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The following excerpt summarises Chapter 3 of Challenges to Fiscal Adjustment in Latin America: The Cases of Argentina, Brazil, Chile and Mexico by Pablo E. Guidotti (Universidad Torcuato di Tella), published on 22 February 2006.
Argentina’s saga of success and trauma under Convertibility remains one of the most heatedly debated events in the country’s recent economic history. On the one hand, by adopting in the early 1990s a quasi-currency-board arrangement – called Convertibility – Argentina was able to sustain a period of rapid economic expansion, grounded on both the return of macroeconomic stability and the implementation of an ambitious agenda of structural reform and deregulation. On the other hand, despite its initial success, economic growth stalled after the Russian default in mid-1998. After a protracted recession, the Convertibility regime ended in 2001 in a crisis of unprecedented depth, characterised by devaluation, widespread default on public and private debts, financial turmoil and a cumulative drop in output of almost 15% in 2001 and 2002.
The origin and causes of the 2001 debacle are at the core of the current policy debate. For some analysts, the fixed exchange-rate regime that underpinned Convertibility contained in its rigidity the seeds of its own destruction, despite having allowed the Argentine economy to recover from hyperinflation and grow at unprecedented rates for a good number of years before its collapse. For others, still convalescent from several decades of macroeconomic mismanagement, Argentina fell victim of an unusual sequence of external shocks plaguing emerging market economies in the second half of the 1990s, in particular the capital market crises in Asia and Russia, the sharp decline in commodity prices, the strong appreciation of the US dollar and the successive devaluations in Mexico and Brazil. Finally, for many observers it was not the exchange-rate regime per se the centre of Argentina’s problems but its lax fiscal policy that, the argument goes, allowed the public debt to balloon to unsustainable levels. Furthermore, as dollarisation was widespread, devaluation and default became intertwined from the point of view of investors.
This chapter does not attempt to develop a comprehensive analysis of the causes of the collapse of the Convertibility regime in 2001, an issue that already attracted the attention of several analysts. Rather, its objective is to re-examine the role of fiscal policy in the 1990s in light of three crucial policy decisions taken at the beginning of the decade; namely, the conclusion of the Brady debt restructuring, the recognition of pre-existing arrears with pensioners and suppliers, and the privatisation of the pension system, while considering the restrictions imposed on debt sustainability by the capital market volatility experienced by emerging markets in the second half of the decade.
The conclusion of the analysis is that these three policy decisions taken together amounted to a large fiscal bet, encouraged by the optimism that prevailed in capital markets at the beginning of the decade. Given the dominant role that liquidity considerations would have played after the crises in Asia and Russia, the kind of fiscal dynamics that emerged in the remainder of the decade left fiscal policy effectively with little room for manoeuvre, despite the government’s efforts to contain expenditure.
Pension reform and public finances
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