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Argentina’s slow-motion default gave emerging-market investors and governments across the region ample time to restructure investment portfolios and adjust fiscal policies. As a result, the Argentine crisis will not trigger major financial turmoil in Brazil and other Latin American countries. However, the regional political contagion from a debt default could be significant, especially in countries holding presidential elections in 2002.
In efforts to address Argentina’s economic crisis, the new government devalued the peso by more than one third last weekend. The move follows the country’s long-expected debt default that finally occurred in late December 2001. Six months ago an Argentine default likely would have triggered severe financial turmoil in Brazil, Chile and other Latin American economies.
However, in August 2001 the International Monetary Fund gave Argentina $8 billion and postponed the inevitable default by another four months. During this period international investors and governments in Brazil and other emerging markets restructured investment portfolios and adjusted fiscal policies, significantly reducing the risks of regional financial contagion.
As a result, although foreign banks and multinational companies in Argentina will sustain heavy losses, the country’s economic collapse will not topple Brazil and other emerging markets like dominoes this year. But it could have significant social and political consequences throughout the region, especially if the emergency economic measures implemented Jan. 7 by new President Eduardo Duhalde fail to calm the country’s simmering social unrest.
Latin America’s financial markets so far have absorbed Argentina’s default and devaluation with hardly a stir. In fact, Brazil’s currency from early October until the end of 2001 appreciated 23 percent against the U.S. dollar, while the Brazilian stock exchange rose 30 percent in the same period despite an abruptly slowing economy, the Financial Times reported. This can be attributed to the Brazilian government implementing the right fiscal and monetary policies during the last six months, while also obtaining $15 billion in contingent financing from the IMF.
Brazil, like investment-grade Chile, in effect has “decoupled” its economy from Argentina’s woeful financial situation. This is a sign that investors have learned to make effective risk judgments about individual countries, a lesson gained after a string of emerging market crises that began in Mexico in December 1994 and then rolled across Asia, Russia and Brazil. Argentina ended 2001 with a 2.36 percent allocation in the JP Morgan EMBI+ Index, down from around 25 percent, while Brazil’s allocation increased to 25.4 percent.
However, in Argentina’s case the investor reaction is also a reflection of the fact that, unlike in Mexico in 1994 and Russia in 1998, the months-long evolution of the Argentine default was analogous to the “slowest train wreck in history,” according to David DeRosa, finance professor at the Yale School of Management. When Argentina officially suspended payments on its foreign debts Dec. 23, 2001, no one was surprised or panicked.
There are several other reasons why Argentina’s debt default will not spread to other emerging markets. For one, many countries have eliminated their old fixed exchange-rate systems since the 1997 Asian crisis, reducing their vulnerability to international currency problems. Moreover, Argentina’s default is happening during a time of increased liquidity in developed-world money markets, following joint monetary easing by G7 central banks.
Also, $98.8 billion of the more than $150 billion Argentine foreign debt is in bonds rather than loans from commercial banks, which considerably reduces the global credit risks of a default.
Although regional economies have some protection, Argentina’s default and devaluation will still cripple its own financial system and leave foreign banks and multinational firms operating in the country with billions of dollars in losses. John Welch, chief Latin America economist at Barclays Capital in New York City, predicts that Argentina’s banks will lose at least $16 billion overall and will require urgent government measures aimed at recapitalizing the financial system.
Spanish banks and companies will suffer the heaviest losses. Economists with the British financial group HSBC estimate that the exposure of Spanish banks and multinational firms is the equivalent of 7 percent of Spain’s GDP. Those facing huge losses include Banco Vizcaya Argentaria, Santander Centro Hispano and telecommunications giant Telefonica.
Other multinational companies likely to be hard hit financially include France Telecom, Italy’s Camuzzi and Telecom Italia, Ontario-based Azurix, and U.S.-based Liberty Media Co. and Metropolitan Life Insurance Co. U.S. banking behemoths like Citigroup and FleetBoston Financial Corp. also face heavy losses in Argentina.
Although the threat of economic contagion has been reduced, the political violence that racked the country during December, and which forced the resignation of former President Fernando de la Rua, is only the latest sign of a growing wave of popular discontent sweeping across Latin America after a decade of U.S.-centered free-market reforms.
More than 211 million Latin Americans – 43.8 percent of the region’s total population – live below the poverty line, according to the Chile-based U.N. Economic Commission on Latin America and the Caribbean. Many poor and frustrated Latin Americans increasingly feel that free-market policies, or “neoliberalism” as they are referred to in the region, have made the yachts of the wealthy few much bigger while confining the poor to a shrinking and sinking boat.
In countries that will hold presidential elections this year, including Brazil, Colombia and Ecuador, populist candidates opposed to free-market ideas and U.S.-centered trade agreements will use Argentina’s social and economic woes to justify their assertions that the U.S. government is trying to impose failed policies on the region.
Socialist leader Luiz Inacio Lula da Silva, who leads the field in all presidential polls 10 months before Brazil’s October elections, has pledged to roll back some reforms and oppose Brazil’s entry into the U.S.-led Free Trade Area of the Americas (FTAA). In Colombia, where a new president will be elected in May, Liberal Party candidate Horacio Serpa also has promised to scrap free-market policies in favor of more protectionist economic and social measures.
There is still strong political resistance to free-market policies in Ecuador, where presidential elections will take place next October, despite the U.S. dollar’s adoption more than a year ago. Moreover, neither of the leading contenders for Ecuador’s presidency, former presidents Leon Febres Cordero and Rodrigo Borja, have pro-reformist credentials.
The Bush administration has announced it stands ready to help Duhalde after the new economic measures are in place. Duhalde plans to seek $15 billion in aid from the IMF to support the country’s international reserves position in the coming weeks. Washington likely will support the IMF aid package as part of an orderly debt restructuring process that Duhalde wants to complete before his two-year presidency ends Dec. 10, 2003.
However, any efforts to pursue a bilateral trade agreement with Argentina, as part of a bigger U.S. support strategy, will probably run afoul of domestic political obstacles in Washington, D.C, and Buenos Aires. Duhalde already has announced that he plans to pursue closer ties with Brazil, Argentina’s partner in the troubled South American Customs Union (Mercosur), and with the European Union. Duhalde can be expected to back Brazil’s position in FTAA talks with the United States, demanding significant U.S. concessions on agriculture, intellectual property and anti-dumping rules before agreeing to further open up Argentina’s markets.
Any attempt by the Bush administration to sign a trade agreement with Argentina also must overcome resistance in the U.S. Congress and especially in the Senate, where senior Democratic Party leaders were angered by the highly partisan manner in which the House of Representatives approved trade promotion authority for the president in December 2001.
