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The Debt Crisis Comstock, Art 1995

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This document is brought to you for free and open access by Lehigh Preserve. It has been accepted for inclusion by an authorized administrator of Lehigh Preserve. For more information, please contact [email protected]. THE DEBT CRISIS Art Comstock

Introduction which largely reflect the ineffective past politi­ cal and economic policies of the government. In Aprill982, Argentina declared default on I then analyze the effects of the crisis on the the servicing of its foreign-denominated-debts. Argentine economy and the current attempts This event has been called "one of the most trau­ to rebuild and restructure. Finally, I examine matic episodes in the history of world financial proposed solutions to the crisis and the poten­ crises on account of its intensity and length." tial effectiveness of each. (Montanaro, p. 73) Its effects on Argentina and the rest of the world still linger today. Origins of the Argentine Debt Crisis The Argentine debt continues to limit the nation's quest for development. Rather than A financial crisis can be defined as a momen­ investing in its future, Argentina continually tary lack of liquidity. It is usually caused by the pays for its past spending. Until recently, eco­ inability of financial institutions to make debt pay­ nomic progress has been slowed while scarce ments. Then, a "snowballing" effect occurs as resources are sent abroad to pay the debt. In investors panic, removing their funds from the order for Argentina to develop further, a solution system. A dangerous financial collapse ensues. must be reached; but the country cannot do it However, countries in the intermediate alone. The United States must make every effort stage of their industrialization process (like to help alleviate the crisis and create a mutually Argentina) often have very different underly­ acceptable solution. Mter all, the United States ing reasons for a financial crisis. In such has not only a financial interest, but also a polit­ instances, the main contributing factor can ical and a future investment interest in the res­ often be classified as a structural insolvency of olution of the Argentine debt crisis. the foreign sector. The situation evolves from In order to develop a solution, it is crucial a sustained growth in foreign debt due to cer­ to understand the nature of the crisis and the tain characteristics in the economic system. changes in the Argentine political structure These countries generally have a primary and that have occurred up to the present. In this an industrial sector which are distinct from article, I review the origins of the debt crisis one another. The primary sector is highly pro-

33 ductive and efficient, but the industrial sector (Montanaro, p. 73) The Argentine financial sys­ is immature and undeveloped. tem began with a policy of "financial repres­ For instance, in the Argentine case the pri­ sion" which forces a transfer of savings towards mary sector- farming- has been successful the protected sectors of the manufacturing due to the fertile land of the pampas. But, the industry, thus promoting an import-substitut­ industrial sector's relative productivity lagged ing industrialization. The newly established behind to such an extent that it could not com­ Banco Central de la Republica Argentina pete internationally with industries of more (BCRA) implemented such a structure, which developed countries. This inefficiency created brought about a period of temporary econom­ problems due to the exchange rate. In order to ic growth. The BCRA took upon itself all be competitive, the Argentine exchange rate responsibility for the government's decisions in was set at a level which allowed what was pro­ the financial sector, in the cost of credit, and it:J. duced in the agricultural sector to be exported the reward for saving. It imposed high reserve competitively. Thus, the exchange rate was set requirements and interest rate restrictions on on the basis of the competitiveness of the pri­ loans. Taken together, these factors created a mary sector, without recognizing the ineffi­ system that rewarded productive investments ciency of the industrial sector. In other words, and punished the accumulation of liquid assets. Argentina created a pampan dollar that could (Montanaro, pp. 73-74) not be sustained by the underdeveloped indus­ Over a period of about thirty years, this trial sector. (Wionczek, p. 236) model managed to sustain a stable and efficient As Argentine industry began to grow, how­ financial structure. Its success was mainly a ever, it required more and more foreign result of this government encouragement of exchange for importing raw materials and cap­ savings through investment in the economy. ital goods. But, because of the protective tar­ Such a trend in savings is often a necessary iffs established to make industrial products ingredient for the economic growth of an more competitive on the international market, underdeveloped financial structure into a devel­ the industrial sector did not export. All gener­ oped financial structure. However, these polit­ ation of foreign exchange was then left to the ical decisions throughout this period limited primary sector, which was growing much more the overall growth of the Argentine economy. slowly than the industrial sector. Eventually, Due to this financial repression policy of gen­ the primary sector could no longer supply the erating economic growth through import -sub­ foreign currency needed by the industrial sec­ stitution, the Argentine economy remained tor, and the foreign exchange reserves were closed to foreign investment and dependent exhausted. In order to continue its economic solely upon government institutions for pro­ activity and pay its foreign debt, the govern­ ductivity and growth. The domestic industry ment thus resorted to attracting foreign capi­ was sheltered from competition, due to the pro­ tal and credit. Of course, these funds only cre­ tective tariffs mentioned earlier; and as a con­ ated more debt payments that went unpaid as sequence Argentina experienced low growth as the cycle continued. And as the crisis in the compared to other developing countries. balance of payments progressed, more foreign Furthermore, as a result of the structural insol­ indebtedness was incurred to finance expendi­ vency of the foreign sector as mentioned earli­ ture in foreign currency. The end result was a er, the balance of payments crisis worsened; and growing accumulation of foreign debt and peri­ the government unwisely chose to increase the odic crises in the balance of payments. money supply in order to service the interest This structural insolvency of the Argentine payments on the foreign debt. As a result, infla­ system may have been the underlying cause of tion began to rise steadily in the middle 1970s. its foreign indebtedness, but ineffective politi­ In fact, in 1976 the annual rate of inflation was cal and economic policies further increased the about 382 percent, compared with an average structural difficulties. In fact, the financial his­ of only around 25 percent between 1960 and tory of Argentina beginning in the 1940s can be 1974. (Montanaro, p. 76) termed as one of "backward development." The new government regime that took

34 control in 1976 hoped to alleviate the inflation opportunities between the official and the effec­ problem by freeing the economy and increas­ tive rate of exchange, the plan failed. Market ing productivity in the government-owned investors recognized the discrepancy between industries. A plan of financial deregulation, the position held by the monetary authorities along with the abolition of foreign trade laws and the true position of the peso in the market, which previously hampered international and they continued to profit from it. exports, was also implemented. The plan's Furthermore, due to the discrepancy intention was to stimulate competition through between the crawling peg exchange rate and the a laissez-faire approach. Soon afterwards, the true rate, a banking "euphoria" erupted in the Banking Act of 1977 allowed banks to have late 1970s. The Argentine financial system and direct control over interest rates on deposits, the number of banks expanded rapidly. In fact, yet still called for a 100 percent guarantee by deposits grew by 86 percent and credit grew by the government of domestic deposits. In other 110 percent over the three years preceding the words, the act allowed the banks, investors, and crisis (1979 to 1981). Also, the spread between market competition to determine the going bank rates on loans and deposits increased sig­ rates. As these and other deregulatory measures nificantly. This difference showed the inexpe­ continued, an increase in M2/GOP 1 from .12 to rience of a banking system which had never had .245 followed in the next year. (Montanaro, the opportunity for correct risk evaluation due p. 77) This increase in the money supply rela­ to thirty years of financial repression. tive to GOP growth showed the inability of the Along these same lines, foreign speculation economy to grow at a rate equal to the increase further accentuated the debt problem. Financing in the monetary base, which was a result of the in pesos became the primary method by which money expansion freedom suddenly given to to acquire financial assets to use as collateral for banks. By allowing interest rates to float freely, dollar debts. This speculation was caused both the government opened the financial market by the greater profitability available due to the for product innovations in investments such as high differential between interest rates in time deposits and acceptance certificates of Argentina and those rates on the dollar, and by deposits; and so investors concentrated on these the overvaluation of the peso as stated above. For new short-term, profit-making opportunities. these reasons, between 1979 and 1981 the for­ However, this shift towards other investment eign currency debt obligation expanded from $19 opportunities only furthered the decrease in billion to $35.7 billion. And foreign debt overall long-term demand deposits that had been showed an increase of $30 billion from 1976 to occurring over recent years. 1982, while GOP shrank over the same period. Another unsuccessful move by the finan­ On February 2, 1981, the peso was deval­ cial system was the establishment of an active ued by ten percent in an attempt to eliminate crawling peg exchange rate from the peso to the the discrepancy between the official and the dollar. The crawling peg system bound mone­ effective exchange rates and to discourage for­ tary authorities to future quotations of eign speculation. Within a few months, finan­ exchange rates for a certain period, with the cial authorities were again forced to devalue the hope of limiting the amount of devaluation. In peso, this time by thirty percent. However, it essence, monetary authorities were forced to was all too late. A dramatic rise in U.S. dollar maintain the established rate of exchange for interest rates triggered a financial panic. Since that period, even if market forces called for an most loans were granted at a variable interest adjustment, in order to slow the fall of the peso rate, the reduction in the likelihood of against the dollar. The main intent was to Argentine debtors making the payments scared instill some confidence in the peso's stability investors. Foreign short-term credit agree­ and to reduce investors' dangerous inflationary ments were not renewed, and the flight of pri­ expectations. But as a result of the arbitrage vate capital rose sharply. Foreign investors became fearful of an Argentine default and thus

1 began to withdraw M2/GOP is the rati o of the money supply, including their capital. As a conse­ bank deposits, to the gross domestic product. quence, a spread of insolvency occurred, which

35 progressed from firms, to the banking system, reduce government expenditures and increase to the government, and to the central bank. revenues through higher taxes, the effects were Finally, in 1982 Argentina was forced to limited. The reasons were again the inefficien­ default on its foreign currency debts. Another cy of the tax system as well as a budgetary round of panic soon spread, followed by even process based on bilateral negotiations with spe­ more massive flights of capital. Virtually all cial interest groups. Due to the political sup­ international lending to Argentina likewise port of these influential groups, many federal ceased, and the bulk of private foreign debt was expenditures that could have been eliminated then assumed by the government. As the pub­ were still kept. Even though government expen­ lic sector undertook the debt denominated in ditures in real terms were cut by 10.5 percent foreign currencies of the private sector, a still and tax revenues were increased by 10.7 percent larger budget deficit had to be financed domes­ between 1983 and 1985, the above restrictions tically, which again stimulated inflation as the hampered further reductions in expenditures public sector attempted to raise money through and increases in revenues. (Bowne, p. 9) its own domestic means. With the public sector debt still out of con­ trol and inflation still accelerating, the The Crisis and Its Effects Argentine government in 1985 initiated a plan to stabilize the economy. This new effort, called Upon declaration of default, investors the Austral Plan after the hoped-for restoration quickly pulled out of Argentina. All faith in the of the value of the new currency, was based on Argentine economy was lost. Short-term loans a strict wage and price freeze, a fixed exchange became the only form of investment, as restric­ rate, positive real interest rates, and fiscal tions were imposed upon Argentina by the inter­ adjustment. The government fixed the exchange national capital markets. By the end of 1983, rate of the austral to the U.S. dollar with the Argentina's total foreign debt amounted to $45 intention of adding stability and investor confi­ billion, more than double the level of the late dence to the currency. In 1986 the Austral Plan 1970s. Any further investing would need the managed to reduce inflation to an annual rate financial support of the IMF and the World Bank. of 90.1 percent (the lowest level in 12 years), In addition to the continuously increasing while real GDP grew by 7.3 percent over the interest payments, inflation deepened the prob­ 1985 level. However, because the government lem. In fact, the annual Argentine inflation rate could still not maintain control over the bud­ reached over 200 percent by 1982. (Bowne, get deficit, the improvements turned out to be p. 9) This increase had mainly been a result of short-lived. Public revenues declined as export the lack of control exercised by the BCRA and taxes were greatly shrunk to offset low interna­ the government over fiscal policy and the money tional prices for Argentine agricultural prod­ supply. The government and its agents lacked ucts. Also, the BCRA continued to expand cred­ the self-discipline necessary to achieve stability. it to the public sector through rediscounts. Evasion from government taxes was common as Credit increased through the use of these the tax collection system was not strictly instruments by re-valuing the debt already owed enforced, and the federal government lacked the and accepting a value less than the actual face authority to do so. Furthermore, the many value so that creditors were given even more state-owned enterprises were provided with borrowing opportunity. Thus, short-term debt large subsidies due to their inability to meet increased, and the BCRA deficit climbed. market needs. Because of these large subsidies As the rate of inflation remained high and and the tax evasion problem, even larger pub­ even began to rise again, still more stabilization lic-sector deficits resulted. These deficits were attempts were made. In August 1988, the again financed in large part through increases Primavera Plan was adopted. Similar to past in the money supply and external financing attempts, this plan relied upon a wage and price attempts. And as inflation continued to soar, freeze to slow inflation, a gains tax on grain real economic growth turned negative for 1982. sales, and an increase in interest rates. Its sta­ Although strong efforts were made to bilization effor-ts were nearly identical to those

36 of earlier plans, and so its results were likewise hyperinflation. Therefore, the government short-lived. Inflation quickly dropped from 27.6 devalued the austral, implemented a fixed percent per month to 5. 7 percent per month. exchange rate relative to the dollar, instituted (Bowne, p. 9) The fiscal situation improved wage and price controls, and sharply increased slightly, and real interest rates turned higher. public utility rates in order to slow any future As a consequence, inflows of short-term exter­ price jumps. These policies were fairly suc­ nal capital began to rise once more. But once cessful with the monthly inflation rate soon again, the public sector failed to improve. As reduced to 7.2 percent near the end of 1989. more and more citizens evaded their federal tax However, as had been the case in the past requirements and as prices of public goods with previous stabilization efforts, expectations remained relatively high, private investors' of a return of hyperinflation caused a sharp overall lack of confidence in the system height­ decline in the price of the foreign exchange ened. This lack of confidence was manifested markets. As gaps in prices occurred, investor by a decrease in consumption and investment anticipation that these reforms would be unsuc­ in the second part of 1988 and a drop in GOP of cessful caused many to reduce their holdings 1.9 percent for the year. (Bowne, p. 9) in the Argentine currency, thus causing the Furthermore, the Primavera Plan faced decline in exchange markets. As a conse­ sudden failure when yet another crisis in the quence, the government decided to take a dif­ foreign exchange and financial markets ferent approach. The main focus now became occurred in early 1989. Due to the high prices reducing the public deficit, which had been the of public sector goods relative to the prices of principal cause of the inflation. Thus, the similar private goods as noted above, a severe Bonex Plan was implemented in December price imbalance between the two markets 1989, which featured tax reforms and stricter resulted. That imbalance, along with the control of public enterprises and of the lending impending national elections, led to expecta­ activities of public sector banks. Previously, tions of a huge devaluation. Thus, flight from these banks had been financing local govern­ the austral increased, and the gap between the ment deficits through loans which were in turn free and official exchange rates reached an aver­ financed with discounts from BCRA. Hence, age of 165 percent in March 1989. Hence, a public sector banks were financing loans self-fulfilling prophecy was realized when a through other discounted loans. The plan also major devaluation occurred. The nominative eliminated all restrictions on foreign exchange value of the austral declined 146 percent rela­ transactions in order to allow for more freedom tive to its 1988 year-end level. (Bowne, p. 9) of movement of the currency. Lastly, the plan froze short-term bank deposits in which short­ The Bonex and Convertibility Plans term deposit holders (under thirty days) were only allowed to withdraw up to the equivalent In July 1989 the Menem government took of U.S. $1 ,000 from their accounts. The balance control of the Argentine nation. It inherited an of their accounts was then made payable solely economy racked by a hyperinflation so great in Argentine government bonds. These bonds, that the CPI was rising by 196.6 percent per called Bonex 89 , were 10-year U.S. dollar month. (Bowne, p. 9) External creditor rela­ denominated bonds. Investors were thus tions were at a low point as the ability of required to keep their short-term deposits in Argentina to pay its debts remained question­ Argentine banks, creating greater stability in able. In fact, interest payments on commercial the financial community. bank debts had gone into arrears in April1988, Once again, though, the Argentine econ­ and payments to the World Bank were often omy slipped into its old ways as the financing late. As a result, the IMF and the World Bank of government expenditures went undisciplined programs designed to help alleviate the and unrestrained. As funds for the social secu­ Argentine inflation problem had failed. rity system and provincial governments became The key objective of the new government depleted, the BCRA again expanded credit lines. was to stabilize prices and hence reduce the It lent funds to the social security system and

37 to provincial banks that were facing deposit provincial banks, in strengthening the social runs. Events turned full circle as the provin­ security system's finances, and in rescheduling cial banks ignored the dictates of the Bonex public sector debt. Since its implementation in Plan and continued to lend for the purpose of March 1991, the inflation rate has dropped from financing provincial government deficits. Once 27 percent per month to .4 percent per month again downward market pressure was exerted in June 1994. For the year 1993, the annual on the austral due to the credit expansion, and inflation rate was only 7.4 percent. along with this pressure came a resurgence of In order to achieve such successful results, price inflation. three important structural changes in the gov­ Therefore, in a pattern that was becoming ernment had to be implemented. First, the all too common, still another stabilization pro­ independence of the BCRA had to be established gram was created in 1991 in an attempt to and enforced. No longer could it be used as a reduce the public sector deficit by raising pub­ "tool" of the government to make money and lic utility rates and taxes. This latest effort is to finance debt. Second, the deregulation of the titled the Convertibility Plan, and it is based on economy had to occur. Economic restrictions two basic principles: such as import tariffs were lowered in order to 1) There is to be full international encourage international trade. Other legisla­ reserve backing for the monetary tive restrictions were likewise removed in order base. The monetary base also may to allow the private sector to provide several not exceed BCRA's gross interna­ public services, including telephone, electrici­ tional assets at a fi xed rate of one ty, and natural gas. Markets were finally peso per U.S. dollar. In other allowed to function freely, and competition was words, the money supply can only promoted. Third, privatizations of several state be increased when backed by a enterprises were put into effect. This last mea­ similar increase in the level of sure helped to reduce the government's out­ international reserves. Thus, fis­ standing debt, to increase reserves, and to cal self-discipline is imposed by not increase tax revenues from the new owners of allowing the government to the enterprises. It has also led to renewal of increase the money supply when­ direct foreign investment in Argentina. Overall, ever the public or financial sector the privatization program has raised about $9.7 needs to be financed. Further­ billion in cash proceeds for debt repayment and more, the peso is made fully con­ has reduced public sector debt principal by vertible to the U.S. dollar at a one­ $13.4 billion through December 1993. to-one rate. 2) The fiscal deficit is to be eliminated The Brady Plan and a surplus in the primary cur­ rent accounts balance is to be As of December 31 , 1993, non-financial achieved. In doing so, the govern­ public sector debt (federal government and pub­ ment will be able to service its debt lic utility debt, but not provincial debt) was and thus eliminate the need for $66.3 billion. A total of 92 percent of this net further borrowing. non-financial public sector debt was denomi­ The Convertibility Plan began in March nated in currencies other than the Argentine 1991 and has been in effect ever since. Its suc­ currency (mainly in U.S. dollars). (Bowne, p. 44) cess has won the support of the IMF, which Earlier, in April 1992, Argentina had designed a financial program for the Argentine announced an agreement with the U.S. and the public sector. Up through the first quarter of IMF to refinance this debt under the Brady Plan. 1994, Argentina has attained or surpassed the In brief, the Brady Plan was to reduce the debt IMF primary balance targets. Overall, the plan amount conditional upon the Argentine gov­ has also been successful in reducing tax evasion ernment's carrying out of structural economic and raising tax rates, in reducing public sector reforms that met the approval of the IMF, such employment, in providing stricter discipline for as removing government-imposed impediments

38 to productivity and competitiveness and attract­ linger strongly in people's minds, and any hint ing capital from abroad. Then, the existing debt of such a return would stimulate panic and col­ would be converted into a form acceptable to lapse of the economic system. Thus, it is of the banks involved, while it would also reduce utmost importance that the money supply and the overall debt burden. Basically, the Brady the exchange rate are kept in check. Moreover, Plan called for governmental policies involving strict regulations over the daily actions and capitalism and competition to be fully imple­ interactions of provincial banks must be insti­ mented in order to reduce the debt burden. tuted and enforced in order to keep the financial The reduction of debt by the Brady Plan sector sound. In doing so, investor confidence occurred through the use of par bonds, discount will increase further and possible credit oppor­ bonds, and floating-rate bonds. These bonds tunities will then become more readily available. were exchanged for previously outstanding com­ Second, state reforms must continue mercial bank debt, including interest arrears. along the lines followed in recent years. For Overall, this plan reduced the face amount of instance, competition and privatization projects debt denominated in foreign currency by near­ must be encouraged. Argentina must join the ly $3 billion and reduced by about 35 percent rest of the world with an open and free market. the net present value of the interest service. However, as previously mentioned, these steps As a result of this reduction, the Argentine must be implemented gradually so as not to public debt as a percentage of GOP declined alarm investors or trigger yet another panic. from 68.7 percent in 1989 to 25.9 percent in Third, the government must continue to 1993. (Bowne, p. 44) Just as importantly, peo­ follow tight budgeting procedures. Until ple's confidence returned to the system as recently, the executive branch of the govern­ Argentineans brought deposits from other ment has not been required to submit a bud­ banks back to Argentine banks. In fact, $35 bil­ getary proposal to the legislative branch. The lion in foreign assets were returned over this Convertibility Law now requires the govern­ same period. Furthermore, investment ment to prescribe a budgetary proposal for increased significantly to about 19 percent of expenditures. This budget is supposed to be GOP by the end of 1993. closely maintained. Of course, due to the lack Pursuant to this plan, Argentina has refi­ of experience with such procedures, this nanced over 96 percent of its commercial bank process is still in its early stages and improve­ debt. An estimated $28.5 billion of debt, $9.2 ment in the financial budgeting methods is billion of which was interest arrears, was needed. But it is still important that such a pro­ accepted by the IMF under the regulations of cedure be continued and enforced in the future. the plan. About 85 percent of those arrears to These are the three most important polit­ foreign banks was released in October 1993, and ical and financial objectives that must be pur­ the remaining 15 percent was released in April sued if Argentina is to recover fully from the 1994. (Bowne, p. 44) debt crisis of 1982. Only if these objectives are met will the proposals to reducing the foreign­ Restoring Confidence denominated debt as assumed by the public sec­ tor finally succeed. As shown by the many previous plans that failed, greater discipline and stricter reforms in The Future of the Argentine Debt government policies are necessary in order for Problem Argentina to avoid falling back into its former state of hyperinflation. Furthermore, success As we have seen, from the onset of the debt requires additional progress in three major crisis in 1982, a number of proposals to resolve areas if the necessary confidence is to be the Argentine debt problem have been intro­ restored in the system. duced. In each case, though, the proposals have First, and most importantly, the govern­ revolved around two crucial questions: 1) who ment must continue to display monetary and fis­ should bear the losses and 2) what reforms are cal discipline. Memories of hyperinflation still required to reduce the chances of a similar sit-

39 uation arising in the future. for Argentina to raise itself up to the standards Initially, the "solutions" required only the of production and living of other developed debtor country, Argentina, to sacrifice and make nations. Greater success with its investments the necessary adjustments and reductions in will occur only through 1) the implementation general expenditures; but, these "solutions" of free-market-oriented policies including the seem to have ignored the responsibility of the encouragement of competition and privatiza­ lending institutions who are at least partly tion, 2) the reduction of barriers, by developed accountable for their own previous lending countries, to Argentine exports, and 3) more decisions to absorb some of the losses. Several robust domestic economic policies. These poli­ of these proposals, which simply attempted to cies must also center around investment in the reschedule the debt payments, were basically Argentine people. Furthermore, Argentina has ineffective since they just postponed and to improve the climate for enterprise. For increased the arrears of the already extraordi­ example, the government must reduce inter­ nary debt level. vention in industrial and agricultural pricing For example, although the Brady Plan and focus more on improving infrastructure appeared to solve a portion of the Argentine and institutions. Finally, firm macroeconomic problem through a reduction in the face value policies must be followed. As already stated, of the debt, the basic premise has once again inflation must be held in check and fiscal been to refinance the debt through new debt. deficits kept low. Incentives for savings and In sum, the attempt was to create a market-ori­ investment must be set in place. It has been ented system for Argentina in order to help it well-established in the financial world that high eventually repay the debt. However, the plan domestic savings and investment rates are nec­ may in fact just be delaying the need for anoth­ essary for a country to reach a more economi­ er Brady Plan to be put in place at the maturi­ cally developed stage. ty of the newly issued bonds. The end result of these policy improve­ The reason why finding a solution is so dif­ ments will be both economic growth and finan­ ficult results from the age-old Argentine prob­ cial growth. If such developments occur, in lem of a lack of exports. The only way out of addition to the necessary political reforms men­ the problem in the long run is to increase the tioned earlier, then a "solution" can be both volume of exports. Export expansion can be reached and maintained. achieved only if the Argentine economy grows, a condition which of course requires capital. The Involvement of Other Nations From where can this capital come? At the most obvious level, lending institutions need to As previously stated, the Argentine debt provide some of this capital, as is the case with crisis is a two-sided problem. Both the bor­ the Brady Plan. However, Argentina cannot rower and the lenders are partly to blame. The remain entirely dependent on foreign bank lesson to be learned by both parties is that an loans and bond issues. As noted above, it must optima/level and composition of debt does attempt to create a trade surplus so that its exist, and that the amount of debt undertaken exports can help finance the repayment of inter­ was far too great. The key, however, is for all est. More importantly, the private sector needs countries involved to more carefully search for to provide some of the capital. Only if this this optimal level, to take precautions to reduce domestic market for generating capital devel­ the chances of such a crisis from occurring ops will long-term success be achieved, and again, and to continue to search for methods to only then will large-scale foreign investment reduce the debt problem. return to Argentina. Borrowing and lending nations must real­ The only long-term solution then is to ize that country financing should be done with ensure that the returning foreign investment more equity and less debt. Of course, such is devoted to projects that generate more pro­ measures will transfer more control from the duction and benefits than their investment cost. borrowing country to the investor. However, Those funds must be put to good use in order this transfer will then increase the country's

40 capacity to carry debt by improving its produc­ as 14 cents on the dollar. Overall, the Argentine tivity through wise investments. This increase foreign debt was reduced by $5 billion, and in private sector productivity will in turn raise interest costs were cut by nearly $500 million overall output and hence the debt capacity of per year. the country as a whole. Furthermore, because equity investors will be sharing a portion of the Conclusion risk, they will search more thoroughly for good investments. Foreign investors must also be The Argentine debt crisis is not over, and able to generate sufficient foreign exchange to perhaps it can never be solved. It has evolved pay their own way, which will increase the from decades of structural insolvency, backward country's capacity to service foreign financing. financial repression, and unwise political and Among the possible measures to increase economic policies. Its history is long and bit­ equity and reduce debt in country financing are ter, while improvements are only recent and debt-for-equity swaps and privatization. In a possibly short-lived. debt-for-equity swap, a portion of the debt is However, Argentina is a country full of traded or sold for equity in domestic compa­ potential. Perhaps these past few successful nies. This instrument requires a government years are a signal of what the future holds. In appreciation of and initiative toward increased order to progress further, though, Argentina foreign investment and a more open economy. must pursue economic policies that instill con­ However, no major government intervention fidence in the minds of its people. Monetary should be necessary since an open economy and fiscal discipline must be maintained, espe­ should attract the foreign investment anyway, cially during government transitions. The providing the country with the foreign economy must grow through the stimulation exchange necessary to buy back the debt in the of investment. In other words, the domestic secondary market. The important step, again, market must develop further in order to is the opening of the economy in order to allow advance the privatization program and achieve for the other benefits to follow. a growth in exports. In addition, debt-for-equity swaps could be Of course, such reforms will not occur - combined with the already successful privati­ nor will the debt crisis end - overnight. But zation program. The debt could be exchanged if Argentina can continue along its recent path for ownership shares in state enterprises, as of improvement and if the United States and the happened in 1992 with the sale of the Argentine other countries of the world make every telephone company, ENTEL. The government attempt to aid in Argentina's development, then split the company into two parts, selling 60 per­ at least the worst aspects of the debt crisis can cent of each part through debt-for-equity swaps. be alleviated. No matter how gradual the Several foreign and domestic banks and tele­ process may appear, a solution is attainable. Its phone companies were involved in the swaps. success, though, can only be assessed through Other U.S. banks contributed some of the debt the passing of time. In the words of Argentina's from their own balance sheets, thus easing the Undersecretary to the Minister of Economics, burden. However, the bulk of the debt was Dario Braun, "We're renting stability, and each acquired on the secondary market where the month we have to pay the rent." (Braun) defaulted Argentine debt was trading for as low

41 REFERENCES

Argentina Economic Report. Ministry of Foreign Affairs, Eichengreen, Barry and Peter H. Lindert. The International Centro de Economia lnternacional, August 1992. Debt Crisis in Historical Perspective. Cambridge, Argentina: Economic Trends Report. U.S. Embassy, Buenos Massachusetts: The MIT Press, 1989. Aires, Argentina, June 1994. Kessler, Ana de, Diputado de Ia Naci6n. Personal interview, "Argentina Expecting More Talks on Debt," American Buenos Aires, August 1994. Banker, Volume 157, August 10, 1992, p. 10. Kettell, Brian and George Magnus. The International Debt Bour, Enrique. Personal interview, Buenos Aires, August 1994. Game. Cambridge, Massachusetts: Ballinger Bowne of London. The Republic ofArgentina: Information Publishing Company, 1986. Memorandum Addendum. London, England, August Kraus, James R. "The New Latin America," American 17, 1994. Banker, Volume 157, September 22, 1992, p. 6A. Braun, Dario. Subsecretario de Programaci6n Macroeco­ Kuczynski, Pedro-Pablo. Latin American Debt. Baltimore, n6mica, Ministerio de Economfa. Personal interview, Maryland: The Johns Hopkins University Press, 1988. Buenos Aires, August 1994. Montanaro, Elisabetta. "The Banking and Financial System Caballos, Dr. Carlos, Professor of Economics, Catholic in Argentina: The History of a Crisis," pp. 72-83. University. Personal interview, Buenos Aires, August Pastor, Robert A. Latin America's Debt Crisis. Boulder, 1994. Colorado: Lynne Reinner Publishers, Inc. , 1987. Dorfman, Miguel, Economic Planning Secretariat, Ministry Wionczek, Miguel S. Politics and Economics ofExternal Debt of Economy and Public Works and Services. Argen­ Crisis. Boulder, Colorado: Westview Press, Inc., 1985. tina-A Country for Investment and Growth -1994.

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