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'The Tango Effect'

Argentina: The Epidemic Spreads in Latin America

Uruguay financial crisis
A woman looks at exchange rates on display in Montevideo, Uruguay, July 30, 2002. In response to the peso's collapse, Uruguay's Central Bank suspended all banking operations in the country for an unspecified period beginning July 30, 2002 (Photo: AFP). 

After its marked failure in the Asian crisis of 1998, the International Monetary Fund (IMF) is under scrutiny by the world financial community for not heeding the warnings about the possibility that the Argentine crisis would infect the economies of the region.

The severe crisis in Argentina, the worst in the country’s history—which has doubled the poverty index in less than a year to around 50 percent of the population—has crossed the borders despite predictions to the contrary by the IMF.  The feared “tango effect” already has struck the weakened economy of Uruguay, which is extremely dependent on all that occurs in economic and financial affairs on the other side of the Río de la Plata.

At the same time, it threatens Brazil with an explosive cocktail of economic instability and political turbulence caused by the impending triumph of leftist Luiz Inácio Lula da Silva in the approaching presidential elections in October.

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The ripples from the crisis have also been strongly felt in Paraguay—the other partner in the Common Market of the South (Mercosur)—and even in Chile and Mexico, where Bank of Mexico governor Guillermo Ortiz has forecast that financial turbulence will continue in coming weeks. [On July 15, Paraguay’s president declared a state of emergency after protesters angry over economic policies clashed with police.—WPR]

“It is difficult to determine if the IMF got it wrong or not. There is a host of decisions that go beyond our credit analyses. We cannot know if in reality it is a question of a defined strategy,” Cristian Krossler, Standard & Poor’s analyst in Argentina, told Proceso.

For Krossler, this much is clear: “Uruguay is, without doubt, the country that is suffering most from the disasters in Argentina. In Brazil, obviously there is some contagion, which has become mixed with the electoral theme, and there are people who are scared. And Chile suffers in an indirect manner through the impact on investments.” Many Argentine officials privately grin with satisfaction when the word “contagion” is mentioned in the markets. While no one dares to show his smile in public and they prefer to put on a sober expression more in tune with the crisis, the government of Eduardo Duhalde is convinced that a generalized crisis would serve Argentine interests by sealing an elusive accord with the IMF. Should that crisis explode, it would drag everyone down into the same predicament.

The need to sign an agreement is urgent. Beginning July 15, the country will have to disburse US$1.7 billion to pay obligations on loans from the Inter-American Development Bank, the World Bank, and the IMF. If it fails to do so, Argentina will move into “total default,” and no one dares to contemplate the future of a country in crisis that faces such a bleak scenario.

To avert a definitive break, Economy Minister Roberto Lavagna spent last week in Washington trying to move negotiations forward. But there he met a wall that proved difficult to scale. “The Argentines obviously are in no hurry to discuss the restructuring of the banking system. That surprised and disappointed me,” declared IMF managing director Horst Köhler in an interview with a German daily. Köhler referred to the report from the IMF representative in Buenos Aires, the Englishman John Thornton, who observed that the Duhalde government had not made the progress necessary to warrant dispatch of a negotiating mission to the Argentine capital.

Thus, the Argentine government sought to forge a type of “continental alliance” to press demands as a bloc for urgent IMF aid and support from Washington to avert a greater “contagion” from the crisis.

But Buenos Aires’ appeal for help from its Latin American partners fell on deaf ears. No government in the region wanted to remain hitched to the rapidly unfolding crisis that Argentina is suffering. And they kept their distance, like someone who avoids contact with a smallpox victim. “I never spoke about that matter….The problems of Brazil are different. The economic situation is very solid. We do not have the same problem that other countries are experiencing,” Brazilian President Fernando Henrique Cardoso hastened to clarify.

A little while later, it was Uruguay’s turn. Its foreign affairs minister, Didier Opertti, said that he was not familiar with the Argentine plan: “We have not been able to check out (that version) in all its details. It has been discussed and has been in the press, but officially the government has taken no position.”

Most diplomatic of all was Mexican President Vicente Fox, who told the daily Clarín of Buenos Aires—where he will arrive July 4 for the expanded Mercosur summit—that he is inclined to speak with George W. Bush, but without involving his country in the crisis. “We want to be at Argentina’s side during these difficult times. For our part, we continue to desire to see what Mexico can do for Argentina and Brazil. And if they ask us to speak with President Bush, we will do so.”

Argentina seems to be more alone than ever in its attempt to close an agreement with the IMF, all the more so after the concerns expressed at the G-8 summit in Canada over the crisis and particularly its effects on Brazil.

José María Aznar, Spain’s prime minister and the current representative of the European Union, appealed to G-8 leaders to express their “confidence” in Brazil’s economic policy and, according to European spokesmen, the meeting dealt with the “urgency” of taking measures to avoid a wider contagion.

That same day, June 26, in a disturbance in Buenos Aires, a protest by unemployed Argentines demanding urgent social assistance was suppressed. The result was two dead, 17 injured, and 160 arrested in a show of the country’s volatile atmosphere.

After several months of insisting that the Argentine crisis was a strictly local phenomenon, the IMF was forced to retreat at the beginning of June and recognize that Uruguay had fallen into the snares of Argentina’s misfortune.

“There was a strong contagion in Uruguay, which has a close economic relationship with Argentina, above all in financial areas. Some Uruguayan banks depend on Argentine banks, and much of their deposits are from Argentines who, fearful of a repetition of the corralito (the freeze on term deposits currently in force in Argentina), began to withdraw their deposits,” Argentine economist Aldo Abram told Proceso.

On June 20, Uruguay abandoned its policy of exchange-rate bands and permitted the free float of the dollar. The first reaction was a devaluation of the Uruguayan peso, which fell from 16 to 25 pesos against the dollar before stabilizing in subsequent days at 23 pesos. The second reaction came from the Uruguayan population: That night, the people took to the streets of Montevideo to bang their pots, the standard battle cry of all protests in neighboring Buenos Aires.

Two days later, Uruguayans watched in astonishment the familiar movie played out on the other side of the Río de la Plata: The appreciation of the dollar fueled increases of between 10 percent and 30 percent in the prices of principal goods such as meats. Sugar prices rose by 20 percent as the sector said that it must pay in dollars for its raw materials, while bread prices increased by 10 to 12 percent.

The new reality that has hit Uruguayans is a faithful reflection of the crisis: In May alone, $1.387 billion left the country, or 12.44 percent of total deposits in the banking system.
In the view of Standard & Poor’s analyst Krossler, Uruguay fully shares the suffering of the Argentine crisis “in various respects, especially in terms of business links and a traditional symbiosis between the two countries. Fifty percent of depositors in Uruguay do not reside in that country, and the majority are Argentines.”

But the IMF is not prepared to allow Uruguay to fall into the Argentine “black hole.” The international organization approved an increase of $1.5 billion in the existing standby credit line for Montevideo, including authorization for the government of Jorge Batlle to draw down “immediately” up to $508 million. These funds will be targeted to meet obligations on maturing foreign debts, replenish depressed international reserves, and create a Financial System Assistance Fund.

The announcement was made one week after the IMF first recognized that “the Argentine crisis that is affecting the region has had a more adverse effect on the Uruguayan economy than previously anticipated.”

“The IMF is on top of the matter. It is working to prevent the contagion from growing much greater. In Uruguay, it is attacking the contagion in a positive manner, identifying the problems, and bringing them to light—all of the things that did not take place in Argentina,” Krossler argued.

But the shocks of the “tango effect” were inevitable for the Uruguayan economy. The government has revised economic goals for this year, which now anticipate a fall in gross domestic product of between 6 and 7 percent instead of the 2-percent decline previously estimated following four years of recession. Inflation is now placed at 12 percent, setting aside the previous projection of 9.9 percent.

Demands for the resignation of Economy Minister Alberto Bensión have rained down on Uruguay’s political establishment. “One must take care with the demand for the minister’s resignation because one must take care of the political system,” said Sen. Luis Alberto Heber of the National Blanco Party, part of the government coalition with Batlle’s Colorado Party.

Meanwhile, Brazil suffers in two ways. On the one side, the growing distrust in the face of an eventual triumph of leftist Luiz Inácio Lula da Silva in the October presidential elections has sown fears in the markets, ignited a surge in the dollar and in country risk (second in the world after Argentina), and provoked the fall of the São Paulo stock exchange.

In the meantime, the “tango effect” has cut into the line and stirred things up among foreign investors. Krossler commented that “obviously there is some contagion, and that is getting mixed in with the electoral theme, and there are people who are scared.”

But for American economist Raymond Collit, chief of the Financial Times office in São Paulo, “The main problem is internal, with a combination of growing foreign debt and fears that a Lula government might stop paying its heavy international obligations. Moreover, the international market, after Argentina, today is more susceptible to this type of problem. Investors got burned with Argentina and now they distrust Brazil. They think that, although the risk may be small, it is better to get out. The Argentine crisis created the conditions for Brazil to fall into this situation. It is a type of contagion over the long term, a rejection of market reforms affecting the confidence of investors.

“One can criticize not only the IMF, but also the U.S. government. In Brazil, one perceives a great deal of resentment at Washington’s growing attitude of indifference in recent months, evidenced in the measures against free trade in the steel industry and in agriculture subsidies, among others.”

Abram argued that investors think that Brazil “can repeat Argentina’s errors, and these people are fleeing in desperation from Brazil. But if [José] Serra [a leading opponent of Lula in the presidential race] were ahead in the polls, none of that would be happening now.”

The Brazilian financial market has become accustomed to a dangerous word: collapse. The dollar on June 26 reached its highest quotation since July 1994, when [then Finance Minister] Cardoso launched the Real Plan [introducing the real as Brazil’s currency as part of an economic-stability program that reduced quadruple-digit inflation to single digits in a few months]. It closed that day at 2.87 reals, and a steadily growing number of analysts believe that it will continue rising so long as Lula continues to lead in the polls and investors remain convinced that the “tango effect” has invaded the country of the samba.

The dollar had strengthened by 10.2 percent in the first 25 days of June. Neither the 1.1 billion in dollars sold in just 12 days by the central bank of Brazil nor the additional $10 billion in aid approved by the IMF succeeded in calming the market. “There is a crisis of confidence. If the central bank had not intervened, the dollar would have shot up even more,” said Alvaro Brandao, director of the Brazilian consulting firm Agora Señor.

The central bank of Brazil had to raise its inflation projections for this year and 2003 as a result of the rise of the dollar. Inflation this year will be 5.5 percent, a half-point more than previously expected, and 6.1 percent in 2003, 1.6 percentage points more than the earlier forecast. The flight of foreign capital from the São Paulo stock exchange totaled $274 million over 20 days in June. At the same time, the country-risk premium [on Brazilian debt in international markets], which was around 700 basis points just five months ago, now exceeds 1,500 basis points. Meanwhile, foreign investment is falling sharply. In May, the registered total was 30 percent lower than that in the same month of 2001. The authorities expect an inflow this year of $18 billion, against $23 billion in 2001 and $33 billion in 2000.

Cardoso appeals to the spirit of the nation’s soccer fans to shore up the confidence of the country. “Today we must seek what Felipao (Luiz Felipe Scolari, coach of the national soccer team) said: ‘We have done well up to now, but we can do more, and we are going to do more,’ ” said Cardoso before Brazil played Germany in the final of the World Cup in Japan.

But the big difference that separates what is happening in Brazil from what has occurred in the rest of the region is that no one here is going out to bang pots—rather, they take to the streets to dance the samba over the triumphs of the national team in the World Cup. When all is said and done, the joy of the samba tends to drown out the melancholy of the tango.

In Chile, meanwhile, the contagion has had only a glancing effect on investments, although there has been a small devaluation of the peso. “The minor contagion that Chile suffers is totally indirect. There is pressure on the currency, but that is due to the deterioration of the image of the region. The banks are not exposed to the Argentine crisis, although some companies with business ties to that country may suffer the ripple effects of the crisis,” said Krossler. In Abram’s view, “Chile has a tradition of economic stability and will be able to face the effects successfully.”

In the meantime, Argentines are wondering if the IMF has erred again in its predictions. “They have got it wrong again,” said analyst Julio Sevares in Clarín, the nation’s largest-circulation newspaper. “Suddenly Uruguay was forced to devalue, and in Brazil the dollar and country risk have surged. Then everyone looked at Argentina and began to cry, ‘Contagion!’ as in a medieval city attacked by the black plague,” he wrote.

But no one believes that the IMF will come to the rescue of Argentina so soon. “Argentines are saying now: ‘You’ve seen what’s been happening, so help us—and if you don’t, it will be worse each time.’ But they are not scaring anyone,” Krossler summarized.

 
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