ARGENTINA: Wall Street demands, and gets, austerity



Fearful of the country's deepening economic crisis, Wall Street bond traders have demanded, and received, dire austerity measures from Argentinian President Fernando de la Rua in a bid to ensure that the debts owed them will be paid off.

Now into its third year of recession, with its export revenues stagnant and its official unemployment rate running at nearly 17%, Argentina has been having growing difficulties meeting repayment commitments on its US$130 billion debt.

A US$39.7 billion IMF rescue package, negotiated in December, and a June US$29.5 billion debt swap, whereby short-term debt was traded for longer-term debt, seemed to have calmed traders' nerves about the risk of default. But, on July 11, a routine issuing of US$850 million in 91-day treasury bills to finance upcoming repayment commitments turned into disaster.

Bond traders demanded a premium rate of interest for buying the bonds, 14%, up from 9% only two weeks earlier and more than 10% higher than the interest rates offered on similar-termed US Treasury bills.

While Wall Street traders were the most demanding about the terms on which they would buy more Argentinian debt, even local banks were unenthusiastic.

The high interest rates on short-term bills will exacerbate the country's twin burdens of mountainous debt and economic shrinkage.

The rate rise sent the Argentinian Merval stock exchange index tumbling 12%, caused overnight interbank interest rates to soar as high as 150%, provoked US$3 billion in capital flight, and prompted credit agency Standard and Poors to downgrade Argentina's credit rating from B to B-.

The events had flow-on effects internationally, with currencies and stock markets dipping in Brazil, Mexico, Chile and across Latin America, and even as far afield as Turkey and Bulgaria, as fund managers moved to reduce their exposures in the "emerging markets".

The sharp hike in interest rates on government debt has forced the hand of de la Rua and his economy minister, Domingo Cavallo. Cavallo was appointed in March, after his predecessor, Ricardo Lopez Murphy, was forced to resign after only days in office following massive public protests against his austerity plan.

Cavallo was initially greeted as a saviour by international bond traders. When finance minister in the early 1990s, he became popular with business circles for pegging the Argentinian peso at a fixed one-to-one rate to the US dollar and hence killing hyperinflation.

But this time around, the bond markets have been less than happy with his unwillingness to follow his predecessor by announcing similarly harsh austerity measures — and began almost immediately to increase the heat, by demanding premium interest rates on rollover loans.

In a televised national address on July 15, President de la Rua announced a raft of tough austerity measures aimed at ending the country's US$1.5 billion annual government deficit by December, saying that the package was "not negotiable" because the state had "exhausted its financing".

The package includes a 8-10% pay cut for nearly a quarter of a million public servants and equivalent cuts in pension benefits for retired government workers, many of whom receive as little as US$300 a month. Funds for services and development will also be cut to Argentina's impoverished provinces.

The austerity plan is de la Rua's seventh since taking office in December 1999.

After tough negotiations over the weekend of July 14-15, the country's opposition leaders, including the Peronist governors of 14 provinces, signed the cuts plan on July 17.

The response from the country's workers has been angry, with public sector unions marching through the capital, Buenos Aires, on July 18 and going out on strike on July 19, and residents blockading highways in the provinces. Dignitaries attending the July 14 wedding of Cavallo's daughter were verbally abused and pelted with eggs.

The protests are unlikely to be short-lived. Argentinians, particularly in the provinces, are angry at years of government austerity and are reaching flash point.

Argentina's predicament is partly bound up with the tougher demands of bond traders since the 1998 world financial crisis and partly with the economic course it has pursued.

Successive governments during the 1990s have doggedly sought to maintain the one-to-one "peg" with the US dollar as a way of ensuring economic stability. Argentina has been unable to maintain the US's growth rates, however, meaning that the peso is now greatly overvalued.

As the country can't easily devalue its currency to make exports cheaper (as its neighbours have done), nor lower interest rates (under the peg, they are set by the US Federal Reserve), the result of sticking with the US dollar has been a cycle of deflation and recession — and the consequent threat of default on the foreign debt.

Wall Street analysts are starting to convince themselves that the only two options the country has is to default or to devalue the peso and abandon the peg.

Most investment houses have reportedly already drawn up spreadsheets on how to save as much as they can in the event of either an orderly or disorderly default. The banks would likely punish the country dearly for any default, or even partial renegotiation, by charging premium rates of interest for years.

A devaluation, however, would have catastrophic results for the people of Argentina. Argentinians pay virtually all their bills in US dollars, from credit cards to rent, and devaluation would make the cost of living crushingly expensive.

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