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Managing the Financial Crisis: Argentina (2002) Mario I. Blejer

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 Financial Crisis: Argentina (2002) Mario I. Blejer

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  1. Managing the Financial Crisis: Argentina (2002) Mario I. Blejer

  2. 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

  3. 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

  4. 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?

  5. THREE APPROACHES: 1. The loss of competitiveness of the Argentine economy 2. Macroeconomic policy inconsistencies 3. The “Sudden Stop” argument

  6. 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%

  7. 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%

  8. 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%

  9. 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

  10. 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

  11. 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

  12. 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

  13. Credit to Private Sector

  14. 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.

  15. 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

  16. 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

  17. EMBI Index Public SectorLoans / Net Worth (%) Private Deposists - IndexDec 00 =100 (2nd axis)

  18. 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

  19. 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

  20. 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

  21. 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.

  22. Only feasible intermediate solution: slow the pace of the bank run and, at the same time, try to avoid excessive liquidity expansion.

  23. 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.

  24. Choice of Foreign Exchange Market Strategy: high interest rates vs. FE market intervention: substitutes or complements?

  25. persevere to the point where greed> panic

  26. The central bank provided rediscounts to illiquid banks and financed about 1/3 of the deposit drop

  27. 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.

  28. 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.

  29. Initially deposit withdrawals continued

  30. However, the trend reversed after four months

  31. The need for the provision of liquidity from the Central Bank where largely reduced

  32. 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.

  33. 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

  34. 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

  35. 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

  36. Indeed, as always, greed> panic

  37. 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

  38. 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

  39. 2. Financing the Public Sector and the “Crowding Out” Effect

  40. 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

  41. 4. The Role of Foreign Banks -- Do they reduce financial vulnerability? -- Can they provide, implicitly, LOLR function?

  42. 5. Capital Controls Does capital account integration reduce financial vulnerability? Long run desirability vs. short run, transitional, risks Capital controls and crisis management

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