Question

Argentina: Anatomy of a Financial Crisis Case Study Preparatory Questions

1. What were political and economic conditions like in Argentina in December 2001/January 2002?

2. What was the Convertibility Plan? What was it intended to accomplish?

3. What causes (both internal and external) were behind the predicament Argentina found itself in with the de-pegging of the peso and the resignation of 5 presidents in late 2001/early 2002?

4. Could the massive default by Argentina have been avoided? If so, how?

Answer 1

1) The crisis of December 2001, also known as Argentinazo, resulted in ahuge change in the way Argentina now is. A strong peso hurt exports from Argentina and caused a protracted economic downturn that eventually led to the abandonment of the peso-dollar parity in 2002. This change, in turn, caused severe economic and political distress in the country.

In March 1991 Argentina announced its Convertibility Program, it was intended to improve policy credibility and to establish macroeconomic stability. The Convertibility Program established a currency board which would hence legislate, fixed exchange rate of 10,000 Australes per U.S. dollar. Any change in the exchange rate could be further disturbed or introduced only through new legislation. The currency board was required to provide full backing in U.S. dollars for any issue of Australes, and subsequently for the new peso. US dollar recieved the status of legal tender here in Argentina.

2) The intent of the Convertibility Program was to establish strict discipline on Argentinean monetary and fiscal policy. The currency board made sure that the government did not face any fiscal defecit. The currency board rules also constrain the Central Bank's ability to pursue an active monetary policy. With a commitment to convertibility at a fixed exchange rate, money supply can only respond passively to changes in money demand. If citizens want to hold more domestic currency, they can exchange their foreign currency assets for domestic currency at a fixed rate.

3) The reasons both external and internal included the following:

1.   A hard currency peg
2. currency overvaluation
3. economic rigidities
4. inappropriate fiscal policy
5. external shocks
6. large scale foreign currency borrowing
7. A sudden stop in capital inflows and enduring IMF support

4) The crisis could be stopped if the fiscal defecit was not continously funded and removed through foreign borrowings. The act of pegging, instead of enduring the open market of exchange should have stopped and a fair play of trade must have been adopted to escape the crisis.