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Argentine Financial Crisis Can Aydinoglu Andres Perez Jennifer Koyce Vic Chidgopkar Erik Deneergaard.

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Presentation on theme: "Argentine Financial Crisis Can Aydinoglu Andres Perez Jennifer Koyce Vic Chidgopkar Erik Deneergaard."— Presentation transcript:

1 Argentine Financial Crisis Can Aydinoglu Andres Perez Jennifer Koyce Vic Chidgopkar Erik Deneergaard

2 Introduction Argentina  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?

3 Agenda:  Theoretical Background  Case of Argentina  Case of East Asia  Comparisons and takeaways  Prevention policies  Business implications

4 What is a Financial Crisis?  A financial crisis is a disruption to financial markets  Extreme adverse selection and moral hazard problems  Financial markets become unable to efficiently channel funds to productive investment opportunities.

5 Stages of a Financial Crisis Increasing Vulnerability Currency Crisis Full fledged Financial Crisis

6 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

7 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

8 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 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

9 Increasing Vulnerability:  Fiscal deficit was resolved by privatizations – Unions have a lot of power. There is no possibility to reduce salaries – 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

10 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

11  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

12 Argentina’s debt: US$150b

13 Case of East Asia Background:  The Five Asian-Crisis Countries: IndonesiaPhilippines ThailandSouth 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

14 Case of East Asia Increasing Vulnerability: FebJunJulAugSepOctNovDec Chain of Events in 1997 Speculation on baht 2nd attack on baht Thailand floats the baht Malaysia floats the ringgit Indonesia floats the rupiah Kia seeks Korean court protection from creditors Indonesia obtains IMF package of $35Billion KRW depreicates10% KRW falls 1000 to USD Korea floats won & obtains IMF assistance

15 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

16 Case of East Asia Full Fledged Financial Crisis: Non-Performing Loans as a % of GDP

17 Case of East Asia The Recovery:  Rates of economic growth have rebounded in  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

18 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

19 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

20 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

21 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

22 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 but a banking problem, political, legal, & corruption problem…….  Not a currency problem, but a banking problem, political, legal, & corruption problem…….

23 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

24 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.

25 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

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27 Factors Leading to Crises Deterioration 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 Crash Devaluation Value of $ up $ denom. debt up Deterioration of Non-Financial B/S Collateral values down Net worth of companies down


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