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