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March 10, 2005
Martin Wolf on Argentina's Successful Refinancing
He writes:
FT.com / Comment & analysis / Columnists - Martin Wolf: Argentina holds a weak hand: What are the lessons of Argentina's successful debt restructuring? For a success, in its own terms, it unquestionably is: Argentina has gained 76 per cent acceptance of a deal to reduce $100bn in debt by about 70 per cent in net present value. Everybody needs to learn the lessons. But Argentina also needs to exploit its opportunity. Alas, it seems more likely to deserve its reputation for never losing an opportunity to lose an opportunity.
The first lesson is that if a sovereign has decided that it makes more sense to default than to service its debts, only a more powerful sovereign can change its mind.... The second lesson.... Lending to sovereigns can indeed be risky, particularly to those with a deserved reputation for imprudence.... The third lesson is that worries over the moral hazard caused by rescue packages have been hugely exaggerated. Both creditors and debtors now realise that official assistance will not rescue them from the consequences of an insolvency. Creditors have experienced huge losses. Argentina has discovered that the International Monetary Fund lent it the rope with which to hang itself. The external help did not insure Argentina's politicians but made the results of their mistakes more painful.
The fourth lesson is that, however costly a default may be, not defaulting is occasionally costlier still. The costs to the defaulter are obvious: a painful crisis, a lost reputation, higher interest rates and financial disarray. This is not a route to be followed lightly, as Brazil under president Luiz Inacio Lula da Silva rightly concluded. But once creditors realise that the costs of not defaulting are, in the eyes of the indebted country at least, greater than those of defaulting, a vicious circle ensues: interest rates soar, credit dries up, the economy weakens, credibility further deteriorates and interest rates go up still further. In 2001, Argentina's economy was contracting while interest rates on its foreign loans were vastly above those on US treasuries (see chart). In this situation, not defaulting became an incredible and so ultimately infeasible option.
The fifth lesson is that once default becomes the least bad option, the optimal default is likely to be deep.... The sixth lesson is that the international community in general and the IMF in particular need to rethink their approach to life after a default....
Where, finally, might Argentina go now? The country is, alas, capable of throwing away any opportunity. Yet that is all default offers.... From the asymmetric conversion of bank liabilities and assets into pesos, which did such damage to the financial system, to the refusal to permit adequate adjustment of utility prices, which is undermining needed investment, short-sighted populism holds sway. By crowing over the scale of the default rather than regretting its necessity, Néstor Kirchner, the president, can only have frightened creditors and foreign investors further. Argentina is demonstrating once again why it has been both a serial defaulter and long-running economic failure. That may be the least important of the lessons. It is among the most depressing, all the same.
But countries should be able to default and restructure their foreign debt without having real GDP per capita fall by a quarter and without destroying their domestic financial system. Argentina's default was extraordinarily costly, for reasons that seem to me to boil down to large-scale political incompetence.
Posted by DeLong at March 10, 2005 11:21 AM
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Comments
"But countries should be able to default and restructure their foreign debt without having real GDP per capita fall by a quarter and without destroying their domestic financial system. Argentina's default was extraordinarily costly, for reasons that seem to me to boil down to large-scale political incompetence."
The incompetence was economic, not political, I think. Namely, the refusal to recognize that price stability is only sustainable when spending is kept below the level at which deficits begin to mushroom, and also to recognize that fiscal austerity is not feasible in an environment where the lack of price competitiveness and rigid labor markets generate high unemployment.
Also, I think Brad doesn't seem to realize in that quote that the 25% fall in real GDP between 1998 and 2002, and the destruction of the financial system happened in part because of the failed efforts to _avoid_ default, that is, the worst part of the collapse occurred either before or shortly after the Dec. 2001 default. It's not as if unemployment was at 5% before default and then shot up to nearly 25%. By the time default occurred, the collapse of the economy was a fait accompli.
Posted by: andres at March 10, 2005 01:02 PM
excellent point
Posted by: scorpio at March 10, 2005 01:14 PM
Is there a good example of a country that managed a less costly foreign default? I'm having a hard time thinking of a case not from the 1930s.
Posted by: P O'Neill at March 10, 2005 01:46 PM
mmm. How about Russia? (Not a rhetorical question.) The scale and nature of the default aren't really comparable, it seems. I would bet there will soon be papers comparing the two.
Posted by: Jean-Philippe Stijns at March 10, 2005 02:54 PM
Admittedly, I'm more familiar with the Asian imbroglios, and Brazil's then I am w/ Argentina's. A friend there who knows politics swears by the political incompetence theory. However I tend to think it's as most other international financial meltdowns; a combination of factors, wagers, and participants. Though there are usually many equally culpable characters and circumstances, that fact is often obscured by the aftermath of pointing fingers.
Posted by: arlie at March 10, 2005 02:56 PM
And what will OUR default look like?
If it takes place under George W. Bush's stewardship, I would venture to guess it would look something like a bad, lost, possibly nuclear weekend.
Posted by: Ralph at March 10, 2005 04:57 PM
the idea that moral hazard created by the US/IMF bailouts in Mexico/Asia did not have a significant impact on Argentina's build-up of debt is specious at best.
other than that the rest of article from FT seems fine as far is it goes
but the comments at the end from Prof DeLong seem a little odd. From a general economic framework - it is entirely logical and reasonable that a greater magnitude of default would be positively correlated with greater economic decline. Professor?
in this case the combination of political incompetence and moral hazard was so immense that a deep default and huge economic shock were basically inevitable.
Posted by: alex at March 10, 2005 05:26 PM
I think Andres is right on this one; the fall in GDP looks very much to me like a consequence of the attempt to avoid the default, rather than the default itself.
Posted by: dsquared at March 10, 2005 05:28 PM
This, and the other topics on the subject, are really interesting and informative, but they beg one question...you trying to say something about the US, Professor?
Posted by: Stuart at March 10, 2005 05:47 PM
Andres and DSquared
[T]he fall in GDP looks very much to me like a consequence of the attempt to avoid the default, rather than the default itself.
Agreed, though I throughly reject the premise that the peg which was maintained by ever more austerity was properly implemented. The peg involved needlessly limiting labor needs for the sake of a steady flow of international capital.
http://www.econstats.com/IMF/IFS_Arg1_67R__.htm
Courtesy of Colin Danby...
Posted by: anne at March 10, 2005 06:06 PM