Argentina’s presidential election on October 27, 2019 has once again put the global limelight on the country. The issue on hand is how the leader with a new mandate will deal with the rapidly deteriorating economy and prevent the country from sliding into another round of depression and default.
The left-wing opposition candidate Albert Fernandez is the current favorite over the incumbent, President Mauricio Macri. Fernandez got 47.7 percent of the vote in the August 11 primary election against 32.1 percent of Macri. If Fernández were to get the same percentage or more votes in the presidential election in October, he would win it outright, without the need for a second round.
Under Argentine election rules, if a candidate wins at least 45 percent of the vote or gets 40 percent with a 10-percentage-point lead over the closest rival, that candidate is declared the outright winner. If there is no outright winner, a second round will be held on November 24, pitting the top two candidates against each other.
Argentine has defaulted on its sovereign debt eight times since independence in 1816, and the country has been punctuated with regular economic crises in the past 70 years. The issue on hand is not so much about Argentine default, but the judgement and approach of the International Monetary Fund (IMF). The organization has an outstanding record-breaking USD 57 billion bailout program instituted in June 2018 with the country, and it had already disbursed USD 44 billion of the bailout and going to release another USD 4 billion by the end of September.
The fact that IMF lent so much money to support a program that is crumbling after little more than a year is unnerving. The organization has overseen 21 bailouts to Argentine, including the most spectacular default of 2001 on USD 100 billion of bonds — at the time the world’s largest default. IMF is envisioned to be its member states’ external financial position watchdog under the 1944 Bretton Woods Agreement and its extensive experience on Argentine is supposedly putting it in the best position to advise the country. What happens cast doubt on the credibility of the IMF.
“It’s another black eye for the IMF in Argentina,” says Benjamin Gedan, who leads the Argentina Project at the Wilson Center in Washington. “They were caught up in the same euphoria as investors. … They thought the No. 2 economy in South America was embracing the Washington consensus.”
President Macri was inaugurated in December 2015. His predecessor Cristina Fernandez de Kirchner signed decrees to increase government spending by an extra USD 27 billion, or 4.5 percent of Argentine GDP (in 2015) in her final days in office. Inflation was running close to 25 percent, and foreign exchange was dangerously low at USD 24.9 billion or 4 percent of GDP.
President Macri projected an image of competence and business savvy. He became a darling of the international financial circle by settling the pending charges in the US court and restore the country’s access to foreign borrowing. He avoided big government spending cut to maintain his popularity and hoped that steady growth and restoring access to the international capital market would dig the economy out of its hole.
For the IMF, it is a wake-up call that the organization should take a fresh look at its assumption on financial bailout.
The unusually loose monetary policy after the Quantitative Easing (QE) in the mid-2010s prompted a global search for higher yields. International creditors cheered the market-friendly Macri and gobbled up as much debt as the country and its companies would issue, including a three and a half times oversubscribed 100-year bond that raised USD 2.75 billion at an interest rate of just 7.9 percent in July 2017. The country was the first junk-rated country to sell the so-called century bond.
The herd behavior of international investors drove the yields of Argentine debt well below what economic, financial, and liquidity conditions warranted, which encouraged Argentine entities to issue more bonds despite the weakening fundamentals.
For a short while, the plan seemed to work, but the debt build-up was scary. By the end of 2017, the public debt stands at USD 321 billion, up by one-third in just two years.
However, the significant deficits needed a constant stream of foreign money to fund it. High domestic interest policy to support the Argentine currency pushed up the value of the peso, and more dollars must be borrowed to finance the deficit. When a loss of market confidence triggered a run in 2018 against the peso, Macri had to turn to the IMF. The insistence of IMF on the flexible exchange rate in the June 2018 agreement caused a fresh bout of selling against the peso when the market tries to test the government resolve to defend the currency. The amended Sept agreement allowed the Argentine government some limited scope to support the peso, but the economic uncertainty hit the economy hard, and all macroeconomic parameters such as inflation, unemployment and exchange rate were moving in a downward spiral.
The story of excessive spending funded by foreign currency borrowing and hoping on strong economic growth to get out of the potential pitfall is a classic case of first-generation foreign exchange crises model originating from past Latin American economic crises. What happens today is history repeating itself.
With unemployment over 10 percent, inflation at close to 50 percent, current account and fiscal deficit running at 5 percent of GDP and value of peso dropping to 56 to one US dollar from 37.69 at the beginning of the year, whoever wins the presidential election must face the reality of negotiating with the IMF on a new package. He should reject the notion that its only choice is between accepting and refusing all demands from the IMF and external creditors. The country must develop a homegrown adjustment and reform program that protects its most vulnerable segments of society. The support of domestic constituents is critical for the country to avoid a repeat of the 1998-2002 Argentine Great Depression in which the country’s GDP saw a dramatic drop of 28 percent.
For the IMF, it is a wake-up call that the organization should take a fresh look at its assumption on financial bailout. The Argentine debacle has shown that the organization has not really changed its dogmatic adherence to the Washington Consensus and still overlook the local social and economic conditions when it design bailout package. The lesson that the organization learnt from the Asian Financial Crisis should not be forgotten.
Out of the three Bretton Woods institutions, the World Bank and its associates, the International Development Association provided around USD 45 billion in 2018 to help development financing. This amount is a pittance compared with what the developing countries need. For the World Trade Organization, the move toward regional and bilateral trade deals has cast a shadow on its future in recent years. As for the IMF, it should keep its relevance and maintain its usefulness in helping member states deal with balance of payment issues. If the IMF cannot perform its designed role, a weakened Bretton Woods institutional setup will bring significant headwind to the global economy.