It is too early to judge whether the Argentinian authorities will master the current problems or whether this is actually a turning point. Other emerging markets are at risk too, and Argentina’s problems may prove contagious. In this context, it is interesting to note that the Asian Infrastructure Investment Bank (AIIB), which many consider to be a tool of Chinese policymaking, has lately been expanding its reach in Latin America and Africa. Chinese involvement in possible future negotiations concerning debt restructuring may be a game changer. Let me briefly discuss these points one by one.
In recent decades, no country has been affected as hard by financial crisis as Argentina. The national government defaulted after the turn of the millennium, unable to pay dollar-denominated debts. After difficult negotiations, the debt was restructured, but due to complex legal problems, Argentina was unable to issue new bonds on international financial markets for a long time.
Things changed after Mauricio Macri was elected president in late 2015. He relied on free-market rhetoric in the campaign and promised to make Argentina a normal country again. Soon after taking office, he settled some remaining legal cases concerning outstanding debt and was able to issue new bonds. International investors appreciated his stance, preferring it to the interventionist policies of his predecessor Cristina Fernández de Kirchner.
Essential elements of Macri’s economic policy are fighting inflation and reducing government spending. At the same time, he wants to implement gradual change, knowing that severe austerity would hurt masses of people and may trigger a popular backlash strong enough to derail his presidency.
Getting this kind of policy mix right is obviously difficult, and in the eyes of international investors, things were recently not going well anymore in Argentina. It bothered them that the inflation target was raised a bit, so the central bank could loosen its restrictive monetary policy. Last week, the outflow of capital became so strong that the central bank had to reverse its course, raising interest rates several times. At 40 %, it is now extremely high. Loan-financed investments have become prohibitively expensive, so economic activity is going to slow down. To reassure international investors further, the Macri government has promised to reduce public spending faster than planned, and that too will be like a break on economic activity.
So far, Macri still seems to enjoy considerable public support, and his policy may work out if he manages to reassure foreign investors in the long run. Success, however, cannot be taken for granted. Argentina’s president has to reassure his people too. In view of recent history, the popular backlash against austerity is all too possible. He has been worrying about this for good reason. That he has turned for to the IMF, asking for help, looks neither good nor "normal".
It is ironic that Macri is now struggling with the long-term impacts of the past financial crisis. A considerable share of the money that he raised with his new bonds was used to repay old debt. In other words, his government has not escaped the vicious circle of borrowing new money to repay old credits. The debt restructuring, which the previous governments had negotiated, was inconclusive. The goal was to free Argentina from this trap, but it was not achieved.
Compounding the worries, Argentina’s current problems do not only have Argentinian causes. The global investment climate has been becoming unfavourable for emerging markets. Debt ratios are high in many places, and a strong sense of uncertainty is marking the global economy and world trade (see interview with Iwan J. Azis on our website).
The dollar is strengthening, and interest rates in the USA have begun to rise slowly. These interrelated trends mean that it is becoming unattractive to borrow cheap money in the USA in order to invest in emerging markets in search of higher rates of return. Money has been cheap in rich nations ever since the global financial crisis of 2008, and as a consequence, capital has been flowing to emerging markets. Debt has been piling up there accordingly.
In view of Argentina’s history of default and inconclusive debt restructuring, financial markets react with particular sensitivity to what is happening there. Nonetheless, serious debt problems are likely to affect other emerging markets too once the trend of capital inflows stops and is reverted. There is a serious risk of new financial crises rocking national economies and even the global economy.
Should that happen, multilateral policymaking will be needed to solve the problems. In the past, the International Monetary Fund and the World Bank were key players in such cases.
In this context, it is interesting to see the AIIB expanding its global reach.
The AIIB is still a rather young institution and its global role is limited accordingly. It is clear, however, that it reflects Chinese ambitions. The Chinese government launched the initiative, made efforts to involve as many countries as possible and proposed to base the bank in its capital city. It clearly wants the new multilateral institution to become a counterweight to the World Bank, in which the USA, EU countries and Japan are the dominant partners.
The USA did not join the AIIB, but several European nations, including Germany, did. Former US President Barack Obama warned that the new institution would be a foreign-policy tool of the People’s Republic, but European governments felt that it made sense to cooperate with China. That friction has grown. President Donald Trump is threatening to launch a trade war against China, while European governments are still keen on tying China into the global order and make it a partner in global-governance matters.
So far, the AIIB is obviously doing its best to join the mainstream. It is teaming up with long-established multilateral institutions. It recently reached agreements with the Inter-American Development Bank (IDB) and the African Development Bank (AfDB) to co-finance projects beyond Asia. It is also cooperating with the Asian Development Bank and the World Bank. Moreover, the AIIB is accepting new members from all over the world. Its board approved Argentina’s application last year, for example. That Beijing is cooperating with China to prevent debt problems in lending countries fits the picture.
What role China will play in multilateral negotiations to resolve financial crises remains to be seen. That it will play a role, however, is certain, not least because Chinese loans have contributed to rising debt levels in many emerging markets and developing countries too. China might join established economic powers, prioritising repayments, or it could support the long-standing demand of developing countries for binding rules on how to systematically deal with sovereign insolvency. Had such rules applied to Argentina in the past two decades, things would have been sorted out and President Macri would not be struggling with the problems he is struggling with.
In future crises, compromises will be needed, but hard to agree on. China’s stance will be important, and the AIIB may prove an important intermediary.
Last updated: Wednesday morning, 9 May, 8:15 Frankfurt time