“The Argentine Business
Environment: Roots of the crisis”
Fernando Cerioni
Argentina prior to 1990
• 1930’s: Argentina economy based on
agricultural expansion
• 1955-1990: Turbulent political, “Stop and Go”
policies, usually contradicting each other
• Government financed budget deficit w/ the
Central Bank  long periods of inflation &
hyperinflation
• “Economic Neo-liberalism” policy in early 90s
Economic Neo-liberalism in Argentina
• New government in place (Menem 1989)
– Follow example of Chile, Mexico and South East Asian
countries  liberalization
– “Convertibility law”: peg Peso to US Dollar. Dollar
backed by reserves at Central Bank. No emission of
peso unless backed by dollars in reserve.
– This would succeed if peso becomes competitive and
helps generate Exports > Imports  and use earnings to
pay foreign debt
Market-oriented plan
• Cavallo’s plan
– High exch rate  Arg products too expensive.
Could be solved if Productivity  > Wages  
Arg prices go down
– Productivity   Arg products competitive & keep
confidence in peso  preventing inflation 
“float” peso when it is undervalued  peso
raises at end of “Peg”  boost to price stability
Argentina 1990 - 2002
• Phase 1 (1990-1995):
– Urgent need to end hyperinflation
• Convertibility Plan created (Cavallo)  Fixed Exchange rate
(“Peg”)
• Massive privatizations & Import tariffs lowered
• Deregulation of economic activities (like mining)
– Initial success (yearly inflation from 3000+% in 1989 to
single digit in 1994)
– Growth achieved 7+ % from 1991-1994
– Benefited
• Ext investors, Local corporative groups and Banking sector
• Middle & lower classes  wages 
– Non-benefited
• Export sector (Exch rate too high, less protection)
• Industrial sector (more competition)
Argentina 1990 - 2002
• Phase 2 (1995-1997):
– Wages  kept prod costs high  Imports > Exports 
Arg competitiveness 
– Terms of trade against Arg: Export prices  relative to
imports
– External shock: Mexico crisis
– Budget deficit mainly due to provinces’ expenditures
– If foreign investor wanted to Convert Pesos to Dollars…
• Central Bank shrinks Money Supply  r  sharply  people
keep Pesos
• But, high r  weaken domestic demand  Wages & Prices 
• But government was not willing to sharply raise r , Wages &
Prices not falling as much as needed  CA deficit remains 
Investors loose confidence in long term Exch Rate
Argentina 1990 - 2002
• Phase 3 (1997-2001):
– External shock: Brazil crisis (Sharp ‘Real’ devaluation)
– 1999: New elected president (De LaRua), radical party
(opposed to previous Menem)
– Despites 15% unemployment rate, Unions resisted
wages decline  no decline in production costs 
competitiveness did not improve
– Arg economy enters in recession
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Lack of growth
Worsened debt issue
Less resources for socially active policies
Loss of confidence in new government
– IMF brings in more loans (~ 19 B for 2000-2003 period)
Argentina 1990 - 2002
• Phase 4 (2001-2002):
– Two key issues still not resolved:
• Fiscal policy adjustments (too rigid)
• Public debt
– Provincial budget deficits did not improve, and required
external capital flows
– Debt continued to grow  Int rate paid by Arg grew 
further imbalance increase  Foreign Debt Growth
– Argentina defaults on $155 B of Central and provincial
debt in December 2001
– IMF brings another loan to boost confidence, but not
enough
– Argentina’s Peso devaluates sharply in January 2002
(from 1 to 1  peaks of 4 to 1 during 2002).
Argentina 1990 - 2002
• Why not devaluate earlier (before default)?
– Fear that breaking the 1-to-1 (thus, devaluating the
peso) would bring high inflation rates again
– Many Argentine people and businesses had a huge debt
in dollars  Devaluation would bring massive
bankruptcies  ripple effect in provinces (which also
had dollar-denominated debts to foreign creditors)
– Hope that situation may improve over time. If US dollar
declines against Yen and Euro (due to large trade
deficits), Arg products would become more competitive.
But, US dollar strengthened in the period 200-2001.
– IMF continued bringing money (loans) and encouraged
Arg to continue with fixed exchange rate (IMF believed in
a fixed exch rate as a viable long-term economic policy)
The Convertibility Program
• Accomplishments:
– Convertibility  Prices stability
– High growth rates: GDP grew 8% yearly in 1991-1995
and 6% in 1996-1998
– Opening of country’s economy:
• Imports grew dramatically: US$ 4.2B in 1990  US$ 21.7B in
1994  US$31.4B in 1998
• Exports also grew: 65% between 1994-1998
• High int rates (low in the US) + privatization  Capital inflow 
Foreign Exchange reserves 
– Massive privatizations  helped to reduce deficit in
public sector  $14.2 B received in 1991-1996
The Convertibility Program
• Missteps:
– Sharp increase in Indebtedness level:
• Govmt to finance budget deficit thru issuance of debt (domestic
& international) in foreign currency (debt servicing as % of total
govm’t expend: 6.6% in 1993  14% in 1999)
• Privatizations income not enough to cover growing public deficit
 increase in public debt (29.5% GDP in 1993  50.3% in
1999)
– Fiscal adjustment
• Government sustained itself thru borrowing (thanks to low
inflation and high growth rates)
• Govmt real expenditures grew 19.3% in 1993-1999; Revenues
declined 4.3% and GDP grew 10.8% in same period
– Privatizations
• Resulted in concentration of productive assets
• Increase in relative prices (consumer expenditure)
The Convertibility Program
• Missteps (continued):
– Needed market reforms not done:
• Reduce provinces deficit
• Deregulate labor market
– High unemployment: 6.5% (1989)  17.5% (1995) 
15% (2000)
• Layoffs in productive sector
• Increase in labor costs
• Very high taxes on wages (40+% average)
– Uneven income distribution:
• Labor rigidities + increased competition in labor market + laborsaving investments  unskilled workers suffered
• Real wages began to decline in 1995 (but unequally, affecting
the lower income sector much harder)
Effect of external shocks in
Convertibility Program
• Four external crisis affected Convertibility program
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Mexico crisis in 1995 (“Tequila effect”)
Asian crisis in 1997
Russian crisis in 1998
Brazilian crisis in 1999
• Mexico crisis
• Liquidity crisis in Arg affected banking sector  credit crunch
• Interest rates grew dramatically
• Unemployment rose to 17.5%, Poverty rate to 22.6%, Industrial
production declined 11%
• GDP decreased 5%, but recovered to 8.1% by 1998
• Asian & Russian crisis
• No effect over banking system (like Tequila did)
• Sharp increase in Interest rate, to keep capitals in country
• Slowed the economy down
Effect of external shocks in
Convertibility Program (cont’d)
• Brazilian crisis
• Brazil devaluates their currency (the “Real”)
• Severe impact on Arg economic growth  30% of
exports went to Brazil
• Simultaneous appreciation of US Dollar relative to
Euro & Yen
• Caused Arg competitiveness to decrease
• GDP decreased by 3.4% in 1999
• Due to lack of economic growth  growth of debt
service becomes a serious issue
Summary – Lessons learned
• Argentina’s Convertibility Plan brought price stability and
growth, but lack of fiscal adjustment played against it
• Some economists consider the Currency board the cause of
all issues  Arg should ‘float’ the Exch rate
• High growth of indebtedness fueled by price stability, opening
of the economy, privatizations and incentives for foreign
investments
• High indebtedness in dollars is very risky. Portfolio equity
investments and direct investments in P&E do not have this
issue
• Economy liberalization, privatizations and incoming foreign
investment are desirable policies.
• Argentina needs policies to “cushion” financial shocks, ample
international reserves, and more diversified export base