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By: Anish Beeram
On May 22, 2020, Argentina defaulted on its debts after failing to pay back nearly $500 million in delayed bonds. This was Argentina’s ninth default since their nation’s independence and their second time since 2000. Argentina has been a revolving door of economic instability and recently, this was a direct result of the hazardous presidential, geopolitical, and international climate, paired with poor economic strategy. However, the root of the debt crisis: currency. As the Argentine peso progressively lost value against the United States dollar, debt continually accrued.
To understand Argentina’s debt crisis better, one must understand the rise in inflation rates. Then-president Mauricio Macri attempted to stabilize markets by resetting the exchange rate of the peso on the private market. To this end, his administration artificially inflated the price of the peso by buying and selling it for more than it was actually worth on the market. Simply put, he lowered the exchange rate of pesos to USD, effectively allowing Argentine citizens to receive more USD per peso than otherwise possible. Unfortunately, instead of resetting the private market’s exchange rate by setting an example, the public took the excess money and converted it into pesos on the private market, relying on the actual exchange rate based on market value. This process led to consumers having excess amounts of money in pesos, with the intention to increase wealth. Unfortunately, continuing to prop up the peso led to constant devaluation, where it progressively lost value against the dollar. Ultimately, the currency devaluation caused massive spikes in inflation rates, as the market overheated. Consequently, the Macri administration raised interest rates on savings accounts to encourage saving and prevent money from being spent. These measures were, in theory, intended to raise the value of the peso; however, the economy had already begun a death spiral.
Simultaneously, due to a domino effect from a troubled economy, the Argentine Central Bank was financing their budget deficit by printing money and forcing banks to buy government bonds. These bonds simply represented issues of government debt. Considering the state of the peso, this method of funding was not sustainable. As a result, the Macri administration shifted to selling bonds on the international market with extremely high-interest rates. The purpose was to bring foreign investment into Argentina. To external investors, the bonds seemed highly profitable, as a 40% interest rate promised a very high level of return. As a result, foreign financing poured into Argentina; however, selling bonds came with a devastating caveat. Since Argentina had a horrible credit rating on the international market, they conceded that all the terms of the bonds would be in USD. This meant that in order to pay back the bonds, they would need to convert pesos to dollars. In 2017, this financial endeavor lost all prospects, due to a problematic economic trifecta. 1) In America, the Federal Reserve raised its key interest rate. Essentially, this meant that international investors could make more money by investing in less risky American assets, rather than buying new Argentine ones. On the international market, this led to investors selling Argentine assets in bulk, making it impossible for Argentina to get new loans at an affordable interest rate. 2) A widespread drought decimated ⅓ of Argentine agricultural production. Since Argentina makes over half of its money from agricultural exports, this drought drastically cut revenue. 3) President Macri attempted to calm markets by making massive budget cuts. Unfortunately, this caused the peso’s value to drop further while raising interest rates to their highest levels. The government basically wanted no money to be spent in the economy. Despite these measures, the value of the peso continued to drop against the dollar. Meanwhile, the high-interest rates actually worked, and Argentine citizens saved their money. However, the lack of economic activity sunk Argentina into a recession, and considering that the peso had lost ⅔ of its value against the dollar over the bond’s term, the principle on each loan became 3 times more expensive. Ultimately, Argentina had no way to pay off loans that had already been taken out and were bound to mature.
To manage their accumulated debt, Argentina received a $57 billion bailout package from the IMF (International Monetary Fund), the largest in the history of the institution. A bailout package is essentially financial support given to countries by the IMF. However, the loan came with strict conditions. The IMF managing director, Christine Lagarde, explained that the package required heavy austerity measures to be imposed. This essentially demanded the government not to spend an excess of money through a commitment to a zero deficit. Thus, the Argentine government began making large budget cuts, in addition to changing its inflationary metric. The Central Bank shifted from using inflation percentages to setting definitive and verifiable monetary base targets. This new framework entailed containing the supply of money and keeping short-term interest rates high, in order to bring inflation down. This caused the Argentine public to simply stop buying goods. The result of these austerity measures was an economic contraction, as economic growth stalled.
The lack of economic activity had severe repercussions on the Argentine political climate. In the 2019 general election, societal frustration was evident as the incumbent president, Mauricio Macri, lost in a landslide to former Cabinet Chief, Alberto Fernández. Immediately afterward, the Argentine public feared that the change in administration would result in currency controls, in which the government restricts the ability to buy foreign currency. Thus, during the transitionary period, Argentine citizens frantically bought USD on the open market, while they still legally could. This contributed to a massive run on the peso, which drastically dropped its value, and by late 2019, the government postponed $7 billion in short-term local bond payment, while simultaneously pushing for a maturity extension of $50 billion in long-term debt held by foreign investors. In addition, the Central Bank sought to delay the repayment of $44 billion of IMF loans. Considering that 88% of the IMF’s bailout package was used to provide USD to pay down foreign debt, Argentina is attempting to pay off the debt by accruing more debt.
The IMF has now assumed preferred creditor status, which means that Argentina must pay back the debt it owes the IMF before it can pay off any debt owed to foreign investors. Thus, it is very unlikely that investors will receive any returns on their assets in the near future, indicating a lack of future foreign investment into the Argentine economy. Until they can build stronger monetary policy, regain the trust of international markets, revalue the peso, and diversify their economy, Argentina will continue to remain trapped by their own accumulating debt.
Discussion Questions:
How can the Argentine Central Bank pay off the debt owed to the IMF?
What steps can the Fernández administration take to regain the trust of foreign investors?
Will Argentina be able to decrease inflation rates to under 30%?
Does the Argentine Central Bank need to worry about decreasing currency controls?
Will Argentina make economic reforms after its latest default?
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