At his side, Economy Minister Domingo Cavallo looked weary and pale. With Argentina deep in recession and unemployment swelling, Cavallo announced yet another emergency plan–the seventh in 19 months–and the most punishing yet: $1.5 billion worth of spending cuts in the next six months. His predecessor Ricardo Lopez Murphy proposed $2 billion in cuts when he was appointed Economy minister in March. The cuts didn’t take place and were so unpopular that Lopez was deposed two weeks after taking office. Now, Cavallo said, the government would make deep cuts in salaries, pensions and payments to state contractors.
The markets sensed desperation. In Latin America, the Cavallo plan went down like a rock, battering currencies and lighting up the panels at major stock exchanges in scarlet as investors hurried to unload emerging-market liabilities. The Merval, Buenos Aires’s bourse, led the way, dropping 8.2 percent the day after Cavallo’s speech. And that was just the beginning. In neighboring Brazil, the Bovespa index sagged. Even Chile, the region’s most stable economy, and Mexico, currently in its finest hour, took a hit, with stocks, bonds and currencies all falling. The ripples touched nearly every world market, from the Dax to the Dow.
Argentina, the onetime darling of foreign investors, whose economy grew a bullish 45 percent in the first half of the ’90s, has become the continent’s liability. With a $130 billion foreign debt, and mired in the 37th straight month of recession (Cavallo now talks of “depression”), the country is in agony. Foreign investment has vanished. The dollar-anchored economy has priced many goods, such as cars and shoes, out of the market. And last week Argentina’s country risk soared to a staggering 1,650 points–just above Nigeria’s.
Officials vowed that they will not fiddle with the currency board, which backs every peso with a greenback. But just in case, nervous depositors descended on banks Thursday only to find many had run out of dollars.
Latin Americans, for all their different ways and woes, have long shared an abiding faith: come what may, God is on their side. That belief endured even in the punishing ’90s, when financial turmoil inflicted pain from Mexico City to Sao Paulo. Now the faith of even the most ardent believers is wavering. For months Argentina had been flirting with disaster. It came within an inch again last week. Was Latin America’s third largest economy heading for default? And how far would the contagion–dubbed the “Tango effect” –spread? “God is Argentine,” says Health Minister Hector Lombardo. “But he is exhausted.”
What went wrong? The short answer, it seems, is that Argentina had long been living on borrowed time. In his 19 months in power, the hapless de la Rua has tried just about everything. Two Economy ministers have come and gone. De la Rua has raised taxes to plug holes in national accounts and hoisted interest rates again and again to prevent creditors from bolting and to keep the money-go-round turning. As a trump card, last month he brought back Cavallo, the cocksure Economy minister whose currency board–which fastened the peso solidly to the dollar–had saved the country from ruinous hyperinflation in 1991.
For just a moment, Cavallo looked as if he might do it again. He had the drive, a granite ego and plenty of political cachet–everything that the fumbling de la Rua lacked. He took to the skies in his quest for allies and credit for Argentina, only to appear fresh and sharp-eyed for cabinet meetings the next day in Buenos Aires. “He seemed like a candidate for Iron Man,” says financial analyst and former Brazilian Finance minister Mailson da Nobrega. Just last month Cavallo returned from a road trip to Europe, where he had bought some time by persuading Argentina’s creditors to swap $29 billion in outstanding bonds for paper with longer maturities. But it was a desperate play, because he managed to bring investors on board by sugaring the pill with interest rates equivalent to a hefty 15 percent.
It was heroic, but it wasn’t enough. The national budget is bloated, with a lot of money siphoned off into pork-barrel politics and to fund political parties, and persistent provincial deficits have ballooned. The ruling political alliance is in tatters and de la Rua is hemorrhaging credibility. “[Cavallo] has run out of tricks,” says Nobrega. “The crisis in Argentina has become a permanent crisis.”
Many analysts fear it won’t end in Argentina. From Taipei to Pretoria, emerging markets watched wearily last week. Many have problems so dire that a Tango effect would push them over the brink. In Taiwan, for instance, homegrown economic and political problems sent the currency to a 14-year low against the dollar last week, while the stock market reached depths not seen since August 1995, when China lobbed missiles in the direction of the island. Southeast Asia and South Korea could find themselves in similar straits as investors flee all emerging markets. The Philippines and Indonesia are most vulnerable. Lorenzo Lichauco, chief representative of HSBC Securities (Philippines), said Manila’s plan to float new government bonds was at risk: “Any capital-raising exercise by government will be more expensive. Philippine debt papers will go down. Yields will move up.” Ramon Isberto, spokesman for Philippine Long Distance Telephone, was more succinct: “The market sucks.”
You don’t have to tell that to Latin Americans. Argentina’s neighbor to the west, Chile, is already showing signs of being infected. Almost 15 percent of Chile’s exports go to Argentina, and many Chilean firms have invested massively there. In recent weeks the Chilean peso has depreciated rapidly; since the eruption of the Argentine crisis it has lost almost 15 percent of its value. Growth prospects have declined to less than 4 percent in 2001, and the rate of unemployment has remained stubbornly high.
Of course, Brazil has been hardest hit. Last week marked the seventh year of the real plan, the bold economic reform that launched Brazil’s strong currency and ended inflation. But no one was celebrating. Ever since Argentina’s economy began to slide late last year, businesses and investors have made a run on dollars. As a result, the real has lost 31 percent on the year. To combat the rising dollar, Brasilia has tried to saturate the market with greenbacks and boost interest rates to scorching levels (26 percent for one-year futures). But the higher interest rates are bitter medicine, driving up the cost of public-sector debt, slowing the economy and pushing prices upward. Some skeptics even speculate that Brazil–also in the grip of a nationwide energy crisis–is the next candidate for an even greater bout of contagion. “Argentina today is Brazil tomorrow,” says Lawrence Pih, a wheat importer who has felt the impact of a weakening currency.
But Argentina is still the most unstable domino. Many analysts say the question is not if, but when the country will run out of options and default on its debt payments. “I’m surprised it hasn’t happened already,” says Eduardo Giannetti, a respected Brazilian economist. In this most pessimistic scenario, default will lead to devaluation. Since the banking system is backed by government bonds, it would collapse. With the vast majority of the country’s commercial and personal loans denominated in dollars, while most people’s income is in pesos, there would be massive bankruptcies from devaluation alone, even before you add in the effect of the bank collapse. In short: widespread economic conflagration–carnage far bloodier than Brazil’s 1999 devaluation. A better comparison would be to Argentina’s last serious economic collapse, in 1982, from which it took almost a decade to recover.
One possible solution is an eleventh-hour political union, where crisis galvanizes foes into allies–at least until the October elections. The threat of financial meltdown did seem to concentrate the minds of Argentina’s fractious political class. By the weekend de la Rua appeared to have achieved broad political backing, including support from the leader of his party, former president Raul Alfonsin. Economic consultant Artemio Lopez of Fundacion Equis was unimpressed, pointing out that Alfonsin, who had to abandon his presidency five months early in 1989 in the midst of economic turmoil, has “zero credibility” with the public: “How weak is this package if it depends on the support of Alfonsin?”
Still, it’s a promising start. Though the opposition Peronists have yet to ink a deal with de la Rua, they met with him Friday and suggested they would back the austerity plan. They, like the ruling Alliance coalition’s Radicals faction, led by Alfonsin, would prefer to see the spending cuts come from something other than wage and pension reductions. Now the formidable political task for de la Rua will be getting the opposition–and his own party–to stay the course once the draconian cuts start to take effect. Equally daunting will be getting the spendthrift provinces, mainly controlled by the Peronists, to go along. Says Abel Viglione, economist at liberal-leaning think tank FIEL, “The economic problem is not grave. It is a strictly political problem.”
If de la Rua can solve the political puzzle, then, under Cavallo’s plan, the cuts will mop up the red ink, impose less pain on Argentines than a default would, stop the country’s slide and restart tepid growth. But analysts point out that the latest measures do nothing to deal with inefficient state spending and a regressive tax system, both created by a political and economic elite more interested in protecting its own vested interests than the wider good of the country.
Skeptics add that even if the latest crisis forces the politicians to unite long enough to pull Argentina out of its nose-dive, they are unlikely to do enough to prevent another crisis a few months from now. The greatest hope is to limp to congressional elections in October. The vote will probably deal a fatal blow to the weak Alliance government and shake up the political scene. Though it’s impossible to say who will land on top, optimists hope the changeover will lead to a government, perhaps including Cavallo as vice president, dedicated to more coherent economic management.
Argentina’s fate will weigh heavily on emerging markets and especially Latin America. But the world has also learned something since Mexico, circa 1995, and the beginning of the era of contagion. Today’s investors are less exposed, better hedged and better versed on the morning after in a submerging market. In fact, a growing body of opinion in the region says the sooner Argentina devalues, the better. “An acute, deep crisis is far better than long-drawn-out agony,” says economist Giannetti of Brazil.
Washington is willing to watch and wait. The Bush administration has shown no appetite for financial-crisis management. Treasury Secretary Paul O’Neill has made no secret of his distaste for former president Bill Clinton’s IMF-style rescue schemes. George W. Bush sent a note of support to de la Rua last week, and U.S. national-security adviser Condoleezza Rice said Argentina should stay the course of IMF discipline.
In Buenos Aires, the mood, while still gloomy, had brightened slightly by the weekend, with the Merval posting its first gain in days (5.6 percent) and investment bank Bear Stearns placing a “buy” recommendation on Argentine bonds. While disaster was still in the air, some analysts believed that the sheer fear of default would force politicians to make the sacrifices to put public finances back in order–at least for now.
