Lessons from Argentina

The Malta Independent on Sunday Lessons from Argentina

The unthinkable has happened. Argentina has exploded ` politically and economically.` Devaluation of the peso is now a foregone conclusion even though attempts to create a parallel third currency will try to camouflage it and cushion its social consequences. Default on its USD 155 billion foreign debt has been announced and applauded by the citizens who were being squeezed dry` with pay and social security cuts to enable the country to continue servicing its foreign debt.

I had warned in various contributions I wrote earlier this year that this explosion seemed unavoidable. I had expressed concern at the high level of exposure which Maltese investors, especially those dependant of fixed income with a rather low risk tolerance profile, had on emerging market sovereign debt in general and Argentina in particular.

Many considered my contribution alarmist. The authorities did not move until it was too late when the MFSC issued a statement warning investors to beware Argentina`s sovereign debt as highly risky. Many Maltese unsophisticated investors are now crying for Argentina with not much they can do but wait for new developments.

Yet the lesson for us should go deeper than that. Argentina`s economy was brought to a state of misery due in particular to two principal factors. Firstly it tried to defend` a totally uncompetitive rate of exchange regime which rendered the country uncompetitive in foreign markets and forced the economy to endure a four year long recession.

Exchange rate stability is a virtue which needs preservation and active re-enforcement when the economy is growing at a normal rate.` It is like a balanced diet for a healthy person. But when the person gets sick the balanced diet is no cure. Timely and correctly dosed medicine is the only thing that can restore health. And when a country loses its competitiveness a fixed rate of exchange policy could be a noose round the neck. Instead of medicine correctly dosed at the right time sick Argentina continued to be fed a balanced diet suitable for an Olympic form athlete. The result is further loss in competitiveness, further economic contraction, widening budget deficits and horrendous amassing of foreign debt at high rates to justify the lender`s risk premium.

Drawing this in a local context it makes no sense whatsoever for the government and the monetary authorities to rule out that devaluation of the local currency could be part of the cure needed by our sick contracting economy. Granted, devaluation on its own offers no long term solution.` But as a part of a total re-structuring plan it could well be an indispensable part of` the therapy treatment. Unless, that is,` we prefer the Argentina route allowing the economy to contract and the national` debt to rise whilst waiting for solutions from heaven.





The second lesson from Argentina is that a country cannot keep borrowing for ever at a rate much faster than its economic growth. We have been doing this for 15 years. Our national debt exploded from near zero to 62% of the GDP in less than 15 years` with speed gaining momentum since 1996 when the annual public deficit reached high percentage of the GDP. Add to this another Lm400 million odd of public debt still unrecognised as such, but still very much so ( in the Treasury Clearance Fund and dead bank loans guaranteed and serviced by the government) and the percentage of national debt to the GDP shoots up to close to 90% which makes Argentina`s debt at 55% of the GDP look healthy.

The obvious question pops up. Why did Argentina`s debt become unsustainable whereas Malta continues to sustain and amass the debt with no comparable consequences` The answer is in the way the debt is structured.` Whilst Argentina`s debt is mostly in foreign currency at high rates of interest and with short maturity profile necessitating active roll-over management of the debt,` our national debt is mostly internal denominated in Maltese liri at a rather low rate of interest and with a comfortable spread giving it a long term profile.

For as long as local investors keep their faith in the local financial system which keeps feeding savings to fund the national debt Argentina`s consequences will be averted. But if the economy keeps contracting, government keeps coming back for more and the international investment scenario recovers from the grim scenario it fell throughout 2001 there could well come the time when local investors prefer to invest externally forcing the government to seek external financing.` That could signal a very serious twist to the national debt problem.

I put it across to my readers.` Are we building an Argentine model of disaster with a rigid rate of exchange model forced upon an uncompetitive and contracting economy that keeps amassing its national debt at an alarming speed as the increased taxation extracted is frittered away on recurrent expenditure including the heavier burden of servicing the ballooning debt` Argentina`s lessons underline the timeliness necessary for administering the right solutions. We have been playing around with a public sector debt in unsustainable high figures since 1996 and 2002 will be the 7th consecutive year of such problems. Some stitch in time!` May the Lord spare us an Argentina.