The Failure of IMF to Monitor Developments in Argentina Was The Major Reason For The 2001 Default Background:

The 2001 default by Argentina was mainly due to IMF failing to monitor and respond to the alarming changes in the Argentinian political and economic landscape. The IMF continued to finance Argentinian debt (Fig.1& Exhibit 7) and failed to address: Argentinas lax fiscal policy, during times of rapid growth when fiscal surpluses should have been achieved as a buffer against future economic slowdowns. The currency board, which did not permit exchange rate adjustment to take place through nominal depreciation. Large swings in the volume of global capital flows. The slow pace of structural reform in some critical areas, which prohibited the ability of domestic wages and prices to adjust quickly Institutional and political factors which prevented the prompt implementation of corrective measures. Against this background, some additional factors helped to trigger the crisis and to exacerbate the impact of these underlying weaknesses. The impact of slow growth and high interest rates due to the higher risk premium on Argentine bonds on the debt to GDP ratio and Weak banking system, which contributed to the loss of confidence.

Three major events that IMF did not address in Argentina: Currency Board Pegged Exchange Rate: Argentinian currency was pegged to the United States dollar. The nominal exchange rate was set at 1:1 starting 1990 and continued to remain so through to 2001, the height of the crisis (Exhibit 1a). This led to more trade but also created a current account deficit (Exhibit 3). The external debt generated during this period, to finance the deficit led to an increase in the debt-to-GDP ratio from 32% in 1991 to 52% in 2001 (Table 1). This left Argentina in a highly vulnerable position with respect to external shocks. As the U.S. Dollar appreciated, so did the Argentinian Peso. This was an unfavourable situation for the Argentinian economy, since there was a cyclical difference between the US and Argentinean economies (Case page 5). The effect of this overvaluation was further compounded by the devaluation of the Brazilian Real. Brazil being a competing economy in Latin America and contributed to the widening of the trade deficit. Mobility of Capital Argentina relied heavily on capital inflows as the domestic savings rate was quite low. This was a reflection on the relatively slow development of domestic financial markets (Exhibit 5 & Exhibit 6) When there was a reduction in global capital flows to emerging market economies in 1998, it became costly for Argentina to raise funds on international capital

markets (Exhibit 9). Due to the pegged currency rate system, and because of the relatively small size of its export sector, Argentina could not easily adapt to the shock through a rapid depreciation of the real exchange rate.(Figure 2) Although Direct Investment, mainly from the IMF, kept on increasing, the Net Portfolio investment declined $22.8 Billion in 1999 to $3.3 Billion in 2001. This was due to people losing confidence in the country and capital leaving the country (Exhibit 3). In 2001 alone Argentinean banks experienced a total deposit outflow of over $19.4 Billion which is 23% of the total deposits(Exhibit 6)

Lack of Monetary Independence No control over interest rates The fixed exchange rate provided the buyers and sellers predictability of inputs and outputs; however convertibility obliged Argentina to align its monetary policy with that of the United States, despite cyclical differences between the two countries. The exchange rate peg forced an increase in the debt service ratio from 33% to 66% of GDP between 1991 and 2001 (Figure 1). This further suppressed the growth of exports and contributed to the widening the current account deficit. Due to the outflow of capital, the foreign currency reserves declined. The decline in forging currency reserves implied a tightening of the money supply. This should have resulted in wage and price deflation. But due to rigid labor laws and strong union pressure, the public sector wages in Argentina remained high keeping the inflation level consistent with that of the United States (Exhibit 10) and inconsistent with Argentinas productivity. This further destabilized the confidence of investors and lenders within and to Argentina. The cost of borrowing for prime companies in Argentina spiked between July to November 2001 (Exhibit 8), further hampering the pace of economic recovery and growth. The cost of borrowing on the international capital markets increased for Argentina in the same time period and total amount of external debt required to finance the deficit increased from 27.7% in 1993 to 58.3% in 2001 (Exhibit 11) Conclusion: The IMF failed to monitor and account for these significant events and changes in Argentina and continued to finance Argentina despite of its precarious position leading to a default. The recent events of the Asian crisis, where IMF was heavily criticized for it ineffectiveness in preventing the outcome, played heavily into the IMFs decision to continue funding Argentina regardless of covenant violations (over fifty percent of times). IMF financed Argentinas unsustainable debt levels without demanding political, fiscal and exchange rate reform. The result was the eventual default in 2001. Alternatives to the IMF action: IMF could have made funding contingent upon reforms. Political and fiscal reform preceded by an unpegging of the exchange rate would have prevented the default by easing the pressure put on Argentina by the three prongs of inflexible exchange rates, inability to control capital flows and lack of monetary independence.
References:

The role of the IMF in Argentina, 1991-2002. (2003, July). Retrieved from http://www.imf.org/External/NP/ieo/2003/arg/
Di Tella, V., & Rafael, I. (2004). The 2001 crisis in Argentina: An IMF -sponsored default? (A). Boston: Harvard Business Press.

Table 1. Argentina: Key Economic Indicators

1991 1992 1993 1994 1995 1996 1997 1998 1999 Real GDP growth (percent) Real private consumption (percent) Real government consumption (percent) Real fixed investment (percent) Inflation (CPI, Dec/Dec, percent) Money (M1, Dec/Dec, percent, in pesos) Quasi- money (Dec/Dec, percent, in pesos) Current Account (in billions US$) (In percent of GDP) Total Exports growth (in US$, percent) Total Imports growth (in US$, percent) External debt (in billions of US$) (In percent of GDP) Debt service ratio / exports (percent) International reserves (in billions of US$) 6.0 10.0 13.8 14.3 14.3 18.1 22.3 24.8 26.3 25.2 14.6 33.6 27.5 30.9 25.2 30.2 39.4 50.0 57.6 75.4 70.8 66.3 68.3 62.3 32.9 58.8 62.7 27.4 30.3 72.2 30.5 11.3 85.7 33.3 -4.6 15.8 24.1 3.4 -15.3 0.4 -16.6 98.6 109.8 124.9 141.4 144.5 146.3 140.3 38.2 40.3 42.7 47.3 51.0 51.5 52.2 -2.1 3.4 8.5 17.8 28.9 13.6 9.0 0.7 -10.5 11.8 -0.6 136.8 -0.4 -0.2 71.4 -6.5 -2.8 54.3 22.3 -4.7 -5.2 -2.0 20.8 31.2 14.5 4.9 5.0 -19.2 -8.8 -3.1 -4.4 -1.7 148.6 49.0 33.0 8.2 1.6 14.6 12.8 0.0 1.6 -9.2 -20.1 ... ... 84.0 ... ... 17.6 ... ... 7.4 0.4 0.8 2.2 8.9 0.1 3.2 17.7 0.3 3.4 2.6 0.6 -2.1 10.5 ... 10.3 ... 6.3 ... 5.8 6.1 -2.8 -4.4 5.5 5.5 8.1 9.0 3.9 3.5 -3.4 -2.0 2000 2001 -0.8 -0.7 -4.4 -5.7

13.7 -13.1 3.9 1.6

6.5 -12.6 0.7 -1.8

-6.8 -15.7 -0.7 -1.5

-8.0 -11.2 -3.4 -4.3

-6.8 -12.2 -14.5 -11.9 -2.5 -4.2 -4.9 -4.2

Exchange rate (peso/$, end-period) 0.99850.99050.99850.99951.00000.99950.99950.99950.9995 0.99950.9995 Real effective exchange rate (endperiod)1 Terms of Trade ( percent change) Primary balance (in millions of pesos) Federal government (in millions of pesos) Provincial government (in millions of pesos) Overall balance (in millions of pesos) Federal government (in millions of pesos) Provincial government (in millions of pesos) -945 -1,501 -596 -1,758 -2,191 -3,248 -1,192 -114 -1,964 -4,125 -3,313 -245 37 1,307 1,607 -416 -2,976 -6,020 -4,282 -4,453 -8,180 -6,468 -1,190 -1,464 710 -854 -1,235 -243 -1,287 -1,620 -2,527 -188 938 -774 -2,693 -1,441 -151 -2,607 -6,224 -7,212 -4,396 -6,418 12,304 -9,781 371 2,278 3,928 4,177 2,776 1,107 -1,392 1,450 2,187 21 3,150 -483 1,043 3,685 2,890 1,156 -1,420 -1,580 2,388 1,413 -2,672 1,709 140.5 165.5 178.0 169.5 163.2 163.7 176.3 171.2 178.2 185.6 185.7 7.6 6.1 -7.8 14.4 -4.5 9.9 0.2 -5.1 -8.4 7.5 -5.8

Source: IMF database; the Ministry of Economy of Argentina; and Global Development Finance.