Argentina, a country well-acquainted with defaults, is on the precipice of yet another debt crisis. Argentina’s external debt has increased rapidly over the past two years, with much of that debt denominated in U.S. dollars at a time when the domestic currency is weak. The risk of a repeat of 2001, when the country defaulted on $93 billion of external debt, declined because the International Monetary Fund has already issued funds to the country. And even in the event of a crash, it is unlikely to trigger a global crisis. But the austerity measures that come with IMF assistance won’t be popular at home. The ability of this government and future governments to forge ahead could be the difference that enables Argentina to break its long cycle of economic instability.
Booms and Busts
For 15 years after its 2001 default, Argentina was frozen out of international capital markets. When it finally regained access to those markets, the government was faced with the task of normalizing an economy that had become extremely distorted by populist and interventionist policies. To have the funding for necessary reforms, the government had no choice but to take on debt.
It has certainly done that. External debt totaled $253.74 billion in the first quarter of the year, according to the government statistics agency. This is about 40 percent of Argentina’s gross domestic product and five times as much as its international reserves, but one of the bigger issues is the rate at which it’s growing: Foreign debt increased by $30.79 billion in 2016, $52 billion in 2017 and $19.19 billion in just the first quarter of 2018.
Another issue is the seemingly bottomless fall of the Argentine peso. Argentina is part of the trend of emerging markets experiencing depreciating currencies and ballooning external debt with short- to medium-term maturities. Approximately 70 percent of Argentina’s foreign debt is held in U.S. dollars. At the same time, Argentina’s domestic currency has lost half its value against the dollar in the past nine months, significantly complicating debt servicing. Between now and the end of the year, it requires nearly $27 billion to meet its financing needs. It needs another $40 billion for next year. And Argentina’s central bank reserves cannot cover this alone. Its international reserves stand at $51.44 billion but were as high as $61.73 billion in March before the central bank started multiple spending sprees to stabilize the peso. Adding to the concern is the question of rollover ability since the government relies heavily on short-term debt issuances by the central bank in pesos and dollars.
That said, the likelihood of Argentina’s troubles affecting other countries fell once the IMF entered the picture. Buenos Aires has already received $15 billion of a $50 billion IMF loan and is in talks to expedite the release of the remaining funds. Argentina plans to use $13.4 billion of the funds already received this year and $11.7 billion next year to pay debts, while raising another $8 billion on local markets.
Even without the IMF assistance, the global financial system is somewhat less interconnected now than it was 10 years ago, according to a report by McKinsey Global Institute. The report also noted that global banks interested in correspondent relationships with local banks in emerging countries are now subject to stricter cost-benefit analysis. Investors interested in Argentina will also be well aware of the country’s financial past. Spanish, U.S. and U.K. banks have the highest exposure among counterparties resident in Argentina, according to the Bank for International Settlements, but all of these countries’ financial systems are large enough that Argentina’s individual impact on them would be minimal.
As far as individual institutions go, the two major ones holding Argentine debt are U.S.-based Franklin Templeton and Black Rock. Their assets under management as of June 30 were $724 billion and $6.3 trillion, respectively. Neither fund provides specifics on its Argentine holdings, but in the event of repayment issues, Templeton would be vulnerable only if it held a quarter or more of Argentina’s total external debt, while Black Rock could hold all of Argentina’s external debt and not face an existential risk. In other words, Argentina could exacerbate a crisis that starts elsewhere, but it’s unlikely to trigger any crisis outside its borders on its own.
40 Years of Debt Problems
Inside Argentina, however, it’s a different story. Until now, the administration of President Mauricio Macri has approached economic reforms and restructuring gradually. It feared that drastic moves would shock the economy and reignite political instability. But gradual proved to be too slow, and recovery came too slowly. Moreover, Argentina suffered a harsh drought whose effects on soy and corn crops drove the country toward recession. At that point, the IMF loan was unavoidable.
By accessing the IMF loan, the government is throwing gradualism out the window and replacing it with austerity. When the IMF grants a loan, it does so conditionally. In Argentina’s case, this means the IMF has a large say over the country’s 2019 budget. It requires the government to reduce its fiscal deficit from 2.7 percent of GDP this year to 1.3 percent next year and 0 percent by 2020. It also demands that government spending on social welfare be more targeted and that limits be placed on spending increases. The government, moreover, reintroduced export taxes on services and goods (particularly grains) to generate 68 billion pesos ($1.79 billion) this year and 280 billion pesos next year. And the plan calls for the central bank to post more reasonable inflation goals and act more independently from the government.
Austerity is hard for any country to swallow, let alone one as accustomed as Argentina is to large government subsidies and welfare spending – not to mention protests. Argentina has spent the past 40 years struggling with its debt problem. During the military dictatorship (1976-83), the government tried to open the economy, forsaking import substitution, and the country’s external debt exploded from $7 billion to $45 billion while GDP remained stagnant. Debt became more heavily concentrated in the public sector, and when the Latin American debt crisis hit in 1982, Argentina suffered immensely. For the next eight years, the country rationed international credit. But moves to again open up the economy accelerated indebtedness, culminating in the 2001 default.
Now, Argentina has again taken on large amounts of debt to normalize and open its economy. The IMF loan this time will likely help the country avoid falling into yet another debt crisis and default, but there will inevitably be a public backlash against austerity. This backlash will affect the ability of the current government and future governments to continue with austerity and to structurally reform the economy. After all, in 2001 when the IMF believed Argentina did not comply with the conditions of its support program, it suspended payments to the country.
Argentina has been labeled a potential regional leader given its location, size and resources. But these years of debt and economic crisis have prevented Argentina from making the most of its wealth, developing its economy and building its military. Government subsidies and trade schemes to keep the economy afloat during turbulent economic downturns have resulted in less competitive industry and manufacturing sectors. They have also discouraged investment and production in both energy and agriculture. And even as the country reconsiders its relationship with the military post-coup, there are no funds to modernize equipment and technology. Argentina’s ability to avoid another debt crisis this time could be the difference between continuing its period dive into economic malaise or breaking from the cycle – and potentially increasing its national power in the years ahead.