaluation Office report is expected to further refine and broaden lessons, including examination of the Fund's internal decision-making process in the period leading up to the crisis.
Public Information Notice: IMF Executive Board Discusses Lessons from the Crisis in Argentina, March 24, 2004.