With or without the IMF? Economic Recovery after Devaluation in Argentina and Brazil
Andres Gallo
University of NorthFlorida
Abstract
The recent economic experiences of Argentina and Brazilare quite similar and different at the same time. Both countries had to devalue (Brazil in 1999 and Argentina in 2002), a party, or coalition, from the center-left came into power, social conditions were deteriorating, and foreign debt problems were mounting. Nonetheless, the policy choices in the aftermath of the devaluation were different. While Brazil opted for a market friendly approach to reestablish confidence in the economy, Argentina declared default and contradicted IMF’s recommendations. This paper compares the experience of both countries in regards of which had the best strategy for recovery. The economic performances show that both countries recovered in a similar fashion, underscoring the need of the IMF to help on the recovery.
Introduction
The recent experience of the IMF in Latin America is far for promising. The failure of Argentina’s economic program in 2001 represented a hard blow to the effectiveness of the International Monetary Fund’s (IMF) rescue policies and diminished the institution’s support among both developing and developed countries. In many instances,Dr.Baer analyzed the relationship of Brazil and other Latin American countries with the IMF and other international institutions (Amann and Baer, 2005; Baer, et. al., 2002, Baer, 2001, Amann and Baer, 2000). One of his main concerns is how countries deal with IMF’s proposed policies and how many degrees of freedom governments have. This paper is an attempt to evaluate how much a country needs the IMF. The recent experience of devaluation and recovery of Argentina and Brazil offers an interesting case of analysis. After the devaluation in 1999 Brazil pursued an economic policy closely monitored and supported by the IMF, while Argentina, after the crisis of 2001-2002 pursued a more independent policy that, in many cases, opposed the IMF’s recommendation. This paper compares the performance of both countries and compares the benefits of whether or not to pursue an IMF recipe to get out of a balance of payment crisis. As it shows, following the IMF recipe is not guarantee for either success or failure.
Crisis and Recovery in Argentina and Brazil
In the late 1990s and early 2000s Brazil and Argentina went through economic crises and devaluation. Both countries came from fixed exchange rate regimes, although the Convertibility program implied a higher degree of economic, and political, compromise to the fixed exchange rate (Baer, et. al., 2002). In the end, the inconsistencies of these regimes, the contagion from the Russian and Korean crises, and the inability to generate economic growth forced a devaluation and abandonment of such policies. Even though the economic crisis was severe in both countries, the Brazilian economy was able to react in a better fashion to the devaluation, while the Argentine economy underwent the most serious economic depression of its history (Table 1). In Brazil the economy came to a stop in 1998 and 1999 (close to zero GDP growth) but quickly recovered after the devaluation (Amann and Baer, 2003). On the Other hand, Argentina went through a deep recession from 1999 to 2001, but the devaluation could not stop the economic debacle. As a result, the economy dropped by 18.4% from 1999 to 2002 (Gallo, et. al., 2006). Brazil transitioned to a floating exchange rate without major shocks on the economy, but Argentina went through rough times, which involved the default of government debt, the pesification of all contracts in the economy, bankruptcy of the banking system, and borderline maxi-devaluation cum hyperinflation before the government was able to restore some macroeconomic stability (Gallo, et. al., 2006). As the data show, the impact of the economic crisis and the devaluation was stronger in Argentina than Brazil.
Many studies addressed the reasons for the economic crisis and weaknesses of the economic models in each country (Corrales, 2002; Fraga, 2000, Amann and Baer, 2002; Manzaetti, 2002; Boinet, et. al., 2005; Dominguez and Tesar, 2005; Calvo and Talvi, 2005; Alvarez Plata and Schrooten, 2004; Goretti, 2005; Buscaglia, 2004). Even though the debate is far from closed, this paper concentrates on the aftermath of the crisis and which strategies both countries followed to be able to restart economic growth.
Table 1
Brazil Economic IndicatorsGDP Real Growth / GDP per Capita / Inflation Rate / Exchange Rate / Investment / Debt / Exports / Imports / Trade
ppp 2000 US Dollars / % GDP / % GDP / % GDP / % GDP / % GDP
1990 / -4.2 / 6,497.2 / 2947.7 / 20.1 / 25.9 / 8.2 / 6.9 / 15.2
1991 / 1 / 6,447.2 / 432.7 / 19.7 / 29.7 / 8.7 / 7.9 / 16.6
1992 / -0.5 / 6,292.5 / 951.6 / 18.9 / 33.0 / 10.9 / 8.3 / 19.2
1993 / 4.9 / 6,537.9 / 1927.9 / 0.03 / 20.8 / 32.8 / 10.5 / 9.1 / 19.6
1994 / 5.9 / 6,767.5 / 2075.8 / 0.64 / 22.1 / 27.9 / 9.5 / 9.2 / 18.7
1995 / 4.2 / 6,940.1 / 66.0 / 0.92 / 22.2 / 22.8 / 7.7 / 9.5 / 17.2
1996 / 2.7 / 7,021.1 / 15.7 / 1.01 / 20.9 / 23.4 / 7.1 / 9.2 / 16.3
1997 / 3.3 / 7,176.1 / 6.9 / 1.08 / 21.4 / 24.5 / 7.5 / 10.1 / 17.7
1998 / 0.1 / 7,099.7 / 3.2 / 1.16 / 21.1 / 30.7 / 7.3 / 9.9 / 17.2
1999 / 0.8 / 7,137.2 / 4.9 / 1.81 / 20.1 / 45.7 / 10.3 / 11.8 / 22.1
2000 / 4.4 / 7,300.8 / 7.0 / 1.83 / 21.5 / 40.4 / 10.7 / 12.2 / 22.8
2001 / 1.3 / 7,350.6 / 6.8 / 2.36 / 21.2 / 45.4 / 13.2 / 14.2 / 27.4
2002 / 1.9 / 7,393.9 / 8.4 / 2.92 / 19.7 / 50.6 / 15.5 / 13.4 / 28.9
2003 / 0.5 / 7,305.5 / 14.7 / 3.08 / 19.7 / 46.8 / 16.4 / 12.8 / 29.1
2004 / 4.9 / 7,531.3 / 6.6 / 2.93 / 21.3 / 36.8 / 18.0 / 13.4 / 31.4
2005 / 2.3 / 6.9 / 2.43
2006 / 3.5 / 4.6 / 2.18
Source: World Development Indicators (WDI), World Bank, at and Euromonitor, 2006.
Table 1 (Continuation)
Argentina Economic indicatorsGDP Real Growth / GDP per Capita / Inflation Rate / Exchange Rate / Investment / Debt / Exports / Imports / Trade
ppp 2000 US Dollars / % GDP / % GDP / % GDP / % GDP / % GDP
1990 / -1.3 / 8,998.5 / 2313.9 / 0.49 / 14.0 / 44.0 / 10.4 / 4.6 / 15.0
1991 / 10.5 / 9,864.3 / 171.6 / 0.95 / 14.6 / 34.5 / 7.7 / 6.1 / 13.7
1992 / 10.3 / 10,755.3 / 24.9 / 0.99 / 16.7 / 29.9 / 6.6 / 8.1 / 14.7
1993 / 6.3 / 11,174.3 / 10.6 / 1 / 19.1 / 27.2 / 6.9 / 9.3 / 16.2
1994 / 5.8 / 11,682.7 / 4.1 / 1 / 19.9 / 29.1 / 7.5 / 10.6 / 18.1
1995 / -2.8 / 11,254.4 / 3.3 / 1 / 17.9 / 38.2 / 9.6 / 10.1 / 19.7
1996 / 5.5 / 11,756.6 / 0.2 / 1 / 18.1 / 40.8 / 10.4 / 11.1 / 21.5
1997 / 8.1 / 12,571.2 / 0.5 / 1 / 19.4 / 43.8 / 10.5 / 12.8 / 23.3
1998 / 3.9 / 12,955.8 / 0.9 / 1 / 19.9 / 47.3 / 10.4 / 12.9 / 23.3
1999 / -3.4 / 12,400.2 / -1.1 / 1 / 18.0 / 51.4 / 9.8 / 11.5 / 21.3
2000 / -0.8 / 12,173.6 / -0.9 / 1 / 16.2 / 51.9 / 10.9 / 11.5 / 22.4
2001 / -4.4 / 11,523.2 / -1.1 / 1 / 14.2 / 57.3 / 11.5 / 10.2 / 21.7
2002 / -10.9 / 10,676.7 / 25.8 / 3.06 / 12.0 / 146.9 / 27.7 / 12.8 / 40.5
2003 / 8.8 / 11,363.9 / 13.4 / 2.9 / 15.1 / 128.2 / 25.0 / 14.2 / 39.2
2004 / 9 / 12,221.6 / 4.4 / 2.92 / 19.1 / 110.6 / 25.3 / 18.1 / 43.4
2005 / 9.2 / 9.6 / 2.9
2006 / 7.3 / 10.1 / 3
Source: World Development Indicators (WDI), World Bank, at and Euromonitor, 2006.
Post Crisis Economic Model in Brazil
In the aftermath of the crisis, the Brazilian economy faced an economic policy dilemma (Amann and Baer, 2003; Goretti, 2005). Many commentators believed that the government was going to revert to old policies of irresponsible monetary emission to finance budget deficits[1]. However, the management of the devaluation allowed the economy to show a quick economic recovery with a low inflation rate and a smooth transition to a flexible exchange rate (Amann and Baer, 2003). The monetary and fiscal restrain helped the economy to make the transition and stabilize just a year after the devaluation[2]. Nonetheless, the Argentine crisis and the upcoming presidential election in 2002, with the growing possibility of Lula being elected president, increased the uncertainty on the economic performance (Boschi, 2005; Goretti, 2005)[3]. While Cardozo’s party offered a continuation of a policy of open markets and orthodox policies, Lula’s candidacy rode on the back of a political coalition with deep roots on social and welfare policies. Lula’s campaign tried to emphasize that his government will not promote a strong departure from orthodox policies. Financial markets reflected this nervousness on their performance and lack of interest on Brazilian assets[4]. Nonetheless, Lula’s victory did not bring chaos but a continuation of the policies that enabled the economy an ordered way out of the crisis[5]. The government pursued a policy of dialogue and collaboration with the IMF, while at the same time tried to adjust to the social demands from their constituencies. Economic policy followed an orthodox pattern of floating exchange rate and consistent monetary and fiscal policies, which quickly restored confidence on the path of the economy[6]. The result was economic growth and a higher degree of predictability of government’s policy (Table 1). Investors changed their pre-electoral view of Lula, and realized that his government was not going to change the economic model for the Brazilian economy.
Social policies were more difficult to implement, since the orthodox economic model limited the ability to pursue dramatic changes on social resources or income distribution[7] (Figure 1). Total expenditure as percentage of GDP did not change from the levels reached by the previous government. There was not significant change on the percentage of total government expenditure devoted to social welfare programs. As a result, the government focused on the redesign of social programs within the budget limits. Nonetheless, corruption scandals and lack of speed on the reforms undermined the success of such policies and hurt Lula’s support from its political base.
Figure 1
Source: Own elaboration based on Euromonitor 2006.
This year, the government faces the challenge of a new presidential election and the need for Lula to improve his chances of being reelected[8]. The flexible exchange rate led to an appreciation of the Real with respect to the US dollar, which reduced the competitiveness of Brazilian exports. The economy has slowed down and the uncertainty of the election creates some uneasiness among investors. On the political front, Lula’s government tried to boost popularity by cancelling all debt with the IMF, a decision that Argentina quickly followed[9].
Post Crisis Economic Model in Argentina
Argentina’s recession was much more severe than in Brazil (Table 1). The collapse of the financial and banking system in late 2001 led to a political crisis without precedent, in which five presidents were named and resigned in a span of ten days (Corrales, 2002; Manzetti, 2002). In early 2002, the provisional government declared the default of all foreign debt, the devaluation of the peso and the modification of all contracts in the economy according to the new reality of the country (Gallo, et. al., 2006). The management of the crisis was far from ordered and in many cases represented desperate attempts to maintain some kind of stability amid the general economic chaos (Corrales, 2002). Economic activity came to a halt and GDP plunge in a recession that seemed to never end (Table 1). The government was very close to hyperinflation in its attempt to control fiscal and monetary policies, and the IMF decided not to help the country in the solution of the crisis[10]. After one year of effort the economy stabilized and economic activity started to show signs of recovery. The deep devaluation promoted import substitution industries and the favorable international prices fostered agricultural exports, the only bright spot during the recession years[11]. A new government was elected in early 2003 to deal with a difficult economic situation[12]. The government was in default of its debt, the banking system was bankrupt, the contracts with privatized companies were suspended and the economy was just showing some signs of recovery (Gallo, et. al., 2006). The Government followed a monetary policy focused on sustaining the exchange rate at three pesos per US dollar, in order to maintain the competitiveness of the domestic industry and agricultural exports (Table 1). The income from exports was quickly monetized by the Central Bank leading to an increase in domestic demand[13]. As a result, the economy started to recover and quickly showed signs of improvement (Table 1). Inflationary pressures were too low, given the low level of utilization of industrial capacity and high unemployment rates[14]. On the fiscal side, economic activity increased resources and the default allowed the government to save resources and run fiscal surpluses[15]. This economic model continued throughout 2005 and 2006, while the IMF recommended a more flexible exchange rate and an immediate agreement with debt holders. Because of the opposed points of view, the government decided to close all channels of communication with the IMF and pursue a more independent economic policy[16].
In early 2005 the government gave debtors a “take it or leave it” offer for the defaulted debt, leading to the highest cut on sovereign debt in history[17]. The IMF did not support this program, but debtors, faced with no other choice, accepted the deal (Sturzenegger and Zettelmeyer, 2005). The restructuring of the debt allowed the government to go back to financial markets, although the initial premium was high (Figure 2). The fiscal situation continued under control and the favorable international conditions, high prices for exports and low interest rates, allowed for a sustained economic growth (Table 1).
By late 2005 the economic expansion was straining the industrial installed capacity and employment had dropped dramatically[18]. As a result, inflationary pressures appeared[19]. The government resorted to exert political pressure on different industries and later to directly control prices, set prohibitionsto export meat and increases on taxes on exports[20]. To minimize the criticisms and opposition from the IMF, the government followed Brazil’s example and cancelled the debt with the IMF using Central Bank reserves. The Central Bank continued to sterilize the inflow of US dollars in the economy, allowing the country to maintain an exchange rate close to three pesos per US dollar and containing the domestic demand. Nonetheless, the interest rate on short term notes have increased due to both, the volume of the debt and the increase on the US interest rates.This policy is generating a cost in terms of short-term bonds the Central Bank has to issue to pursue this policy[21]. Investment has remained the Achilles’ heel for this economic model, as price controls, contract and judiciary uncertainty and heterodox policies do not promote much investment beyond the real state boom and public works. Nonetheless, the policy of confrontation with the IMF has given political and economic payoffs to the government, despite the challenges ahead.
Comparing economic performance in the aftermath of the crisis
In order to assess the benefits of counting wit the support of the IMF, while undergoing an economic crisis, this section compares the performance of the main economic indicators for Argentina and Brazil. According to the policies described previously, Brazil followed an IMF friendly policy pattern, with a floating exchange rate, fulfillment of its debt payments, adequate fiscal and monetary policies while Argentina followed policies in direct opposition to the IMF and the international financial community, i.e. defaulting its debt, controlling the exchange rate through monetary emission and market controls, sterilizing the inflow of foreign exchange, using controls to stop inflation but maintaining a surplus on fiscal accounts.
International markets reacted to the differences on the economic crises in both countries (Figure 2). While the high jump on country risk in Brazil, due to the devaluation of 1999 implied a jump of more than 500 basis points, it seems small compared with the jump of more than 6000 thousands of basis points in Argentina from June 2001 to June 2002. The Brazilian economy followed with a high jump on risk in 2002 fueled by the fear of contagion from Argentina and the possible election of Lula. Nonetheless, the country risk strongly declined by the end of 2002 and beginning of 2003 as markets realized that Lula’s policies were consistent with the sustainability of the economy and the Argentine crisis was limited to the domestic market. Finally, in 2005, Argentina returned to international markets and the country risk dropped substantially, as the government moved out of default and started to pay interests on the new bonds.
Figure 2
Source: Own elaboration from Ministry of Economy, Argentina,
In terms of economic growth, the performance has been quite different. The effect of the devaluation on the Brazilian economy meant a slowdown for the economy, while the Argentine crisis produced a decline on real GDP of 18.4% (from 1998 to 2002). However, the recovery in Argentina has been strong, with a growth of 38.9% from 2002 to 2006, while Brazil grew 11.6% in the same period. As a whole, the Brazilian economy grew 21.2% from 1997 to 2006, while the Argentine economy reached a growth rate of 13.4%. As a result, part of the explanation for the amazing performance of the Argentine economy in the last few years can be explained by the strong negative effect of the crisis on the economy. This negative effect is seen on the loss of GDP per capita measured on constant US Dollars. In Argentina, GDP per capita fell by 2.8% from 1997 to 2004, while in Brazil it increased by 4.9% in the same period (Figure 3).
The devaluation produced an adjustment of the nominal exchange rate in Brazil, while it drastically changed relative prices in Argentina (Figure 4). This difference on the effects of the devaluation is reflected on the abrupt change on trade balance in Argentina (Figure 5). The devaluation cum recession increased the trade surplus from 1.3% of GDP in 2001 to 14.9% in 2002. This surplus declined in the last few years because of the economic growth, but it is still higher than in Brazil, due in part to the differences on exchange rate policies each country applied.
Figure 3
Source: Own Elaboration from World Development Indicators (WDI), World Bank, at
Figure 4
Source: Own elaboration from IMF Financial and Monetary Statistics, at
Figure 5
Source: Own Elaboration from World Development Indicators (WDI), World Bank, at
Argentina had a similar effect in total debt as percentage of GDP, which abruptly increased to 147% in 2002, and declined in 2005 as a consequence of the default. In Brazil the debt burden increased in 1999, as a result of the devaluation, but it did not go out of control, fluctuating with the changes on exchange rate.
In the case of investment, Argentina suffered a strong setback, with low levels of investment from 2000 to 2003. This deficit on real investment has not been complemented by foreign flows of direct investment, which drained in 2001. While Argentina had higher inflow of capital as percentage of GDP during the 1990s, Brazil surpassed that levels from 2000 to 2004 (Figure 6). Moreover, the decline on the inflow of capital to Argentina is more noticeable when we take into account the value of investment in US Dollars (Figure 7).
Figure 6
Source: Own Elaboration from World Development Indicators (WDI), World Bank, at