Redollarization to Worsen the Argentine Crisis Sabyasachi Mitra

Passing judgment in a landmark case the Supreme Court of Argentina recently declared that the deposit of US $247 million that the province of San Luis has with the state-owned Banco de la NaciAon has to be returned to the province in dollars. This has led to the fear that the Court has in effect declared as unconstitutional a one-year-old decree issued by the Argentine President that led to the conversion of billions of dollar-denominated bank deposits into pesos. The Court ruled 5–3 in favour of redollarization. The ruling however has run into controversy with accusations of biasedness against two of the judges who have ruled in favour. Of the two, one has a dollar-denominated account, while the other had made his opinion public even before the ruling was announced.

While many have blamed Argentina’s political class for the debacle, the fact is that the country’s policies during the 1990s were being advocated as exemplary by neoliberal economists all around the world. Argentina’s ‘growth’ during this decade after years of stagnation was hailed as a success of the IMF–World Bank guided economic reforms. And in the early 1990s the reforms did seem to work. But a series of external shocks, starting with the Mexican peso crisis of 1994 and 1995, the Asian crisis in 1997 and 1998, and most importantly the Brazilian devaluation in January 1999, left the country in the midst of an economic collapse. Economic growth turned negative, and interest rates rose amidst fears that Argentina might default on its debt. The higher rates of interest virtually hastened Argentina’s debt default.

In order to maintain investor confidence the Argentine government focused all its efforts on just attaining investment-grade rating in the credit markets. Virtually all commitments to domestic constituencies, public employees and pensioners were abrogated by the government in order to exhibit its commitment to serve Argentina’s external debt. But nothing that Argentina did helped it regain the confidence of its investors. The more regressive measures the Argentine government took—retrenchment, cuts in government salaries, sharp fiscal cutbacks—the more jittery did the investors and creditors become.

Nothing seemed to work for the government in Argentina. It seemed apparent that the one-to-one fixed rate on exchange of peso–US dollar that was in place since 1991 had become unsustainable, not only in respect to the US dollar, but also vis-à-vis other currencies. Anticipation of devaluation triggered fears about the peso losing its value and hence led to eagerness on the part of all Argentineans to convert their deposits into US dollars. The government also planned a freeze on the prices charged by the foreign-owned companies providing public utility services like electricity, gas and telephone services. Exports of foreign-owned oil companies were also to be brought under the tax net.

Even then Argentina had to devalue its currency, and when the pesofication was carried out, for every dollar held, an account holder in a dollar-denominated account was given 1.4 pesos. However, the devaluation did not help Argentina much in shoring its exports. Primary among the causes behind this failure is the recession in major industrial countries, the shift of the United States to selective protectionism, and competition from other developing countries, most of them in a position similar to that of Argentina, with each trying desperately to grab a share of the world’s primary products market to rev up its foreign-exchange earnings.

It is under this situation that Argentina decided to first freeze fixed-term dollar current and savings accounts, initially for a year, and later decided to convert dollar-denominated bank deposits worth billions of dollars into pesos. Holders of current accounts of less than US $10,000 were allowed to convert dollar savings into pesos at 1.4 pesos for each dollar, or withdraw US $500 every month.

It is a fact that the recent ruling by the Argentine Supreme Court has been a ‘narrow’ one in the sense that this ruling in favour of ‘redollarization’ will apply only on the amount deposited by San Luis province in the Banco de la NaciAon. However, policy makers fear that this judgment will open a can of worms, as it will encourage numerous other depositors, many of whose dollar deposits had been similarly pesofied under the Presidential decree. Many Argentineans are seeking to ‘redollarize’ their accounts and are fighting against the government in the court to achieve the same.

The Argentine government as well as the country’s banks that are holding these deposits have warned that there are not enough dollars with them to oblige depositors if the Supreme Court instructs the banks to redollarize all dollar-denominated bank deposits that have been converted into pesos. If all such claims have to be converted back into US dollars, the banks will need an estimated US $10–20 billion to meet such demands. Argentina currently has just about US $10 billion in foreign-currency reserves.

In fact the economy might run into greater trouble if the decision of the Argentine Supreme Court is extended to include all depositors who had dollar-denominated deposits in December 2001. The amount in such deposits with Argentine banks was then about US $50 billion. Most of this money has since been withdrawn in pesos and now the amount remaining with these banks in dollar-denominated accounts is worth around US $10 billion.

While the depositors who deposited their savings in dollars have welcomed the decision, and are hoping for a similar verdict when their lawsuits come up for discussion in the court, the nation will be thrown into further financial chaos if the ruling has to be implemented. Senior advisers to Mr Eduardo Duhalde, the interim President of Argentina, have suggested that issuing bonds would be the only means of repayment if the Supreme Court passes a similar ruling in favour of other depositors. The advisers have suggested that the bonds would be denominated in dollars, complying with the court ruling. However, these would be repayable over a period of ten years to enable the recovery of the Argentine economy instead of leading it to an abyss.

The proposal of the advisers is not likely to find acceptance among the depositors. It might be no more acceptable to them than the decree ordering pesofication of their deposits. And with the Presidential Election being just round the corner, slated to take place in late April, the chances of retaining power by the ruling Peronist Party might take a beating in that case.

For more than a decade, till January 2002, one peso was valued at one dollar. The two currencies were used almost interchangeably in ordinary transactions and banks accepted deposits in either currency. However, the people of Argentina considered the American currency to be stronger, and most preferred to maintain dollar-denominated accounts in Argentine banks. In January 2002 Duhalde abolished the system when the country faced an economic collapse. All dollar accounts were transformed into peso deposits, and the peso was delinked from its one-to-one convertibility with the US dollar. The peso was floated on the currency market and has lost about 70 per cent of its value vis-à-vis the dollar since then. On 5 March 2003, the day the Argentine Supreme Court delivered its judgment on the San Luis province’s appeal against pesofication, the peso was quoting at 3.175 pesos to an American dollar.

Redollarization will result in problems galore for the banks. Not only the deposits, but loans were also pesofied when the decree for pesofication was passed. Banks will lose a lot of money if the loans they have given out are not redollarized along with the dollar-denominated deposits.

The Supreme Court order will also jeopardize Argentina’s relationship with the IMF. In January this year the government promised to keep the nation’s money supply under tight control in return for the IMF’s allowing the nation to roll over nearly US $7 billion in debts with the Fund. The country does not have access to any credit since December 2001, when it declared the world’s biggest sovereign debt default. Redollarization may drain whatever resources the country has in its hands, and might further impede economic recovery. It is going to put further pressure on the country’s fragile banking system. Argentina’s public debt today is about one-and-a-half times the GDP of the country.

If the Argentine government is forced to redollarize, it will make the economy vulnerable to external pressures as the country will then have to agree to whatever conditionalities the international financial institutions impose on the country in lieu of the extra dollars that Argentina might need. The government’s capacity to print money, go for deficit financing, and create employment and generate domestic demand will be nullified. And this is definitely not going to help Argentina come out of the economic ruins that the country is now in.

Nearly 60 per cent of Argentines currently have no savings and many have to do odd jobs or even scavenge for a living. Whatever chances remain of addressing their needs by the government would vanish once the meagre resources left with the government go to pay the deposits in dollar-denominated accounts in Argentina’s banks. The government now hopes that this ruling is an exception, that it doesn’t become a precedent, and doesn’t translate into similar rulings in all pending cases in which Argentine depositors have challenged the ‘pesofication’ decree.

Even as Argentine depositors in dollar-denominated accounts expect a ruling in their favour, the only way out of the mess with relatively less damage to the national economy seems to be the issuance of the ten-year bonds suggested above. In fact on 31 May 2002 the government had signed a decree to that effect. Standard and Poors has listed the important measures spelt out by the Argentine government in that decree.[1] The measures are as listed below:

  • Depositors with special needs (above 75 years old, in need of medical treatment) will be entitled to choose a dollar-denominated bond with a five-year maturity.
  • In exchange for the reduction of deposits that will result from depositors choosing government bonds, banks will provide the government with sufficient guarantees to access the Central Bank’s financing to purchase the government bonds. Only if these new government bonds default, or after the external debt restructuring takes place, will banks be entitled to use their pledged assets to cancel the loans granted by the Central Bank to finance this deposit-bond swap, which would finally allow financial institutions to reduce their exposure and their balance sheet to the Argentine government.
  • The period to choose government bonds in exchange for rescheduled deposits expires thirty working days after the signature of the present decree.
  • Those rescheduled deposits not exchanged by government bonds will be converted into securities and listed in local markets. These new securities will be accepted to acquire new stocks and new CP placements. Depositors will also be entitled to use these certificates to cancel loans granted by the same bank that issued the deposit.
  • The government bonds can be used to cancel mortgage and personal loans.
  • The government will prepay the bonds if the holder wishes to use them to acquire government assets, new cars, finance the construction of new buildings, and the like, within certain limitations.
  • Depositors with funds in sight accounts will be entitled to bid for acquiring the new ten-year dollar bond.
  • Banks will be allowed to create new savings and current accounts that will not be subject to the restrictions of cash withdrawals imposed on ‘old’ accounts, both in pesos and dollars.
  • New loans and deposits can be indexed to inflation, despite this measure’s contribution to the continuous increase in most of the economy’s prices.
  • Banks will receive government bonds in compensation for the asymmetric pesofication of assets and deposits, as well as the reduction in equity caused by the banks’ dollar-denominated cross-border debt, which was no longer backed by dollar assets after the pesofication of the economy. Banks will be compensated by a peso bond for the difference of 0.4 that resulted from the conversion of dollar assets into pesos at the 1:1 parity, while dollar deposits were converted at the 1:1.4 parity. Banks will be entitled to receive a dollar bond to compensate the loss in equity caused by the dollar liabilities that were not subject to pesofication (mainly cross-border debt).
  • Investors whose government bond holdings had been converted into pesos may request the redollarization of their holdings if they accept the government’s invitation to participate in an eventual external debt restructuring.

Argentine banks and the IMF are pushing the government to convert deposits into obligatory bonds. And this seems to be the only way out of the situation that the Supreme Court ruling has landed the country in. However, with the Presidential elections slated for 27 April, the present government might just try to pass the onus of this unpopular but unavoidable decision to the next government.

It is true that no country, more so if it is pursues an open-economy approach, can for long maintain a fixed-currency regime if its economy does not grow compatibly with the rest of the world. The move might be able to provide short-run stability to a country whose currency blows in whatever direction speculative traders decide it should. However, if the country performs poorly, people are bound to lose confidence in the local currency, and will want to convert their deposits into international currency. This will lead to an increased demand for international currencies (like the American dollar), and hence to a further weakening of the domestic currency. Trying to maintain a fixed-currency regime or a forcible conversion of all foreign-currency denominated accounts into domestic currency will lead to protest from both domestic and foreign investors, and loss of investor confidence, particularly that of foreign investors. Dollarization will definitely lead to reduced control of countries over their economies. The move would also require countries to match domestic currency creation with dollar inflows. This will hamper the efforts of national governments at generating additional demand, and would be costly in terms of growth and jobs.

Countries like Ecuador and Turkey are today in a similar situation after pegging their national currencies to the American dollar. The Turkish lira’s crawling peg against the dollar collapsed in February 2001 after a row between Bulent Ecevit, the Prime Minister, and the President Necdet Sezer. Since then, the IMF-backed reform efforts have concentrated on trying to rebuild a shattered banking system damaged by holding large unhedged dollar liabilities, suddenly made more expensive by the collapse of the crawling peg.[2] Shifting expectations about the performance of the US economy might affect economies of nations that have pegged their currencies to the US dollar. A lot of these expectations might be merely speculative in nature. Further dollarization could spell trouble for nations whose economic cycles are not in sync with those of the US. For example, the Fed’s decision to notch up interest rates to reduce growth in the United States would have a negative impact on a dollarized foreign country that needs to stimulate growth.[3]