Latin American lesson

The way the Argentinian economy has dealt with its inability to pay its debts is an insight into what the future holds for Greece and Europe.

ft.com

The leading lady is both tough and glamorous; betrayal, back-stabbing and intrigue are rife – and there are plenty of instalments still to come.

No, not another over-the-top soap opera of the kind Latin America does so well. This is a real-life drama unfolding in Argentina and starring the couple that runs the country. It revolves around a battle for control of the central bank and billions of dollars of its reserves waged by a government in default and virtually cut off from international credit.

The saga began in December when President Cristina Fernndez – whose government faces litigation from unpaid creditors, almost a decade after Argentina defaulted on nearly $100 billion – decreed the transfer of $6.5 billion of reserves to the government to pay off debt, unleashing an unprecedented political crisis that has exposed her desperation to find revenues without reducing spending.

The 2001 meltdown followed the collapse of the decade-long peg of the peso to the dollar at parity, which in turn pushed the country into what Fernndez’s husband, Nstor Kirchner, president from 2003 to 2007 and widely seen as the power behind his wife’s throne, simply calls "hell”.

As economic recovery spurs renewed enthusiasm for the emerging markets of Latin America, this latest crisis provides an uncomfortable reminder of the perils of a country without access to international markets spending beyond its means.

The story also has resonance elsewhere. Greece, struggling to stave off default a hemisphere away, is staring into a similar abyss. "The lesson for Greece is that you can’t have an expansionary fiscal policy with a fixed exchange rate,” says Martn Redrado, the central bank chief fired in February by Fernndez for refusing to hand over the reserves.

In Buenos Aires the fiscal situation does not look promising. In 2009 Fernndez’s government spending bill rose by about 30 per cent compared with 2008 and shows no sign of slowing, says Daniel Kerner of Eurasia, a consultancy. Heavy taxes on the farm sector, combined with economic recovery, have helped boost state coffers; tax revenues hit a record in January. But economist Luis Secco says spending grew twice as fast as revenues in 2009 once exceptional income was stripped out. Meanwhile the government has to find an estimated extra $7 billion to ensure it meets its debt repayments this year.

Fernndez says it is "logical” to use reserves to pay off debt, since they offer the cheapest form of financing available. (The country managed to borrow from Venezuela for a while but rates were punitively high.)

Some economists agree that it can indeed make sense in certain circumstances. But in this case the use of presidential decree rather than congressional debate has raised questions about the government’s real motives for commandeering the central bank’s funds. "I think they want to use the reserves for current spending...no one doubts that now,” says Luis Mara Corsiglia, a former director at the central bank.

Last year spending pressures were high because of important mid-term elections, in which the government fared badly. With presidential elections due next year, in which either Fernndez or her husband could seek a second term, spending is unlikely to be curtailed for the foreseeable future.

The president also sees a strong, well-funded state as essential to creating jobs, boosting growth and reducing the poverty caused by the 2001 crash. The resulting political system has led to cash being siphoned off and stymied change, preventing the country from regaining the wealth and influence its vast natural resources bought it a century ago.

Keeping up with the Joneses

The contrasts with its neighbours are stark. Brazil, a fellow member of the Group of 20 leading nations, forms one of the four fast-growing emerging Bric economies along with Russia, India and China. Chile, just across the Andes, has recently joined the rich nations’ Organisation for Economic Co-operation and Development.

Argentina, whose largely European population is accustomed to looking down on its neighbours, has become a laggard. In 1993 its per capita gross domestic product in US dollar terms was twice that of Brazil and Chile, and its free-market reforms during the same decade made it a favourite of the pro-market Washington consensus. But within a dozen years, the other countries were streaking ahead. "Brazil’s economy is five times the size of Argentina’s and the financial system is 20 times in terms of credit,” says Guillermo Glattstein of Banco Santander Ro, Argentina’s leading private sector bank. "We could have aspired to that if it hadn’t been for the last decade.”

The tragedy is that Argentina entered the 20th century as one of the world’s richest countries and left it an international financial pariah. For many, it has now quite simply become invisible or irrelevant. The country’s assets, once a core holding in emerging market portfolios, are considered rich fodder for speculators and vulture funds but too risky for many others. Even with the central bank crisis in full swing, bankers at January’s World Economic Forum in Davos had nothing to say. "There was no mention, no nothing,” says one delegate. "It’s the worst relationship when you are ignored.”

Fernndez’ government has made a speciality of surprising investors with unpredictable and unorthodox policy moves. Defeated in her attempt to raise taxes on farm exports in July 2008, she bounced back with the snap nationalisation of private pension funds in a move widely seen as a brazen asset grab to fund spending.

The current central bank crisis, entirely self-inflicted, blew up at about the most embarrassing moment for the government.

With the prospect of Argentina finally unveiling an offer to the holders of $20 billion still in default since 2001 that could pave the way for its return to capital markets, bonds had been rallying and risk spreads of the country’s bonds over comparable US Treasuries were shrinking.

Redrado’s refusal to transfer reserves for debt repayment was an attempt to maintain the central bank’s autonomy and to provide legal protection against unpaid bondholders seeking to seize reserves.

Although the president has finally managed to fire the governor, congress must next month debate whether she is to be permitted access to the funds. Having lost its majority in the midterms, the government’s ability to push through legislation is limited. Economists and politicians say she is rallying governors with the promise of cash for their hard-up provinces in exchange for swaying lawmakers from their areas to back the plan.

Pliable monetary policy

There is unlikely to be any fresh opposition from the central bank. In Redrado’s place, Fernndez has nominated Mercedes Marc del Pont, whom markets see as a pliable political ally unlikely to rock the boat. In addition, the Yale-trained development economist, who moves to the central bank from running the state-owned Banco de la Nacin, has in the past proposed changing the bank’s charter to give it a role in helping sustain growth and create jobs, making it more of a development bank than merely the guardian of the peso.

Upon nomination Marc del Pont immediately vowed that there would be no abrupt exchange rate shifts or change of course from monetary policy under Redrado, which he describes as more restrictive than expansionary. But some analysts take little comfort from this, saying the bank under the former governor was not fully independent and indeed helped finance the Treasury. Alberto Ramos, an economist at Goldman Sachs, notes that under Redrado "monetary policy has been to a large extent subordinated to a profligate fiscal stance”. As a result, "maintaining the current direction of monetary and exchange rate policy is not particularly assuaging, as what is needed is a recalibration of the monetary policy stance”.

More of the same, then, is likely to mean more inflation. This is particularly worrying in a country with bitter recent memories of hyperinflation, and where accuracy of official consumer price data has been in doubt for the past three years, to the extent that the central bank under Redrado stopped using them. The government says inflation was 7.7 per cent last year; private economists reckon it was nearer double that.

Argentina is seeking to revive its fortunes with its forthcoming debt swap, offering a new bond on terms similar to those made in the restructuring of 2005, when holders were paid 30 cents on the dollar. It insists the offer will not be derailed by the central bank struggle and should go ahead within weeks.

But the debate about using central bank reserves to help pay off debt has highlighted another issue that has incensed owners of defaulted bonds – known as 'hold-outs' because they have been holding out for a better offer than was made in 2005. Argentina keeps a large chunk of its reserves at the Bank for International Settlements in Basel, the bank for central banks, with the aim of putting them beyond the reach of litigation by creditors, former officials have confirmed. Robert Shapiro, co-chair of American Task Force Argentina, a US lobby group representing hold-outs, says the country keeps 80 per cent of its reserves at the bank, about $38 billion. A BIS official responds that the data are confidential but "the figures quoted by the media are grossly overstated”.

Fernndez may take heart from the distraction provided by an escalating diplomatic battle with the UK over oil and gas exploration around the Falkland Islands, over whose sovereignty they fought a brief war in 1982. British companies are due to start drilling next week, sparking Argentine outrage.

Meanwhile, she has sought to deflect attention from the central bank crisis this month, perching for cameras in stilettos on a quad bike after meeting Argentine winners in this year’s Dakar rally, an off-road endurance test held in Argentina and Chile for the past two years. During one speech in January, she urged consumers to eat more pork, saying it boosts your sex life and is more appetising than Viagra.

But she faces a tough time getting her reserves plan past congress and, the longer the soap opera continues, the more damaging it may prove to an already battered international image.

Its failure to pay creditors for so long saved Argentina money for a while, says Shapiro. "But in the long term it’s an economically debilitating strategy...Who wants an economy that looks like Argentina’s today?”

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