Here comes that familiar failing as fears of a currency crisis resurface
On Wednesday, protests brought the streets outside congress in Buenos Aires to a virtual standstill. “People were unhappy about the rises in utility prices and public transport,” says Joe Foley. “They were trying to get them overturned.”
Once a resident of Preston, near Manchester, Foley now works for the city’s tourist board and has lived in Latin America’s third largest economy for over seven years.
“It’s amazing how the atmosphere can change in just a few weeks,” he says. People were feeling quietly optimistic about the economy just a month ago, Foley explains. But the country’s plea for financial support from the International Monetary Fund, the global lender of last resort, has revived old fears.
Inflation is once again getting out of hand. It has triggered a sudden outflow of money from the country as investors lose heart. On May 4, the central bank responded by raising interest rates to 40pc. It was the third hike in a week.
Argentines are used to high inflation. When they nip out to get a pint of milk they, and the farmers producing it, know it will most likely be worth about a dollar.
In the past few years, a rate of well over 20pc has become normal. But these rules of thumb are no longer holding. The currency devaluation threatens to become a mini crisis.
The emerging market’s currency has lost close to 20pc of its value against the US dollar this year, with a dollar now worth close to 23 pesos. Mexico, 1994 Also known as the “Tequila Crisis”, the Mexican peso lost 15pc of its value overnight, and triggered a classic example of capital flight. Trade liberalisation
Russia, 1998 Contagion effects from the Asian crisis and poor economic management caused a collapse in confidence. Annual yields on ruble denominated bonds hit led to an influx of inward foreign investment, mostly via highly liquid stocks and bonds. GDP shrank by 6.2pc, short-term interest rates reached 71.5pc. It required a $50bn IMF bail-out.
200pc as debt repayments were funded by selling off foreign exchange reserves. This added to ruble weakness and led to mass debt defaults. The ruble was floated and output fell by 4.9pc. The milk is getting pricier, fast. Efforts from the government, led by President Mauricio Macri, aim to wean the country off highly subsidised rates for public transport and gas. Upping train tickets by close to 35pc has also had a complicating effect on inflation.
Another gamble has been Argentina’s 100-year bond. It was a much vaunted way to attract foreign investment under Macri’s more market-palatable regime of economic reform – led by slashing public spending and setting an inflation target of 15pc. It reached 105pc of its face value late last year. Despite Macri’s best efforts, it is now trading closer to 85pc.
There are now growing concerns over an overheating US economy. The massive Trump regime tax cuts could cause problems for other emerging markets. Quicker-than-hoped interest rate hikes from the US Federal Reserve are often bad news for some emerging markets which, as Argentina does, still hold substantial amounts of debt in dollars and may not have much by way of foreign currency reserves.
In Argentina, this effect has been enough to scare many investors into moving their money elsewhere, triggering capital outflows.
Argentina is not alone among emerging markets in seeing inflation ramp up as fears of interest rate hikes have spooked markets.
There’s a significant difference in the approaches of governments, however.
While Argentina has hiked rates, Turkey’s president, Tayyip Erdogan, describes himself as an “enemy of interest rates”, dashing hopes that the Turkish central bank might assert its Asia, 1997 The “Asian Flu” followed a gold rush of investment into emerging markets. Bad loans, a hike in US interest rates and then investors suddenly pulling out of markets
Argentina, 2001 Negative growth from 1998 was compounded by government overspending, and other currency crises upped borrowing costs. A perfect storm of currency, sovereign debt including Indonesia and South Korea, scarred City memories. Faith fell in each country and the dollar rose 87pc against a basket of Asian currencies. Markets took a record bashing.
and banking crises began. Spreads between US and Argentine government bonds reached 5,000 basis points. The IMF cut off funds and 24 people died in protests. The nation defaulted. independence. There were signs that as the lira lost 13pc of its value and touched a new record low against the dollar, Erdogan might have begun to face the reality of inflationary pressures.
He called a crisis meeting on Wednesday with key economic advisers but that brought only a vague statement about bringing the forces of inflation and interest rates into line.
Unlike Erdogan who has his sights on re-election, Macri has acted swiftly, crossing what many in Latin America regard as a political Rubicon.
After hiking interest rates, he turned to the International Monetary Fund for support.
Funding is expected to come in the form of a standby arrangement, which has stricter lending conditions, but allows for greater sums and lending periods than the flexible credit line that was originally mooted.
The IMF is a bogeyman in Argentina. Macri’s move may well calm markets and investors, but it will threaten his political support.
The economic crisis of 2001 was devastating, ravaging the prosperity of even middle class workers, as the vast injection of IMF sums failed to be matched by sound management.
It is widely accepted that the cause of the crisis was the decision to peg the peso to the dollar, in what was termed the convertibility regime.
In 2001, the IMF pulled the plug and the country went bust. It has since issued hand-wringing mea culpa papers on what went wrong.
But the legacy of the Argentinian default is still fresh in the minds of its people.
With the capital markets closed, liquidity must come from the IMF again, explains Martin Castellano of the Institute of International Finance.
Argentina is short on reserves and lacks the flexible lines of credit granted to the better established economy of Mexico or the sovereign fund of Chile, says Castellano, who spent a decade at Argentina’s central bank from 1999 to 2010.
“Compared to 2001 I think it’s a totally different scenario,” he says. The fundamental difference is that the financial sector in Argentina now mostly operates in pesos.
“In 2001, it was a dollarised system, with 80pc of the mortgage market operating in dollars. Now the system works mostly in pesos,” Castellano says.
Macri is also considered to be a credible leader of an economically sound regime by many investors.
Alberto Ramos of Goldman Sachs believes that negotiating an IMF programme was the right policy move.
“It will likely allow the authorities to continue down a path of gradual fiscal adjustment without being exposed to shocks to external funding conditions,” he says. Other big capital is no longer flowing as quickly to some of these economies, people start to focus on the next structural components such as a current account deficit and start to take fright.”
Mcdonagh sees, as other observers, a marked distinction between Argentina and Turkey.
Where Erdogan’s policies have amplified risks, Macri has tried to address them.
Mcdonagh said: “The institutional quality in Turkey is not as high as it was back then [in the 2000s].”
Old rules, where a stronger dollar weakened currencies in emerging markets, still apply to an extent, but fundamental differences matter.
Investors with long-term interests in emerging markets are more likely to keep faith if administrations are prepared to put their populations through short-term discomfort, economists argue.
The struggles in Argentina and Turkey may have killed some of the buzz in emerging markets, but it is not a widespread crisis – yet.
“It is different [in Argentina] this time,” Castellano says.
“There is now a broader set of instruments to provide stability to the market.
“But the political opposition will make Macri pay a significant price as a result of reaching out to the IMF.”
Emerging market strife A history of turmoil
The Turkish lira, left, has plunged in value against the dollar this year; main, attempts at economic reform in Argentina have led to protests in Buenos Aires