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AYUSH GUPTA(1520408)
CHETAN R. BAGRI(1520410)

Case Study: Argentina Currency Crisis

During the 1980s, the Argentina economy was characterized by hyperinflation,
international indebtedness and debt defaults, and recessions. In the early 1990s,
the Argentina government introduced a series of economic and monetary reforms,
including fixing the Argentina peso to the U.S. dollar at a rate of 1 to 1. Under this
arrangement, Argentina could only print pesos if it had U.S. dollar backings (note:
this monetary arrangement is referred to as a currency board).
Under this currency board arrangement, Argentina was only able to expand the
peso portion of its money supply in relation to its net inflows of U.S. dollars
(resulting from trade growth). The policys impact on inflation was almost
immediate; the inflation rate went from 2,300% in 1990 to 25% in 1992 and to less
than one percent b y 1996 (see exhibit 1).
The Argentina economy, however, did not fare as well. The restrictive currency
board policy resulted in rising unemployment (up to 16% in 1996) and slow
economy growth (recessions in 1995 and 1999-2000).
As part of the 1991 reforms, the Argentina government permitted residents to hold
their money deposits in banks in either pesos or U.S. dollars. This was seen as
promoting confidence and discipline in the banking and political system.
However, the recession which began in 1999 proved to be the demise of the
currency board and the exchange rate regime. The recession which lasted
through 2001, resulted in massive government deficits and a general perception
that the peso had become overvalued (recall the fixed rate was 1 to 1).
As economic conditions continued to deteriorate and as the pesos worth become
more and more uncertain, a massive conversion of pesos into U.S. dollars within
the Argentina economy began; eventually leading to capital flight out of the country
itself. The government responded by closing all banks on December 1, 2001 and
then limiting the withdrawal of funds from banks and the conversion of pesos into
The social repercussions of the governments response were dramatic. Riots took
place in the streets of Buenos Aires in December. The President, Fernando de la
Rua was driven from office and his successor, Adolfo Rodriguez Saa, was also
forced out of office after one week on the job.
Saa was succeeded by Eduardo Duhalde, who on Sunday, January 6, 2002, in his
first act of presidency, devalued the peso from Ps1/1$ to Ps1.40/1$. The markets
were not impressed with this new rate and on Monday, February 11, 2002, the
Argentina government moved to a floating rate regime. Over the course of time,

the peso began a period of depreciation, eventually settling around 3.5 (see exhibit
Exhibit 1: Inflation in Argentina, 1980 - 2001

Exhibit 2: Peso Exchange Rate, January 2001 December 2002

Argentina was rated as one of the worlds 10 richest countries in the beginning of the
twentieth century. But in 1980s inflation plagued the country and as a result
Argentina lost trust in the peso and invested in U.S. dollars and shipping their capital
abroad. To solve this carols Menem in 1989 took control of the country and set out to
implement free market reform and to restructure monetary and economic policies
.He tightened fiscal management and also established the convertibility law which
pegged the Argentine peso 1:1 with the U.S. dollar, but the governments ability to
respond to external shocks was severely reduced. In effect, Argentinas exchangerate and monetary policies were determined de facto by the United States, and
Argentinas interest rates were determined by the U.S. Federal Reserve. When world
commodity prices declined, the U.S. dollar, and hence the Argentine peso,
strengthened against other currencies. Concurrently, Argentinas main trading
partner, Brazil, devalued its currency. As deflation set in, both the Argentine
government and many private companies found it difficult to pay their debts. Tax
revenues fell, while public spending increased. Interest rates payments went
primarily to overseas investors, thus further draining the economy. When Argentine
banks were pressured to buy government bonds, a bank run ensued. Following the
governments default on its debt, the currency board was abandoned, and the peso
was allowed to float against the dollar. In the latter half of 2002, the Argentine peso
was trading at about 27 cents to the dollar.

1) What has been Argentinas experience with the IMF? Has the IMF been
helpful or not?
Argentina has had a somewhat tumultuous relationship with the IMF. Initially when
the country sought help from the IMF, the IMF refused saying that Argentina would
have to restructure its banking system, fiscal policy, and exchange rate policy.
Eventually the IMF did grant loans to Argentina, but then was difficult to negotiate
with when Argentina had trouble repaying those loans. Argentina allow to pay
interest only on $ 21 billion debt over the next three years to repay most of the debt,
including overdue interest, Argentina proposed a plan to its creditors asking them to
write off 70 percent of the present net value of their government bonds .The IMF
and Argentina did finally agree to terms, this way Argentina closed on the biggest
debt restructuring in history with the help of IMF however, both are working to
establish a long term relationship.
2) How has the fall in the value of the peso affected business opportunities for

doing business in Argentina and in exporting and importing?

The biggest effect of the fall in the value of the peso for companies doing business in
Argentina was hyperinflation. The central bank printed pesos to keep banks solvent
but this led to increase inflation. Also, companies with dollar denominated debt were
badly hurt as the cost to repay that debt escalated rapidly. In 2003 new president of
Argentina nester Kirchner economy of Argentina rebounded significantly the country
experience hyperinflation after the abandonment of the pesos peg to the dollar; the
devaluated peso is now one of the causes of the economy recovery. The pesos were
trading at 0.9920 pesos per dollar on December 31, 2001, but it fell to 3.39 pesos on

December 31, 2002. Next few years the peso is nearly 70% cheaper against the
dollar than it was in the 1990s, resulting in increased exports of farm product and
other commodities. The devaluation has also resulted in new foreign direct
investment and increased business with Brazil. The declining peso helped exporters
to be more competitive but made the prices of imported goods increase faster than
the prices of domestic goods.

3) Should HSBC invest more money in its operations in Argentina? What

factors should they monitor as they make their decision?
HSBC should continue to be cautious in its approach to increased investment in
Argentina HSBC is one of the top banks in the world in foreign-exchange trading in
1998 HSBC entered in Argentina .in their first year of operation the bank had loss of
$13 million but earned a profit of $67 million in 1999 and expected profits to
continue growing at 100 percent but due to the depreciation of the peso in Argentina
HSBC forced to rethink loans and to decide if the political and economic instability
of the country was worth the risk of continued operations. Although the situation
appears to be stabilized, it is still potentially volatile. The company should monitor
the governments actions carefully, particularly its actions regarding the repayment
of foreign debt. Also, if the government requires that dollar denominated loans
issued by HSBC and other banks in the past be allowed to be repaid in Pesos, HSBC
should be very reluctant to issue any more dollar denominated loans. After suffering
a $210 million loss in 2002, the Argentina subsidiary of HSBC recorded profit of
$48 and$156 million in 2003 and 2004, respectively.