Part II. The 1995 Currency Crisis in Argentina by Ma³gorzata Jakubiak
2.5. Conclusions
There is evidence that the 1995 Argentine financial crisis coexisted with weak credibility of the currency board and risk-averse investors. A calibration of a model of contagious currency crisis to Argentine data done by Choueiri (1999) shows that if we are to believe that investors were sufficient-ly risk-averse, this financial turmoil could be attributed to the Tequila effect from the Mexican devaluation alone. Moreover, the economic fundamentals of Argentine economy did not matter in triggering the crisis [Choueiri, 1999].
Although there were speculative attacks on the peso, Argentina did not devalue the currency. Instead, the mon-etary authorities depleted its exchange reserves, and real interest rates rose. This situation matches the definition of
a currency crisis given by Eichengreen, Rose and Wyplosz (1994). The currency crisis occurred, although there was no change in the nominal exchange rate. As a result of cur-rency pressures, the bank runs followed.
The characteristics of the 1995 Argentine crisis are perfectly captured by the second-generation theoretical models of the currency crises. Speculations about the pos-sible devaluation of the Argentine peso increased the probability of this devaluation. The authorities were then facing a choice between short-term and long-term eco-nomic goals. The government had reasons both to aban-don the peg and to defend it, but the latter only at a cer-tain cost. Finally, the currency pressure was not directly related to economic fundamentals.
The interesting question is what would happen if the monetary authorities decided to devalue the peso. First of all, it should be noted that Argentina, with its high exter-nal debt stock, was financially fragile. Large real deprecia-tion would have surely risen country risk premium. From this point of view, if the devaluation had taken place in 1995, it would have had destabilizing effects, to the finan-cial system in particular.
On the other hand, as the real exchange rate was depre-ciating gradually following the crisis, real interest rates stayed high for long, thus adversely affecting investment and output. It is then tempting to assume that if a country had decided to devalue, the current output and employment would not have fall as much as they did in 1995. However, is it a possible outcome? Firstly, it should be remembered that when the crisis hit, it aggravated the already existing problems in the banking sector, and in the whole economy in general. As the experience of some of the East Asian countries indicate, devaluation does not have to be an immediate remedy, when the real-economy problems lie in the lack of transparency of the banking and enterprise sec-tor, even when domestic financial market is relatively well developed. There is also a problem of an initial overshoot-ing. And output may fall as well in such situation. Secondly, Argentine GDP started to rise during the year following the crisis, and its growth rate has been impressive. It should be remembered, that the Argentine economy has been grow-ing, on average, by 4.7% during the period 1991–1999 notwithstanding two recessions [Pou, 2000].
To sum up, it is hard to believe that the Argentine eco-nomic performance would have been better if the authori-ties devalued the currency in 1995. The credibility of the anti-inflationary policy would have been destroyed and the country risk would have been much higher, indicating high-er vulnhigh-erability to subsequent exthigh-ernal shocks. Besides, there were positive changes in the Argentine banking sys-tem brought about by the crisis and by the decision to con-tinue the existing exchange rate policy. It is also doubtful, whether the real economy response would be much differ-ent than it was in 1995.
Appendix: Chronology of the Argentinian Crisis
December 1994 Devaluation of Mexican peso December 1994
-February 1995
International: growing perception about Argentina country risk by international investors;
outflow of portfolio capital; prices of the Argentine debt start falling
Domestic: shift to q uality in the banking sector (deposit portfolio reallocation towards dollar deposits and larger banks); fears that the fixed exchange rate regime may be abandoned
February 1995 BCRA (central bank) slightly changes its charter to allow more flexible use of rediscounts to aid banks
End of February 1995 Rumors that the authorities are contemplating suspending convertibility of deposits;
Full scale run on deposits 1-22 March 1995 All banks losing deposits
The authorities more actively helping banks – BCRA losing 41% of its foreign reserves, reducing the monetary base coverage by 20%
Creation of the two Fiduciary Funds to facilitate mergers and acquisitions between private banks and to facilitate privatization of small provincial banks
April 1995 Amendment in the central bank charter which allows more flexible help in providing liquidity to troubled banks in an emergency situation
March-May 1995 Agreement with IMF about significant financial support and the announcement of a new fiscal package
Deposits of largest banks stop falling
May-December 1995 BCRA rebuilds its exchange reserves and introduces new set of prudential measures Falling interest rate spreads
Mergers and acquisitions in the banking system Gradual recovery of deposits
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3.1. Introduction
The financial turmoil that erupted in Thailand in 1997 did not fit into any group of models of financial crises exist-ing in the economic literature at that time. It is just recent-ly when researches tried do develop the so-called third generation models. The Thai experience is an example which confirms that financial crises occur when macroeco-nomic as well as microecomacroeco-nomic fundamentals experience vulnerabilities.
This paper seeks to explore the country-specific factors lying behind the Thai financial crisis. It provides analysis of macroeconomic and microeconomic roots of the crisis. It shows that while macroeconomic imbalances played an important role, the close relationship among banks, corpo-rations and the government created additional problems, which resulted in many bankruptcies and led to a sharp and unexpected economic downturn. The financial crisis con-tributed to a sharp contraction in domestic demand and activity. Also, the paper describes the sequence of the crisis and its management.
Having relatively strong macroeconomic fundamentals (excluding a deteriorating current account balance, falling investments and some foreign exchange reserve indicators) the Thai authorities did not face any dramatic external shock as in the second-generation models. In Thailand, as in all Asian countries there was a boom-bust cycle in segments of the asset market (stocks, land prices, and real estate) preceding the currency crisis.
Starting from the late eighties, prudent macroeconomic policies have supported a period of rapid economic growth and price stability in Thailand. However, in recent years the combination of a fixed exchange rate (which was linked to a basket of other currencies but with a strong dominance of the U.S. dollar), an increasingly open capital account, and impres-sive economic growth, attracted short-term capital inflows.
These inflows were often channeled to over-invested sectors
due to weak prudential regulations in the banking sector enhanced by risky investments and poor corporate gover-nance [1]. The huge amount of short-term investments left the economy vulnerable to sudden shifts and external shocks.
These began to materialize in 1996 as a sudden drop in exports led to a high current account deficit. At the same time, slowing economic activity and a weakening in the financial position of banks and finance companies led to debt-servicing difficulties and an increase in non-performing loans (NPLs). Starting from May 1997, the Thai currency market was destabilized by a series of currency attacks of increasing intensity. The Thai authorities attempted to defend the baht by increasing short-term interest rates and intervention in the market. As a result, the Bank of Thailand reserves were depleted, to significant extent, and the baht depreciated sharply.
From the beginning of the crisis, economic policies have been progressively strengthened through: suspension of unlivable finance companies, expenditure cuts in the central government budget, and an increase in the central bank interest rates. Probably the most important action was a change in the Thai exchange rate regime, effective on July 2, 1997, from the so-called fixed but adjustable peg to a managed float. Building on these steps, the govern-ment developed a comprehensive medium-term econom-ic poleconom-icy package, wheconom-ich was implemented with the help of the IMF. It was focused on the stabilization of the curren-cy and strengthening of the financial system.
3.2. The Way to the Crisis
Simplifying the classification, the economic fundamentals can be divided into two broad categories: macro and micro-economic. At the onset of the crisis, macroeconomic fun-damentals in Thailand remained relatively sound and did not show many signs of vulnerability.