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Managing the Financial Crisis: Argentina (2002) Mario I. Blejer. Managing the crisis:. Assess the Nature and the Root Causes of the Crisis Define the Tradeoffs Define and Operational Strategy Persevere in the Implementation Learn some Lessons. The Nature of the Argentina Crisis.

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managing the crisis
Managing the crisis:
  • Assess the Nature and the Root Causes of the Crisis
  • Define the Tradeoffs
  • Define and Operational Strategy
  • Persevere in the Implementation
  • Learn some Lessons
the nature of the argentina crisis
The Nature of the Argentina Crisis

The Argentine crisis is both a CURRENCY and a BANK crisis – Inter-related but caused by a number and combination of different factors

Analytically, better to distinguish between them in an explicit manner

the currency crisis
THE CURRENCY CRISIS

The Currency Crisis reached its peak with the January 2002 devaluation. It is usually analyzed in the context of the ARGENTINE CURRENCY BOARD SYSTEM, established in 1991 as an anti-inflationary devise.

The question to be analyzed is: What were the weaknesses and the main causes for the demise of the convertibility regime?

slide5
THREE APPROACHES:

1. The loss of competitiveness of the Argentine economy

2. Macroeconomic policy inconsistencies

3. The “Sudden Stop” argument

slide7

As percentage of GDP

3,0%

60%

2,0%

50%

1,0%

40%

0,0%

30%

20%

10%

0%

1993

1994

1995

1996

1997

1998

1999

2000

2001

Overall Result

Primary Surplus

Total Debt (2° axis)

EMBI Spread (2° axis)

Fiscal misalignement turned the burden of the debt unsusutainable

-1,0%

-2,0%

-3,0%

-4,0%

slide8

As percentage of GDP

3,0%

60%

2,0%

50%

1,0%

40%

0,0%

30%

20%

10%

0%

1993

1994

1995

1996

1997

1998

1999

2000

2001

Overall Result

Primary Surplus

Total Debt (2° axis)

EMBI Spread (2° axis)

Fiscal misalignement turned the burden of the debt unsusutainable

Public

Debt

-1,0%

-2,0%

-3,0%

-4,0%

slide9

As percentage of GDP

3,0%

60%

2,0%

50%

1,0%

40%

0,0%

30%

20%

10%

0%

1993

1994

1995

1996

1997

1998

1999

2000

2001

Overall Result

Primary Surplus

Total Debt (2° axis)

EMBI Spread (2° axis)

Fiscal misalignement turned the burden of the debt unsusutainable

-1,0%

-2,0%

Country

Risk

-3,0%

-4,0%

slide13

Capital Flow s and Economic Activity (Accumulated 4 quarters - U$Sm. GDP Cyclical Component)

Capital Flows Private Sector

8%

15.000

10.000

6%

5.000

4%

0

2%

-5.000

0%

-10.000

-2%

-15.000

-4%

-20.000

Russian Crisis

GDP Growth

-6%

-25.000

-8%

-30.000

-10%

-35.000

IV 98

IV 94

IV 96

IV 95

IV 01

IV 97

IV. 00

IV. 99

slide14

Sudden Stops in Argentina and Chile

(Private Capital Flows, Percentage of GDP

4%

8%

7%

3%

6%

2%

5%

Argentina

4%

Argentina

Chile

1%

3%

0%

2%

1%

-1%

Chile

0%

-2%

-1%

1998-I

1999-I

2000-I

2001-I

1998-II

1999-II

2000-II

2001-II

1998-III

1999-III

2000-III

1999-V

1998-IV

2000-IV

slide15
THE BANKING CRISIS

While the problems of convertibility and the consequent exchange rate uncertainty played a role, the banking crisis was largely caused by the government “abuse” of the banking sector, given its inability to to adjust the budget deficit

slide16

Private Sector Deposits (in bn Arg. Pesos)

Finance Minister

“Corralito”

Resignation

80

75

70

65

Devaluation

Interest

60

rate

"

ceilings

55

50

Sep 00

Dec 00

Mar 01

Jun 01

Ago 01

Nov 01

Feb 02

Apr 02

Jul 02

slide18
The main cause for the banking crisis was the fear was that banks would be rendered insolvent by government policy and that deposits would be confiscated.

An important reason behind this fear was the fact that private sector assets were being displaced by public sector assets in bank’s balance sheets.

slide19

Private Sector assets have been displaced by Public Sector assets in bank’s balance sheets

100%

80%

$ 76 MM

60%

40%

$ 43 MM

20%

0%

Dec-99

May-00

Oct-00

Mar-01

Aug-01

Jan-02

Jun-02

Public Sector

Private Sector

slide20
The increasing banking exposure to the public sector was accompanied by

1. a rapid decrease in deposits and

2. a sharp increase in country risk

slide21

EMBI Index

Public SectorLoans / Net Worth (%)

Private Deposists - IndexDec 00 =100 (2nd axis)

slide22
November 2001:withdrawal restrictions on bank deposits (“corralito”).
  • December 2001: Riots the De la Rua and Cavallo government.
  • First two weeks of January 2002: --public debt default --currency board is abandoned and the currency devalued --bank assets and liabilities are pesifiedasymmetrically - i.e. at different rates
the abandonment of the currency board was traumatic
The abandonment of the currency board was traumatic:

-- Complete loss of confidence in the banks, the currency, and the government

-- Continuous bank run

-- A run on the peso that pressured strongly the exchange rate

-- No money market or debt instruments for open market operations

the tradeoffs and the dilemma for the central bank
The Tradeoffs and The dilemma for the central bank
  • Having regained the LOLR function the CB could provide the liquidity needed to finance the bank run. Pesos would fly to the exchange market – risk of hyperdevaluation and hyperinflation.

OR

slide25
The CB could restrain the rediscount facility and let banks deal with the deposit run. May prevent hyperinflation, at the risk of the total collapse of the banking sector.
slide26
Only feasible intermediate solution:

slow the pace of the bank run

and, at the same time, try to avoid excessive liquidity expansion.

the strategy followed
The Strategy Followed

-- Provide liquidity support to banks to prevent massive bank closures.

-- Develop sterilization instruments at the Central Bank --the LEBAC-- to mop up liquidity and to compete with the U$S.

-- Utilize part of CB reserves to intervene in the foreign exchange market to slow the pace of depreciation and to avoid chaotic conditions.

slide28
Choice of Foreign Exchange Market Strategy:

high interest rates

vs.

FE market intervention:

substitutes or complements?

slide31
The market for Central Bank ST Bills (LEBAC) was actively developed, initially with 7 days maturities and then with 14 and 28 days, in Pesos and U$S. Interest rates reached 140% initially.
slide32
Intervention in the foreign exchange market prevented disorderly behavior but did not peg the rate, that devalued from 1 to 3.6 Pesos per Dollar. Intervention in the first five months was about U$S 2 bn.
slide38
The demand for LEBACs grew strongly.

-- LEBACs with up to one year maturities were introduced successfully.

-- By October interest rate has fallen to 8-45% range, according to maturities.

slide39

Average duration and cost of LEBACs in pesos

Days

ANR 14d %

140

140

Average

Cost

120

120

100

100

80

80

60

60

Average

Duration

40

40

20

20

0

0

15-mar

14-apr

14-may

13-jun

13-jul

12-aug

11-sep

11-oct

10-nov

10-dec

9-jan

Decrease ofaverage cost and duration of LEBACs

slide40
The exchange rate stabilized and started to appreciate. The CB has stopped selling and is actively buying reserves to prevent a large appreciation in the exchange rate.

In total the CB has regained more than the initial stock of intervention

slide42

12%

4,0

3,5

9%

3,0

2,5

6%

2,0

1,5

3%

1,0

0,5

0%

0,0

Jn

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

CPI

Nominal Exchange Rate – monthly average (2° axis)

The stabilization of the exchange rate

has also resulted in a sharp decline

in level of inflation

slide44

The Financial System needs restructuring

Financial statements situation - Dec2001/Dec2002

180

160

Loans to Private Sector

140

120

100

45%

17%

80

60

54%

40

21%

20

0

Dec 01

Dec 02

Loans to the Public Sector

slide45
LESSONS

1. The Potential Fragility of Financial Institutions

Solid and solvent financial structures could deteriorate quickly in the face of inadequate interventions and policies.

The fact is that weak financial sectors are not necessarily crisis prone. Crises are generated by inconsistent policies and an unstable macroeconomic environment

slide47
3. The Importance of Proper Liquidity Management

Availability of liquidity is a crucial element in the prevention and the management of financial crises

LOLR does not guarantee stability but its absence accelerates the erosion of confidence

slide48
4. The Role of Foreign Banks

-- Do they reduce financial vulnerability?

-- Can they provide, implicitly, LOLR function?

slide49
5. Capital Controls

Does capital account integration reduce financial vulnerability?

Long run desirability vs. short run, transitional, risks

Capital controls and crisis management