Public Information Notice No. 04/26

Public Information Notice: IMF Executive Board Discusses Lessons from the Crisis in Argentina

March 24, 2004

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.

Background

In 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, and the Argentine peso, which was 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, but the road back to sustained growth and stability remains long.

The severity of the crisis—and the fact that it occurred in a country that was widely hailed as a model performer less than five years earlier and that had been engaged in a nearly uninterrupted program relationship with the IMF since the early 1990s—make Argentina particularly important to examine so that lessons can be drawn for other countries and for the Fund. The staff paper discussed by the Executive Board examines the origins of the Argentine crisis and its evolution up until early 2002, with a view of drawing out such lessons both for countries' efforts to prevent crises and for the Fund's surveillance and use of its resources. This report will be complemented by an evaluation by the IMF's Independent Evaluation Office, which is scheduled to be discussed by the Executive Board in May 2004.

Executive Board Assessment

Directors welcomed this opportunity to consider the lessons from the financial crisis that engulfed Argentina in 2001. In light of the great hardships that the crisis has brought to the people of Argentina, they underscored the importance of learning from the experience to help prevent such crises in the future and alleviate their consequences should they occur. In view of Argentina's prolonged program relationship with the Fund during the years leading up to the crisis, it is all the more important that these lessons are fully incorporated into the Fund's work. While recognizing that this process is already well underway, Directors welcomed the staff paper as an important contribution. Some Directors noted that a more in-depth analysis of past discussions between the staff and the Argentine authorities and of the Fund's internal decision-making process would be desirable. In this context, Directors looked forward to the forthcoming report of the Independent Evaluation Office on the role of the Fund in Argentina, which, together with the present staff paper, will further enhance the Fund's learning culture and help improve its policy advice.

Directors generally concurred that the crisis reflected the interaction of several sources of vulnerability that were already present during the boom years of the 1990s: the deteriorating public debt dynamics—driven to a sizable extent by off-budget spending; the constraint on monetary policy imposed by the currency board; and structural and institutional weaknesses, some of which had plagued Argentina for a long time. Many Directors also pointed to the continued willingness of the private financial community to finance Argentina's growing borrowing requirements as a factor that facilitated the buildup of vulnerabilities. These vulnerabilities became particularly evident with the onset of the economic slump in 1998 in a context of heightened political uncertainty and exogenous financial shocks. On the one hand, the vulnerabilities limited the authorities' room to provide fiscal stimulus in view of the adverse implications for the public debt dynamics while the currency board limited the scope for a more supportive monetary policy. On the other hand, the authorities were unable to garner support for the large fiscal adjustment that would have been needed to arrest the adverse debt dynamics. Ultimately, they could find no way out but to abandon the exchange rate peg and default on their debt service obligations.

While recognizing that no policy area should be singled out as the sole source of the crisis, Directors viewed Argentina's public debt dynamics as playing a central role. Of particular relevance for crisis prevention is that , prior to the economic downturn, the level of debt relative to the size of the economy was not in a range considered alarming, and that the authorities' fiscal policies were viewed as sustainable. Directors pointed to a number of reasons why the outcome turned out to be much worse than expected, in particular: the failure, in assessing the "danger level" of debt, to take account of the exchange rate regime; the comparatively small share of exports and their concentration; the political and administrative factors limiting the room for maneuver on the fiscal side—including the constraints imposed by fiscal federalism; the large share of public debt denominated in foreign currency; and the relative lack of flexibility of Argentina's labor and product markets. Directors agreed that the Argentine experience underscores the need for rigorous implementation of the framework for assessing debt sustainability—along with strengthened analysis of balance-sheet weaknesses, notably currency mismatches—with a view to making careful assessments of what level of debt is sustainable taking into account country-specific constraints, including foreign currency constraints.

Directors noted that growth projections for Argentina during the 1990s—by the authorities, the Fund, and market participants—were, in hindsight, too optimistic, leading to too complacent a view of Argentina's fiscal performance. These projections in turn reflected an overly sanguine reading of the impact of reforms undertaken in the early part of the decade as well as of the prospects for future reform. To guard against over-optimistic projections, Directors underscored the importance of stress testing the assumptions on economic growth and other key variables underlying sustainability assessments. They asked the staff to reflect further on approaches that would help strengthen the realism of macroeconomic projections, particularly in a program context. They also noted that Argentina's experience calls for a careful and critical assessment of the links between structural reforms and growth.

Directors discussed the role of Argentina's currency board, which turned from being a source of strength to becoming a liability. This regime initially served Argentina well in bringing down inflation from very high levels and in maintaining credibility through some turbulent market conditions during the 1990s. However, it became a handicap to adjustment in the face of the adverse shocks of the late 1990s, and by lending credibility to the exchange rate peg, it allowed Argentina's public sector to borrow excessively in the international capital markets, thereby raising the cost of the eventual collapse. In light of this experience, Directors stressed the critical importance of ensuring that the chosen exchange rate regime is supported by fully consistent macroeconomic and structural policies. In addition, many Directors saw a need for timely consideration of a clear exit strategy, although the difficulty of finding the best way to exit from a currency peg was also acknowledged. In view of these constraints, some Directors supported the view that emerging market economies with significant access to international financial markets are likely to be best served by more flexible exchange rate arrangements.

Directors emphasized the important role that structural weaknesses had played in aggravating Argentina's key vulnerabilities. In particular, weaknesses in fiscal institutions, including in intergovernmental fiscal arrangements, tax administration, and expenditure management, made it difficult to adjust when needed. The trade regime was partly responsible for a narrow export base that was relatively unresponsive to market signals, while labor market reforms undertaken in the first half of the 1990s had fallen short of introducing sufficient flexibility to allow the economy to adjust to shocks. To reduce vulnerabilities arising from the reliance on external borrowing, Directors highlighted the importance of efforts to develop domestic financial markets along with sound debt management policies. They also underscored the importance of close cooperation with the multilateral development banks in promoting structural reforms that would underpin more sustained output and employment growth.

Directors noted that Argentina's experience, with serious imbalances emerging in a country long regarded as a "star performer", underscores the need for strong and effective Fund surveillance in all countries. They stressed, in particular, the need to move forward in implementing recent policy changes that strengthen surveillance in program countries, by stepping back from monitoring program implementation to undertake a fresh and critical assessment of policies from a medium-term perspective. Directors underscored the need for candor and clarity in surveillance, and, in particular, called for a more proactive stance by the Fund in cases in which the exchange rate regime is inconsistent with other constraints on policies. They saw recent initiatives for Article IV consultations in program countries and for ex post assessments of countries with a longer-term program engagement with the Fund as beginning to address these concerns, and looked forward to taking stock of progress made in the context of the biennial surveillance review. Some Directors saw merit in exploring more confidential ways to allow the Fund to discuss, and communicate to member countries, serious concerns about emerging vulnerabilities. A number of Directors also considered that Argentina's experience underscores the need for surveillance to pay greater attention to the regional context and global conditions affecting a country's policy outlook.

Directors discussed the implications of the Argentine experience for the difficult decisions that the Fund may have to face on committing its resources to countries whose debt sustainability is in question. Many Directors underscored the need for caution in such circumstances, noting the vital importance of safeguarding the Fund's resources and the risks to its credibility that would arise from implicitly supporting policies that are extremely likely to fail. While the Fund can be under pressure to provide its seal of approval despite serious concerns over fiscal and external sustainability, these Directors cautioned that yielding to such pressure can devalue the signal the Fund provides. Other Directors, however, pointed to the difficulty of judging a country's prospects of success, and considered that the Fund will inevitably need to continue to make judgments in weighing the risks of failure against the high and immediate costs of withdrawing support in difficult circumstances. Directors looked forward to discussing these issues further on the occasion of the forthcoming review of experience with the new framework for exceptional access, which some Directors suggested should also consider exit strategies from exceptional access.

In discussing the implications of Argentina's experience for sovereign debt restructuring, many Directors expressed the view that the costs of the crisis could have been attenuated if Argentina had been able to find an orderly way to restructure its debt at an earlier stage, although it was recognized that the economic dislocation costs of an early restructuring would likely still have been significant. They noted the need for continued further efforts toward a more orderly approach to sovereign debt restructuring.

Directors discussed the lessons from Argentina's experience for conditionality and ownership in Fund-supported programs. They noted that in Argentina, there was strong support for the currency board but not for the other policies needed to make it work, illustrating that ownership of policies is not sufficient to guarantee their viability, and that both the authorities and the Fund have to work toward building domestic ownership for policies that are viable and can be implemented. Noting the failure of past programs in Argentina to tackle some key structural issues with important implications for macroeconomic vulnerability, Directors stressed that a rigorous application of the Fund's Conditionality Guidelines should help ensure that those structural reforms that are critical to macroeconomic objectives are effectively covered.

While today's discussion was based on the staff's internal review of the crisis in Argentina, Directors will discuss the review being conducted by the Independent Evaluation Office on the role of the Fund in Argentina following the Spring 2004 meetings. They expected the Independent Evaluation Office report to further refine and broaden the lessons learnt, including by examining the Fund's internal decision-making process in the period leading up to the crisis.