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What Will Devaluation Bring to Argentina? - 2002-01-03


Argentina's new President, Eduardo Duhalde, is poised to devalue the Argentine currency by up to 40 percent as part of a broader policy to lift the South American nation out of its economic crisis. How Mr. Duhalde handles the devaluation may be key to his ability to stay in power, given the widespread unrest over the economic situation which forced out two presidents in the past few weeks.

The people standing outside a Bank of Boston branch in the Buenos Aires neighborhood of Recoleta seem resigned to the impending devaluation.

For merchant Gloria Fernandez, there seems to be no other solution to Argentina's economic crisis, but to devalue the peso. She said, "There is no other way out because the country can not afford to keep the current rate, so unfortunately we have to wait and see what happens." She went on to say the devaluation would hurt many, especially those who have to repay their loans in dollars.

Others are hoping President Duhalde will make good on the promise he made Sunday when he was elected by Congress. In his acceptance speech, he pledged that those who have their bank deposits in dollars would get their dollars back, while those who have peso deposits will get pesos. This pledge was addressed to Argentines who have had the choice of opening their savings accounts in dollars or in pesos, but who now fear the banks do not have enough dollars to back up their withdrawals.

But translator Nellie de la Maria, who also stood in line at the bank in Recoleta, remains skeptical. "Well, people were a little bit less worried because he said the money deposited would be returned," she said. "But others, they doubt it." And she doubts it too.

Since 1991, the Argentine peso has been pegged by law one-to-one to the U.S. dollar, with each peso backed by sufficient dollar reserves in the Argentine Treasury. The peso convertibility regime was introduced by then-President Carlos Menem and Economy Minister Domingo Cavallo as a way to end rampant hyperinflation that had made the currency almost worthless. Fixing the peso's parity with the dollar restored monetary stability and promoted economic growth.

Despite the peso's stability, many contracts in Argentina were made in dollars. Most rents, mortgages, business loans and other transactions were made in dollars, but paid back in pesos.

The system worked well for years. But as Argentina began to borrow more money abroad, and a recession that began in 1998 began to deepen the peso convertibility regime became increasingly unsustainable. The peso's high value also made Argentine goods more expensive abroad, contributing to the decline in production.

Now, with Argentina's dollar reserves dwindling while its public debt rises, the peso has become vulnerable and overvalued. Former President Fernando de la Rua, who was driven to resign in late December by widespread unrest over his economic policies, resisted devaluing the currency during his two-years in office. Political analyst Paula Montoya says the new president appears to have no choice.

"I think we will go to a devaluation," she said. "Reading today's newspapers you can see what we will have. People do not like that but I think it will occur anyway because the economic situation is asking for that. The thing is that we do not know what the plan will do, if we keep pesos and dollars, if the one-to-one becomes 1.30-to-one."

The Duhalde government is expected to unveil its plan to devalue the currency on Friday, and then introduce the measure to Congress as part of a wider economic package aimed at easing the crisis. Congress has to first overturn the convertibility law that pegs the peso-one-to-one to the dollar. The Duhalde government is reported to be considering a 30 to 40 percent devaluation, and keeping the peso at that rate for the next six-months.

This would give it time to obtain more loans from the international financial community, after which the government might allow the peso to float on international markets to find its true value. Economists say what Argentina wants to avoid is hyperinflation, which happens when money becomes worthless - a situation that Argentina experienced in the 1980s.

But some economists say even a devaluation will not help Argentina overcome its economic crisis.

According to economic consultant Jose Luis Espert, Argentina failed to really implement a free market system, cut government spending sufficiently or otherwise take measures to create a sound economy. For these reasons, Mr. Espert says a devaluation will accomplish little.

"Some people think that we need only some kind of devaluation to begin to grow," notes Mr. Espert. "No, I think the crisis is much deeper. I am totally convinced that this crisis is the deepest crisis in our history."

The impending devaluation will cause pain throughout the economy, potentially bankrupting many businesses with dollar debts and making it harder for individuals to repay dollar-denominated loans. Prices for goods and services also are expected to rise.

The consequences of this are unforeseen. But political analyst Rosendo Fraga thinks devaluations always have a negative impact on Latin American presidents.

"The political and social costs of a devaluation are very high in Latin America," said Mr. Fraga. "Ex-President Zedillo in Mexico in 1994 saw his popularity plummet when he devalued, so did President Fernando Henrique Cardoso in Brazil in 1999. Mr. Fraga went on to say in this case Mr. Duhalde will pay even a higher cost in terms of public support, given he only has a two-year term and little popularity to begin with."

Mr. Duhalde and his advisors appear to be well aware of the dangers, especially since the events of recent weeks have shown how Argentines impatient for solutions can bring down presidents. The new government is likely to proceed as carefully as possible, while at the same time appealing for help from the international financial community.

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