At the urging of Germany and France, the ECOFIN agreed on a reform of its
Stability and Growth Pact. The ceilings of 3% for budget deficits and 60% for
public debt were maintained, but the
decision to declare a country in excessive deficit could now rely on certain
parameters: the behavior of the cyclically adjusted budget, the level of debt,
the duration of the slow growth period and the possibility that the deficit was
related to productivity-enhancing procedures. The pact is part of a set of
Council Regulations, decided upon the European Council Summit on March 22-23,
The curse of IMF conditionalities
The problem with the International Monetary Fund's "conditionalities" cure in a
sovereign debt crisis is its insistence on a balance fiscal budget at the wrong
time - during a monetary-induced recession - thus adding to the economic pain
unnecessarily and assigning disproportional burden on the most defenseless
segment of the population, that is, the working poor, and condemning the
impaired economy to an unnecessarily long path toward recovery.
In Argentina, without the Convertibility Law of 1991, economic reform would not
have progressed so far and so fast as to cause the severe debt crisis of 2001.
In December 2001, after four years of deepening economic recession and mounting
social unrest, the Argentina government collapsed and all sovereign debt
payments ceased. The country had failed to pay its debt on time before, but
this time it registered the largest sovereign default in its history.
Argentina's total public debt grew from a manageable 63% of GDP in late 2001 to
a record-breaking and unsustainable 150% of GDP following default and
devaluation in early 2002 because while the debt kept growing, the GDP was
Argentina had to restructure more than $100 billion owed to both foreign and
domestic retail bondholders, with about $10 billion held by US investors, all
demanding payment only in dollars. With free flow of capital funds, the rich
Argentines could convert their pre-tax pesos to dollars to send them abroad and
brought them back with leveraged dollar loan as foreign capital to buy
Argentine sovereign bonds denominated in dollars that offered higher yields.
The rich Argentines were profiting from carry trade with interest rate
arbitrage against the peso in their home financial markets.
IMF loans exacerbated Argentina crisis
There are important questions related to the role IMF played in contributing to
Argentina's debt crisis. The IMF agrees that it may have hurt more than helped
Argentina by lending too much for too long into an untenable situation. The IMF
failed to define a clear threshold for identifying insolvency, which if
available would have helped Argentina avoid its debt crisis.
In not cutting off loans to Argentina sooner, the new additional IMF lending
exacerbated rather than helped Argentina's debt problem. The new IMF loans
displaced other older creditor debt for seniority in repayment, and left fewer
financial resources to be used in assisting Argentina in post-crisis
restructuring. This severely constrained Argentina's debt workout options.
During the Latin American debt crisis of the 1980s, the solvency of US
creditors was of paramount concern for the US government and so they had the
upper hand in negotiating sovereign restructurings. But the George W Bush
Administration rejected the Bill Clinton administration policy of large
sovereign debt bailouts and followed a policy of allowing market forces to
resolve sovereign debt disruptions. This commitment, however, proved easier to
articulate than enforce.
Although the Bush administration did not jump to the bilateral rescue of
Argentina as the Clinton administration had with Mexico in 1995, it did make
smaller efforts to intervene in Uruguay in 2002. In 2002, Uruguay and the US
created a Joint Commission on Trade and Investment (JCTI) to exchange ideas on
a variety of economic topics.
The case of Uruguay
The Uruguay banking crisis imploded in July 2002, precipitating a massive run
on banks by depositors and causing the government to freeze banking operations.
The crisis was caused by a sharp contraction in Uruguay's economy as a result
of over-dependence on neighboring Argentina, which experienced an economic
meltdown itself in 2001.
In mid-2002, Argentine withdrawals from Uruguayan banks started a bank run that
was overcome only by massive borrowing from international financial
institutions. This, in turn, led to serious debt sustainability problems. A
successful debt swap helped to restore confidence and significantly reduced
In total, approximately 33% of the country's deposits were suddenly withdrawn
from the financial system and five major financial institutions were left
insolvent. Hundreds of thousands of depositors in Uruguay, Argentina and Brazil
were left in dire economic conditions after money in their bank accounts
The banking crisis in Uruguay could have been avoided if Uruguayan regulators
had properly overseeing the banks. The Uruguay Central Bank had relied on
transnational banks to self-regulate and was too lax on financial regulation
and too slow in responding to the banking crisis.
The early 1900s was Uruguay's golden era. The country was rich from a very
favorable market for beef and wool while much of Europe was out of food
production during the war years. The country built up enough surplus wealth
that it could support generous social programs and government-run industries
that were introduced by president Jose Batlle. However, when the economy
weakened in post-war 1950s, the weight of the country's social programs and
large government payroll contributed to the country's financial crisis as
Europe came back into food production. The advance of synthetic materials cut
into the market for hides and other animal products produced by Uruguay.
The Tupamaros Marxist guerrilla group interpreted the financial crisis as a
result of social inequities and began a revolution that was crushed by a
US-supported military government that held power from 1973 to 1985.
Following the end of the Cold War, free-market fundamentalism and globalization
of trade and finance was adopted by many Latin American countries, including
Uruguay, implementing free-market reforms to compete in the new globalizing
world trade, resulting in income inequities and rising unemployment.
As a result, South America experienced a revival of left-leaning politics in
Venezuela, Bolivia, Brazil, Chile, Peru, and Uruguay. Uruguay first joined the
trend of moving to the left with the election of president Tabare Vazquez in
2004. Before his election to office, Vazquez campaigned for greater
regionalism, higher external tariffs, import quotas, and public works projects
financed by higher taxes.
There was concern among the world financial community that if Uruguay adopted
protectionist policies while carrying the debt resulting from the 2002
financial crisis, the economy would collapse. However, rather than making a
hard lurch to the radical left, Vazquez named the pragmatic dean of the
Uruguayan University of Economics, Danilo Astori, a social democrat, as finance
minister. Astori is a leader of the Asamblea Uruguay party, which is part of
the ruling center-left Broad Front party. Astori adopted an economic plan that
aggressively courted foreign investment and increased trade opportunities to
keep the Uruguayan economy growing. Social spending was increased, but within
the framework of a balanced fiscal budget.
Vazquez's populist politics and ideology flexibility in achieving his economic
objectives, combined with Astori's relatively pragmatic social democratic view
of how the capitalist world operates, resulted in five straight years of
economic growth despite the global financial crisis of 2008 and 2009. During
the Vazquez administration, poverty was reduced from 37% to 26%, and a free
Internet-ready laptop computer was provided to every child in Uruguay.
Vazquez was praised for his administration's fiscal discipline, which enabled
Uruguay to pay off a huge debt to the IMF made after the 2002 regional
financial crisis. But then, near the end of his term, spending accelerated and
the government went deep into debt despite the strong economy and new tax
Uruguay has a strong political culture that favors substantial state
involvement in the economy, and privatization is still widely opposed by
voters. Recent governments have carried out cautious programs of economic
liberalization similar to those in many other Latin American countries. They
included lowering tariffs, controlling deficit spending, reducing inflation,
and cutting the size of government. In spite of some de-monopolization and
privatization over the past 10 years, the state continues to play a major role
in the economy, owning either fully or partially companies in insurance, water
supply, electricity, telephone service, petroleum refining, airlines, postal
service, railways, and banking. The global financial crisis that began in the
US in 2007 has caused Uruguayan politics to be cautious about the wisdom of the
neo-liberal trends of the past decade.
The current president of Uruguay is Jose Alberto Mujica, (known as Pepe) who
was elected in November 2009 and took office March 1, 2010. Mujica was a former
Marxist Tupamaro guerrilla who participated in assault and kidnapping in the
1960s and spent 13 years in prison. Mujica's image as a leftist radical was
softened during the campaign when he acknowledged that the economy was doing
well and he would not make fundamental changes and would continue the direction
set by Danilo Astori, who had resigned from his ministry on September 18, 2008,
and was succeeded by Alvaro Garcia, a member of the Uruguay Socialist Party.
In February 2010, Mujica and Astori, now vice president, jointly met with a
group of mostly Argentine businesspeople in Punta del Este, where they promised
that their administration would set clear rules, reasonable taxes, and respect
private property rights. The message was that Uruguay plans to follow the path
of South America's "Responsible Left".
US support of IMF loans to Argentina
More to the case in point, when Argentina repeatedly sought help from the IMF,
the United States proved to be one of the strongest voices of support.
Therefore, any criticism of the IMF's costly response to Argentina cannot be
divorced from US policy, which when faced with a serious developing country
financial crisis, was unable to deviate significantly from the course taken by
the previous administration. A proposal for an international bankruptcy agency,
such as the Sovereign Debt Restructuring Mechanism (SDRM) promoted by the IMF,
failed to take hold.
Argentina made a final offer to restructure its sovereign debt in June 2004,
amounting to a haircut of 75% reduction in the net present value of its foreign
debt. Although a better offer was expected by year-end, it was still the
largest proposed write-down in the Post-World War II history of sovereign
restructuring. Both foreign and domestic holders of Argentine government bonds
rejected the workout proposal. Spooked by trouble brewing in Argentina,
emerging-market investors stampeded out of Turkey on November 22, 2000, before
the long US Thanksgiving holiday weekend, causing a financial crisis by
contagion. (See my article
How Turkey's Goose was Cooked, Sep 16, 2003 )