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Argentina and the IMF: The Need for Perspective, Address by Flemming Larsen, Director, Offices in Europe, IMF
November 18, 2003
With regular intervals, articles appear in the European press lambasting the IMF for having first caused Argentina's recent crisis through inappropriate advice in the 1990s, then for failing to prevent a financial meltdown, and finally for being incapable of coming up with solutions to restore rapidly economic growth and external creditworthiness. Too often, these articles misrepresent the facts and provide readers with an inadequate understanding of the origins of the recent crises in emerging market countries and the efforts being undertaken to prevent their recurrence.
The crises originated in a complex mix of country-specific and systemic problems that had been at work from the mid-1990s or even before. With the risk of oversimplification, these typically included not only inconsistencies between exchange rate regimes (often fixed rates) and countries' economic policies and what many (including the IMF) now consider to have been a premature liberalization of short-term capital movements. The crises also were the result of weak financial systems that became too exposed to exchange rate risks as well as large-scale capital inflows driven by cyclical downturns in the industrial countries in the early 1990s. To this can be added a build-up of excess demand; rising asset prices fueled by strong credit expansions; speculative and often imprudent investment decisions; weak governance of enterprises, banks, and in the public sector; and a general lack of transparency. Many of the governments of the emerging market countries also suffered from a sense of hubris, viewing their economic successes as the result of strong fundamentals; they therefore felt little need to look at the experience of other countries or heed warnings from the IMF and others about the risk of financial bubbles and mounting vulnerabilities. In that respect, there was nothing special about the emerging market countries: the industrial countries too are prone to hubris in good times as witnessed in the recent dotcom stock market bubble.
The IMF agrees that not all of its advice and judgment were correct during the build-up to the crises. We had too much faith in countries' ability or willingness to meet the requirements imposed by the fixed exchange rate regimes; we took for granted that countries understood the need for robust banking systems as a precondition of a successful liberalization of capital flows; or we were simply unaware of the full extent of non-performing loans that had built up in the banking system ahead of the crisis, which were only revealed after the panics started. But to suggest that the IMF's advice was the primary reason for the crises is ludicrous.
But when the emerging market bubbles burst, should the IMF not then have prevented the ensuing financial meltdown? And since it did not, is it not yet another sign of the failure of the IMF's recipes? The problem again is a lack of perspective: when both foreign and domestic investors suddenly realize that the bubble is unsustainable and that the country's foreign exchange reserves are quickly being depleted, a financial panic is probably unavoidable. However, what the IMF can do is to limit the extent and duration of the panic and the risk of spillovers to similar countries by helping the government put together a set of responses aimed at restoring confidence. This requires that the country be seen as addressing key weaknesses in policies and institutions and that it is being supported by financial assistance to replenish its foreign exchange reserves; in some cases, there may also be a need to restructure the country's foreign debt.
Sometimes, such crisis resolution measures are put in place rapidly and begin to work relatively quickly, allowing the country to recover vigorously after a brief period of deep duress as in Korea and Thailand. More recently, Brazil and Turkey have also been showing an encouraging degree of success in restoring confidence in the context of their IMF programs. In other cases, the process took longer with uncertainties lingering over issues such as the political situation, the sustainability of the country's external or domestic debt, and doubts about the authorities' ability or willingness to tackle the root causes of their country's difficulties and persevere with long-overdue reforms. In the case of Argentina, all of these factors have contributed to the protractedness of the downturn.
What should the IMF have done differently in the case of Argentina? What are the lessons we have drawn so far? A great deal of work is under way within the IMF to understand what went wrong. This work will be published in coming months. However, there are at least three key lessons that I would highlight at this point:
· Our economic-and political-diagnosis should have been more realistic. Like the government at the time and many private sector economists, the IMF was too optimistic about Argentina's growth potential. This was based on an extrapolation of the strong growth performance in the early 1990s, at the start of the convertibility plan. We mistook a number of temporary and one-off influences for a large, permanent improvement in the growth trend.
· Partly as a result, we did not sufficiently warn the authorities about the consequences of their lax fiscal policy and the potential risk of a fiscal crisis. Such warnings clearly must be made at a very early stage when there is still time to avert disasters.
· Finally, linked to the previous two lessons, the IMF should have insisted on the conclusion we reached by 1998 that the fixed exchange rate regime was unsustainable and that the authorities seemed either unwilling or unable to adjust their policies sufficiently to avoid the eventual meltdown. Those concerns were expressed repeatedly but the authorities refused to consider an exit from the currency board arrangement until the change was forced by markets.
There is sometimes a delicate balance to strike for the IMF and the international community between supporting a member country experiencing difficulties and financing, and implicitly perpetrating, policies that are doomed to fail. In the case of Argentina, we seem to have got the balance wrong. But we shall never know what would have happened if the IMF had stopped its financial support earlier or if we had insisted on a different exchange rate policy. Also, we shall never know what would have happened if the authorities had actually respected the conditions associated with the IMF's support instead of repeatedly failing to implement what had been agreed.
Fortunately, Argentina's economy has now begun to recover with growth projected at 4.8 percent in 2003. And the IMF remains engaged to help the country turn the corner decisively. To this end, the government and the IMF have recently reached agreement on a framework for the country's economic policies and a reform program aimed at strengthening the country's institutions and addressing the weaknesses and problems that were among the root causes of the crisis. The program will be supported by a three-year, $12.5 billion loan arrangement from the IMF. Taking into account Argentina's planned repayments to the IMF over the three years of the program, the Fund's level of commitment to Argentina at the end of the period will remain unchanged. Argentina's economic program has three fundamental elements:
· A medium-term fiscal framework to meet growth, employment, and social equity objectives, while providing a sound basis for normalizing relations with all creditors and ensuring debt sustainability.
· A strategy to assure the strength of the banking system and facilitate the increase in bank lending that is essential to support the recovery.
· Institutional reforms to ease corporate debt restructuring, address issues of the utility companies, and fundamentally improve the investment climate.
These and other reforms in the authorities' program are carefully sequenced for elaboration and implementation over the next three years, and it goes without saying that the success of the program will depend upon the consistency and rigor with which it is implemented. The task for the IMF is to help Argentina to do so.
How can the IMF help lessen the risk of new crises in the future? The current monetary system is still undergoing deep changes as a result of the transformation from government-dominated to market-dominated financial systems underway during the past 15-20 years, including the integration of global capital markets and the emergence of numerous new financial instruments. We fully agree that these developments have exposed some countries to risks, especially countries with shortcomings in their institutions and economic policies. This is why so much of the Fund's work is directed toward advising our members on the requirements needed to limit their vulnerability to crises, on how to lessen the costs when crises do strike, and on how they can position themselves better to benefit from the process of globalization. Closing oneself off from the rest of the world is simply not an alternative.
The rest of the world, however, also needs to facilitate the emerging and developing countries' integration into the global economic system. The best way to achieve that is by dismantling trade barriers and distortions that prevent a country like Argentina from fully benefiting from its comparative advantage in agriculture. The present Doha Round of trade negotiations offers the opportunity for the European Union, the United States, and other industrial countries to make a real difference by finally addressing a serious inequity in the world trading system. We must move beyond the failure at Cancun.
Some critics of the Fund have raised questions about the usefulness of the IMF and have even suggested that the institution is harmful and should be closed down. The notion that countries' exposure to crises and economic setbacks would diminish or even be eliminated by closing the IMF is surely absurd. The right perspective is to view the IMF as the representative of the international community, bringing to bear our accumulated experience and financial resources—obtained by pooling the resources of individual member countries—in an effort to address financial crises cooperatively at much lower economic and social costs than if the crisis-struck country had to deal with its problems alone. Of course, the international community and the IMF make mistakes occasionally in setting the right diagnosis and prescribing the right dosage of medicine. But we also have the capacity to recognize such mistakes and take on board new insights gained from an extensive research effort, close contacts with the economic profession around the world, and ongoing evaluations—internal as well as external—to determine what works, what does not, and why.
And there will always be a need for the IMF as a scapegoat of first resort!
1 The views expressed are those of the author and do not necessarily represent those of the Fund.
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