The IMF’s huge loan to Argentina was not fit for purpose
© picture-alliance/REUTERS/Agustin Marcarian
Coronavirus test centre in Buenos Aires: the pandemic has compounded the economic crisis.
In June 2018, the International Monetary Fund (IMF) lent $ 50 billion to Argentina. It later increased the amount to $ 57 billion. This was the IMF’s largest loan in its history, and its 21st to Argentina.
The purpose of the bailout was to stem capital outflow, support the falling peso and encourage inward foreign investment. In exchange for the loan, the government of Mauricio Macri, who was the country’s conservative president at the time, promised to cut the budget deficit and control inflation.
The programme failed. Capital flight continued, the peso kept falling, and inflation stayed high. In 2019, left-leaning Alberto Fernández was elected president and took office in December. His government cancelled the loan programme and embarked on a debt renegotiation with private creditors. At this point, the IMF had already disbursed $ 45 billion.
In a recent report, the IMF has itself admitted that the bailout did not work: “The programme did not fulfil the objectives of restoring confidence in fiscal and external viability while fostering economic growth.” (See my essay of late 2020 on www.dandc.eu.)
The authors identify several major reasons for failure. In essence, they state the IMF bailout was not fit for purpose. The report admits that the strategy was “too fragile to deal with such a high-risk scenario”. In other words, the IMF not only failed to take appropriate account of the range and complexity of Argentina’s problems. It was also unable to cope adequately with the country’s rapidly changing circumstances.
Consider Argentina’s situation in the run-up to 2018. The country emerged from its 2001 default by closing a deal with her holdouts in 2016. In 2017 it was able to place 100 year debt in international markets for the first time ever. But in April 2018, there was a classic run on its currency and sovereign bonds. In view of persistent financial volatility, many Argentines converted peso deposits into dollar-based assets. As a result, the peso kept depreciating, and that made inflation spike. Moreover, Argentina’s dollar-denominated public debt shot up as a share of GDP, but its fiscal resources were in pesos and limited. In this setting, a huge large loan programme – even one combined with economic reforms – was a very risky strategy.
Another problem was that, the bailout actually increased the worries of international investors and lenders. They knew that the IMF strategy might fail and, in that case, they would be last in line. Multilateral institutions are repaid first. As official money flowed without confidence having been restored, the very size of the loan programme ended up undermining its success.
Insufficient risk assessment
The IMF report identifies a further flaw in its lending: it should have been more realistic about the risks of failure. Setting realistic expectations could have helped to understand early on that the approach was not working. Early warnings are especially important when a country’s fiscal viability is balanced on a knife-edge. “The Fund should be prepared to pull the plug on programmes whose objectives can no longer realistically be met,” the report states.
Further, the authors argue that the IMF should have been more willing to push Argentina’s government to use tough policies such as capital controls. In this case, limiting the outflow of hard currency from Argentina would have made sense. In 2018, Argentine officials pushed hard against such controls, not least because they wanted to display confidence. The IMF acquiesced. That was a mistake, as it has now acknowledged.
The IMF abandoned other useful policy options too quickly, according to the report. For example, it had proposed a debt operation, a provision that would have allowed the government to negotiate more lenient repayment terms in case of persisting financial problems. The Argentine officials rejected it. Such instruments might have let the bailout succeed.
Moreover, the IMF programme did not address one of Argentina’s biggest problems, namely, the connection between its public debt and the dual-currency nature of its economy. Accordingly, there was no obvious tool for addressing it. When the crisis unfolded in 2018, most of the country’s debt was denominated in dollars, but its GDP is mainly produced in pesos. The peso was slightly overvalued before the crisis erupted, but ended severely undervalued as the run persisted. As the value of dollar-denominated debt rose and the peso fell in 2018, the debt-to-GDP ratio soared from 57.1 to 86.3.
This was entirely a currency issue. It can be explained more than fully by the real depreciation. Fiscal policy – raising taxes and/or reducing spending – could not tackle it in a short time span. It is hard to fix a dual-currency economy if the nominal exchange rate is not stabilised first. Argentina’s government, however, did not want a hard currency peg because such a peg had contributed to the devastating financial crisis in 2001 (see Jorge Saborido on www.dandc.eu). A very strong initial peso devaluation coupled with a temporary nominal exchange rate cap could have solved the problem, but it was not attempted. The IMF accepted Argentina’s insistence on a floating currency regime, and that turned out to be self-defeating. Investors did not regain confidence in the economy.
As it turned out, though, the fate of the IMF programme was sealed not by markets, but by politics. When the Macri government lost the 2019 presidential primaries, the IMF programme went off the rails. The peso and the local stock market plunged almost immediately. The country’s risk rating soared 14 % above US treasury bonds. Its fate was finally sealed as the winners of the national presidential and parliamentary elections had other ideas. The Fernández administration finally cancelled the agreement on 24 July 2020.
This chain of events revealed a further flaw in the IMF programme. The report points out that there was no “Plan B” to put in place in case of political change, even though it was the main source of uncertainty throughout 2019.
The way forward
As is true of many countries, Argentina’s economic problems have become worse in the Covid-19 pandemic. Earlier this month, the government concluded a new $45 billion agreement with the IMF to prevent Argentina from defaulting. A controversial new loan will pay for the previous one. Argentina's fractured Congress must approve the deal, and a major challenge is that the ruling Peronist party itself is split on the matter. No doubt, the reputation of the IMF is being diminished by its Argentina problem.
The IMF's assessment of the old deal spells out clear lessons. Bailouts should be tailored to suit local conditions, which include a country’s politics. Governments should have a well-targeted plan for dealing with debt problems, including dual-currency issues. Both the IMF and its borrowers should be open to a broad range of measures for dealing with financial crises.
The IMF’s mission is to restore stability in times of crisis. While Argentina’s persistent crisis has absorbed IMF funds, many low-income countries need support (see contribution by Kathrin Berensmann). Continued improvement in IMF practice is necessary to preserve the Fund’s resources for where they are needed most.
IMF evaluation of Argentina bailout:
José Siaba Serrate is an economist at the University of Buenos Aires and at the University of the Centre for Macroeconomic Study (UCEMA), a private university in Buenos Aires. He is also a member of the Argentine Council for International Relations (CARI).
Correction 10 March 11.15 am Frankfurt time: We added a sentence about divisions in Argentina's ruling party.