Transcript Import Substitution Industrialization (ISI)

Argentine Financial
Crisis
Can Aydinoglu
Andres Perez
Jennifer Koyce
Vic Chidgopkar
Erik Deneergaard
Introduction
Argentina 2001-2002
 One-fourth of all third world debt ($132b)
 18% official unemployment
 30 People dead during riots
 Devaluation cut national wealth by 30%
 Huge costs socially and financially
 Were these avoidable?
 What should have been done by the government?
 What are the strategic implications for businesses?
Agenda:
 Theoretical Background
 Case of Argentina
 Case of East Asia
 Comparisons and takeaways
 Prevention policies
 Business implications
What is a Financial Crisis?
 A financial crisis is a disruption to
financial markets
 Extreme adverse selection and moral
hazard problems
 Financial markets become unable to
efficiently channel funds to productive
investment opportunities.
Stages of a Financial Crisis
Increasing
Vulnerability
Currency
Crisis
Full fledged
Financial
Crisis
Stages of a Financial Crisis
Increasing
Vulnerability
Currency
Crisis
Full fledged
Financial
Crisis
Financial Liberalization Period
•Heavy Lending
•International Capital Inflows
•Higher yields in Ems
•Government Safety Net
•Currency Peg
•Rapid Expansion
•Excessive risk taking due to
•Lack of trained loan officers
•Insufficient bank supervisors
•Weak government regulations
•Moral hazard due to safety net
•High leveraging of corporate sector
Non performing loans skyrocket
Substantial loan losses
Shortening of loan terms
High illiquidity
Deterioration of Bank B/S
Vulnerability to shocks
Stages of a Financial Crisis
Increasing
Vulnerability
Currency
Crisis
Full fledged
Financial
Crisis
Deterioration of financial and non-financial B/S
Central Bank cannot protect currency by raising rates
Speculators start attacks on currency
Central Bank’s Reserves melt down
Collapse of Currency
Stages of a Financial Crisis
Increasing
Vulnerability
Currency
Crisis
Full fledged
Financial
Crisis
Three mechanisms are triggered
•Direct effect of devaluation on B/Ss
•NPLs skyrocket leading to further deterioration
•Depositors panic and bank runs occur
•Depositors panic and bank runs occur
•Inflation shoots up due to higher import prices
•Nominal interest rates increase
•Huge increases in interest payments
•Sharp deterioration and collapse of financial and non-financial B/S
•Contraction in lending and severe economic turndown
Case of Argentina
Increasing Vulnerability:
 Fiscal deficit was resolved by privatizations
– Unions have a lot of power. There is no possibility to reduce salaries
– 1996-2000 Net FDI ($48.9B) covered nearly 90% of the accumulated
current-account deficit over the same period
 When all the public companies were sold, Argentina borrowed
money from international markets
 Fixed exchange rate resolved a huge problem: the inflation
– Prices fell in Argentina through a painful period of deflation
– (1.8% in 1999, 0.7% in 2000 and 1.5% in 2001)
Case of Argentina
Currency Crisis:
 Results from 1990 to 2000
– Exports more than doubled (US$12.4b to US$26.4b)
– Imports rose by nearly seven times (US$3.7b to US$25.2b)
– Inflation was almost zero
 Trigger of ARS currency crisis:
– The devaluation in Brazil (its largest trading partner) made the
country increasingly uncompetitive and deepened the recession
Case of Argentina
Full Fledged Financial Crisis:
 Fiscal Deficit Snowballs
 Government Too Reactionary to pull out of crisis
– Tax revenue declined due to recession and avoidance
– Unwilling to devalue because it would multiply government debt
– Government unable to reduce expenditures due to social
instability
 Bottom Line: Huge fiscal deficit and the weakness of the
economy triggered the default
Argentina’s debt: US$150b
Case of East Asia
Background:
 The Five Asian-Crisis Countries:
Indonesia
Thailand
Philippines
South Korea
Malaysia
 Before the Crisis:
– Average Annual GDP 7% - 8%
– Significant per captia income level increase over the last 30 years
– Attracted nearly half of all capital inflows to developing countries
– Bottom Line: Outstanding economic performance first step to
financial liberalization
Case of East Asia
Increasing Vulnerability:
Chain of Events in 1997
Feb
Jun
Jul
•Speculation •2nd attack •Thailand
on baht
floats the
on baht
baht
Aug
Sep
Oct
Nov
•Indonesia •Kia seeks •Indonesia •KRW
floats the Korean court obtains IMF falls 1000
rupiah
protection package of to USD
from creditors$35Billion
•Malaysia
floats the ringgit
•KRW
depreicates10%
Dec
•Korea
floats
won &
obtains
IMF
assistance
Case of East Asia
Currency Crisis:
 Asian-crisis countries experienced nominal currency
deprecations of more than 50% from July 1997 to 1998
 Reaction: Asian-crisis countries institute currency
controls to avoid speculation
– Example: Sept 1998 Malaysia restricted Foreign Direct Investors
from repatriating their MYR.
– Feb 1999 Foreign Direct Investors able to repatriate their MYR
• However Proceeds now subject to a graduated exit levy scheme on
Principal and Capital Gains
Case of East Asia
Full Fledged Financial Crisis:
Non-Performing Loans as a % of GDP
90
80
70
60
50
1998
1999
2000
40
30
20
10
0
IDR
KRW
MYR
THB
Case of East Asia
The Recovery:
 Rates of economic growth have rebounded in 1999-2000
 Failure of investment ratios to rebound significantly
 Real stock market prices failed to return to pre-crisis level
 Bottom Line: Crisis had long-term adverse effect
Comparisons and Takeaways
 Government Stability
– ARS: Financial Crisis transferred into Political
Turmoil (I.e. 5 Presidents in 2 weeks)
 Fiscal Deficit
– ARS incurred 10 years of Fiscal Deficit
 Banking System:
– Non-performing loans & Bank Runs diluted the assets
• i.e. Bank customers did not have necessary USD to repay
their USD loans
– Devaluation adversely effected the liabilities since
Gov’t mandated Banks absorb the devaluation & not
the bank customers
Financial Policies to Prevent Financial Crises
1.
Adherence and supervision of banks
•
•
2.
maintain balance sheets
provide safety net yet prevent moral hazard
Accounting and disclosure requirements
•
3.
measure risk through quality of information
Legal and judicial systems
•
•
•
4.
property rights
allowable collateral
bankruptcy policies
Market-based discipline
•
•
credit ratings
issue subordinated debt
Financial Policies to Prevent Financial Crises
5.
Entry of foreign banks
•
•
•
6.
Diversify and insulate
strengthen foreign confidence
Less like likely to be bailed out – market discipline
Capital controls
•
•
•
7.
ouflows  devaluation
inflows  debt
effectiveness?
Reduction of role of state-owned financial
institutions
•
8.
not efficient and won’t manage risk if no profit motive
Restrictions on foreign-denominated debt
•
prevents monetary responses
Financial Policies to Prevent Financial Crises
Elimination of “too-big-to-fail” firms
9.
•
no implied rescue – market discipline
10. Sequencing financial liberalization
•
•
•
lending boom precedes information
gradually remove restrictions
well-functioning regulatory structures limit risk, lending
boom precedes information
11. Monetary policy and price stability
•
domestic vs foreign denominated debt
12. Exchange rate regimes and foreign exchange reserves
•
•
•
•
fixed rate
crawling peg
capital flows
low reserves
Is Peso Overvalued? Or Legalized Theft!
 Government repealed convertibility and
confessticated $18 B belonging to peso holders
 Goal to boost exports and GDP
 Prior to devaluation: Exports (10% of GDP);
Rest of the GDP
 50% devaluation of peso will result- Export 5%;
GDP 0.5%
 Central Banks instead of devaluation should sell
assets - & Dollarize
 Not a currency problem, but a banking problem,
political, legal, & corruption problem…….
Managerial Implications: Micro




Uncertain Monetary and Fiscal Policy
Banking and Political Stability
Tax Structure and Tariffs on Import or Exports
Corruption at all Levels
– Parallel Economy (cash transactions)
 Legal System - Delays & Cost
 Unreliable Police Protection
 Bureaucratic and Expensive Public Workforce
– Provincial legislators’ salary - $300,000/year
Managerial Implications: Macro




Tax Structure - VAT etc.
Tariffs on Import and Exports
Stability of Local Vendors and Customers
Fluctuating Exchange Rate - minimize inventory
& cash collection cycle
 Reliability of local banks
 Use Financial Models to Minimize Risk
– debt.
Managerial Implications: Macro






Government approvals - Corruption
Litigation is Time Consuming and Costly
Illegal Tactics used by Local Competition
Safety of Local Employees
Unreliable Political and Banking System
Use Local Resources and Minimize
Dependence
Factors Leading to Crises
Deterioration in Bank’s B/S
Uncertainty Up
•Collapse of an institution
•Sustained Recession
•Political Instability
•Contraction of Lending
•Interest Rates Up
Capital Outflows
Dilution of Credit Quality
Stock Market Crash
Devaluation
•Value of $ up
•$ denom. debt up
Deterioration of Non-Financial B/S
•Collateral values down
•Net worth of companies down
More Adverse Selection
•Borrowing short, lending long (liabilities up, assets down)
•Less ability to monitor credit quality
•Moral hazard and adverse selection further up
•Bank runs
•Collapse of Banks