Argentina’s politically intractable foreign-debt crisis serves as a powerful reminder that the International Monetary Fund still has no answer for dealing with the volatility of international capital flows to emerging economies.
It also underscores the need for reform at the Fund itself.
Given that debt defaults have littered Argentina’s history, we need to go back at least two decades to understand the current situation. For most of the 1990s, Argentina had successfully implemented a fixed exchange rate, which the IMF saw as a sensible option for containing inflation. The approach proved so successful that Argentina attracted substantial international capital inflows, allowing it to fund a large external deficit.
But by 1998, the exchange rate was looking overvalued in the context of adverse terms of trade, a strong US dollar, and capital-flow crises in Asia and Russia. It seemed that some flexibility should be added to the exchange-rate regime, but it wasn’t clear how to do it. Departing from a fixed rate is always a traumatic experience, with obvious winners and losers.
Meanwhile, the IMF remained sympathetic to Argentina’s woes, because the country had followed its recommendations and had friends in Washington, DC. Enjoying the benefit of the doubt, Argentina clung to the fixed-rate regime. The IMF extended generous support, and urged its usual all-purpose policy prescription: fiscal tightening.
Austerity might have worked if the only problem had been temporary illiquidity. But Argentina had borrowed too much, and its lenders realized that its exchange-rate regime was unsustainable. In December 2001, the IMF reluctantly ended its support. Argentina’s then-president, Fernando de la Rúa, made a dramatic helicopter departure as the economy descended into chaos. Amid bank closures, 20% unemployment, and a 28% decline in GDP, the country defaulted on its foreign debt.
By 2010, the mess had been sorted out and the foreign debt rescheduled. With the arrival of a new business-oriented president, Mauricio Macri, in 2015, the cycle could start again. This time, at the IMF’s urging, Argentina adopted a pure floating exchange rate. With the external debt trimmed by rescheduling, foreign capital flowed in once again. Investors were willing to buy even 100-year bonds from a country with eight sovereign defaults in the last two centuries.
Investor enthusiasm, and the domestic political honeymoon, lasted as long as the international environment remained benign. But when inflows faltered in 2018, the IMF had to step in once again, closing the external funding gap with a stunning $50 billion loan program (later raised to $57 billion).
But, again, the external funding problem was not a temporary phenomenon, and the Argentinian electorate soon began to bristle at the reforms demanded by the IMF. With accumulated foreign debt over $100 billion and most of the Fund’s money already disbursed, Argentina announced a unilateral debt “reprofiling” late last month.
For the Argentine people, this is grim news; for the IMF, it represents a fundamental policy failure. It is now clear that fiscal austerity and a floating exchange rate are inadequate to cope with capital-flow volatility. The only question is what should come next, not just for Argentina, where the IMF will struggle to salvage its loan program, but for the Fund itself.
For starters, the IMF must devise better ways of resolving unsustainable sovereign debt burdens. Unsustainable domestic debt can always be resolved through rescheduling or bankruptcy. But international debt is another matter, and here the IMF’s record leaves much to be desired. In the 1998 Asian crisis, the Fund strongly resisted rescheduling. In the 2010 Greek crisis, it allowed creditors (mainly foreign banks) to protect themselves from their own foolishness. And in Argentina’s case, it refused to use its clout to override vulture bondholders who had subverted the 2010 rescheduling, even as it rolled out a massive loan program.
Second, the IMF should face up to the fact that unconstrained international capital flows are too volatile for fragile emerging economies. Having long opposed capital controls, it has belatedly – and unenthusiastically – endorsed “capital flow management,” but only as a last resort when all other measures (namely, painful austerity) have been exhausted.
Rather than being at the bottom of the policy toolbox, inflow constraints should be routine for many emerging economies. The IMF should articulate its support when countries apply such constraints to fickle portfolio inflows. Emerging economies should not run substantial external deficits just because foreign investors feel euphoric. The same investors will depart en masse when conditions change.
Third, instead of reluctantly tolerating exchange-market intervention, the IMF should actively promote it when market volatility is clearly disruptive. A number of Asian economies have demonstrated the benefits of well-disciplined market intervention. The Fund should use their experiences to develop operational guidance.
Fourth, IMF shareholders need to review the organization’s internal governance. The Argentine program is merely the latest in a series of decisions in which larger members’ politically motivated interests seem to prevail, while the unwieldy Executive Board is largely sidelined.
Traditionally, Argentina has been treated favorably in Washington, DC (relative to, say, the Asian crisis countries in 1997-98). The swift approval of the $50 billion program, and its casual enlargement to $57 billion, has added to the impression that the country receives special treatment despite its chronic inability to manage its debt.
When the time comes for a post-mortem, the victim will be blamed. Argentina’s political and governance deficiencies will be held up as evidence of what went wrong, and not without justification. But that is beside the point. It is the IMF’s job to operate in challenging environments. To do so effectively, it must reform itself alongside Argentina’s troubled economy.
Stephen Grenville, a former deputy governor of the Reserve Bank of Australia, is a non-resident fellow at the Lowy Institute in Sydney. Copyright: Project Syndicate, 2019, published here with permission.