Argentine Financial Argentine Financial CrisisCrisis

Can Aydinoglu

Andres Perez

Jennifer Koyce

Vic Chidgopkar

Erik Deneergaard

IntroductionArgentina 2001-2002 One-fourth of all third world debt ($132b) 18% official unemployment 30 People dead during riots Devaluation cut national wealth by 30% Huge costs socially and financially

Were these avoidable? What should have been done by the government? What are the strategic implications for businesses?

Agenda:

Theoretical BackgroundCase of ArgentinaCase of East AsiaComparisons and takeawaysPrevention policiesBusiness implications

What is a Financial Crisis?A financial crisis is a disruption to

financial marketsExtreme adverse selection and moral

hazard problems Financial markets become unable to

efficiently channel funds to productive investment opportunities.

Stages of a Financial Crisis

Increasing Vulnerability

Currency Crisis

Full fledged Financial

Crisis

Stages of a Financial Crisis

Increasing Vulnerability

Currency Crisis

Full fledged Financial

Crisis

Financial Liberalization Period

•Heavy Lending•International Capital Inflows

•Higher yields in Ems•Government Safety Net•Currency Peg

•Rapid Expansion•Excessive risk taking due to

•Lack of trained loan officers•Insufficient bank supervisors•Weak government regulations•Moral hazard due to safety net

Non performing loans skyrocket

Substantial loan losses

Shortening of loan terms

High illiquidity

Deterioration of Bank B/S

•High leveraging of corporate sector

Vulnerability to shocks

Stages of a Financial Crisis

Increasing Vulnerability

Currency Crisis

Full fledged Financial

Crisis

Deterioration of financial and non-financial B/S

Central Bank cannot protect currency by raising rates

Speculators start attacks on currency

Central Bank’s Reserves melt down

Collapse of Currency

Stages of a Financial Crisis

Increasing Vulnerability

Currency Crisis

Full fledged Financial

Crisis

Three mechanisms are triggered•Direct effect of devaluation on B/Ss•NPLs skyrocket leading to further deterioration

•Depositors panic and bank runs occur•Depositors panic and bank runs occur•Inflation shoots up due to higher import prices

•Nominal interest rates increase•Huge increases in interest payments

•Sharp deterioration and collapse of financial and non-financial B/S•Contraction in lending and severe economic turndown

Increasing Vulnerability:

Fiscal deficit was resolved by privatizations– Unions have a lot of power. There is no possibility to reduce salaries– 1996-2000 Net FDI ($48.9B) covered nearly 90% of the accumulated

current-account deficit over the same period

When all the public companies were sold, Argentina borrowed money from international markets

Fixed exchange rate resolved a huge problem: the inflation – Prices fell in Argentina through a painful period of deflation – (1.8% in 1999, 0.7% in 2000 and 1.5% in 2001)

Case of Argentina

Case of Argentina

Currency Crisis: Results from 1990 to 2000

– Exports more than doubled (US$12.4b to US$26.4b)– Imports rose by nearly seven times (US$3.7b to US$25.2b)– Inflation was almost zero

Trigger of ARS currency crisis:– The devaluation in Brazil (its largest trading partner) made the

country increasingly uncompetitive and deepened the recession

Fiscal Deficit Snowballs

Government Too Reactionary to pull out of crisis– Tax revenue declined due to recession and avoidance– Unwilling to devalue because it would multiply government debt– Government unable to reduce expenditures due to social

instability

Bottom Line: Huge fiscal deficit and the weakness of the economy triggered the default

Full Fledged Financial Crisis:

Case of Argentina

Argentina’s debt: US$150b

Case of East AsiaBackground:

The Five Asian-Crisis Countries: Indonesia Philippines

Thailand South Korea Malaysia

Before the Crisis:– Average Annual GDP 7% - 8%– Significant per captia income level increase over the last 30 years– Attracted nearly half of all capital inflows to developing

countries– Bottom Line: Outstanding economic performance first step to

financial liberalization

Case of East AsiaIncreasing Vulnerability:

Feb Jun Jul Aug Sep Oct Nov Dec

Chain of Events in 1997

•Speculationon baht

•2nd attack

on baht

•Thailandfloats the baht

•Malaysiafloats the ringgit

•Indonesiafloats the rupiah

•Kia seeksKorean court protectionfrom creditors

•Indonesiaobtains IMFpackage of $35Billion

•KRWdepreicates10%

•KRWfalls 1000to USD

•Koreafloatswon &obtainsIMF assistance

Case of East Asia

Currency Crisis: Asian-crisis countries experienced nominal currency

deprecations of more than 50% from July 1997 to 1998

Reaction: Asian-crisis countries institute currency controls to avoid speculation– Example: Sept 1998 Malaysia restricted Foreign Direct Investors

from repatriating their MYR.– Feb 1999 Foreign Direct Investors able to repatriate their MYR

• However Proceeds now subject to a graduated exit levy scheme on Principal and Capital Gains

Case of East Asia

Full Fledged Financial Crisis:

Non-Performing Loans as a % of GDP

0

10

20

30

40

50

60

70

80

90

IDR KRW MYR THB

199819992000

Case of East AsiaThe Recovery: Rates of economic growth have rebounded in 1999-2000

Failure of investment ratios to rebound significantly

Real stock market prices failed to return to pre-crisis level

Bottom Line: Crisis had long-term adverse effect

Comparisons and Takeaways

Government Stability– ARS: Financial Crisis transferred into Political

Turmoil (I.e. 5 Presidents in 2 weeks) Fiscal Deficit

– ARS incurred 10 years of Fiscal Deficit Banking System:

– Non-performing loans & Bank Runs diluted the assets• i.e. Bank customers did not have necessary USD to repay

their USD loans

– Devaluation adversely effected the liabilities since Gov’t mandated Banks absorb the devaluation & not the bank customers

Financial Policies to Prevent Financial Crises

1. Adherence and supervision of banks• maintain balance sheets• provide safety net yet prevent moral hazard

2. Accounting and disclosure requirements• measure risk through quality of information

3. Legal and judicial systems• property rights• allowable collateral• bankruptcy policies

4. Market-based discipline• credit ratings• issue subordinated debt

Financial Policies to Prevent Financial Crises

5. Entry of foreign banks• Diversify and insulate• strengthen foreign confidence• Less like likely to be bailed out – market discipline

6. Capital controls• ouflows devaluation• inflows debt• effectiveness?

7. Reduction of role of state-owned financial institutions

• not efficient and won’t manage risk if no profit motive

8. Restrictions on foreign-denominated debt• prevents monetary responses

Financial Policies to Prevent Financial Crises

9. Elimination of “too-big-to-fail” firms• no implied rescue – market discipline

10. Sequencing financial liberalization• lending boom precedes information• gradually remove restrictions• well-functioning regulatory structures limit risk, lending

boom precedes information

11. Monetary policy and price stability• domestic vs foreign denominated debt

12. Exchange rate regimes and foreign exchange reserves• fixed rate• crawling peg• capital flows• low reserves

Is Peso Overvalued? Or Legalized Theft!

Government repealed convertibility and confessticated $18 B belonging to peso holders

Goal to boost exports and GDP Prior to devaluation: Exports (10% of GDP);

Rest of the GDP 50% devaluation of peso will result- Export 5%;

GDP 0.5% Central Banks instead of devaluation should sell

assets - & Dollarize Not a currency problem, but a banking problem, but a banking problem,

political, legal, & corruption problem…….political, legal, & corruption problem…….

Managerial Implications: Micro

Uncertain Monetary and Fiscal Policy Banking and Political Stability Tax Structure and Tariffs on Import or Exports Corruption at all Levels

– Parallel Economy (cash transactions) Legal System - Delays & Cost Unreliable Police Protection Bureaucratic and Expensive Public Workforce

– Provincial legislators’ salary - $300,000/year

Managerial Implications: Macro

Tax Structure - VAT etc. Tariffs on Import and Exports Stability of Local Vendors and Customers Fluctuating Exchange Rate - minimize inventory

& cash collection cycle Reliability of local banks Use Financial Models to Minimize Risk

– debt.

Managerial Implications: Macro

Government approvals - Corruption Litigation is Time Consuming and Costly Illegal Tactics used by Local Competition Safety of Local Employees Unreliable Political and Banking System Use Local Resources and Minimize

Dependence

Factors Leading to CrisesDeterioration in Bank’s B/S

•Contraction of Lending•Interest Rates Up

More Adverse Selection

Dilution of Credit Quality

•Borrowing short, lending long (liabilities up, assets down)•Less ability to monitor credit quality

•Moral hazard and adverse selection further up•Bank runs

•Collapse of Banks

Uncertainty Up•Collapse of an institution•Sustained Recession•Political Instability

Capital Outflows

Stock Market CrashDevaluation•Value of $ up•$ denom. debt up

Deterioration of Non-Financial B/S•Collateral values down•Net worth of companies down