Transcript Argentina Crisis

Currency Crisis
Presented By: Eruj Arshad
What is Currency?
A currency is a unit of exchange, facilitating the
transfer of goods and/or services. It is one form of
money, where money is anything that serves as a
medium of exchange, a store of value, and a standard
of value.
What is Currency Crisis?
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A currency crisis, which is also called a balance-of-payments crisis,
occurs when the value of a currency changes quickly, undermining
its ability to serve as a medium of exchange or a store of value.
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Currency crises can be especially destructive to small open
economies or bigger, but not sufficiently stable ones.
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Governments often take on the role of fending off such attacks by
satisfying the excess demand for a given currency using the
country's own currency reserves or its foreign reserves (usually in
Euros or United States Dollar).
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Crises develop as an interaction between investor expectations and
what those expectations cause to happen.
What Causes Currency Crisis?
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Government Policy, Central Banks and the Role of Investors
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Fixed-exchange rate economies have 2 options
Eat into the country’s foreign reserve
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Let the exchange rate fluctuate
Cont…
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Anatomy of a Crisis
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Capital Flight
Results in worse exchange rate
Difficult to fund country’s capital spending
Currency Crisis Faced by Different Countries
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Asian Crisis
Latin America Crisis
Russian Currency Crisis
Argentina Crisis
Common Factors
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The countries borrowed heavily
Currency values increased rapidly
Uncertainty over the government's actions made
investors jittery
Asian Crisis [mid 1997]
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The East Asian crises, which erupted in mid-1997, have been one of the
most serious and challenging economic events of the 1990s.
Also known as the IMF crisis.
East Asia consists of Japan, China, South Korea, Taiwan, and the countries
of the Association of Southeast Asian Nations, ASEAN
Thailand, Indonesia and South Korea had large private current account
deficits and the maintenance of Fixed exchange rate encouraged external
borrowing and led to excessive exposure to foreign exchange risk.
Different opinions about the causes of crisis
1)
Misguided macro-management
2)
Irresponsible, and over reactive behavior of external Financial
markets
3)
Importance of a combination of fragile domestic financial markets
(a result of inadequately administered financial deregulation and
opening) and large and volatile capital inflows and outflows.
How it started?
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The crisis started from Thailand
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As the crisis spread, most of Southeast Asia and Japan saw
slumping currencies, devalued stock markets and other asset prices,
and a precipitous rise in private debt.
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IMF stepped in to initiate a $40 billion program to stabilize the
currencies of South Korea, Thailand, and Indonesia, economies
particularly hard hit by the crisis.
Reasons
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Thailand, Indonesia and South Korea had large private current account deficits and
the maintenance of fixed exchange rates.
As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal
Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off
inflation. This made the U.S. a more attractive investment destination relative to
Southeast Asia, which had attracted hot money flows through high short-term
interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian
nations' currencies were pegged, thus making their exports less competitive. At the
same time, Southeast Asia's export growth slowed dramatically in the spring of
1996, deteriorating their current account position.
Policies adopted that distorted incentives within the lender-borrower relationship.
Strict monetary and contractory fiscal policies implemented by the
governments on the advice of the IMF in the wake of the crisis led to
bank run kind of a situation.
Latin- America Crisis [1998-1999]
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External Factors:
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Massive short-term capital outflows provoked a deep recession. If Latin
America had grown 5.3% in 1997, in 1998 growth diminished to 2.3% and in
1999, regional GDP growth was a mere 0.3%
‘Rescue’ loans were intended to save and bail out the big international
creditors’ investments, which were of a mostly short-term nature, thus
increasing ‘moral hazard’.
Latin American countries borrowed at historically low rates, but then interest
rates increased sharply
Most of the debt was US dollar denominated. Hence, to pay for the debt, LA
nations needed US dollars.
Capital began leaving the countries.
Russian Crisis-A glimpse of Events
Russian Crisis [1998]
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Also known as the Ruble Crisis
Petroleum, natural gas, metals, and timber accounted for more than 80% of
Russian exports
When the East Asian financial crisis broke out in 1997, prices for Russia's two
most valuable sources of capital flows, energy and metals, dropped.
Non-payment by the manufacturing & energy sector-main cause of the crisis
Ruble was allowed to float freely.
By 1998 inflation had reached 84%
The government began facing difficulties selling ruble denominated debt due to
adverse domestic political developments, weak commodity prices, and global
economic events.
On August 13, 1998, the Russian stock, bond, and currency markets collapsed as a
result of investor fears that the government would devalue the ruble, default on
domestic debt, or both.
Russian government abandoned to defend the exchange rate peg, declared
unilateral default on $40 billion in short-term domestic treasury debt, of which
about one third was held by foreign investors, and placed a 90-day halt on
commercial external debt payments.
Argentina Crisis
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A result of bad policies by the Government
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Main blunders :
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increasing tax rates,
freezing bank deposits,
devaluing the peso, and
forcibly converting dollar bank deposits and
contracts into pesos (“Pesofication”).
Cont..
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The conventional view of Argentina’s crisis as it unfolded in 2001
was that
 Argentina’s monetary system, locally known as “convertibility,” was a
currency board;
 The peso’s exchange rate of 1 per dollar made the peso persistently
overvalued;
 Argentina’s exports suffered, triggering recession and default.
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According to the conventional view, the way to end the recession
was to allow the peso to float.
Causes of Crisis
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External forces provoked a recession.
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Impact of The East Asian currency crisis of 1997-98 and the Russian currency
crisis of August 1998
Brazil, Argentina’s largest trading partner
In Jan 1999, Brazil allowed its currency to float.
The Brazilian real quickly depreciated from 1.21 per dollar to 2.18 per dollar
before recovering somewhat. Brazil’s economic growth fell from 3.3 percent in
1997 to 0.1 percent in 1998 and was only 0.8 percent in 1999. After years of
gains, Argentine-Brazilian trade was flat in 1998 and shrank in 1999.
Cont..
Menem’s Debt
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Mishandled government finance
Avoided tackling the big problems of inflexible labor laws, inefficient
mandatory health care organizations, and overstaffed government
bureaucracies
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Starting in 1994, the federal budget was in deficit continuously.
The government financed the deficit through debt borrowing.
Argentina relied heavily on international capital flows to finance the
large gap in national spending.
1994, the federal government’s gross debt was about US$70 billion
By the third quarter of 2001, the debt was twice as large, at US$141
billion, while GDP was US$271 billion—only 5 percent bigger than
1994 in nominal terms and smaller in real terms per person.
Cont..
De la Rúa’s Tax Increases:
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Responded incorrectly to the debt problem.
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Instead of reducing government spending, the country attempted to levy taxes
against the citizens to solve their problems.
Historically, Argentines paid very little taxes with about 40% not paying any
taxes. Thus, increasing taxes was met with high resistance and little success
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Three large tax increases
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Took effect in January 2000, increased income tax rates for people
earning more than 30,000 pesos a year; subjected retirement benefits
of more than 24,000 pesos a year to tax; and increased the wealth tax
(assets tax), beverage taxes, tax surcharges on automobiles, and the
special tax on tobacco.
2.
The so-called Competitiveness Law imposed a financial transactions
tax, which became effective in early April 2001. The rate was initially
set at 0.25 percent and later raised to 0.4 percent.
3.
In August 2001, the government raised the financial transactions tax
by decree to the legal maximum of 0.6 percent
Cont..
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Loss of Export Competitiveness
 High government deficits and debt would not have been a major problem
if the economy had been able to generate capital inflows through trade.
But, the economy had very poor export growth and entered a recession in
the late 1990’s.
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As the dollar strengthened against other currencies in the 1990’s,
Argentina’s exchange rate became overvalued.
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An overvalued fixed exchange rate eroded Argentina’s export
competitiveness. Also, the Brazilian currency devaluation hurt Argentina.
Brazil was their main trading competitor, so Brazilian goods were relatively
much cheaper.
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Since Argentine exports were too expensive relative to their competitors,
the economy exported too little and imported too much.
Cont..
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The Argentine government entered a “debt trap” by mid 2001
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The government financed the deficit through debt borrowing. Argentina
relied heavily on international capital flows to finance the large gap in national
spending.
Interest rates in dollars within Argentina rose substantially, because of concern
that loans and deposits in dollars were also at risk from government policies.
Lack of confidence in government.
In July 2001, when rating agencies reduced the credit rating of Argentina’s
government debt, it rose above 16 percentage points, and by the end of
October it exceeded 20 percentage points.
Government policies “contaminated” the private sector in late 2001 and
2002
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Problems spread to the private sector.
Fear of freezing bank deposits was developed
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Pesofication.
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Lessons Learned
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An economy can be initially solvent and still succumb to a crisis. Having a
low amount of debt is not enough to keep policies functioning.
Trade surpluses and low inflation rates can diminish the extent at which a
crisis impacts an economy, but in case of financial contagion, speculation
limits options in the short run.
Governments will often be forced to provide liquidity to private banks,
which can invest in short-term debt that will require near-term payments.
If the government also invests in short-term debt, it can run through
foreign reserves very quickly.
Maintaining the fixed exchange rate does not make a central bank's policy
work simply on face value. While announcing intentions to retain the peg
can help, investors will ultimately look at the central bank's ability to
maintain the policy. The central bank will have to devalue in a sufficient
manner in order to be credible.
Is Pakistan Facing Currency Crisis?
As Reuters reports,
“Pakistan has been running unsustainable fiscal and balance of
payments deficits”.
 Pakistan’s economy is the weakest and most vulnerable to rising oil prices
and international financial crisis.
 The country’s foreign reserves have dwindled to around $4.5 billion
 The political crisis has contributed to a huge exodus of foreign capital and
exacerbated the country’s economic problems.
 As much as $1.2 billion a month was fleeing Pakistan in the summer. The
rupee has slumped by more than 30 percent against the US dollar since
the beginning of the year and share prices have crashed by 40 percent
since their all-time high in April.
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Devaluation of Rupee
Devaluation is nothing but an official decrease of value of a currency in relation to
gold and other currencies indicating a desperate attempt made by the
government to promote and boost its exports.
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Pakistan’s economy has been crippled by fuel and food inflation and a domestic
insurgency which has panicked foreign investors. This combination of factors has
triggered a 25-30 per cent devaluation of the rupee since the start of the year, a crash
within the stock markets and a looming foreign debt crisis.
Rupee record low against dollar
Factors involved in dollar-rupee parity
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law and order situation
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flight out of capital
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meager foreign exchange reservoirs
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huge gap between import and export bill
Cont..
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Inflation rate floating more than 25 percent
Widening current account deficit
Heavy government borrowing to cover a budget deficit
$500 million euro bond debt obligation which was due in February
Mismanagement in privatization process and
Last but not the least the lack interest of financial managers to formulate such
policies which could pull the country out of crises.
Why devaluation ?
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Two reasons:
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persistent adverse trade balance and
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disequilibrium in balance of payment
Export primary goods
Government has only one option in hand to stop the imports of luxury
items
Pakistan is perhaps the second country after the US, which has seen its
trade deficit widen irrespective of the value of the currency.
What should be done?
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Do not depend on US
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Must keep the people informed about all crucial decisions
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some of the demands of the
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IMF, i.e., increasing revenue, reducing budget deficit and bank borrowing, cutting
down non-developmental expenditure are the measures any sensible government
should have undertaken to keep the economy of the country on sound footings
Cont…
Out look
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The country needs a bail-out package to avert current financial crisis.
Pakistan will continue to remain at the bottom line in the region
Fears of prolonged economic crisis.
Unsettled local and foreign investors
There will be no restructuring of economy in the near future
GDP growth will be further affected
Fresh Investment will take time to make in-roads
Government's policy towards foreign investment got the setback
Exportable surplus to remain low
Foreign exchange reserves position getting from bad to worse
Inflation continues in double digit
local products eroding
Thank You!!