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Argentine-brand monetarism backfires

D. Sambandhan

ARGENTINA is in the news since January for its currency and debt problems. In December, a massive debt default and restrictions on currency withdrawal led to large-scale violence, looting and even deaths, which eventually saw the exit of five presidents in two weeks. Prolonged flirtation with hyperinflation before returning to some semblance of monetary stability is not unusual in Latin America. But Argentina's problem is distinctly different. It has been badly hit following a long spell of monetary and financial stability coexisting with some reasonable growth, at least in the first half of the 1990s.

One would have thought that Argentina's macro-economic fibre was tougher, especially with its currency pegged to the US dollar on a one-to-one basis. For more than a decade, it prided itself as a basin of exchange-rate stability and a symbol of Bank-Fund-inspired success story. Further, Argentina survived the global recession that followed the South-East Asian meltdown.

But the current unprecedented debt crisis — which has evoked little IMF support — fully exposes the vulnerability of convertibility regimes operating under a fixed exchange-rate framework for long spells and the costs associated with it.

It is also a grim reminder that, at times, even bold monetary experiments — like launching of the Currency Board to contain inflation and inflationary expectations — are not enough to reverse years of policy neglect and abuse of political power.

In today's integrated world economy — with massive capital mobility, inflation swings and interest-rate differentials, which lead to considerable exchange rate volatility — a truly fixed exchange rate is difficult to implement and harder to sustain.

How then did Argentina hold on to a fixed exchange rate regime for more than a decade, especially when the global economy witnessed one currency crisis after another? Argentina must have sacrificed various policy options to gain the advantage of a fixed exchange rate regime, without really understanding the tremendous political and economic costs associated with it.

During the late 1970s and through the 1980s, huge capital flows into Argentina did not get invested in productive capital assets. As the money vanished into tax havens abroad, the votaries of international capital flows could hardly defend themselves.

There was growing unemployment, of both the skilled and unskilled, and the collusive oligopoly by certain domestic and foreign banks resulted in money laundering that virtually wiped out all growth and employment possibilities. For Argentina, the 1980s was rightly termed as the "lost decade" , which saw a huge build-up of external debt and hyperinflation.

The Currency Board experiment did have short-term relevance. Little did the authorities realise then that this system — like the old-fashioned, but much discredited, gold standard — of currency arrangement would require stringent monetary discipline.

Under the Currency Board arrangement, Argentina's money supply was virtually tied to the dollar (exchange reserve) component of the monetary base.

That is, for every peso in circulation, there must be a dollar as reserve — the peso was pegged to the dollar at par. What were the consequences? The money supply became an endogenous variable, and largely become governed by dollar inflows via international trade, service and capital account channels. In the process, the central bank lost its control over the monetary policy. Ultimately, `net capital movement' towards Argentina emerged as a key component. The expectation was the degree of globalisation, denied by the Argentine authorities thus far, would define the quantum of money supply and take care of the shortcomings of a restrictive monetary policy.

Besides the monetary constraints, which virtually ended the central bank's monopoly in printing notes, the system also imposed fiscal restrictions.

As the central bank could no longer accommodate the discretionary fiscal policy of the government, the Treasury was constrained by taxation and borrowing, which had their limits and costs. In the event, fiscal austerity automatically followed, in keeping with the IMF's obsession with fiscal deficit correction.

In the face of curbing indiscriminate money creation, the easy way out to protect public expenditure and keep the fiscal machinery running was `the path of privatisation' — again, an IMF conditionality. In the process, valuable government assets were sold at throwaway prices, and foreign ownership of banks was also encouraged.

But soon the limitations of this sort of revenue mobilisation began to show up. A series of scandals broke out, especially as the number of revenue-earning government assets began to dwindle.

Realising that the Currency Board arrangement had an inherent deflationary bias, money supply began to be eased. It was felt that holding government bonds could support a third of the domestic money supply. While this modification was welcome insofar as imparting much-needed elasticity to the process of money supply creation, it was also increasingly becoming inconsistent with the convertibility regime operating under rigid fixed exchange rates.

Thus, in 2000-01, the very monetary experiment that helped combat inflation in 1991 and reduce it to negligible levels in 1998 and 1999 triggered a confidence crisis on the peso. With the printing of money far exceeding the dollar reserves, the peso-dollar peg at unity was increasingly becoming unsustainable. While the IMF was ready to bail out Argentina with a $40-billion package in early 2001, it kept off during the latest currency turmoil and insisted on more fiscal austerity and downsizing of government.

The Bush administration, too, was not enthusiastic about any bailout and barely honoured the former President, Mr Bill Clinton's promise of an enhanced aid package. Argentina's last-ditch effort to renegotiate its loans at reduced rates strengthened speculation about the peso's future.

The market seemed convinced that only devaluation, and not dollarisation, would be sustainable. Thus ended the decade-long peso-dollar peg.

The unwillingness to abandon the unrealistic currency parity of the peso even after the South-East Asian crisis was beyond comprehension. Ironically though, Argentina, which was in deep recession by the late 1990s, became a haven for capital fleeing the troubled South-East Asian Currency Zone.

The self-imposed restrictions for the sole purpose of containing inflation had huge costs in terms of unemployment and output foregone. Had the peso-dollar peg been broken — after the Brazilian and Russian currency debacles at least — Argentina would have had more policy options and exchange rate flexibility which would have helped soften interest rates and ease the recessionary stranglehold.

The late 1990s, for Argentina, was the last opportunity to move away from `dollarisation' and towards the Keynesian devaluation route to address the real problem of massive unemployment. But that was not to be. Argentina suffered a prolonged recession, and the impending `debt crisis' sparked political discontent. And the inevitable devaluation came too late in the day.

The introduction of a dual exchange rate and the proposal to launch a third currency, `Argentino', are again pointers towards more drastic realignments in exchange rates and the currency system as well. Peso seems to be poised for more troubles. It will be long before Argentina's economy gets rolling again.

The peso-dollar parity has taken its toll on growth and employment. To let off the steam in the pressure-cooker-like situation obtained during the period of medicated Currency Board, the authorities must know whether exchange rates are being adjusted too little or too much.

For this, there is no better guide than the chaotic forex market. To restore order, the exchange rate has to explode and one cannot bicker even if the market errs, because, in a crisis situation, exchange rates do not walk, but gallop.

(The author is on the faculty of School of International Studies, Pondicherry University.)

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