[Senate Hearing 108-879]
[From the U.S. Government Printing Office]



                                                      S. Hrg. 108-879

 
                      ARGENTINA'S FINANCIAL CRISIS

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    INTERNATIONAL TRADE AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                                   ON

 ARGENTINA'S CURRENT ECONOMIC AND POLITICAL SITUATION, FOCUSING ON THE 
     BILATERAL RELATIONSHIP BETWEEN THE UNITED STATES AND ARGENTINA

                               __________

                             MARCH 10, 2004

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


   Available at: http: //www.access.gpo.gov /senate /senate05sh.html

                                 ______

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

             Martin J. Gruenberg, Democratic Senior Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                 ______

            Subcommittee on International Trade and Finance

                    CHUCK HAGEL, Nebraska, Chairman

                   EVAN BAYH, Indiana, Ranking Member

MICHAEL B. ENZI, Wyoming             ZELL MILLER, Georgia
MIKE CRAPO, Idaho                    TIM JOHNSON, South Dakota
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       JON S. CORZINE, New Jersey
LINCOLN D. CHAFEE, Rhode Island

                Joseph Cwiklinski, Legislative Assistant

       Catherine Cruz Wojtasik, Democratic Legislative Assistant

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                       WEDNESDAY, MARCH 10, 2004

                                                                   Page

Opening statement of Senator Hagel...............................     1

Opening statements, comments, or prepared statements of:
    Senator Bayh.................................................     2

                               WITNESSES

Roger F. Noriega, Assistant Secretary for Western Hemisphere 
  Affairs, U.S. Department of State..............................     4
    Prepared statement...........................................    35
Randal K. Quarles, Assistant Secretary for International Affairs, 
  U.S. Department of the Treasury................................     6
    Prepared statement...........................................    36
Adam Lerrick, Leader of the Negotiations Team of the Argentina 
  Bond Restructuring Agency plc, Director, Gailliot Center for 
  Public Policy, and Friend of Allan H. Meltzer Professor of 
  Economics, Carnegie Mellon University..........................    20
Michael Mussa, Senior Fellow, Institute for International 
  Economics......................................................    23
    Prepared statement...........................................    39

                                 (iii)


                      ARGENTINA'S FINANCIAL CRISIS

                              ----------                              


                       WEDNESDAY, MARCH 10, 2004

                               U.S. Senate,
   Subcommittee on International Trade and Finance,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Subcommittee met, at 1:05 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Chuck Hagel, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Good afternoon. The Argentina debt crisis 
has become an important issue and, as we know, Argentina has 
struggled through a series of structural economic reforms 
dating back to the early 1990's. Unfortunately, this has 
resulted in one of the largest defaults by a debtor nation in 
history.
    Argentina is now faced with billions of dollars in debts, 
both the International Monetary Fund, IMF, and private 
investors who took a significant stake in Argentina's future. 
The impact of this financial crisis is being felt not only 
Argentina, but also throughout the world, particularly in the 
United States, which is a key player in the IMF and has a major 
private investment in Argentina.
    Historically, the United States has played a significant 
role within IMF in influencing the policies that have assisted 
Argentina with its past financial restructuring. The United 
States has assumed this role because of its strong bilateral 
ties with Argentina and its historic influence on the economies 
of South America. Investors from Europe, Japan, and throughout 
South America look to the United States for leadership in 
institutions like the IMF.
    This hearing today will examine what the implications of 
the Argentine crisis are for the United States and its role in 
the IMF. Argentina, South America, and countries throughout the 
world will continue to look at this crisis in the context of 
what the United States did to help resolve these problems. 
Close examination and scrutiny will be made of the roles that 
the United States and IMF played in protecting the rights of 
investors in Argentina.
    Ironically, Argentina was considered, in the recent past, 
one of the wealthiest countries in the world. It is a nation 
rich in natural resources, and has been an important 
international trading partner for the United States and the 
entire South American economy.
    Unfortunately, the early economic policies of former 
Presidents de la Rua and Duhalde caused Argentina to fall into 
a state of 
financial, political, and civil disarray. These economic 
policies included a massive devaluation of the peso, increased 
taxes, and frozen bank deposits, all which led to civil unrest 
and a succession of finance ministers.
    When current President Kirchner came to office in May 2003, 
Argentina had defaulted on its foreign debt obligations of 
approximately $140 billion. Included in this default were 
private creditors, mostly holding sovereign debt in the form of 
bonds, valued in excess of $80 billion.
    Argentina's failed economic policies resulted in the IMF 
adopting several bailout plans. In early 2003, the IMF approved 
an interim $6.8 billion agreement with Argentina. In September 
2003, the IMF approved an additional 3-year standby agreement 
with Argentina for $12.5 billion.
    This afternoon, we will hear testimony about the massive 
Argentine bond default. What will be the impact on future U.S. 
direct investment in Argentina and the region as a result of 
this crisis? What is the role of the IMF in protecting private 
investment when a foreign government defaults on its 
obligations?
    We look forward to hearing the testimony of today's 
witnesses. Our first panel will be Assistant Secretary of the 
Treasury for International Affairs, Mr. Randy Quarles, and 
Assistant Secretary of State for Western Hemisphere Affairs, 
Mr. Roger Noriega. The second panel will include Mr. Michael 
Mussa, a Senior Fellow at the Institute for International 
Economics, and Mr. Adam Lerrick, of Carnegie Mellon University.
    We appreciate very much all of you coming forward today 
with your thoughts and testimony, and we look forward to 
engaging in a question-and-answer period that will delve even 
deeper into the issue that we are about today.
    With that thank you, let me now ask the Ranking Minority 
Member of the Subcommittee, the distinguished Senator from 
Indiana, Senator Bayh, for his comments.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman. I thank you for 
holding this hearing today. It is a matter of great importance 
not only to our country and to Argentina, but also to the 
global financial system. I think your priorities are well-
placed in holding this hearing, and I want to thank all of 
those in attendance today who are interested, and also our 
panelists as we look forward to having the benefit of your 
expertise.
    Just a few quick comments, Mr. Chairman. I think there are 
some very important issues at stake in today's hearing.
    The first that I would mention is nothing less than the 
credibility of the International Monetary Fund, and through it 
the global financial system, through which we attempt to deal 
with countries experience financial crises. We run the risk, if 
this is not handled well, and we do not continue to use every 
reasonable method to convince the Argentines to deal honestly 
with their creditors, of running substantial moral hazard in 
the future.
    I regret to say that we may be on the cusp of a situation 
where default, such as Argentina, may appear to be the 
reasonable thing to do on the part of creditor nations. If they 
can default without consequence, I am afraid that this may set 
a precedent that may come back to haunt us in the longer-term.
    I am also afraid that the credibility of the IMF is at 
stake if we maintain a financial fiction of pretending that a 
country is not in default based upon a mere technicality when, 
to any reasonable observer, default is in fact what has 
occurred. We have avoided offending the United States taxpayers 
by being honest with them and saying that we have wasted money 
by putting it through the International Monetary Fund into 
Argentina, but in the long-run, this will only serve to 
undermine the commitment of the U.S. Government and, through 
us, our taxpayers to long-term interventions of this type.
    I think honesty is the best policy. If Argentina is, in 
fact, in default, merely technically propping them up, 
maintaining this fiction, will do nothing but undermine the 
credibility of the U.S. Government in dealing with our own 
public, and therefore, as I mentioned, undermine our own 
commitment in this area in the long-term, which I think would 
be very unfortunate, Mr. Chairman.
    I agree with something former Treasury Secretary Larry 
Summers once said. He said it is in the United States' best 
interests to advocate the forward defense of America's 
financial interests, and by that trying to deal with the spread 
of contagion before it gets out of control. But I think in this 
case we have gone beyond that and run a very real risk of 
creating substantial moral hazard going forward. As I said, 
default may, in fact, appear to be the reasonable thing to do, 
given the Argentine experience.
    Second, another major issue is the behavior of the private 
international financial community. I hope it is clear to all of 
the representatives of the major creditors in the audience 
today who have loaned money to the Government of Argentina 
that, going forward, you have to be out of your minds to issue 
loans like this. That should be abundantly clear by now. And 4 
or 5 years from now, I hope you do not forget this experience, 
when interest rates provided by Argentina have gone up to try 
and attract foreign capital, I hope you do not forget this 
experience.
    They call it a risk premium for a reason. Your capital is 
at risk, and no one will be coming running to your rescue in 
the future to try and help you with the situation. But the 
Argentine behavior, it has been deplorable in many respects, 
but it should no longer come as a surprise. So, going forward, 
I think you need to make these investments and realize that you 
are on your own, and if you invest in countries that stiff-arm 
the global financial structure, in this case the IMF, or stiff-
arm you, well, you should not be surprised if the results are 
similar going forward.
    The analysts and the executives in your companies that 
authorize these loans because the interest rates looked 
attractive compared to more secure instruments I think bear 
some measure of responsibility here as well. There is something 
called political risk. We have seen it in Argentina in 
abundance. And going forward, I hope that you will insist upon 
accountability in your own ranks for short-term lending 
strategies that appear to prop up your returns, but in the 
long-run place your capital at risk. Again, do not surprised if 
the IMF does not ride to your rescue, if the U.S. Government 
does not ride to your rescue. How many times do we have to 
learn this lesson before it finally sinks in? So, I hope you 
will hold some in your own ranks to account for this.
    Finally, to the Argentines themselves, it is a great 
country. You have a great people. It is lamentable what has 
happened in your country, and I would say that delay can no 
longer be tolerated, playing semantic games can no longer be 
tolerated.
    If we are going to rectify the situation and get your 
country back on the path to growth, which the citizens of 
Argentina deserve, I see in the paper today, Mr. Chairman, that 
Argentina has now agreed to engage in negotiations, not merely 
discussions, and that they are going to recognize the group of 
creditors and so forth. I think a fair amount of skepticism is 
in order as to whether this will, in fact, constitute more than 
a semantic difference, whether there will be, in fact, a 
significant improvement in the dialogue taking place with the 
creditors and some realistic attempt to try and solve this 
problem.
    I would encourage the Argentines, unless you simply do no 
longer desire to have private capital invested in your country 
by 
investors from other countries, unless you no longer to have a 
relationship with the IMF, with the World Bank, with other 
multilateral institutions, please, please make a sincere 
aggressive effort to try and resolve this situation. I know it 
is not easy, but my final piece of advice would be short-term 
political expediency in the long-run rarely turns out to be 
wise public policy, and yet I fear that at the altar of short-
term domestic political expediency, long-term sound policy for 
the people of Argentina may be being sacrificed.
    Having said that, Mr. Chairman. I want to thank you for 
conducting these hearings. I look forward to hearing from our 
witnesses today.
    Senator Hagel. Senator Bayh, thank you.
    Before I ask Secretary Noriega to begin with his testimony, 
let me advise the witnesses that we will most likely have some 
votes throughout the hearing. We have been advised that the 
first might come as early as 1:30. That is approximately 15 
minutes from now. When that occurs, we will go as far as we 
can, with some time remaining on the vote, and then what I will 
do is, with the concurrence of Senator Bayh, is gavel a recess. 
We will go vote and come back. That way we will get the full 
benefit, each of us, of the testimony and the questions.
    Thank you.
    Secretary Noriega.

                 STATEMENT OF ROGER F. NORIEGA

       ASSISTANT SECRETARY FOR WESTERN HEMISPHERE AFFAIRS

                    U.S. DEPARTMENT OF STATE

    Mr. Noriega. Thank you very much, Mr. Chairman and Senator 
Bayh. I appreciate the opportunity to discuss Argentina's 
current economic and political situation, as well as our 
bilateral relationship with that country. I especially 
appreciate the chance to share the panel with my Treasury 
colleague, Assistant Secretary for International Affairs Randy 
Quarles, whose day-to-day management of this issue has been 
critical in producing what we regard as positive results.
    My comments, very briefly, which I will submit in writing, 
will address the political and regional context for our policy 
toward Argentina. Argentina is a close and valued ally of the 
United States. It has been through very tough times in the past 
several years. We are pleased that it has now begun its 
political, economic, and social recovery. The Bush 
Administration hopes to see Argentina succeed over the short-
term and the long-term. Argentina's agreement with the IMF 
yesterday is a key part of reaching that objective, and we 
believe it is very good news that Argentina and the IMF reached 
that agreement on the program's second review, with Argentina 
making a $3.1-billion payment to the IMF.
    Mr. Chairman, President Kirchner has stressed that he wants 
to make Argentina a more predicable nation. He also has sought 
to root out corruption, restart the Argentine economy, and 
refurbish Argentina's stature in the world. He is facing a very 
daunting set of challenges to deal with the fallout of the 
recent economic crisis, as well as treat the institutional 
weaknesses that are the root of that crisis.
    He has made an important start, we believe, in addressing 
this complicated, tough agenda, aided by talented Argentine 
people. With their support, he is making progress. Because he 
enjoys considerable popular support, he is well-positioned to 
seek the reforms that we believe are critical to Argentina's 
continued progress and development over the long haul. On the 
economic front, these reforms include revising the system of 
revenue sharing between the federal and provincial governments.
    Bilaterally, we welcome President Kirchner's policy of 
maintaining close contact with the United States. He has met 
twice with President Bush since taking office in very candid 
exchanges on the issues that confront our bilateral 
relationship and those which President Kirchner is confronting 
at home.
    Other officials in our Administration, of course, maintain 
regular dialogue on economic issues at the highest levels. 
Neither we, nor the Government of Argentina, however, have lost 
sight of the fact that we have other ties that link us--
political trade, cultural, scientific, educational, and social 
areas.
    As one of my predecessors used to admonish, we have to 
remember that Argentina is a country, not just an economy. It 
is indeed in our interest that Argentina occupy its rightful 
place as one of the global leaders in the promotion of 
democracy and human rights and in other values that we share.
    In our deep and broad relationship, we address one another 
cooperatively on a range of issues. One specific area of a 
continued engagement is counterterrorism. As you know, Mr. 
Chairman and Senator, Argentina suffered devastating terrorist 
attacks in 1992 and 1994, and our shared experience with 
terrorist attacks on our home soil creates a special bond 
between our countries. Argentina has been a leader in this 
hemisphere in promoting cooperation in addressing the threats 
to our common security from those tied to terrorist 
organizations and those invovled in money laundering and 
trafficking in arms and drugs, particularly in the Tri-Border 
Area where Argentina has been a leader in addressing some 
security concerns that we share.
    I also want to highlight Argentina's important role in 
seeking to advance the cause of democracy, peace, and stability 
in the hemisphere and elsewhere. Argentina has peacekeeping 
forces today serving in five U.N. missions from Cyprus to 
Kosovo to the Congo, and Argentina has recently offered to play 
a role in helping address the crisis in Haiti.
    Argentine diplomacy has also been active on challenging 
regional issues including Bolivia and Venezuela. For example, 
in Caracas, President Kirchner, in February, met with 
representatives of the democratic opposition. So the leadership 
of Argentina is important.
    As I mentioned a moment ago, our discussions with Argentina 
on economic matters have occurred at all levels involving 
several executive branch agencies, but I also wanted to commend 
the role that has been played by Members of Congress who have 
visited Argentina in this period and met with Argentine 
officials in Washington and on trips because it is important 
that the Argentine authorities hear this message from our 
Government, from all levels, and from all branches of 
Government, on some essential elements that we think are 
important to its economic future and recovery.
    Our consistent goal has been to back Argentina's efforts to 
restore economic stability, as well as to restart economic 
growth, culminating with a 3-year economic program that 
Argentina launched with the IMF in September 2003 to lay the 
basis for long-term economic growth.
    This program provides a solid framework, we believe, for 
sustainable growth that will benefit the Argentine people and 
the region. And Argentina's progress on this score is a 
positive message, we believe, to the rest of the region.
    As the United States, we can and will be helpful, but 
ultimately the shape of the IMF program, and Argentina's 
performance under that program, are in the hands of the 
Argentine Government and the Fund. Yesterday's payment provides 
solid encouragement for the program's success.
    Mr. Chairman, as friends, the United States and Argentina 
can and do speak openly and frankly to one another, while 
sharing common goals in the hemisphere. The United States also 
shares Argentina's conviction and determination that it can and 
will reverse its severe collapse of the last few years and 
return to the prosperity that it once enjoyed.
    We stand ready to help to continue supporting Argentina's 
efforts, and through them strengthen all of our shared goals 
for our countries in this region and throughout the world.
    Thank you very much, Mr. Chairman.
    Senator Hagel. Secretary Noriega, thank you. Your full 
statement will be included in the record.
    Thank you.
    Secretary Quarles.

                 STATEMENT OF RANDAL K. QUARLES

         ASSISTANT SECRETARY FOR INTERNATIONAL AFFAIRS

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Quarles. Thank you, Mr. Chairman and Senator Bayh.
    I am pleased to be here to discuss the Administration's 
economic and financial policy toward Argentina, particularly 
the U.S. stance with regard to Argentina's engagement with the 
International Monetary Fund since 2002.
    I think it is worth spending a moment putting the 
engagement since 2002 in the historical context. As you 
mentioned at the outset, Mr. Chairman, Argentina had made good 
strides in the early 1990's in dealing with hyper-inflation and 
some of the economic challenges that they had faced in the late 
1980's. But the excessive budget deficits during the 1990's 
that were driven largely by fiscal arrangements that required 
the central government to fund spending decisions by the 
provinces without any effective central budget constraint this 
led to the buildup of a large debt burden that the government 
could not service any longer by the end of 2001. Faced with 
that situation, the government defaulted on its debt, and it 
abandoned the pesos pegged to the U.S. dollar. And that 
economic crisis was accompanied by political instability that 
eventually led to a new interim government that was led by 
President Eduardo Duhalde.
    Now, in the wake of that fault in devaluation, real GDP 
fell by 11 percent in 2002, inflation rose to over 40 percent, 
the peso depreciated by 69 percent, unemployment rose to 24 
percent, severe economic consequences. In addition, seeking to 
avoid a complete collapse of the banking system, the government 
imposed far-reaching deposit controls. Other government 
actions, in particular, forced the conversion of dollar-
denominated financial contracts into pesos that further 
weakened the banking system. On the monetary side, the 
authorities were struggling with the provincial creation of 
multiple quasi-currencies that at one point represented an 
astonishing 50 percent of the total currency in circulation, 
and the provinces had issued these quasi-currencies during the 
crisis to finance their spending in the face of collapsing 
revenues.
    It was in that context that the U.S. Government began 
working with the Duhalde Administration and the IMF throughout 
2002 in an attempt to develop a new IMF program and a set of 
policies that would stabilize this chaotic economic situation. 
Argentina's authorities took an extended period of time to 
develop such a program, in part, because of the deeply 
unsettled political situation. I think everyone is familiar 
with the fact that there were five presidents in the period of 
a month immediately after the collapse.
    Argentina then, after this extended period of development 
of a program, launched an 8-month transitional IMF program in 
January 2003, which the United States strongly supported. The 
purpose of the transitional program was to stabilize the 
Argentine economy in the most basic way because the most basic 
things were going deeply wrong. The program's 8-month length, 
very short for an IMF program, was long enough to last through 
the presidential elections in May, and for a sufficient period 
of time after that to give the incoming government enough time 
to develop its policy priorities. And then the focus of the 
transitional program was on macroeconomic stabilization. The 
expectation was that then a new administration that would come 
in with the elections in May would have a political mandate to 
pursue the more difficult reforms that would be needed to lay 
the basis for sustained economic growth.
    First, you had to stabilize the situation, and then the 
more difficult structural reforms could be made by a new 
government that would come into place in May.
    Argentina performed well under that transitional program. 
It met its IMF fiscal and monetary targets by wide margins. The 
central government signed bilateral agreements with the 
provinces that set clear limits on the provincial deficits in 
2003. Basically, they plugged this hole in the bucket that had 
led to the crisis in the first place. The government launched a 
program to retire the quasi-currencies, which was critical to 
ensuring that the federal government and the provinces lived 
within their means and that retirement of currencies is now 
complete. And in the context of improved macroeconomic 
policies, the government was able to lift the freeze on bank 
deposits without the inflationary surge or the collapse in 
deposits that many had feared.
    The transitional program helped to boost confidence in the 
economy, and that confidence underpinned the acceleration of 
economic growth in early 2003. Real GDP for the year as a whole 
grew an impressive 8 percent. Unemployment fell to 16 percent 
by the end of the year. Inflation fell to under 4 percent. And 
during that same period, the peso appreciated 15 percent, 
foreign exchange reserves increased by about $3.5 billion. In 
short, the transitional program fulfilled its objectives, which 
was to stabilize the situation so that a new government could 
come in and begin taking the more difficult steps that would be 
necessary for medium- and longer-term economic growth.
    As the Kirchner Administration came into office, it faced 
the dual challenges of consolidating the achievements of the 
transitional program and then of undertaking the actions that 
were needed to lay the basis for sustained economic growth in 
the future. That latter means both adopting reforms to deal 
with the root causes of the Argentine crisis, which I described 
very briefly at the outset, as well as taking steps to address 
the problems that were created by the crisis and that included 
resolution of Argentina's defaulted debt. So the 3-year program 
that was launched in September 2003 was designed around those 
objectives.
    The fiscal and monetary framework of the program, as well 
as the institutionalization of central bank independence, the 
gradual shift to inflation targeting was designed to entrench 
macroeconomic stability in order to keep the current recovery 
going.
    Fiscal problems, as I had outlined, were at the core of 
Argentina's financial crisis. The 3-year program not only 
mandates strict limits on provincial deficits in borrowing, but 
also provides for a comprehensive reform of the federal 
provincial fiscal framework to prevent the problems that led to 
the crisis from reoccurring, and that includes new measures to 
strengthen tax administration to fight illegal tax evasion.
    In addition, the crisis and the government actions during 
the crisis seriously damaged Argentina's banking system. The 
program establishes a framework for restoring health to the 
banking system by providing compensation from the government to 
address balance sheet damage that was done by the previous 
government, clarifying the regulatory environment, establishing 
capital standards designed to facilitate the strengthening of 
balance sheets over time, requiring banks to develop business 
plans for achieving specified capital requirements.
    Another key area affected by the crisis was the utility 
sector. Under its program, Argentina has undertaken to work 
with the World Bank to resolve the problems in the utility 
sector, including ending the price freeze, redesigning a tariff 
structure, reestablishing a coherent regulatory framework, 
renegotiating concession contracts, and finally a key objective 
of the program is to facilitate the successful resolution of 
Argentina's defaulted debt.
    Argentina has about $100 billion in private-sector claims 
outstanding. Its debt restructuring is the most complex in 
emerging markets' history. That is not only because of its 
size, but also because of the number of different currencies, 
the number of different legal jurisdictions in which it was 
issued, as well as the number of different types of bondholders 
involved, including sizeable holdings by retail investors in 
Italy, Japan, and Germany.
    The program provides the broad policy framework to underpin 
a debt-restructuring agreement between Argentina and its 
creditors. The program requires Argentina to work in good faith 
with its creditors, to reach a collaborative agreement that 
restores debt sustainability.
    IMF lending policies require transparent and constructive 
negotiations by Argentina with its private creditors to secure 
the broad creditor support in a debt restructuring that is 
needed to achieve a sustainable debt situation to facilitate 
Argentina's progressive reintegration into international 
capital markets. Argentina is going to need substantial 
investment to generate economic growth for the long-term.
    Argentina has continued to perform well under this program 
on its fiscal and monetary policies at least under the program. 
It has extended the gains that it has made under the 
transitional program. The government's budget performance to 
date exceeded the program targets by a significant margin. 
There has been important progress in strengthening the 
institutional and legal framework for tax administration. In 
the area of intergovernmental finances, the central government 
has concluded agreements with the provincial governments, 
limiting provincial spending and borrowing consistent with the 
requirements of the program.
    Progress in some other structural areas of the program up 
to now has been less satisfactory. Although the government has 
implemented new regulatory standards for the banking system, 
there have been delays in finalizing the agreed compensation to 
banks for the action that was taken by the government during 
the crisis. Bank lending remains depressed. Argentina's 
progress with the World Bank on reform of the utility sector 
has also been slow, although the Argentine Government did 
recently agree to raise tariffs on electricity and gas for the 
first time since the crisis.
    It continues to be essential for Argentina to make progress 
on debt restructuring with its private creditors. The 
government's announcement that it has made arrangements for the 
hiring of investment banking advisers to handle its debt 
exchange is a step forward. In addition, we expect to see, over 
the upcoming weeks, Argentina take the concrete steps necessary 
to negotiate with representative creditor groups on the terms 
of its restructured debt. Only with a negotiation process that 
builds mutual trust can Argentina achieve the broad creditor 
support that is needed for a comprehensive and a sustainable 
debt restructuring.
    Let me just conclude by saying that we want Argentina to 
succeed, to succeed in stabilizing its economy in the wake of 
crisis, to succeed in resolving its defaulted debt and to 
succeed in laying the basis for long-term economic growth. That 
will require rigorous implementation of this program. We have 
been a forceful advocate for IMF engagement with Argentina in 
pursuit of these ends, and we are continuing to work with 
Argentina and the IMF to encourage this implementation.
    Senator Hagel. Secretary Quarles, thank you.
    I have been informed that a vote has begun, and if my 
distinguished colleague agrees, we will take a short recess, 
vote, and then come back and get to the questions.
    Thank you.
    [Recess.]
    Senator Hagel. We will resume activity of this 
distinguished panel now that Senator Bayh and I have voted, and 
we may get a reprieve here for a few minutes. I am aware of the 
schedules of both of our witnesses on the first panel, so we 
will get right to the questions.
    Thank you.
    Let me begin a couple of my questions with Secretary 
Noriega. In your opinion, what impact has this crisis had on 
regional relationships in South America. You alluded to some of 
that, Secretary Quarles did as well, as the fabric is woven 
together by not just economics, but economics affect political 
and geopolitical security interests. And if you could give us 
some sense of the larger political sense of those relationships 
in South America, good, bad, or maybe nothing has been affected 
by this Argentine problem.
    Mr. Noriega. It is a good question, Senator. I think it is 
important to note that Argentina has, particularly in the 
1990's, established itself as a very good friend of the United 
States. Sending forces to Iraq in 1991 is one example of that 
very close relationship.
    And so our neighbors in the region naturally judge us by 
how we treat our very best friends. I think there was, 
therefore, some concern, when there was a perception that the 
international financial community was cutting Argentina loose 
and letting its economy collapse. Sophisticated observers, I 
think, recognized, however, that the United States made an 
effort.
    They also, frankly, ascribed the troubles to Argentina's 
own decisions, the institutional problems in Argentina, 
corruption, et cetera. Frankly, the level of sympathy from 
other countries in the region was not that high, and they 
recognized that Argentina had, through its own policies, sewn 
the seeds of the problems that they have encountered.
    Nevertheless, there is this question of whether the United 
States is or is not with its friends. In particular, in the 
last 18 months to 2 years, I think they have seen the United 
States going the extra mile, helping Argentina to interpret for 
the other developed countries that have a stake in this crisis, 
and serving as a bridge between our other G-7 partners and 
Argentina. I think that certainly has come through in the last 
few weeks and days really.
    We have not seen other countries for example, Brazil--
looking at the brinkmanship that Argentina has practiced as an 
example or a model that they want to follow. I think the 
Brazilians would like to see Argentina succeed. They have taken 
a very different approach in their dealings with the IMF, 
though. I do not really see a contagion in terms of the way 
Argentina has behaved vis-a-vis the IMF.
    Senator Hagel. Secretary Quarles, would you like to add 
anything?
    Mr. Quarles. I think, simply to underscore the point that 
Secretary Noriega made, that I do not think, particularly with 
respect to the debt default, with respect to Argentina's 
economic stance, generally, that is something that will be 
emulated by other countries in the region.
    Senator Hagel. We hope not.
    Mr. Quarles. The consequences of it were so dire for 
Argentina, the collapse in GDP, the rise in unemployment, 50-
percent of their population, by their figures, under the 
poverty line, that I do not think that Argentina is viewed as a 
model for the region or that its policies are viewed as 
successful policies, and I think we have seen that in the fact 
that other countries are not emulating their approach.
    Senator Hagel. Thank you.
    Secretary Quarles, in your opinion, what additional 
measures could have or should have the IMF taken in Argentina, 
given the proportion of this default and this debt?
    Mr. Quarles. I think in considering what the IMF could have 
or should have done, you look at the context, and there I think 
that the criticism of the transitional program that I described 
as weak, needs to be looked at in the context of what it was 
trying to achieve in that very chaotic situation, stabilizing 
the macroeconomic foundations.
    I actually think that the judgment that that is what that 
program should focus on, and limit itself to that, so that it 
could be effective in doing that with an administration that 
was admittedly an interim administration, without a significant 
political mandate, is a judgment that events have borne out, 
with the success of stabilizing the macroeconomic situation.
    I think, then, what the IMF could and should do now going 
forward is to ensure that focus is placed on the structural 
reforms that I described and in a way that really places focus 
on the reforms that Argentina needs to accomplish in a 
prioritized way. For example, with respect to this recent 
disbursement and Letter of Intent that has just been announced 
by the IMF and Argentina, a central focus was placed on 
changing the attitude with respect to the debt negotiations to 
getting Argentina to agree that they will negotiate with all 
representative groups of creditors. And my understanding is 
that Argentina has done this. That is what has been announced 
by the Fund, and that is what we in the United States will 
expect to see going forward.
    We will expect to see additional progress on compensating 
the banks and addressing the banking sector issues that 
Argentina has begun to address, but has not yet addressed as 
much as we would have preferred to see by this point and, 
similarly, with respect to steps that need to be taken in the 
utility sector.
    So what the IMF can, and should do, is not lose focus on 
these structural reforms that Argentina needs to take. I do not 
think that some of the criticism that the IMF program has been 
toothless, that it has been overly weak, is justified because, 
in fact, it does focus on the important structural reforms that 
are necessary given what the nature of the crisis was, given 
what the root causes of the crisis were.
    But what has to happen is that the implementation of those 
reforms needs to be vigorous, and the Fund needs to ensure that 
Argentina is vigorous in implementing them.
    Senator Hagel. Two quick questions in regard to two points 
you just made, one on the banking system.
    First question--and I know you addressed some of this in 
your testimony, as you just have noted now--do you believe the 
banking system, as it currently exists in Argentina, is capable 
in fact of the structural reforms and putting itself back 
together as a functioning financial service industry? And give 
me some reason why, if you believe that--and I assume you do--
why you think that, aside from what you said in your statement.
    And the other question is this: With this crisis in 
Argentina, I assume this will lead to IMF learning something, 
adjusting, recalibrating in how it deals with other debtor 
nations, and I would like you to address that as well.
    Mr. Quarles. Certainly. With respect to the banking system 
being able to reestablish itself, yes, I do think that that is 
possible. I think that the elements of the program that address 
the banking system create a framework in which that can happen. 
It is a process that is not going to happen overnight. It is 
going to take time. The damage that has been done to the 
Argentine banking system has been severe, but it is a system 
that can reestablish itself, over a period of several years, to 
health.
    Some of the reasons that I think that this has begun to 
happen, I mean, Argentina has taken steps in strengthening the 
regulatory framework that is going to be required for a healthy 
banking system, for immediately after the crisis, there was a 
significant amount of regulatory forbearance, basically 
preventing the banks from having to face their problems by not 
acknowledging the problems. You are never going to fix the 
problem if you are ignoring the problem.
    That regulatory forbearance has ended, and banks are being 
required to face the problems by the regulators, and that is 
the first step toward the health of a banking system. We 
discovered that in our own financial system issues at the end 
of the 1980's and early 1990's that ending regulatory 
forbearance was the way to eventually move toward the health of 
a system, and Argentina is beginning to do that.
    They have also imposed capital standards, improved their 
capital standards, established a framework for bringing banks 
up to those standards. The road map has been laid out, and that 
is obviously an important part of getting a banking system back 
to health, is that you know you have laid out the map as to how 
it is going to happen.
    I think they have not yet done as much as they need to do 
in dealing with the role of the public banks versus the private 
banks in Argentina. Public banks in a banking system are 
frequently a source of malaise and ill health. They have been 
in Argentina, and I think that needs to be dealt with going 
forward. But all of these are issues that can be dealt with, 
but it is going to take a long time.
    I am sorry, the second question?
    Senator Hagel. The second one is what has the IMF learned, 
what should they learn? And this then would lead to changes in 
the way IMF in the future deals with debtor nations.
    Mr. Quarles. I believe there are a few things. I think it 
is clear that the IMF could have been more vigorous during the 
1990's in pressing Argentina on problems that it knew were 
there, particularly this hole in the fiscal bucket, that at the 
end of the day was really the root of the crisis, this fiscal 
Federalism problem where the provinces were allowed to spend, 
require the central government to borrow to fund that spending 
with no ability of the central government really to limit that 
spending.
    That is something the IMF was aware of. It was something 
they certainly had spoken to Argentina about in the context of 
their regular Article IV consultations that they do every year 
with every country in the Fund, but it was not stressed 
sufficiently.
    I think that increased transparency of countries that are 
members of the Fund, requiring them to be more transparent to 
the market about information that is relevant to the market, 
about the views of the Fund, the information that they are 
getting from the Fund, the advice they are getting from the 
Fund requiring countries to be more transparent about that is 
something that the Fund should be increasingly strong about. 
They have pushed that.
    I think they need to push it more but basically, what the 
Fund needs to learn, and I think it is a lesson that they are 
beginning to implement, is that they cannot be complacent about 
problems like this and need to both push countries themselves, 
with the advice that they are giving, and push countries to be 
transparent about the advice that they are getting in order to 
prevent problems like this from occurring.
    Senator Hagel. Secretary Noriega, did you have a comment on 
that?
    Mr. Noriega. No, sir, I think it was adequately addressed.
    Senator Hagel. Thank you.
    Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman.
    There are no television cameras in the room here today, at 
least none that I can see, so you do not have to be worried 
about being captured on film.
    I would like to ask for a show of hands. Anybody in the 
audience today representing any of the creditors?
    One, two, three. That is it? Some of the rest of you prefer 
to be unidentified.
    Let me start, Secretary Quarles, with you then. As you 
know, the IMF requires as a part of their agreements to require 
that the country in question, Argentina, for our purposes 
today, is making ``a good-faith effort'' to reach an agreement 
with its creditors.
    Do you think Argentina has been making a good-faith effort 
to reach an agreement with its creditors?
    Mr. Quarles. That question was central to the recent 
negotiations between the Fund and Argentina as to whether they 
have been making a good-faith effort and will be making a good-
faith effort going forward.
    There are certain things that we think Argentina needs to 
do in order for its efforts with its creditors to be viewed as 
good-faith efforts, and we have been very clear about them with 
Argentina. We have been very clear about them with the Fund.
    We think that they need to negotiate, not just talk, but 
negotiate, with all representative creditor groups. That 
includes the Global Committee for Argentine bondholders and 
other representative creditor groups. That is going to be 
essential to achieving a successful debt restructuring.
    We think they need to hire and retain investment banks. 
Now, they have made progress on that. When we walked in the 
room, I do not think that had finally been assigned, but we 
expect it to be. And the hiring and retention of investment 
banks to advise them on this process is absolutely critical to 
it going forward.
    They need to work with those banks to identify a minimum 
threshold for achieving a debt restructuring that has broad 
creditor support.
    Senator Bayh. Say that again. They need to----
    Mr. Quarles. They need to work with their investment banks 
in defining a minimum threshold that is going to be necessary 
in the debt restructuring, a threshold of acceptance of the 
debt restructuring, to show that there is broad creditor 
support for that restructuring.
    Senator Bayh. Is a 10-percent pledge of repayment 
sufficient to generate a broad base of creditor support in your 
opinion?
    Mr. Quarles. Our stance is that we do not want to take a 
view----
    Senator Bayh. You do not want to get in the middle of it.
    Mr. Quarles. Exactly.
    Senator Bayh. Let me put you down as agnostic in response 
to the question of good faith. Any of the representatives here 
from the creditors, raise your hands if you think that 
Argentina has been making a good-faith effort.
    Let the record show that no hands were raised.
    The agreement that was just signed, as I understand it, Mr. 
Secretary, required that transparent and constructive 
negotiations take place. I assume that is more or less the same 
thing as making a good-faith effort or is there some 
substantive difference between those two?
    Mr. Quarles. No, we think that the two are importantly 
related. I do not think that there is a substantive difference.
    Senator Bayh. In your opinion, will the IMF ever be repaid 
or are we simply going to continue to rollover these loans ad 
infinitum?
    Mr. Quarles. No, we will not roll them over ad infinitum. 
Yes, the IMF will be repaid. That is something that we have 
also been very clear about with the Argentines. We expect the 
international financial institutions, the IMF and the MDB's, 
the World Bank, and the Inter-American Development Bank to be 
repaid, and Argentina has the capacity to do that, and I 
believe they will do that.
    Senator Bayh. Hopefully, at some point in the not-too-
distant future. I mean, you would have to say most observers 
looking at the current situation would have to say that it 
might not be ad infinitum, but it does not appear that it is 
going to be any time soon.
    Mr. Quarles. We have been clear with Argentina that they 
must be continually, that the exposure of the IFIs to Argentina 
must be declining over time, and we expect that to happen.
    Senator Bayh. Well, it would be very helpful for them to 
agree to some schedule that they could then be held accountable 
for adhering to because I think you are right. My initial 
comments to the point, I think it is vitally important that the 
United States continue to be engaged in addressing global 
financial crises. It is in our long-term best interests. At the 
same time, we have to be candid with the American public and 
say that this is not altogether a risk-free or a costless 
enterprise. And if there is a situation where a default has 
occurred or a de facto default has occurred, it is better to 
acknowledge that.
    But let us just say I hope you are correct. I hope you are 
correct. I think that is an important question to get nailed 
down with some schedule that we can try and adhere to.
    With regard to the structural reform, I was very encouraged 
to hear a lot of the things you had to say--the political 
reform, some of the other things that have been done. As you 
are probably aware, though, there has been I think a fair 
amount of skepticism is in order here. I regret to say that, 
but there is a history of pledges being made, commitments being 
made that are then not adhered to, of steps being taken, at 
least in theory, but then not being fully, and I think you used 
the word which I would say is the key word in all of this, not 
implemented.
    And so I think, in some respects, this is the triumph of 
hope over experience. We have to focus on the actual 
implementation of the political reform, the other reforms that 
have been enacted or committed to, and I think, frankly, it is 
going to take some zealous oversight.
    So you are here today to testify to us. I do not want to be 
unfair about this, but part of this is just a question of trust 
and that, frankly, there is not a lot of trust left after this 
long history. And I know some previous governments are to blame 
for that, and so forth and so on, but are you and your 
colleagues going to zealously participate in overseeing the 
actual implementation of this new process?
    Mr. Quarles. We are going to be very engaged, as a 
shareholder of the Fund, in doing that. There will be regular 
disbursements under the program. At every one of these 
disbursements, it will be necessary to evaluate how Argentina 
is performing, both under the program and in the continuing 
resolution of its outstanding debt. And we do not intend to be 
lax in ensuring that these elements of the program are 
implemented.
    Senator Bayh. There were domestic political reasons, as I 
understand it, for the relationship that evolved between the 
central government and the provinces, and some of the other 
problematic situations that developed over time in Argentina, 
and I assume that some of that domestic political pressure has 
not entirely gone away. So put me down, as I am by nature an 
optimist, but put me down as a skeptic until we actually see 
some steps taken on the process, on the road toward 
implementation. But I appreciate your commitment and that of 
your colleagues toward seeing this through.
    Just a couple of other questions. Japan, Italy, and I 
believe Britain all declined to approve December's disbursement 
from the IMF. Do either one of you have any idea, do you want 
to give us the reasons why they declined to do that?
    Mr. Quarles. Let me just phrase it as their stance with 
respect to Argentina, as opposed to their votes on the board. I 
think we do for a variety or reasons. Governments seek to 
maintain the confidentiality of board votes. The board 
directors are not supposed to reveal----
    Senator Bayh. This was reported in the popular press.
    Mr. Quarles. I understand. But let me just phrase it as the 
stance of those countries with respect to Argentina's progress 
at the end of January in implementing the IMF program. I do 
think that they were concerned about the degree to which 
Argentina was proceeding in good faith in restructuring its 
debt, but that is a question that people could have differing 
views about at that point.
    Argentina certainly had met with a large number of creditor 
groups. People had differing views about the value of those 
meetings, but this is a very complicated debt restructuring. 
Taking off my assistant secretary hat and putting back on my 
lawyer hat from my time as a lawyer with a Wall Street law 
firm, for the nearly 20 years I spent there, this is the most 
complicated sovereign deal that has ever been done. It is going 
to take a long time.
    It is a very complicated process, and there were reasonable 
differences of view at the end of January as to whether 
Argentina was proceeding in good faith or not, in good faith 
with a very difficult job or not in such good faith with a very 
difficult job.
    Senator Bayh. Can I hazard a theory, Mr. Quarles? Feel free 
to disagree. Because the foreign policy ramifications of the 
situation are more important or, to us, have more significance 
to us than the other three countries, they are not completely 
without significance to them, but given our position in the 
world, it is a bigger priority for us. They placed more weight 
upon the good faith of the negotiations, the progress toward 
trying to resolve these financial disagreements.
    So our position of continuing to favor the disbursements 
was influenced by our own foreign policy, which are not 
illegitimate, but they are separate.
    Mr. Quarles. You are absolutely right that foreign policy 
concerns are not illegitimate, but I would say that, again, at 
the time that those decisions were made and those disagreements 
were, those differences of view, were present, it was not 
principally foreign policy decisions that were driving it.
    There were genuine differences of point of view of the 
financial professionals involved in the finance ministries of 
all of the relevant countries involved as to whether we really 
could say that there was not good faith on the part of 
Argentina at that time.
    Senator Bayh. Fair enough. I just wanted to point out that 
apparently some other countries were taking a little bit firmer 
attitude toward this on the financial side of things.
    My last point, Mr. Chairman, and you have been very 
patient. I believe, Secretary Quarles, and my dictating skills 
are not so great, but as best as I was able to take down your 
comments, you said something to the effect that Argentina will 
need substantial foreign investment going forward to try and 
stabilize and grow the economy the way we would all like to see 
it take place.
    Given this history, I just find it to be breathtaking, how 
the foreign banks were treated, the utilities, the creditors 
are getting diddled, the IMF has been given the runaround, et 
cetera. Where will that capital come from? Why would they make 
those investments?
    Mr. Quarles. No, I think that is a very important question. 
It is another reason why I do not think that the Argentine 
model is ultimately going to be a siren call for other 
countries in the region because, in the near-term, there is 
going to be difficulty for Argentina, even if they ultimately 
successfully resolve this debt.
    Senator Bayh. Here is my concern, and I will let you go. 
For the moment, the country seems to have been stabilized. It 
seems to be heading back in a better direction, and I am afraid 
that the long-term lessons may be lost, and they may basically 
take the attitude, okay, we could do all that, and it worked 
out okay, and that it will only be a period of years from now, 
when they are cut off from international investment and from 
multinational assistance, et cetera, that the full cost of this 
course of action will be made apparent.
    In the meantime, other people look at the situation and 
say, you know, they are still there. Things seem to have 
stabilized. They are heading in a better direction. Why should 
we, speaking of other countries, take on the domestic pressure 
of doing the tough, but right, thing?
    Mr. Quarles. That is an acute observation and a subtle and 
serious concern. But I do think that the short-term costs to 
Argentina have been so great, as we already described, and the 
medium- and long-term costs of not making some of these steps 
that we have been talking about today will also be significant 
and obvious enough that this period, there may be a period of a 
year or two where it might seem that, oh, things are going 
better and medium- and long-term costs would not be obvious if 
Argentina were not to address some of these questions.
    But that is a brief enough period, and the original costs 
and the medium- and long-term costs will be obvious enough that 
I think that will be clear to other countries in the region, 
certainly, to their governments, even to the extent there might 
be some threads in these countries that might find it 
attractive or not understand the situation.
    Senator Bayh. You have both been very patient today. My 
final point is that unfortunately it seems that memories are 
short. They are short in the public sector. They are short in 
the private sector. People reach for high rates of return in 
the near-term, perhaps forgetting the lessons of the past about 
putting capital at risk, and I am afraid that sometimes people 
take the path of least resistance in domestic political terms, 
even with the long-term financial costs.
    I am afraid that one of the reasons for this hearing, I 
understand, is that we want to get on the record this history 
so that perhaps we can learn from it and not repeat it.
    Mr. Noriega. Mr. Chairman, may I add a few comments on a 
couple of these issues?
    Senator Hagel. Yes.
    Mr. Noriega. I think, if you read what President Kirchner 
has said, one of his concerns is he recognizes that Argentina 
has made commitments over the years and has not taken them very 
seriously. One of his commitments to his own people and to us 
is that he wants to break that cycle, and he wants to meet 
these commitments.
    He has driven a very hard bargain with the IMF, and he has 
managed to exceed, in significant ways, the macroeconomic 
targets he set for himself. He has to move along the rest of 
this agenda, and we have been very, very clear to him that he 
has to do these important things to get domestic credit moving, 
attracting investment, being more predictable to those 
companies that, frankly, do want to continue to do business in 
Argentina.
    In the last few weeks, I think it should be noted that our 
partners in the G-7 and the United States have been united, 
really, worked very, very closely together. There is not really 
a division, and that united front has been influential, I 
think, and important.
    President Bush met with President Kirchner in January and 
said, you have to do some of these essential things to help me 
help you. And so his credibility with Kirchner is high, and 
President Kirchner recognizes that his credibility with 
President Bush is at stake. I think he has recognized that he 
has political space at home, he has economic space to do some 
of these other things that are being required of him now.
    One of the important things now is dealing with 
restructuring his credit and negotiating in good faith with his 
creditors. The last Letter of Intent really sets out, in very 
detailed terms, measurable steps that they can take and we will 
be considering whether they take them, developing a time table 
and a process that will ensure meaningful negotiations and 
empowering investment banks to carry out these negotiations. So 
you have the profit motive, frankly.
    We know what is at stake here, Senator and Mr. Chairman, 
and that is the essential property rights of these people, the 
attrac-
tiveness of the Argentine economy to investment, getting that 
economy going, and I think President Kirchner is recognizing 
that too. We are working very closely with our partners. I do 
not think there is any space between us in holding them 
accountable, in moving forward down the rest of that agenda 
that will be necessary to jump-start that economy.
    Senator Hagel. Thank you. Secretary Quarles, picking up a 
little bit on where Senator Bayh left off his line of 
questioning, in your opinion is there private investment 
capital available today in Argentina?
    Mr. Quarles. The amount of certainly foreign direct 
investment in Argentina is very small, and I think that the 
amount of capital from outside the country and, frankly, from 
inside the country, the amount of investment that is available, 
is greatly constrained by the situation.
    I do think that it is certainly within the capacity of 
Argentina, and it is one of the reasons why we are so focused, 
why we have been so focused on changing the course with which 
they were approaching the debt restructuring and pushing them 
to address some of these questions about compensating the banks 
and addressing the utility sector.
    I do think it is possible for Argentina to change that 
situation and attract foreign investment again.
    Senator Hagel. Let me ask you how do you measure that? Is 
that measured by the IMF? The question that I ask, direct 
investment capital, I have heard different reports--it is not 
empirical data--that, in fact, there is a significant amount of 
private capital washing around in Argentina. I do not know 
that. But how do you measure that, if there is capital or not 
or some? How were you led to the conclusion that you had just 
shared with us in answering my question?
    Mr. Quarles. The Argentine Government has statistics with 
which it measures certainly the amount of foreign capital 
available. Bank lending, for example, is about 7 percent of 
GDP, and in a country like Argentina, an emerging market like 
Argentina, it should be closer to 20 to 40 percent of GDP. And 
it is statistics like that, that add up to the picture that the 
availability of capital for investment in Argentina is severely 
constrained. But as I said, I think there are steps that 
Argentina can take, that it is beginning to take, that can 
change that situation.
    Senator Hagel. But if that does not occur, then the 
scenarios, the sources of recapitalizing the banking structure 
and reorganizing the banking structure are somewhat dim.
    Mr. Quarles. Yes, I agree with that.
    Senator Hagel. Then, why would American investors be 
tempted back into Argentina, given the current situation. I 
understand what you were saying. While they were in a position 
they could do it, somewhere down the road they have to start 
addressing these issues, but these are down-the-road dynamics 
which are important, yes, and a political dynamic is important, 
but if there is little capital flowing in, and everyone stays 
out because of the huge, I would suspect, unprecedented default 
here, then what would incentivize or tempt anyone back in.
    Mr. Quarles. That is a very important question, and it is 
one of the reasons why we are being so clear about the 
structural forms we think Argentina needs to make because it is 
only through doing that that they will be able to attract 
future capital.
    Argentina is a country that has significant resources. It 
has natural resources. It has resources in its people. As you 
noted at the outset of this hearing, it has been one of the 
richest countries in the world and could be so again. And those 
opportunities will, if there is a sufficiently facilitating 
investment climate, be attractive to both domestic and foreign 
investors.
    Capital will return to a country like Argentina that has 
the ability for economic returns that Argentina offers if there 
is the right investment climate. And it is trying to address 
those issues that the IMF agreement includes some of these 
structural reform elements that we have been talking about 
today.
    Senator Hagel. Let me ask you--and I know you both have to 
leave and comply with another commitment--outside the financial 
services industry, the utilities, what could Argentina be doing 
that it is not doing to address the utilities industry issue? 
Obviously, restructuring debt, could there be a change of 
ownership? What are the options are that I am not aware of ?
    It does not mean that they are not occurring, but I have 
been somewhat aware of some of the specific utilities issues 
that we are dealing with down there, and it seems to me there 
has been some very limited imagination used by the Argentines 
in dealing with that specific sector.
    Mr. Quarles. The most direct and straightforward thing that 
Argentina can do is move more rapidly. They have begun in some 
sectors, but not broadly, to raise the tariffs, the utility 
rates, basically, to allow the utility rates to be raised to a 
market rate to allow the utility companies to make the 
necessary profit, to then continue to invest. Now, obviously, 
that is politically very difficult. I think it is something 
that could be done more quickly.
    The second thing, however, is that Argentina has agreed to 
engage with the World Bank in thinking through exactly these 
sorts of questions. The World Bank is ready to provide 
assistance to Argentina as a program is worked out to address 
the utility sector issues, and that also is something that 
Argentina can do, is to be more forward-learning, faster, if 
you will, in its engagement with the World Bank on working 
through these questions.
    Senator Hagel. We could spend the afternoon, obviously, 
pursuing the questions that we have asked and your answers and 
other questions, but I very much appreciate both of you coming 
up here this afternoon.
    We may well have additional questions for the record from 
other colleagues who were not able to attend today. Senator 
Bayh may have additional questions, as may I. So we will leave 
the record open until the end of the week and may well forward 
you some questions for the record.
    Any additional comments that either of you would like to 
make?
    Mr. Noriega. Thank you, sir.
    Mr. Quarles. No.
    Senator Hagel. Thank you.
    Mr. Quarles. Thank you very much.
    Senator Hagel. If the second panel would move up, we would 
appreciate it.
    Thank you.
    Professor Lerrick and Mr. Mussa, thank you for joining us 
today. We appreciate very much your time and your effort and 
look forward to your testimony.
    Professor Lerrick, let us begin with you.

                   STATEMENT OF ADAM LERRICK

             LEADER OF THE NEGOTIATIONS TEAM OF THE

            ARGENTINA BOND RESTRUCTURING AGENCY PLC,

        DIRECTOR, GAILLIOT CENTER FOR PUBLIC POLICY, AND

       FRIENDS OF ALLAN H. MELTZER PROFESSOR OF ECONOMICS

                   CARNEGIE MELLON UNIVERSITY

    Mr. Lerrick. Thank you, Mr. Chairman.
    First, let me say I appear before the Subcommittee wearing 
two hats; first, as the Director for the Center of Public 
Policy at Carnegie Mellon and, second, as leader of the 
negotiation team for the Argentine Bond Restructuring Agency, 
which is known in the market as ABRA.
    ABRA is the largest creditor in the Argentine debt 
restructuring. It holds approximately $1.2 billion, a nominal 
amount of Argentine bonds, and the interests of an estimated 
30,000 to 40,000 retail investors in Germany, Austria, 
Switzerland, and the Netherlands.
    ABRA was one of the three founders and is a member of the 
Steering Committee of the Global Committee of Argentina 
Bondholders, which represents directly holders of more than $37 
billion of bonds or more than two-thirds of the $53 billion of 
Argentine debt held by foreign investors. All of the major 
constituencies of Argentina's foreign bondholders are 
represented, both geographically and by type of investor. 
Italy, Germany, Austria, Japan, and the United States dominate. 
Retail and institutional investors share power to match their 
equal shares of Argentina's debt.
    How did we get here? Well, we have a developing nation of 
38 million people, insignificant in the world economy and 
largely dependent on agricultural exports, that was able to 
borrow an extraordinary $100 billion in the capital markets. It 
became the largest debtor in the emerging world with 25 percent 
of the global total. The most sophisticated global hedge funds 
and portfolio managers, along with the most naive Japanese 
farmers and Italian pensioners readily purchased these promises 
to pay without any regard to the debtor's capacity to pay. The 
credit worthiness of the borrower was irrelevant. It was the 
bailout policies of the Clinton Administration in the 1990's 
that socialized the risks and privatized the returns from 
emerging market lending.
    In 1995, in Mexico, Lawrence Summers, then-U.S. Treasury 
Under Secretary, gave life to a financial anomaly: An asset 
with a high rate of return and with an unwritten AAA guarantee 
from G-7 governments via IMF bailouts. The natural laws of the 
risk return tradeoff were contravened. The demand was 
explosive. Annual bond issuance by Latin American governments 
instantly quadrupled from $9 billion to $37 billion.
    Bailouts grew with borrowing. The $50-billion package from 
Mexico was promised to be a one-time event. Instead, there 
followed in swift succession: In 1997, Thailand for $17 
billion, Indonesia for $34 billion, and Korea for $57 billion; 
in 1998, Russia for $16 billion and Brazil for $42 billion; 
and, in 2002, Turkey for $10 billion and Argentina for $20 
billion. Loss largely bypassed the private sector that, with 
the exception of Russia, did not write off a single dollar on 
sovereign lending to large emerging nations. A quarter-trillion 
dollars in risk was shifted from the balance sheets of private 
creditors to official ledgers.
    In 1996, the Group of 10 took note of the moral hazard 
inherent in bailouts, with a promise that they would act ``to 
discourage expectations that large-scale official financing 
packages will be available to meet debt service obligations to 
the private sector.'' But as time went on, an overriding, but 
unspoken, U.S. Treasury policy, without legislative 
endorsement, held that development in emerging economies was a 
global public good and that a high flow of affordable funding 
to these markets, beyond official capability, must be 
encouraged at all costs.
    Even as the IMF was warning the Argentine Government behind 
closed doors that its fiscal policy was unsustainable, the Fund 
continued to support the nation publicly. In 5 years, starting 
in 1995, bondholders doubled their investment from $50 billion 
to $100 billion.
    By 2000, G-7 taxpayers were staring at a long list of 
payouts down the road. Excesses were finally halted by the Bush 
Administration in December 2001, when the IMF stood by and a 
clearly insolvent Argentina was allowed to default on its 
massive debt to the private sector.
    The second problem is that now the IMF has a tiger by the 
tail. The economist, John Maynard Keynes once wrote that ``if 
you owe the bank 100 pounds, you have a problem. If you owe the 
bank 1 million pounds, the bank has a problem.''
    Just as past bailout policy had allowed Argentina to 
dominate emerging bond markets with $100 billion of debt to the 
private sector, it permitted Argentina to accumulate $30 
billion of debt to the official sector and to hold the 
disproportionate share of official lending.
    Argentina is now the IMF's third-largest debtor, with 15 
percent of the Fund's portfolio. It is the second-largest 
borrower with the Inter-American Development Bank, with 17 
percent of loans outstanding; it is the World Bank's fifth-
largest exposure, with 7 percent of total risk.
    Nothing is more feared by the multilateral agencies than 
default. It not only threatens their capital structure, but 
also even more dangerous, calls into question the long-held 
posture that official loans are riskless and consequently have 
no cost to donor country taxpayers. As then-Secretary of 
Treasury Robert Rubin stated to Congress, when he requested the 
$18-billion appropriation for the IMF in 1998, ``It does not 
cost one dime.''
    Default to any of the international financial institutions 
by a major borrower opens a Pandora's Box of policy issues. Why 
are the multilateral agencies providing funds at subsidized 
interest rates to developing borrowers that enjoy full access 
to the capital markets? What are the costs and risks for G-7 
taxpayers? What has been the effectiveness of past efforts? Why 
are the costs of participation in these institutions not 
accounted for in the U.S. budget? When new funding is 
requested, Congress will be called upon to scrutinize the 
merits and costs of international financial institution 
programs relative to completing uses of scarce public monies.
    Twice in the past 2 years, Argentina has successfully 
played the default card. To combat IMF conditions of reform, 
the Argentine Government halted payments to the World Bank and 
Inter-American Development Bank in late 2002. Similarly, in 
September 2003, Argentina defaulted to the IMF for a day until 
an agreement on the government's terms was signed.
    The emerging market is watching. Lending to governments is 
a tricky business. We no longer live in an era where the 
governments of private-sector lenders send the Navy to collect 
on their bad loans. There is no collateral, no security, no 
ability to enforce the contract, and no ability to seize 
assets. The only rational reason to pay is there is more to 
gain from paying than from not paying.
    Argentina has made a preemptive decision. Payments to the 
country's lenders are now deemed discretionary expenditure, not 
fixed obligations. Government-sponsored posters of ragged 
children crystallized a new concept, the social debt. To 
provide a better quality of life for citizens, takes priority 
over the financial debt to the Nation's creditors.
    If Argentina even comes close to imposing the 90-percent 
debt reduction it currently is demanding, a level of relief 
that has not been obtained by even the poorest African nations, 
how can Latin American leaders or any developing-country 
politician justify to their electorates stringent fiscal 
efforts to honor obligations to foreign lenders? Why not 
schools and hospitals, instead of repaying rich foreigners? The 
resulting defaults will cascade through the international 
capital markets.
    At the beginning of this statement, it was noted that ABRA 
was the largest creditor in the Argentine debt restructuring. I 
mis-
spoke. The debt held by the IMF is a 13-time multiple. In order 
to qualify for IMF loans, the rules of the Fund require 
governments in default to the private sector to demonstrate 
good-faith efforts to restructure their debt. Is it not a 
conflict of interest to ask this agency to rule on a debtor's 
good faith toward what are competing creditors at a time when 
its own balance sheet is threatened?
    Every month that Argentina delays its restructuring, it 
saves $700 million in accumulating interest. Since the default 
in December 2001, this adds up to more than $20 billion. 
Instead of relying on exhortation and a vague and subjective 
standard of good faith, the IMF should create automatic 
financial incentives that encourage governments to restructure 
defaulted foreign debt without delay. As a condition of 
desirable Fund loans that carry highly subsidized interest 
rates and no repayment for 3 years, the IMF should require an 
accelerated 5-percent monthly prepayment until the country 
comes to terms with its private creditors.
    The Argentine crisis is the creature of a misguided 
international financial policy. When the expectation of 
bailouts no longer intervenes, then market forces will limit 
the debt a government can accumulate, and the IMF will no 
longer be at the mercy of its large borrowers.
    Senator Hagel. Professor Lerrick, thank you.
    Mr. Mussa.

           STATEMENT OF MICHAEL MUSSA, SENIOR FELLOW

             INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Mussa. Thank you, Mr. Chairman.
    In your invitation to this hearing, you asked for an 
assessment of the economic and financial dimensions of United 
States policy toward Argentina, particularly United States 
positions with regard to Argentina's engagement with the 
International Monetary Fund since 2002.
    Now, I have a long prepared statement. Let me try and 
summarize five key points.
    Senator Hagel. Your full statement will be included for the 
record.
    Mr. Mussa. Thank you.
    First, in 2002 itself, the first half-year, the Argentine 
economy continued to collapse in a massive depression that 
ultimately took GDP about 25-percent below its mid-1998 peak, 
saw the currency depreciate by two-thirds, saw inflation pick 
up, the banking system collapse, and many other calamities.
    In the context of this catastrophe, one can look to the 
policies of President Duhalde, and there is I think much to 
criticize in those policies. There is no doubt, and the 
deliberations at the IMF ultimately made this clear, that the 
policies of the Duhalde Administration failed to meet the 
normal standards for an IMF program.
    Nevertheless, the Duhalde Administration did successfully 
avoid a recurrence of hyper-inflation. They halted the collapse 
of confidence and, at mid-year, the economy began to recover. 
Argentina, also, in 2002, paid a net of $3 billion to the 
international financial institutions.
    In my view, while far from perfect, this was good enough to 
justify a rollover of large payments coming due to the Fund and 
other IFI's, without which Argentina would have been forced 
either to exhaust its reserves or default on its official 
debts. And the U.S. Administration, I believe, was right in 
pressing a somewhat reluctant IMF to come to the interim 
agreement which was reached in December 2002.
    Second, while I think this was the right approach at that 
time and under those circumstances, I believe it would have 
been better to do this in a new special IMF facility that would 
have emphasized that situations like Argentina could be treated 
as special cases, but only if they met quite specific criteria.
    Countries, in general, could not expect to simply rollover 
their IMF debts nor could they expect the IMF to certify that 
they were making good-faith efforts to deal with private 
creditors, credits in default, even when no such efforts were 
being made at all.
    However, in the desperate circumstances of 2002, no 
efforts, other than saying ``we will get back to you later,'' 
to deal with private creditors really made much sense. But it 
should have been made explicit that: This was a special 
response to a special circumstance. Other countries should not 
count on it, except in exceptional circumstances, and Argentina 
should not count on continuing treatment of this kind as its 
own situation improves.
    Third, the interim IMF program of 2003. I agree with 
Assistant Secretary Quarles that, on the whole, this program 
worked pretty well, despite continuing controversies over the 
freeze on utility rates, court actions to free deposits, and a 
number of other irritations.
    There was, however, a stumbling block in the negotiations 
for the new IMF program to take effect after the administration 
of the new President, Nestor Kirchner, had taken office and had 
an opportunity to formulate its policies and priorities. That 
new issue was the issue of Argentina's efforts to deal with the 
external private debt then in default.
    It is fair to say that in negotiations over the start of 
that program, this issue was kicked down the road, rather than 
resolved. But that too was a reasonable solution as of August/
September 2003, based on Argentina's commitment to begin a 
serious process of discussions with its external creditors and 
to present an offer in Doha, at the time of the World Bank/IMF 
annual meetings, that would indicate to creditors what 
Argentina was prepared to do.
    Fourth, when that offer was made public, it became clear, 
to the extent that it was not clear already, that the 
Argentines did not intend to make very generous payments to the 
holders of their external sovereign debt. The face value was to 
be written down 75 percent, and the effective reduction in 
value, including deferred interest payments, was more like 90 
percent. This compares with a 65-percent recovery rate, on 
average, from many other emerging-market debt restructuring and 
a recovery rate from even restructuring of official debts to 
poor countries that is generally above the 10-percent range. 
For instance, for Iraq, former Secretary Baker has achieved 
agreement on the principle of one-third recovery by official 
lenders.
    Needless to say, creditors were not pleased by the prospect 
of what I describe as not a haircut or even a scalping, but a 
beheading. As the dissatisfaction of creditors became known, 
and as the major shareholders of the IMF came to recognize from 
their own assessment of the Argentine offer, dissatisfaction 
with Argentina's proposals, vis-a-vis its external default, 
grew. Those dissatisfactions manifested themselves in the 
abstentions by more than a third of the voting power of the IMF 
Executive Board on the occasion of the first review of the new 
IMF program.
    Normally, countries vote, yes, on virtually every country 
matter. A one-third abstention on a country matter is virtually 
unprecedented in the history of the IMF. So there was a message 
in that vote, and that message was later reinforced by the 
discussions at the Boca Raton G-7 ministerial meeting, where 
press reports indicated that the assembled ministers agreed 
that the managing 
Director of the IMF should be asked to give a tough message to 
President Kirchner about the need to get more serious 
concerning the debt restructuring.
    Now, here I think again the proper actions were taken, but 
maybe there was a bit too much of a delay and lack of clarity--
at the time of discussion of the agreement of August/September 
2003--and, subsequently, a bit too much of a delay in making 
public official concerns about some of the deficiencies of the 
Argentine offer.
    Finally, I think there is a key issue about establishing 
the proper role and function of the IMF and the international 
community in dealing with situations like Argentina and its 
default on its external credit. The issue is not the narrow 
question of pressing Argentina to serve its creditors or 
pressing its creditors to agree to a large write-down to 
benefit Argentina. The issue that is central to the 
international community is the integrity and deficiency of the 
functioning of international credit markets.
    If we are going to have international credit markets in 
sovereign obligations, then those markets need to be able to 
deal with situations of sovereign default. They will arise from 
time to time. They can be dealt with only if two broad 
principles are observed:
    One, creditors need to be prepared to accept significant 
write-downs in the value of their claims when a debtor really 
cannot afford to pay the contractual terms of the debt that is 
outstanding.
    Two, debtors cannot be allowed to simply walk away from 
their obligations because they do not want to pay or find it 
politically convenient at home to announce that they will not 
pay when they really do have the capacity to pay significant 
returns on their outstanding claims.
    The issue for the international community is how to enforce 
those two broad principles. I think, in the case of Argentina, 
we have seen some considerable slippage relative to what has 
been done in past instances, and the leadership of the United 
States, particularly within the context of the International 
Monetary Fund, will be important in repairing that situation.
    Senator Hagel. Mr. Mussa, thank you.
    Let me ask each of you, especially in light of Professor 
Lerrick's testimony, do you think we should just abolish the 
IMF?
    Professor Lerrick.
    Mr. Lerrick. No, Mr. Chairman. The IMF has a very useful 
role to play. In fact, it has a number of very useful roles to 
play. The principal one is to act as a lender of last resort 
for developing countries in the international financial system. 
However, that is not the function that the IMF played in the 
case of Argentina. There are very strict rules, guidelines that 
have been established over more than a century of central bank 
intervention in domestic credit markets, and those were clearly 
violated in the case of IMF intervention in Argentina. It was 
for another purpose; there was another goal involved.
    But let us be clear, the responsibility of the IMF is the 
stability of the international financial system. It has no 
responsibility for the prosperity of any individual country. 
That is not what it was created for. Therefore, central banks 
have, for over 100 years, established methods of intervention 
that follow that key rule. And this rule was not followed in 
the case of Argentina.
    The problem in the case of Argentina is that there was a 
different policy that was being pursued. The goal was to ensure 
a large supply of low-cost capital to emerging markets, far 
beyond what the official sector could provide. So the only way 
of achieving this objective was--since the private sector only 
responds to two things, risk and return, and the official 
sector was not prepared to subsidize investments by paying 
returns to private investors to send money to developing 
countries--was to eliminate the risk. And that is what was 
achieved through IMF bailouts. And that is how we got into this 
situation.
    If we eliminate bailouts, then what will happen is the 
markets themselves will control the amount of funds that go to 
emerging economies. Countries like Argentina will not be able 
to borrow so much. They will then not be able to force bailouts 
and they will not gain their leverage over the official sector 
by holding them hostage through large loans by the IMF, the 
World Bank, and the IADB.
    Senator Hagel. But you note in your testimony not only the 
Argentine issue, but you also mention 1995 in Mexico, Lawrence 
Summers, then-U.S. Treasury Under Secretary, gave life to a 
financial anomaly, an asset with a high rate of return and with 
an unwritten AAA guarantee from G-7 governments. And then you 
went on, actually, prior to the Mexican 1995 issue, it was the 
bailout policies of the Clinton Administration in the 1990's. 
So it is not just Argentina.
    Mr. Lerrick. No, it is not just Argentina. It was the 
policy regarding developing countries.
    Senator Hagel. It is a course of actions taken in events 
that----
    Mr. Lerrick. Absolutely. But Argentina is the most 
egregious example.
    Senator Hagel. Then what are the options?
    Mr. Lerrick. The options are to let the markets function.
    Senator Hagel. So you would just let Mexico go down, 
Argentina go down----
    Mr. Lerrick. No. No, each case is----
    Senator Hagel. Structural changes in the IMF?
    Mr. Lerrick. No, each case is different--each situation 
must be evaluated separately. It is very clear that Argentina 
was clearly insolvent. There is no role for a lender of last 
resort in stabilizing an insolvent borrower. There is a role 
for a lender of last resort in providing liquidity to a 
borrower that is solvent but at the moment does not have the 
resources to pay its obligations. In the case of an insolvent 
borrower, where--and again, intervention should only take place 
when there is concern for the stability of the entire 
international system--it does not matter what will happen to 
any individual country. And so therefore, if you have a case 
like Argentina, where the center of the crisis, Argentina, is 
clearly insolvent, the intervention from the IMF should not be 
to lend to Argentina. The intervention from the IMF should be 
to announce that, for any other economy affected by the crisis, 
that is potentially a victim of contagion, the IMF will lend 
freely. But they will not lend to the insolvent center of the 
crisis.
    This has been followed in the United States. There is the 
example Drexel Burnham. When Drexel Burnham was insolvent, the 
Federal Reserve did not lend to Drexel Burnham to forestall the 
insolvency. The Federal Reserve announced to the entire 
financial system that anyone else who suffered from the 
insolvency of Drexel Burnham could come to the Federal Reserve 
and obtain liquid resources immediately. And that is what 
should have happened in the case of Argentina.
    Senator Hagel. Mr. Mussa.
    Mr. Mussa. Well, I also agree the IMF--I might say, 
particularly the IMF Pension Fund--should not be abolished. I 
disagree with a fair bit of what Adam said, both in his 
prepared remarks and just now. But I wanted to focus on the 
announced topic of the hearing.
    Senator Hagel. I appreciate that, but I would also be 
interested in your response to Professor Lerrick's comments to 
my question.
    Mr. Mussa. Indeed.
    Senator Hagel. Thank you.
    Mr. Mussa. The IMF has the established function of an 
official lender of final resort. I am not going to go through 
the definition of this topic. There is a long Princeton essay 
by Stan Fischer on this subject. But let me read from the 
Articles of Agreement the purposes of the IMF as originally 
stated and still prevailing. This is with regard to Purpose 5, 
which relates to the financing function.

    To give confidence to members by making the general 
resources of the Fund temporarily available to them under 
adequate safeguards, thus providing them with the opportunity 
to correct maladjustments in their balance of payments without 
resorting to measures destructive of national or international 
prosperity.

    It was clearly envisioned that the IMF had general 
resources and it was going to lend them temporarily, under 
adequate safeguards, in order to enable countries to adjust to 
balance-of-payments problems without resorting to unproductive 
measures. That has always been understood to be a central 
function of the Fund.
    One of the important elements ``under adequate safeguards'' 
is that the Fund is supposed to have confidence that it will be 
repaid when it lends money to a country. And as Adam suggests, 
if you are lending money to a government that is insolvent 
already, that raises certain, quite legitimate concerns.
    So, I agree there is a difference between lending to a 
country that has a liquidity problem, which I think was Mexico 
in 1995, and lending to a country that clearly has a solvency 
problem, I would also agree by the summer of 2001, when the 
last $6.5 billion was disbursed by the IMF to Argentina, there 
was no reasonable doubt that Argentina had a solvency problem. 
Very careful thought is required about under what circumstances 
the IMF should be prepared to do that.
    My own view is that once a country reaches the point where 
it is pretty clearly insolvent, the IMF should not lend 
additional money except on the condition that the country 
declare that it needs to do a sovereign debt restructuring. 
That is the way the debt crisis of the 1980's was handled. The 
banks were forced to agree to a rollover of their credits 
before the IMF disbursed. That was done in Ecuador more 
recently and in a number of other cases. And I think that is 
the right approach when you are dealing with a country that is 
insolvent.
    Now, with regard to the AAA guarantee, well, Fannie Mae and 
Freddie Mac are perceived to have AAA guarantees from the 
United States, and their obligations trade at 50 to 75 basis 
points over U.S. Treasuries, partly because they are not exempt 
from State income taxes--we could go into all the reasons, but 
the spread is only 50 to 75 basis points. Emerging market 
sovereign debt in the decade of the 1990's, on average, traded 
at 600 basis points over U.S. Treasuries. If there was an 
implicit AAA guarantee, the market did not seem to recognize 
it.
    I do not dispute that there is some modest amount of moral 
hazard associated with potential IMF lending. But the notion 
that it is of this enormous magnitude of a AAA guarantee just 
does not correspond to the facts in the market or, indeed, what 
holders of sovereign debt have learned not only from the 
Argentine collapse and the Russian collapse, but from the 
Uruguay restructuring, from the Ecuador restructuring, from the 
Ukraine restructuring, and on down the road.
    So, I think there is an issue of moral hazard. It does need 
to be carefully contained. Adequate safeguards through IMF 
funding are important. And careful attention to how IMF 
lending, or not lending, affects the private sector and its 
credit decisions is merited. But we should not exaggerate the 
nature of this problem if we are going to find a rational way 
forward.
    Senator Hagel. Thank you. Let me ask you each--you, I 
believe, heard the question that Senator Bayh put to Secretary 
Quarles regarding the IMF loans to Argentina. And Senator Bayh 
said, Do you believe, Mr. Secretary, those loans will be repaid 
or just rolled over--I think is basically what he said. And if 
I recall, Secretary Quarles said they will be repaid, they will 
not be rolled over.
    I would be interested in a reaction from each of you on 
Secretary Quarles's response.
    Mr. Lerrick. First, Mr. Chairman, I think Argentina has 
given very good evidence of its intention regarding repayment 
of its IMF loans. In September 2003, Argentina signed an 
agreement with the IMF that stated it would repay all its loans 
from 2007 through 2009. And that is the agreement it literally 
signed. Ten days later, Argentina unilaterally announced that 
it would not repay any of those loans until after 2014. That is 
in their written documentation, right on the website of the 
Ministry of Economy.
    Do I believe Argentina will eventually repay those loans? 
Probably. Will they be repaid according to their scheduled 
dates, which are contractual obligations? Absolutely not.
    Mr. Mussa. I basically agree with Adam on that issue. I 
would note, however, that Argentina is paying the interest on 
its IMF loans and on its other IFI loans. So it is the 
principal that is being rolled. But that is not something that 
is supposed to be done under the rules of the IMF. That is one 
of the reasons why I would have favored a special facility to 
set Argentina aside and say that this is not a normal practice; 
they are only very special circumstances. And for Argentina, I 
do not know that I would have gone to 2014. I think that issue 
should be addressed year-by-year or every 2 or 3 years rather 
than implicitly agreeing to a decade of rollovers. I think that 
that is not sound policy.
    Senator Hagel. Thank you. I would be interested in each of 
your thoughts on this. What are the longer-term consequences, 
implications for cost of capital for other emerging nations? 
Obviously, there will be consequences, and there are 
consequences developing, evolving not just with the IMF, but 
certainly within the private capital structure, and not just 
limited to American banks. But for emerging Nations, what are 
the consequences?
    Mr. Lerrick. I think it depend to a very large extent on 
how the Argentine debt restructuring is resolved. If Argentina 
even remotely succeeds in obtaining the 90 percent-plus debt 
reduction it is demanding, how can any other leader of a 
developing country say that his people we must make huge 
efforts to pay the foreigners? It will just be politically 
impossible domestically. If, on the other hand, Argentina, 
after many contortions and delays, is convinced to enter into a 
fair and sustainable restructuring of its debt, which will 
require payments significantly above the terms that it has 
proposed, then the market will learn something. The market will 
learn that these problems do get resolved.
    I disagree with Secretary Quarles's statement that the 
Argentine restructuring is a very complicated process. 
Certainly, yes, there are more than 100 bond issues as opposed 
to five bond issues. But we all have Excel spreadsheets. The 
number of bond issues and currencies, does not make much of a 
difference. The main part of the negotiation of the debt 
restructuring has nothing to do with the terms of the new 
bonds. The real negotiation is over what quantity of resources 
the Argentine Government is willing to devote to repay the 
bondholders. Once you determine the amount of resources the 
government will pay the bondholders, establishing the values 
and conditions of the individual bonds in the restructuring may 
take 2 to 3 hours. In an afternoon it can be done. That is not 
the issue. The real negotiation is what quantity of resources 
will be set aside to repay the bondholders.
    Senator Hagel. Thank you.
    Mr. Mussa.
    Mr. Mussa. I am not as sanguine on solving the problem of 
the distribution among the bondholders. My guess is that the 
Argentine debt restructuring is going to take 15 years, like 
the Penn Central bankruptcy did, to ultimately resolve.
    Also, I would like to believe Adam that the market is going 
to learn something important from Argentina and is going to put 
that lesson to work. And that may well be the case. No doubt, 
some lessons have been learned. But the fact of the matter is 
that interest rate spreads for emerging market borrowers--
leaving Argentina aside--have been headed very sharply downward 
over the last year and a half. They have not yet quite gotten 
to the lows of the spring and summer of 1997, when you could 
sell virtually anything, but the market really has been picking 
up, spreads have been coming down, values have been going up, 
and the volume of new lending, while, again, not at the peak of 
the spring and early summer of 1997, is also picking up.
    Notwithstanding developments in Argentina, and Argentine 
bonds in the secondary market are selling at 25 cents on the 
dollar, which anticipates that there will be an improvement in 
the Argentine offer--but still it will be a pretty aggressive 
haircut. Nevertheless, emerging market spreads much more 
generally are down considerably. This is consistent with the 
fact that we have very low interest rates in virtually all of 
the industrial countries monetary policy making liquidity 
easily available. The global economy is picking up; and we are 
beginning to have a real party.
    The hangover will come, however I think probably not until 
2005 or, more likely, 2006. But the lessons that Argentina 
might teach seem to be a bit blurred by the alcoholic 
environment.
    Senator Hagel. Thank you.
    Mr. Lerrick. Mr. Chairman.
    Senator Hagel. Professor.
    Mr. Lerrick. A very quick comment. Markets are messy. 
Markets do not go to clean and clear solutions in a straight 
line. I agree with Michael that maybe at this level the 
emerging debt market is what we call overdone, that the spreads 
are too tight, do not adequately reflect the risks involved. 
But, there has been one large default. Investors will have 
large losses in the case of Argentina. Well, there will be 
another one in the future. These are high-risk borrowers. The 
market will slowly learn, by experience, what the correct risk 
premiums are, but, it is not going to be a very clean and 
simple solution.
    Senator Hagel. Thank you.
    Mr. Mussa, I noted as I was going through your written 
statement, you suggest that the Argentine Government engaged in 
Enron-like accounting, which included substantial debt issuance 
in 2002 that was outside the government budget. This had the 
effect of masking the true extent of the public sector's cash 
deficit. In your opinion, is this situation anywhere near being 
adjusted for, handled, or rectified by the government?
    Mr. Mussa. Let me say first Argentina is by no means unique 
among national governments in this practice.
    Senator Hagel. Well, we are dealing with that right now on 
the floor of the Senate.
    Mr. Mussa. Yes, indeed. So it is a more general problem. 
The amount of that activity that occurred in Argentina in 2002 
was particularly large, amounting to 12 or 13 percent of GDP. 
So there was a lot off-balance-sheet borrowing, dealing with 
recapitalizing some of the banks, and other issues of that kind 
which was simply done off-budget.
    I think a key worry going forward for Argentina, and Adam 
referred to this as well, is the resources that Argentina is 
prepared to devote to debt repayment, both for the debt now in 
default but also for the domestic debt. We tend to focus on the 
primary surplus--that is the budget position of the government 
excluding 
interest payments. Then, if you can run a primary surplus of 4 
percent of GDP, that surplus is available to pay interest. But 
if, off the books, you are borrowing 5 or 6 percent of GDP, 
then you are really fooling yourself that those resources are 
available to make payments to creditors. And Argentina--and it 
is not just Argentina, but Argentina is, should we say, 
particularly successful in this dubious activity--has a long 
history of doing a lot of off-budget borrowing, where the debt 
grows much more rapidly than the budget deficit would normally 
suggest.
    Secretary Quarles referred to one of the key reasons for 
this, which is the relations between the central government and 
the provinces, where the provinces borrow and the central 
government ultimately has to step in and pay for it. That is 
when the stuff hits the books, when it has to be dealt with at 
the central government level. And there have been a number of 
episodes of Argentine history where that has come to the fore, 
as it did again in 2002.
    But what is the assurance that it will not happen again in, 
say, 2008 or 2012? One of the problems with the Argentine 
offer, among its many deficiencies, is that there is virtually 
nothing that is promised to be paid to creditors in the next 6, 
7, or 8 years. It is almost all what is going to be paid after 
2015. And looking at the economic and financial history of 
Argentina and their budget practices, private creditors, 
rightly, do not have a great deal of confidence in those 
promises.
    Senator Hagel. Thank you. Professor Lerrick, would you like 
to respond to that?
    Mr. Lerrick. No, I think Michael raised many of the key 
issues. One of the points that has been raised--which Secretary 
Quarles raised two or three times--was the goal of achieving a 
large participation of bondholders in the debt restructuring. 
That would be a measure of the effort made by Argentina. How 
many investors thought it was a fair offer, in essence.
    First, let me say it is in no one's interest, not 
Argentina's, not the bondholders, and not the IMF, that we 
should be back doing this again in 3 or 4 years. No one wants 
Argentina to promise to pay more than it is be able to pay. 
This is a difficult process; it is a painful process for 
everyone.
    But the issue, then, is, when we talk about the 
participation rate, one must remember that, of Argentina's 
debt, approximately 25 percent of the bonds is under the 
control of the government because they are controlled by 
Argentine domestic institutions that are subject to government 
influence and government regulation.
    Second, in the last debt exchange the government executed 
in November 2001, domestic institutions exchanged their bonds 
for guaranteed loans. But normally in that practice, the bonds 
are cancelled and therefore their voting rights are cancelled 
along with the bonds. The Argentine Government has not 
cancelled these bonds. It has retained these bonds and seems to 
have every intention of execirsing the voting rights in order 
to force the other, legitimate bondholders to accept the 
restructuring terms.
    This will be most likely decided in a New York court, 
because the bonds are issued under New York law. There were 
many issues where the original amount was, let us say, $4 
billion; $3 billion was exchanged. There is $1 billion still in 
the hands of legitimate bondholders, and the government has 
control of the voting rights, or it thinks it has control of 
the voting rights on the $3 billion that should have been 
cancelled. The threshold to pass amendments to many of the 
bonds is two-thirds.
    The government feels that it can then vote its 75 percent 
holding and force amendments on the remaining legitimate 
bondholders that reduce the value of their bonds, which will 
then induce them to accept a low offer. That will be something 
that will be tested in the New York courts, though.
    So to achieve a 40 percent participation rate, which the 
Argentine Government has said should be deemed a success, is 
not very hard if you control 25 percent of the bonds and you 
control the voting rights on another 15 percent. Therefore that 
should not be a benchmark of success.
    Senator Hagel. Thank you. Last question. You heard some of 
the questions I asked Secretary Quarles regarding 
recapitalizing the Argentine banking system. And you heard his 
responses. I would very much value each of your thoughts on the 
Argentine banking system's ability, given the facts as they 
are, to recapitalize, restructure, and be a vital financial 
services dynamic in the country once again.
    Mr. Lerrick. First, Mr. Chairman, as background, Argentina 
had one of the strongest financial systems in the developing 
world up until approximately 1998, 1999. The Government of 
Argentina, in order to forestall its own insolvency, pursued a 
deliberate policy which bankrupted its financial system. It 
forced all its banks to purchase government bonds, in order to 
keep the government afloat. So the situation in the Argentine 
financial system is the result of the deliberate policy of the 
previous government.
    There is no question that the Argentine financial system 
can restore its own stability. Most of the large banks are 
owned by major international banks--Hong Kong Shanghai Bank, 
Santander, BBVA, have a very large presence in Argentina.
    The parents of these banks certainly have the capital to 
restore the solvency of their subsidiaries. The question 
arises, why would the parent invest additional funds to restore 
the solvency? The only reason it will is if it views Argentina 
as an attractive place to invest its capital. Until that takes 
place, there is no reason, there is no justification for 
Citibank or Hong Kong Shanghai Bank or one of the leading 
Spanish banks to send capital into Argentina to restore the 
stability of their subsidiaries.
    Until the government resolves its problems and creates an 
environment that is attractive for investment, there is no 
reason that the owners of these banks will recapitalize them. 
And this holds true for all foreign investment in Argentina. 
Argentina has very attractive investment opportunities that are 
being negated by the regulatory and economic policies that 
prevail in the country.
    Senator Hagel. Do you see that changing, those regulatory 
policies that negate?
    Mr. Lerrick. My view is that it is not the IMF that is 
going to induce reform or progress in Argentina. What is going 
to induce reform and progress is when the economy of Argentina 
starts to slow. At this moment, the economy is growing at more 
than 6 percent per annum and the government is not paying its 
debts. From the government's standpoint, life does not get any 
better than that. Let us be very clear. However, that is not a 
sustainable situation. Within a year, the economy will probably 
start to slow. And when it slows, that is when there will need 
to be a restructuring of the debt, not because the government 
will need financing, but because the private sector will. Until 
the government restructures its debt, the private sector of 
Argentina, which will be the engine of growth, will not obtain 
access to foreign capital on attractive terms.
    Senator Hagel. Thank you.
    Mr. Mussa.
    Mr. Mussa. I have a slightly different view, also with 
Secretary Quarles. The Argentine economy has been recovering 
quite rapidly. There is a lot of investment going on. That 
investment is being financed by mattress capital, by the 
capital of export firms derive from selling agricultural 
products on world market at, to them, very attractive prices 
because soybeans are up in dollars and the peso is down in 
dollars. So there is a lot of activity.
    The economy is still depressed relative to where it was 5 
years ago. What is not happening is we do not have a credit 
intermediation system, particularly not a credit intermediation 
system run by the banks. Because what happened in Argentina was 
basically the government and courts said if you have debts, you 
do not have to pay. Well, when you declare that, then creditors 
cannot collect, and if banks cannot collect on their loans, 
then they do not make them. That problem is going to be with 
Argentina for a very long time given the history of abrogating 
contracts and changing laws. You do not change attitudes on 
that subject very rapidly. I think there will be long-term 
impairment of the banking system and financial sector as a 
credit intermediary, particularly for longer-term loans. But 
other means of finance, where the financiers have more direct 
interest and control over the enterprise, that goes on.
    Now, recapitalization of banks, I agree with Adam. What 
happened is the banks were made insolvent because of decisions 
by the government--stuffing them with debt, which the 
government then wrote down. Also, the convertability plan, 
which linked the dollar at one-to-one to the peso was abolished 
by the government. Banks had a lot of dollar-denominated and 
peso-denominated loans, they treated them interchangeably, then 
the peso depreciates and all the people who had dollar-
denominated loans from banks say we are not paying, so the 
value of those loans largely evaporated. But the Argentine 
Government did not allow banks to comparably write down the 
value of their deposit liabilities. So the asset side of the 
banks' balance sheet was substantially reduced, the liability 
side was not reduced, and there was an enormous hole in the 
balance sheet.
    Now, that was papered over by phony accounting for some of 
the bank assets. But you cannot paper it over forever, as we 
learned in the savings and loan crisis in the United States. So 
what has to happen to recapitalize the banks is either the 
owners, whose equity capital has already been robbed two or 
three times over, need to put new equity capital in, or the 
government needs to stuff capital in the banks in the form of 
new government bonds.
    That is an important part of what has been happening in 
terms of this off-budget borrowing. To keep the banks afloat so 
that they could pay depositors, the government printed new debt 
which it stuffed in the banks in order to recapitalize them. 
And it needs to do more of that if it is going to bring the 
banks up to full economic capitalization, to a level where 
their owners might be prepared to put in the marginal amount of 
capital.
    But there is a difficulty for Adam and his fellow creditors 
when the government prints the debt to recapitalize the banks. 
Why does that debt have value? Because it drives down the value 
of other debt. So the challenge of bank recapitalization is a 
fiscal challenge and is one of the factors that complicates the 
problem of the debt restructuring. The more the government has 
to spend on bank restructuring, the less is available to spend 
on other things, including paying off the previously existing 
debt.
    And the problem is not just with the private banks. In 
Argentina, we have two very large State-owned banks--one owned 
by the federal government and one owned by the Province of 
Argentina. Those two state-owned banks have been the source of 
enormous 
fiscal mischief over the history of Argentina. And the 
potential for additional expense in recapitalizing them, not 
only for what has happened in the past, but also for what might 
happen in the future, remains a continuing threat to fiscal 
probity in Argentina and its capacity to service its 
obligations.
    Senator Hagel. Gentlemen, you have each been very helpful 
and the Committee appreciates your time and the thought that 
you put into the presentations. And I particularly appreciated 
your willingness to engage the questions, which were of immense 
help. Thank you.
    The hearing is adjourned.
    [Whereupon, at 3:30 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

                 PREPARED STATEMENT BY ROGER F. NORIEGA
           Assistant Secretary for Western Hemispere Affairs
                        U.S. Department of State
                             March 10, 2004

    Mr. Chairman and Members of the Committee, thank you for the 
opportunity to appear today to discuss Argentina's current economic and 
political situation and the status of our bilateral relationship. I 
especially appreciate the chance to offer my views in the company of my 
Treasury colleague, Assistant Secretary for International Affairs Randy 
Quarles, and the other distinguished persons who will testify before 
you. Their presence here, and your interest in holding this hearing, 
attest to the importance of Argentina in this hemisphere and the world.
    Argentina, a close and valued ally of the United States, has been 
through much over the last several years. We are pleased that it has 
now begun its economic and social recovery. Mr. Quarles and others will 
certainly highlight the economic and financial background and the 
latest status of the IMF negotiations. I simply want to add that the 
Bush Administration is united in wanting to see Argentina succeed over 
both the short and long-term, and believes it can do so by fully 
complying with the program it negotiated with the IMF.
    Since assuming the presidency in May 2003, President Kirchner has 
sought--in his own words--to make Argentina a more predictable nation, 
one whose word can be relied upon. He also has sought to root out 
corruption, restart the Argentine economy and refurbish Argentina's 
stature in the world.
    We believe he has made an impressive start on these daunting 
challenges, aided by the talented Argentine people, who strongly 
support him. Congressional and provincial elections last year also 
showed strong support for the new government. As a result of this 
voting, President Kirchner's party has a majority in both houses of 
congress, holds 16 of the country's 24 governorships, and is now well-
positioned to seek the reforms critical to Argentina's future progress. 
These reforms include revising the system of revenue sharing between 
the federal and provincial governments, and finalization of 
compensation to the banking sector for losses associated with 
government actions during the 2002 crisis.
    Bilaterally, President Kirchner and his government have maintained 
a policy of close contact with the United States. President Kirchner 
has met twice with President Bush since taking office in the Oval 
Office in July 2003 and in Monterrey at the Special Summit of the 
Americas in January 2004. At both meetings, President Bush underscored 
that we want Argentina to succeed, but that it also needed to help 
itself.
    This Administration regularly discusses economic issues with the 
Argentine Government at the highest levels. In these discussions, we 
also raise commercial and business process issues that U.S. firms have 
experienced and relayed to us. Neither we nor the Government of 
Argentina, however, have lost sight of the other ties that link us--
including those in the political, trade, cultural, scientific, 
educational, and social areas.
    Our deep and broad relationship permits us to address cooperatively 
a range of issues. One specific area of continued engagement is 
counterterrorism. Argentina suffered devastating terrorist attacks in 
1992 and 1994, and our shared experience with terrorist attacks on our 
home soil creates a special bond between our countries. The U.S. works 
closely with Argentina, Brazil, and Paraguay through the 3 + 1 regional 
cooperation mechanism to fight terrorism, money laundering, and drug 
and arms trafficking in the Tri-Border Area. We also cooperate closely 
in the non-proliferation and scientific spheres, to cite other areas.
    I also want to highlight Argentina's important role in seeking to 
advance the cause of democracy, peace, and stability in this hemisphere 
and elsewhere. Argentina has peacekeeping forces serving in five UN 
Missions from Cyprus to Kosovo to the Congo. Argentina has been 
supportive of efforts to address the crisis in Haiti, and it is 
considering participation in the multinational effort there. Argentina 
has continued its deployments, and is considering a role in Haiti, 
despite its very real economic and financial constraints. Argentine 
diplomacy has also been active on challenging regional issues including 
Bolivia and Venezuela. In Caracas recently, President Kirchner met with 
democratic opposition leaders. On Bolivia, Argentina has supported the 
Mesa Government and just signed a $1 billion natural pipeline agreement 
that eventually could lead to Bolivia earning up to $500 million per 
year through exports.
    Prior to closing, permit me to discuss in more detail our 
political-level contacts with the Argentine Government on its financial 
problems. Our open, frank, and continuous discussions with Argentina on 
financial and business matters have occurred at all levels and involved 
several executive branch agencies. The Administration also appreciates 
the role of a number of Members of Congress who have spoken to 
Argentine officials, in Washington and on trips to Buenos Aires, on the 
need for Argentina to both grow and set its financial house in order--
two mutually reinforcing goals.
    These current activities continue our positive engagement with 
Argentina over the last several years on economic issues. In August 
2001, recognizing the key issue of debt sustainability, we made clear 
our preference that part of a funding package be dedicated to support 
voluntary debt restructuring. In the crisis of December 2001, President 
Bush made a prompt offer of technical assistance. We continued our 
policy of engagement once President Kirchner took office. When 
Argentina and the IMF reached an impasse last September over the shape 
of a new IMF program, we worked constructively--and ultimately 
successfully--with all parties to advance an accord.
    Now, as throughout this difficult period, we see our role as 
working cooperatively with Argentina, the IMF, and our G-7 partners 
toward achieving a sustainable economic recovery to benefit the 
Argentine people and contribute to stability and growth in the region. 
We can and will be helpful, but ultimately the shape of the IMF 
program, and Argentina's performance under it, are in the hands of the 
Argentine Government and the Fund.
    In cooperation with the IMF and our G-7 partners, we also have 
worked to limit the regional fallout of the Argentine economic 
situation, most notably in Argentina's close neighbor, Uruguay. To help 
shield the Uruguayan economy, and to also put it on a sustainable 
growth path, the IMF reached a pact with that nation in 2002. We 
assisted in this effort and the United States granted Uruguay a $1.5 
billion bridge loan until the Fund package was approved. This loan, 
that allowed banks in Uruguay to reopen, was paid back, with interest, 
in 7 days.
    As friends, the United States and Argentina can and do speak openly 
and frankly to one another, while sharing common goals for the 
hemisphere. The United States also shares Argentina's conviction that 
it can reverse its severe collapse of the last few years and return to 
the prosperity it once enjoyed. We will support Argentina's efforts and 
through them strengthen all our shared goals for our countries and our 
hemisphere.

                               ----------
                PREPARED STATEMENT OF RANDAL K. QUARLES
             Assistant Secretary for International Affairs
                    U.S. Department of the Treasury
                             March 10, 2004

    Chairman Hagel, Ranking Member Bayh, and other Members of the 
Committee, thank you for inviting me to discuss the Administration's 
economic and financial policy toward Argentina, particularly the United 
States' stance with regard to Argentina's engagement with the 
International Monetary Fund since 2002.

Economic Context
    Let me begin by reviewing the historical context for our 
engagement. Argentina had made impressive strides in the early 1990's 
in ending hyper-inflation and introducing important structural reforms 
in its economy. However, excessive budget deficits during the 1990's, 
driven in large measure by fiscal arrangements that required the 
central government to fund spending decisions by the various provinces 
unhindered by effective central budget constraints, led to the build-up 
of a large debt burden that the government could no longer service by 
the end of 2001. Faced with an increasingly desperate situation, the 
government defaulted on its debt and abandoned the peso's peg to the 
U.S. dollar. The economic crisis was accompanied by political 
instability that eventually led to a new interim government led by 
President Eduardo Duhalde.
    In the wake of the default and devaluation, real GDP fell 11 
percent in 2002. Inflation rose to over 40 percent, the peso 
depreciated 69 percent, and unemployment rose to 24 percent. Seeking to 
avoid a complete collapse of the banking system, the government imposed 
far-reaching deposit controls. Other government actions, in particular 
the forced conversion of dollar-denominated financial contracts into 
pesos, further weakened the banking system. On the monetary side, the 
authorities struggled to contend with multiple ``quasi-currencies''--
representing an astonishing 50 percent of currency in circulation--that 
had been issued during the crisis to finance spending by the provinces 
in the face of collapsing revenues.

Transitional IMF Program
    The U.S. Government worked with the Duhalde Administration and the 
IMF throughout 2002 in an attempt to develop a new IMF program and a 
set of policies that would stabilize the economic situation. 
Argentina's authorities took an extended period of time to develop such 
a program, in part because of the unsettled political situation.
    Argentina launched an 8-month ``transitional'' IMF program in 
January 2003, which the United States strongly supported. The purpose 
of the transitional program was to stabilize the Argentine economy. The 
program's 8-month length was long enough to last through the 
Presidential elections in May and give the incoming government time to 
develop its policy priorities. The focus of the transitional program 
was on macroeconomic stabilization, with the expectation that the new 
administration would have the political mandate for pursuing the more 
difficult reforms needed to lay the basis for sustained economic growth 
and for beginning to address its debt default.
    To be sure, there were risks associated with launching the 
transitional program. Many questioned Argentina's commitment to 
implementing the macroeconomic policies needed to restore stability. 
The presence of large-scale deposit controls created a great deal of 
uncertainty as to the potential inflationary consequences of the 
monetary program. But the United States strongly backed the 
transitional program as the most effective way of putting Argentina 
solidly on the path of economic recovery.
    This judgment proved correct. Argentina performed well under the 
transitional program, meeting its IMF fiscal and monetary targets by 
wide margins. The central government signed bilateral agreements with 
the provinces that set clear limits on the provincial deficits in 2003. 
The government launched a program to retire the quasi-currencies, 
critical to ensuring that the federal government and the provinces live 
within their means. The retirement of the quasi-currencies is now 
complete. And, in the context of improved macroeconomic policies, the 
government was able to lift the freeze on bank deposits without the 
inflationary surge or collapse in deposits that many had feared.
    The transitional program helped boost confidence in the economy. 
This confidence underpinned the acceleration of economic growth in 
early 2003. Real GDP for the year as a whole grew an impressive 8 
percent. Unemployment fell to 16 percent by the end of the year, and 
inflation fell to under 4 percent. During the same period, the peso 
appreciated 15 percent and foreign exchange reserves increased by $3.5 
billion. In short, the transitional program fulfilled its objectives.

Argentina's 3-Year Program
    As the Kirchner Administration came into office, it faced the dual 
challenges of consolidating the achievements of the transitional 
program and of undertaking the actions needed to lay the basis for 
sustained economic growth in the years ahead. The latter meant both 
adopting reforms to deal with the root causes of the Argentine 
financial crisis and taking steps to address the new problems created 
by the crisis, including resolution of Argentina's defaulted debt.
    Argentina's 3-year program launched in September 2003 was designed 
around these objectives.
    The fiscal and monetary framework of the program, as well as the 
institutionalization of central bank independence and gradual shift to 
inflation targeting, is designed to entrench macroeconomic stability in 
order to keep the current recovery going.
    Fiscal problems were at the core of Argentina's financial crisis. A 
poor system of inter-governmental fiscal relations encouraged excessive 
spending by Argentina's provinces. As spending increased faster than 
government tax revenues, deficits were financed by heavy borrowing and 
printing the so-called quasi-currencies. The 3-year program not only 
mandates strict limits on provincial deficits and borrowing, but also 
provides for a comprehensive reform of the federal-provincial fiscal 
framework to prevent the problems that led to the crisis from 
recurring. Since widespread tax evasion and low tax collections have 
been chronic problems in Argentina, the program includes new measures 
to strengthen tax administration and fight illegal tax evasion. The 
program also aims to phase out distortive taxes that were introduced 
during the crisis--such as the financial transactions tax--and replace 
them with a tax regime more conducive to economic growth.
    The crisis, and government actions during the crisis, seriously 
damaged Argentina's banking system. As a result, lending by banks to 
the private sector plunged. Restarting bank lending to the private 
sector is essential for increasing business investment and spurring 
economic growth. Argentina's program establishes a framework for 
restoring health to the banking system by providing compensation from 
the government to address balance sheet damage done by the previous 
government, clarifying the regulatory environment, establishing capital 
standards designed to facilitate the strengthening of bank balance 
sheets over time, and requiring banks to develop business plans for 
achieving specified capital requirements. It also includes measures to 
assess and address the special issues related to the role of public 
banks in the Argentine banking system.
    Another key area affected by the crisis was the utilities sector. 
Under its program, Argentina has undertaken to work with the World Bank 
to resolve the problems in the utilities sector, including ending the 
price freeze and redesigning a tariff structure, reestablishing a 
coherent regulatory framework, and renegotiating concession contracts. 
Utility tariffs had been frozen since February 2002 despite the falling 
peso and rising inflation, creating large losses for the utility 
companies. Ending the price freeze and taking the other actions needed 
to create a stable regulatory framework are essential for encouraging 
investment in this key sector to support Argentina's needs for the 
future.
    Finally, a key objective of the program is to facilitate the 
successful resolution of Argentina's defaulted debt. Argentina has $100 
billion in private sector claims outstanding. Its debt restructuring is 
the most complex in emerging markets history. This is not only because 
of its size, but also because of the number of different currencies and 
legal jurisdictions in which the debt was issued, as well as the number 
of different types of bondholders involved, including sizeable holdings 
by retail investors in Italy, Japan, and Germany.
    The program provides the broad policy framework to underpin a debt 
restructuring agreement between Argentina and its creditors. The 
program requires Argentina to work in good faith with its creditors to 
reach a collaborative agreement that restores debt sustainability. The 
fiscal targets of the IMF program beyond 2004 were specifically left 
undefined above a certain 3 percent floor, precisely to give Argentina 
and its creditors room to negotiate over the terms of the debt 
restructuring. It is the responsibility of Argentina to work with its 
creditors to achieve a debt restructuring deal that will define the 
increase in the primary surplus above 3 percent that is needed to cover 
debt service on performing and restructured debt.
    IMF lending policies require transparent and constructive 
negotiations by Argentina with its private creditors to secure the 
broad creditor support in a debt restructuring needed to achieve a 
sustainable debt situation and facilitate Argentina's 
progressive reintegration into international capital markets. Argentina 
will need substantial investment to generate economic growth over the 
long-term.

Argentina's Performance under the 3-Year Program
    Argentina has continued to perform well on its fiscal and monetary 
policies under the 3-year program, extending the gains it made under 
the transitional program. The government's budget performance to date 
has exceeded the program targets by a significant margin demonstrating 
that with a determined effort Argentina can indeed collect taxes. There 
has also been important progress in strengthening the institutional and 
legal framework for tax administration. In the area of inter-
governmental finances, the central government has concluded agreements 
with the provincial governments limiting provincial spending and 
borrowing, consistent with the requirements of the program. Work on the 
more far-reaching reforms of the system of inter-governmental fiscal 
relations is also moving forward.
    Progress in other structural areas of the program up to now has 
been less satisfactory. Although the government has implemented new 
regulatory standards for the banking system, there have been delays in 
finalizing the agreed compensation to banks for the actions taken by 
the government during the crisis. Bank lending remains extremely 
depressed. Argentina's progress with the World Bank on reform of the 
utilities sector has also been slow, though the Argentine Government 
did recently agree to raise tariffs on electricity and gas for the 
first time since the crisis.
    It continues to be essential for Argentina to make progress on debt 
restructuring with private creditors. The government's announcement 
that it has made arrangements for the hiring of investment banking 
advisors to handle its debt exchange is a step forward. In addition, we 
expect to see over the upcoming weeks Argentina take the concrete steps 
necessary to negotiate with representative creditor groups on the terms 
of its restructured debt. The negotiation process needs to build mutual 
trust and allow creditors real input into the design of the offer. This 
is the surest way for Argentina to achieve the broad creditor support 
needed for a comprehensive and sustainable debt restructuring.

Conclusion
    We want Argentina to succeed: To succeed in stabilizing its economy 
in the wake of crisis, succeed in resolving its defaulted debt, and to 
succeed in laying the basis for long-term economic growth.
    The United States has been a forceful advocate for IMF engagement 
with Argentina in pursuit of these ends. Argentina has made important 
progress during the last year. The current IMF program provides a 
framework for Argentina to raise the living standards of its people and 
move beyond the past to a prosperous future. Consistent implementation 
of this program is the key to success in these areas, and we are 
continuing to work with Argentina and with the IMF to encourage this 
implementation.
                               ----------
                  PREPARED STATEMENT OF MICHAEL MUSSA
          Senior Fellow, Institute of International Economics
                             March 10, 2004

    Mr. Chairman and Members of the Subcommittee, it is a pleasure to 
respond to your request for an assessment of recent developments and 
key issues in the Argentine financial crisis, with particular reference 
to the economic and financial dimensions of United States policy toward 
Argentina and to United States positions with regard to Argentina's 
engagement with the International Monetary Fund since 2002.
    At the outset, it should be emphasized that I am an informed but 
outside observer of the developments and issues that are the main 
subject of this hearing. In July 2002, the Institute of International 
Economics published my study, Argentina and the Fund: From Triumph to 
Tragedy (IIE Policy Analyses in International Economics Num. 67), which 
examined the developments leading up to those that are our central 
focus today. Subsequently, I have maintained a close watch on events in 
Argentina, especially as they relate to its relations with the IMF. 
But, my knowledge of developments in Argentina (since I left the staff 
of the IMF in September 2001) is mainly based on publicly available 
information and does not include detailed knowledge of great deal of 
internal, confidential, and private information that would probably be 
helpful to a complete understanding of the issues before us. 
Nevertheless, I believe that a great deal can usefully be said on the 
basis of publicly available information, including extensive 
documentation that has been made available by and through the IMF.
    As a basis for assessing developments of the past 14 months and key 
current issues, it is essential to recall the desperate situation of 
Argentina in 2002 and (briefly) the conditions that led up to this 
catastrophe during the preceding decade.
    From 1990 through mid-1998, the Argentine economy enjoyed 
spectacularly good performance, with real GDP rising nearly 40 percent 
and hyperinflation giving way to virtual price stability. The 
Convertibility Plan (which pegged the Argentine peso at one-to-one with 
the U.S. dollar) played a central role in these accomplishments; and 
other important reforms (including trade liberalization, privatisation 
of many public enterprises, and financial sector reform) contributed to 
prosperity. Unfortunately, the Argentine Government (including the 
provinces) did not take advantage of these good times to put the public 
finances on a sound footing. Instead, they pursued policies that led to 
a significant increase in the ratio of public debt to GDP. 
Nevertheless, for many years, both foreign and domestic investors 
provided ample demand for government debt issues and for equities 
issued in privatizations.
    The Brazilian crisis of 1998 and the sharp depreciation of the 
Brazilian real in early 1999 were important adverse shocks for the 
Argentine economy. Combined with the general appreciation of the 
Argentine peso because of its rigid link to the appreciating U.S. 
dollar, these adverse external developments helped to pitch the 
Argentine economy into a prolonged recession beginning about mid-1998. 
With recession and deflation, the fiscal position of the Argentine 
Government deteriorated further, and the increase in the ratio of 
public debt to GDP accelerated. Nevertheless, private capital markets 
generally remained well disposed toward Argentina, with interest rate 
spreads on Argentine sovereign debt generally remaining below the 
average for emerging market borrowers until the autumn of 2000. The IMF 
maintained financial support programs for Argentina from 1991 through 
2000, but except for the tequila crisis episode of 1995-1996, actual 
disbursements of IMF support were quite limited.
    By late 2000, it was clear that a major trouble was brewing for 
Argentina--with substantial risk of sovereign default, collapse of the 
Convertibility Plan, and a catastrophic economic and financial crisis. 
Interest rate spreads on Argentine sovereign debt escalated above the 
average for emerging market borrowers, and it appeared that both 
foreign and domestic investors were prepared to flee on signs of 
deepening difficulty. In December 2000, a major international support 
package was arranged under the auspices of the IMF (with about $14 
billion of committed IMF funding and about $6 billion of committed 
funding from other official sources). Most of this funding was to be 
disbursed during 2001, conditional of the Argentine Government's 
efforts to rein in its fiscal deficit and pursue other essential 
reforms.
    This effort ran into difficulty early in 2001 as it became clear 
that the Argentine Government would fail to meet its fiscal objectives 
for the first quarter. Subsequent attempts to reinforce the 
stabilization effort proved inadequate and, in my judgment, by mid-2001 
both sovereign default (and compulsory sovereign debt restructuring) 
and collapse of the Convertibility Plan had become inevitable. However, 
the Argentine Government was not prepared to give up, and the IMF and 
the official community continued to support the Argentines through the 
summer and most of autumn of 2001, including through a disbursement of 
more that $6 billion of IMF support in early September. The collapse 
finally came with massive runs on Argentine banks in late November, the 
freezing of most bank deposits on December 2, subsequent riots that 
brought the resignations of Minister Cavallo and President de la Rua, 
and at end December by the official declarations of sovereign default 
and termination of the Convertibility Plan by (interim) President 
Rodrigues Saa.
    The first half of 2002 was terrible for the Argentine economy. Real 
GDP dropped another 12 to 15 percent, bringing the cumulative decline 
since the peak in mid-1998 to about 25 percent. Domestic inflation 
accelerated under the impact rapid depreciation of the peso which 
declined in value to less than one-third of a U.S. dollar--implying a 
massive increase in the ratio of Argentina's dollar denominated debt to 
its GDP. The financial system effectively ceased to function. The 
freeze continued on many (but not all) deposits. The government imposed 
asymmetric conversion rates for bank deposits and bank loans from 
dollars into pesos. Courts forced payouts of some deposits at 
artificially high conversion rates. Government and court actions 
effectively freed many debtors of much or all of their responsibility 
to make payments to creditors including banks. The value of government 
debt held by banks declined substantially. All told, the effect was a 
massive decline in the value of bank assets relative to bank 
liabilities which wiped out the equity value of banks several times 
over.
    By the summer of 2002, however, the worst was over for Argentina. 
Indeed, on a tour to Buenos Aires to promote my book about Argentina 
and the Fund, I told a number of incredulous Argentine journalists that 
the economy had probably already began an upturn. This daring 
prediction was based on partly on upticks in a few economic indicators 
but mainly on the general pattern that we have observed in virtually 
all recent emerging market financial crises (Mexico and Argentina 1995-
1996; Thailand, Philippines, Malaysia, Indonesia, and Korea 1997-1998; 
Russia and Brazil 1998-1999): after 6 to 9 months of economic and 
financial terror, recovery begins unexpectedly and proceeds at a pace 
far above most expectations.
    Argentina followed that pattern. The policies of the Argentine 
Government (under the administration of President Duhalde) made both 
positive and negative contributions to this result. On the one hand, 
despite a large depreciation of the peso and an initial upsurge in many 
domestic prices, Argentina avoided a bout of hyperinflation--as had 
occurred during the crisis of 1989-1990. Governmental suppression of 
increases in the prices for public utilities and other goods and 
services and restraint on wage increases helped to contain inflation. 
So too did efforts to limit the depreciation of the peso through 
exchange controls, limits on withdrawals of bank deposits, and 
reductions in the demand for foreign exchange arising from the default 
by the government and many private debtors on their foreign exchange 
obligations. The avoidance of hyperinflation, in turn, probably helped 
to limit the collapse of confidence and thereby contributed to the 
economic rebound.
    On the other hand, the policies pursued during the Duhalde 
Administration interfered with the efficient allocation of resources, 
failed to address key problems in 
government finances and the financial sector, perpetrated a huge and 
arbitrary redistribution of wealth from creditors to debtors, and 
exacerbated several of the key difficulties that will impede 
Argentina's path to full recovery in the years to come. In particular, 
it is noteworthy that although the Argentine Government (at both the 
federal and provincial levels) was insolvent and in formal default on 
its external debt, new government borrowing nevertheless effectively 
proceeded at a prodigious rate. The issuance of quasi-currencies by the 
federal government and several provinces was one important mechanism 
for this new borrowing. So too was the direct issuance of new debt 
(declared to be senior to existing debt already in default) to 
recapitalize banks and thereby avoid defaults on deposits.
    The massive issuance of new government debt, however, was not 
reflected in the government budget--which appeared to show highly 
respectable fiscal performance despite grave economic difficulties. 
Instead (in line with the recently exposed accounting practices of 
private enterprises like Enron, Worldcom, and Parmalat), the Argentine 
Government conducted its massive debt issuance during 2002 outside of 
the government budget. This effort was so massive and so egregious 
that, contrary to the language usually employed in politely worded 
statements of the IMF Executive Board, the Public Information Notice 
accompanying the release of the 2002 Article IV IMF Consultation Report 
for Argentina (PIN No. 03/88, released July 25 2003) explicitly notes 
the following:

        The public finances deteriorated sharply in 2001, at both the 
        Federal and provincial level, with the overall cash deficit of 
        the consolidated public sector increasing by 2\3/4\ percent of 
        GDP to 6\1/4\ percent of GDP. The position improved in 2002, 
        owing mainly to the implementation of a revised revenue-sharing 
        agreement with the provinces and tight control over spending. 
        The cash fiscal position, however, conceals the extent of the 
        underlying deterioration in the public finances, as there were 
        large debt-creating expenditures, such as bond issuance in 
        connection with the banking crisis, and capitalization of 
        interest payments. A comprehensive measure would bring the 
        augmented primary and overall deficits of the consolidated 
        public sector in 2002 to 11\1/4\ and 25\1/4\ percent of GDP, 
        respectively. [This compares with an estimate of a zero deficit 
        in the cash primary balance and an estimated deficit of 10.3 
        percent of GDP in the overall cash deficit of the public 
        sector.] [emphasis added]

IMF Policy Toward Argentina in 2002
    Relations between the IMF and the Argentine authorities were 
difficult throughout 2002, and the major sources of these difficulties 
have carried over to 2003 and are still not resolved. Correspondingly, 
the key issues concerning United States policy toward Argentina and its 
relations with the IMF that are the main subject of this hearing have 
their origins in the controversies of 2002.
    In view of the desperate situation in the Argentine economy, one 
might think that Argentina would naturally have been the target for a 
great deal of official assistance during 2002, particularly from the 
IMF. The need for and desirability of such assistance, however, was 
limited by four important factors. First, with the termination of the 
Convertibility Plan, the Argentine peso depreciated substantially 
against the dollar and this (together with a sharp contraction in the 
economy) turned the trade balance from deficit toward surplus, thereby 
lessening pressures on the balance of payments. Second, the Argentine 
Government decided to default on a large volume of its external private 
debt, and the savings in interest and principal payments implied by 
this default were of substantial assistance to the budget and the 
balance of payments. Third, by end 2001, Argentina already had large 
obligations to the IMF and other international financial institutions 
(IFI's) and significant expansion of these liabilities would raise 
concerns for these institutions and for the value of claims of other 
creditors. Fourth, while additional official support might have been a 
superior substitute for large amounts of new off-budget government 
borrowing, it was difficult to assure that the result would not be both 
additional official support and large new off-budget borrowing.
    Even if significant increases in IMF and other official support for 
Argentina were not warranted, there remained the important questions 
about the interest and principal payments due on already existing IFI 
support and of the conditions under which these payments might be 
rescheduled. Interest payments due to the IMF were comparatively modest 
because of the generally low rate of charge on IMF loans; but 
substantial principal payments were due to the IMF on tranches lent 
under the Supplementary Reserve Facility (SRF). Agreement on a new 
program with the IMF was also an essential condition for other IFI's to 
roll over their existing loans or provide net new credits.
    It is no secret that the management and staff of the IMF (and 
probably most of the Executive Board) were dissatisfied with the 
policies of the Duhalde Administration and did not believe that they 
provided an adequate basis for a renewed 
program with the IMF during 2002. Important concerns included the 
following: (i) inadequate fiscal discipline, especially the lack of and 
enforceable arrangement to control deficits at the provincial level; 
(ii) inadequate monetary discipline, specifically relating to the 
continuing issuance of quasi monies by the central and provincial 
governments; (iii) government opposition to any adjustment in public 
utility rates; and (iv) lack of progress in resolving the difficulties 
of the financial sector, including problems with the continuing freeze 
on some classes of bank deposits, asymmetric conversion rates for bank 
assets and liabilities, court actions to force payments of some 
deposits at unrealistically high values, and massive derogation of 
creditor rights through revision and lack of enforcement of bankruptcy 
laws. Absence of virtually any effort to deal with Argentina's external 
private creditors was also a concern, although it was probably 
recognized that progress in this area was difficult in the turbulence 
and uncertainties of 2002.
    Indeed, although the IMF was pressed by some of its major 
shareholders--including the United States Government--to reach an 
``interim'' or ``transitional'' agreement with Argentina in December 
2002 (approved by the Executive Board in January 2003), the staff and 
probably also the management much of the Executive Board of the IMF 
remained convinced that this program failed to meet the normal 
standards for an IMF program. This assessment is reflected in the 
following extraordinary statement in the Staff Report on Argentina's 
Request for this Stand-By Arrangement (IMF Country Report No. 03/101, 
page 9):

        In the staff's view, the transitional program contains 
        insufficient steps to give confidence to restoring medium-term 
        sustainability and, thus, does not provide a basis of an 
        assessment that Argentina would have the capacity to service 
        its obligations to the Fund (or to comprehensively restructure 
        the debt to private creditors.

    Normally, a positive assessment of a country's ability to service 
its obligations to the IMF is an absolute requirement for approval of 
an IMF program. Aside from this staff report on Argentina, I have never 
seen an instance where a negative assessment was given on capacity to 
service obligations to the IMF.
    On the Argentine side, there was also considerable frustration with 
the negotiations over an IMF program during 2002. To the Argentine 
authorities, the IMF's policy prescriptions appeared rigid, 
doctrinaire, and unsuited to the economic and political realities of 
the crisis in Argentina. The political power of the provinces and the 
independence of the courts were seen as key constraints on the policies 
of the federal government. Especially in view of Argentina's history, 
avoidance of another episode of hyperinflation was a key priority of 
the authorities--even if it was achieved partly through policies that 
repressed inflation and distorted relative prices. The apparent success 
of this policy by the second half of 2002, and the ability of the 
government to relax and subsequently remove the freeze on bank deposits 
were seen as under-appreciated by the IMF. So too was the fact that 
Argentina continued to make substantial payments (about $3 billion) to 
the IFI's during 2002--despite the terrible state of the Argentine 
economy. Indeed, the Argentine authorities were concerned that the 
continuation of large payments to the IFIs, without assurance of a 
substantial roll over of scheduled principal payments would, over time, 
massively deplete Argentina's limited foreign exchange reserves and 
undermine confidence in, and the effectiveness of, the government's 
stabilization efforts.
    In my view, the IMF staff was correct in insisting that Argentina's 
economic policies during 2002 did not meet the standard normally 
required for and IMF program. However, I also agree with the Argentine 
authorities that (despite their deficiencies) the policies of the 
Argentine Government were a reasonable response to the very difficult 
economic and political problems confronting Argentina during 2002. 
Thus, while Argentina's policies and performance did not merit a 
renewed IMF program that provided a substantial increase in IMF 
financial support; they did merit a roll-over of already existing IMF 
support and an official endorsement of Argentina's decision to defer 
payments to its external private creditors (as provided for in the 
IMF's ``leanding into arrears'' policy). Accordingly, I applaud 
reported the efforts of the United States Government and other leading 
IMF shareholders in late 2002 to press the IMF to reach an interim 
agreement with Argentina.
    However, I believe that it would have been better if interim IMF 
agreement with Argentina had explicitly recognized the special 
circumstances under which this form type of agreement was appropriate. 
This could have been accomplished formally creating a special category 
of IMF programs and conditionality to deal with cases like Argentina in 
2002. In my study Argentina and the Fund, I called this, `` bifurcated 
conditionality.'' The idea is that for a country in truly desperate 
circumstances, with already large outstanding obligations to the IMF, 
it may be appropriate to roll over existing IMF loans on the basis of 
policies that are weaker than would normally be consistent with IMF 
conditionality for significant new lending. The virtue of this approach 
is that it would make it clear that countries with substantial 
obligations to the IMF could not generally presume that roll overs 
would be easily available. And, even Argentina would need to recognize 
that as economic conditions improved, the conditions for continuing 
roll overs of IMF credits would become meaningfully more demanding.

IMF Policy Toward Argentina in 2003
    The interim IMF program with Argentina was designed to carry 
through the Argentine elections scheduled for the spring of 2003 and 
give the new government an opportunity to formulate the policies on 
which a successor IMF program would be negotiated. Under the interim 
program, relations between Argentina and the IMF proceeded relatively 
smoothly through the early summer. Economic performance was generally 
better than assumed when the interim program was agreed, and this 
contributed to Argentina's compliance with the main macroeconomic 
conditions of the program. Tension and controversy continued over the 
continuing freeze on utility rates, problems with the application and 
enforcement of bankruptcy laws, and sluggishness in addressing key 
problems in the financial sector. But, these difficulties did not 
seriously impede favorable conclusions from IMF reviews of progress 
under the interim program.
    During the summer of 2003, attention shifted toward negotiation of 
the new 3-year IMF program that would take effect in the autumn of 2003 
under the administration of the newly elected Argentine President, 
Nestor Kirchner. In addition to several of the incompletely resolved 
issues from the interim program, a key issue that received much 
increased attention in the negotiations for a new IMF program was 
Argentina's policies toward external private creditors holding large 
amounts of Argentine sovereign debt in default since late 2001. The 
long-standing IMF policy concerning ``lending into arrears'' of private 
creditors required that the countries engage in good faith efforts to 
resolve differences with private creditors. During 2002, current 
conditions and future prospects for the Argentine economy were so 
turbulent and uncertain that efforts to reach understandings with 
external private creditors appeared senseless. However, as economic 
conditions stabilized and improved during 2003, a credible effort by 
the Argentine authorities to begin discussions with external private 
creditors became a much more relevant issue.
    Based on developments at the time and on what we know now, I 
believe that it is fair to say that the difficulties in the 
negotiations over the new IMF program during the summer of 2003 derived 
primarily from the reluctance of the Argentine authorities to commit to 
policies that would promise a substantial return to private holders of 
Argentina's external debt then in default. Continued resistance of the 
Argentine Government to any upward adjustment in rates for the (mainly 
foreign-owed) public utilities was also an issue. The publicly stated 
policy of President Kirchner was that Argentines who had already 
suffered greatly in the current crisis should not be asked to sacrifice 
further to compensate for the losses of external creditors or pay 
increased utility rates to foreign companies that had negotiated 
allegedly unfair contracts with previous Argentine Governments. 
Understanding that higher payments to foreigners necessarily meant, 
other things equal, less for Argentines, it is not surprising that 
President Kirchner's policy enjoyed widespread public support in 
Argentina. Similarly, there was popular support for veiled or explicit 
threats that the Argentine Government would default on payments to the 
IMF and other IFI's unless the IMF agreed to a new program that rolled 
over existing IMF loans and met other conditions deemed acceptable by 
the Argentine Government. In pressing these positions, the Argentine 
Government probably also counted on the IMF's leading shareholders--
especially the United States Government--to press the IMF to reach a 
new agreement rather than incur both the political costs of a breach in 
friendly relations with Argentina and the operational difficulties for 
the IFI's of default on the large volume of loans outstanding to 
Argentina. Moreover, with its trade and current accounts in surplus 
(thanks partly to the effects of default), Argentina faced little need 
for external financing and, accordingly little immediate threat (other 
than the risk of being labeled an outcast from the international 
community) from a possible cut-off of IMF and other IFI loans.
    In the end, with the support of the IMF's major shareholders, a new 
3-year IMF program was agreed with Argentina in August 2003. As 
requested by the Argentine Government, this program provided for a 
complete roll over of the principal payments due on outstanding IMF 
loans (and an implicit promise of similar or better treatment by the 
other IFI's). The key issue of Argentina's treatment of its external 
private creditors (and public utility investors) was not really 
resolved; rather it was ``kicked down the road.'' The Argentine 
authorities agreed to begin a process of engagement with their external 
private creditors and committed to provide an outline of their proposal 
of comprehensive debt restructuring to creditors on the occasion of the 
annual meetings of the IMF and World Bank in Doha, Qatar in late 
September/early October. The content of this outline of an offer, 
however, was not discussed with, or approved by, the IMF. For its part, 
the IMF's approval of the new program implied that, at that time, 
Argentina was making reasonable good faith efforts to deal with its 
external private creditors, as required by the IMF's ``lending into 
arrears'' policy. But, a positive assessment that Argentina was 
continuing to make reasonable good faith efforts vis-a-vis its external 
private creditors was made a performance criteria to be judged by the 
IMF Executive Board on the occasion of each quarterly review of the IMF 
program with Argentina. If Argentina failed to behave responsibly 
toward its external private creditors, the IMF could--and, under its 
rules, should--pull the plug on the Argentine program.
    This approach to dealing with the thorny issue of Argentina's 
treatment of its external private creditors (and other foreign 
investors) was, in my view, a reasonable compromise; and United States 
policy played a constructive role in supporting it. Resolution of 
large-scale defaults is often a complex and time-consuming process; and 
Argentina's sovereign default is exceptionally complicated. Although 
conditions had improved significantly in Argentina by the summer of 
2003; they were nowhere near back to normal. An effort to force a 
resolution of Argentina's default--or to narrow substantially the range 
of options for such a resolution--would have been premature and 
counterproductive.
    Although a compromise that deferred official efforts to press for a 
resolution of Argentina's sovereign default was the right approach in 
the summer of 2003, I believe that the IMF and its leading shareholders 
missed an important opportunity to remind Argentina of its 
responsibilities as a member in good standing of the international 
community. The international community strongly supported Argentina in 
its efforts to forestall a catastrophic crisis in 1995 and again in 
2001. When those efforts failed, the international community understood 
the need, in the dire circumstances of 2002, to roll over most official 
lending to Argentina and to endorse the Argentine Government's decision 
to defer payments to private external creditors. Symmetrically, it is 
reasonable for the international community to expect that Argentina 
would recognize that as economic conditions return toward normal there 
is a responsibility to treat foreign creditors and investors in a fair 
and reasonable manner. This important point was not made with 
appropriate clarity and force at the time of the approval of the new 
IMF program for Argentina in August/September 2003.

Difficulties in Resolving Argentina's Sovereign Default
    President Kirchner has consistently indicated a tough attitude in 
dealing with Argentina's external private creditors. The face value of 
the debt is to be written down by 75 percent and no allowance is to be 
made for interest accrued since the debt went into default at the end 
of 2001. In addition, the outline of the offer for debt restructuring 
presented by the Argentine authorities at Doha (and at other regional 
meetings) implies substantial backloading of interest and principal 
payments and the imposition of coupon interest rates at well below 
market levels. Looking at these proposals, bondholders have concluded 
that in market value terms, the Argentine offer amounts to no more than 
about 10 cents on each dollar of face value plus accumulated arrears. 
This is a much lower return for bondholders in other sovereign 
restructurings by emerging market countries (for example, about 65 
percent recovery in the Brady restructurings) and even lower than the 
returns in restructurings for very poor or devastated countries (for 
example, a 33 percent recovery rate agreed for official credits to 
Iraq). As bondholders see it, the Argentine Government is asking them 
to accept not just a hair cut, or even a scalping, but a beheading. 
Understandably, they have rejected the Argentine offer as grossly 
inadequate--even ``insulting.''
    The revolt by creditors, along with recognition of the substance of 
the Argentine offer, has apparently led to a stiffening of positions by 
some of the IMF's leading shareholders. At the Executive Board meeting 
in January 2004 for the regular quarterly review of the Argentine 
program, Executive Directors representing more than a third of total 
voting power declined to support the review. Such opposition (on a 
country matter) is virtually unprecedented in the history of the IMF. 
In addition, it is reported that at the G-7 finance ministers meeting 
in Boca Raton in February 2004, it was agreed that Argentina should be 
given a message about the need to improve its offer to creditors; and 
the IMF's managing director was dispatched to give this message to the 
Argentine authorities. Thus, the message that regrettably was not sent 
in August/September 2003 appears now to be being sent. Again, I believe 
that this is the right policy for the U.S. Government to support.
    The Argentine Government's position is that it cannot afford to 
make a better offer to its external private creditors and still meet 
its other essential commitments. This position is based on key 
assumptions about the real growth rate of the Argentine economy, about 
the path of the real exchange rate, about the size of the primary 
fiscal surplus, and about interest and principal payments on debt of 
the Argentine Government to the IFI's and to domestic residents (both 
the debt restructured in November 2001 and the newly issued ``senior'' 
debt). Applying the assumed primary surplus (3 percent of GDP) to the 
projected path of the dollar value of Argentine GDP determines the 
amount (of dollars) that is available for the Argentine Government to 
pay interest on all of its debts. Subtracting out interest due to the 
IFI's and on domestic debt yields the residual that is available to pay 
interest on the external private debt now in default. Assumptions about 
the roll over rates for IFI and domestic debt affect the resources that 
are available for principal (or additional interest) payments on the 
external private debt.
    Given reasonable assumptions about the longer-term growth rate of 
the Argentine economy and the path of the exchange rate, these 
calculations confirm the conclusion that the Argentine Government has 
very little room to make payments to external private creditors. 
Indeed, in its analysis of this issue, the IMF staff concluded that 
(see IMF Country Report 03/392 Annex II) `` . . . a primary surplus of 
3 percent of GDP would not be sufficient to cover payments due on 
official debt [mainly to the IFI's] and private [domestic] debt after 
2004; it would also leave no room for payments to [external private 
creditors holding debt now in default].'' [emphasis added]
    Does this mean that the Argentine Government is correct in 
insisting on a 90 percent write-down of the external sovereign debt now 
in default? Not necessarily. Key assumptions used in reaching this 
conclusion are open to question. In particular, there is no compelling 
reason why the primary budget surplus is limited to 3 percent of GDP. 
Other countries that have faced critical fiscal challenges, such as 
Brazil and Turkey, have maintained primary budget surpluses above 4 
percent of GDP. As the Argentine economy recovers toward more normal 
levels, there is no convincing reason why the primary budget surplus 
should not be able to rise somewhat from its present level of a little 
more than 3 percent of GDP.
    The assumption that the domestic debt of the Argentine Government 
should be exempt from further restructuring is also open to serious 
question. In dealing with a sovereign default, two general principles 
should apply: (i) all creditors should be expected to accept 
significant losses; and (ii) losses should not fall disproportionately 
on either domestic or foreign creditors. In this regard, it is 
noteworthy that domestic holders of debt restructured in November 2001 
have already incurred substantial losses (measured by the dollar value 
of their claims); but these losses appear to be substantially less than 
the Argentine Government is requesting from holders of external debt 
now in default. For newly issued domestic debt (which now amounts to 
more than $30 billion), the Argentine Government insists that no 
restructuring is appropriate. But, much of this debt was issued with 
the purpose or effect of compensating Argentines from losses that they 
would otherwise have absorbed as holders of bank deposits or other 
indirect creditors of the Argentine Government. In general, the losses 
sustained by these Argentines are proportionately far less than what is 
being asked of private holders of external sovereign debts now in 
default. If the Argentine Government insists that the primary budget 
surplus cannot be raised above 3 percent of GDP and that external 
private creditors must absorb exceptionally large losses, then further 
consideration should be given to the restructuring of domestic debts of 
the Argentine sovereign.
    The special status of Argentina's debts to the IFI's is also open 
to some question. In the context of the HIPC initiative the IFI's have 
accepted that a write down in the present value of their credits is 
appropriate for highly indebted poor countries pursuing responsible 
policies. If the official community concludes that Argentina meets the 
criteria of HIPC in terms of treatment appropriate for external private 
creditors, then consideration should perhaps be given to HIPC status 
for official credits as well. More generally, however, I see very good 
reasons why credits of the IFI's, especially credits of the IMF, should 
generally be accorded preferred status in sovereign debt 
restructurings. The IMF is the official lender of final resort that 
steps in to aid countries when private creditors are fleeing or 
threatening to flee; and the IMF charges much lower interest rates than 
generally face emerging market borrowers. The IMF can do these things 
because of the protections provided by its preferred creditor status 
and its conditionality. In contrast, private lenders take much greater 
risks in the event of default, but they get paid for this in the high 
interest rate spreads that they typically charge.
    As things now stand, we appear to be a considerable distance away 
from the resolution of differences between the Argentine Government and 
most of its private external creditors. Although quite low, secondary 
market prices for Argentine debt now in default appear to be 
significantly higher than can be justified by what the Argentine 
government has so far put forward as a restructuring offer. If the gap 
remains this large, negotiations between the Argentine Government and 
its disgruntled private creditors are unlikely to get very far very 
fast. In this event, the international community, operating through the 
IMF, needs to be prepared for a breach in its relations with Argentina. 
This breach need not come soon if the Argentine Government shows some 
flexibility in dealing with its private creditor. But it should come if 
and when it is clear that the recalcitrant attitude of the Argentine 
Government is the main reason why negotiations are not making 
reasonable progress.
    This does not mean that the IMF and the international community 
should attempt to set the exact terms of Argentina's sovereign debt 
restructuring. This needs to be left to the negotiating parties. But 
the international community cannot avoid responsibility for 
establishing broad parameters for what is fair and reasonable--both for 
Argentina and its creditors. The key objective is not to press for a 
resolution that particularly serves Argentina's interests or that 
particularly serves its creditors' interests. The objective is to 
protect the integrity and efficiency of international credit markets. 
These markets must be able to deal with situations of sovereign default 
on debts issued under international law (that is, under the laws of 
other countries). Dealing with such defaults in a equitable and 
efficient manner requires both that creditors accept write downs in the 
value of their claims to levels that debtors can reasonably be expected 
to pay and that debtors not be allowed to walk away from their 
obligations on grounds that they do not want to pay as much as they 
reasonably could be expected to pay. Argentina is clearly a case where 
the ability of the international community to enforce these broad 
principles is being and will be severely tested. Principled leadership 
by the United States will be critical in meeting this challenge.