1. ARGENTINA: WHAT WENT WRONG Guillermo Perry Chief Economist LAC, World Bank IDB Annual Meetings Fortaleza, Brazil, March 2002

2. QUESTIONS Was this a first generation crisis – plainly due to excess public expenditures and deficits that led to unsustainable accumulation of debt? If it was, how and when was it caused? Or was it a case of multiple equilibria related to: The fiscal contingencies associated with an eventual nominal depreciation of the currency? Changes in growth expectations due to the protracted deflationary adjustment to external shocks? Are Currency Boards doom to fail in a world of floating currencies and volatile capital flows? Can close trading partners (such as Brazil and Argentina) keep totally different exchange rate regimes?

3. THE FISCAL PROBLEM IN PERSPECTIVE: USSUAL DEBT INDEXES DID NOT LOOK EXCESSIVE Debt ratios: Argentina vs. Emerging countries In percentage 85.127.8133.123.7Turkey 52.35.77.93.0Russia 39.17.411.02.9Poland 35.39.318.73.3Venezuela 27.79.425.72.6Mexico 50.89.825.35.0Colombia 65.015.533.89.5Brazil 55.98.721.64.6Argentina D/GDPI/DI/DI/TI/TI/GDP% I: Public Debt Interest, T: Tax revenues, D: Public Debt Source: Goldman Sachs.

4. BUT, THERE WAS A DETERIORATING TREND IN FISCAL BALANCES SINCE 1995 IN THE FEDERAL GOVERNMENT AND THE PROVINCES

5. SO PUBLIC DEBT INDEXES WERE ON THE RISE

6. THE FISCAL PROBLEM : SOME OF IT WAS AN ILLUSION DUE TO THE CASH COSTS OF PENSION REFORM

7. THE FISCAL PROBLEM: WHEN DOES IT ARISE? ADJUSTING FOR THE ECONOMIC CYCLE

8. THE FISCAL PROBLEM: WHEN DOES IT ARISE? STRUCTURAL DETERIORATION IN THE 96/98 BOOM

9. STRUCTURAL PRIMMARY BALANCES

10. THE FISCAL PROBLEM: WHEN DOES IT ARISE? Fiscal Impulse

11. THE FISCAL PROBLEM: WHEN DOES IT ARISE? THE CRITICAL IMPORTANCE OF GROWTH PROSPECTS

12. THE FISCAL PROBLEM: WHEN DOES IT ARISE? CORRECTING FOR OVERVALUATION OF THE RER

13. CURRENCY BOARD AND SHOCKS: RER OVERVALUATION SINCE 97

14. CURRENCY BOARD AND SHOCKS: DEFLATIONARY ADJUSTMENTS UNDER FIXED PEGS Fuente: Broda. AER paper and proceedings, 2001.

15. CURRENCY STRUCTURE OF REAL AND FINANCIAL ASSETS: TRADE STRUCTURE Source: Un-Comtrade, 1999. Exports of goods.

16. CURRENCY STRUCTURE OF REAL AND FINANCIAL ASSETS: FDI BY COUNTRY OF ORIGIN

17. CURRENCY STRUCTURE OF REAL AND FINANCIAL ASSETS: DEPOSIT DOLLARIZATION

18. A PROBLEM OF MULTIPLE EQUILIBRIA? THE ELEMENTS OF THE PROBLEM PUBLIC DEBT SUSTAINABILITY UNTIL 2000 UNDER REASONABLE GROWTH AND INTEREST RATE PROJECTIONS, AND NO NOMINAL DEVALUATION. A LARGE FISCAL CONTINGECY ASSOCIATED WITH A SHARP NOMINAL DEVALUATION: FIRMS AND HOUSEHOLDS (AND THE FINANCIAL SECTOR) WOULD BE BANKRUPT WITH A NOMINAL DEVALUATION DUE TO HIGH OPEN EXPOSURES IN FOREIGN CURRENCY. THEY MIGHT HAVE ADJUSTED UNDER A DEFLATIONARY RER ADJUSTMENT WAS IT POSSIBLE TO HAVE DEFAULT WITHOUT DEVALUATION? DEFAULT WOULD BANKRUPT THE BANKS (DUE TO LARGE HOLDINGS OF PUBLIC DEBT) AND LED TO DEPOSIT RUNS

19. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT? 1. DOUBTS ABOUT NOMINAL DEVALUATION 1. LED TO DOUBTS ON SOLVENCY DUE TO HIGH FISCAL CONTINGENCY ASSOCIATED WITH DEVALUATION 2. DOUBTS ABOUT FISCAL SOLVENCY 1. DUE TO CHANGED GROWTH EXPECTATIONS UNDER A PROTRACTED DEFLATIONARY ADJUSTMENT 2. LED TO DOUBTS ON CB SUSTAINABILITY DUE TO EFFECTS ON BANKS AND EVENTUAL MONETARY EMISSION TO FINANCE THE DEFICITS

20. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT? CURRENCY RISK BECOMES VOLATILE SINCE MARCH 2001 …

21. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT? … BUT BECOMES IRREVERSIBLE SINCE JULY 2001

22. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT?..WHEN THE GOVERNMENT IS CUT FROM CAPITAL MARKETS AND THERE IS A SHARP DEPOSIT RUN

23. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT? THE DEFLATIONARY ADJUSTMENT OR A CAPITAL FLOWS REVERSAL?

24. A PROBLEM OF MULTIPLE EQUILIBRIA? WHAT TRIGGERED THE SHIFT? CAPITAL FLOWS FALL FOR ARGENTINA BUT NOT FOR OTHER COUNTRIES IN 2001

25. ARGENTINA AND BRAZIL: ARGENTINA NEEDED EXCHANGE RATE FLEXIBILITY TO ADJUST TO SHOCKS IN BRAZIL, NOT VICEVERSA.. ….A CONTRAST WITH NAFTA Regresion de cointegracion: PIB Argentina = -22.14 + 5.67* PIB Brasil (3.77) (0.80) Nota: Errores standard en parentesis. a: constante b: coeficiente de cointegracion Las dos series convergen si: a>0 y b<1 : Brasil converge a Argentina a 1 : Argentina converge a Brasil

26. HOW MUCH CONTAGION? Cross-market Correlations with Argentina (ventana de 60 días – correlación de los cambios)

28. HOW MUCH CONTAGION? Tasa de Cambio Nominal y el spread Argentino (ventana de 60 días – correlación de los cambios)

29. SUMMARY THE ARGENTINE CRISIS WAS DUE TO TWO FACTORS: A FRAGIL FISCAL SITUATION INHERITED FROM THE BOOM YEARS (96/98), EXACERBATED BY THE REQUIRED RER DEPRECIATION AFTER 98 THE SHOCKS AFTER 98 REQUIRED: EITHER A PROTRACTED DEFLATIONARY ADJUSTMENT (Which neither the Argentine society had the stomach to support, nor Wall Street the patience to finance) OR A NOMINAL DEVALUATION FOLLOWED BY A BANK CRASH AND A DEFAULT (In which case everyone will end up worst)

30. LESSONS AVOID FISCAL LAXITUDE IN BOOMS USE PRIMARY STRUCTURAL FISCAL BALANCE GOALS OBTAIN SURPLUSES IN BOOMS KEEP A FLEXIBLE EXCHANGE RATE REGIME AND AVOID DOLLARIZATION IF DOLLARIZED AND SUBJECT TO ASSYMETRIC SHOCKS, EITHER LEAVE THE PEG AND ATTEMPT DE-DOLLARIZATION IN GOOD TIMES, OR DOLLARIZE FULLY AND ACHIEVE STRONG FISCAL STRUCTURAL SURPLUSES, CONSERVATIVE PRUDENTIAL REGULATION AND LABOR MARKET FLEXIBILITY

31. End