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I n t e r n a t i o n a l M o n e t a r y F u n d

Evaluation Report

The IMF and Argentina,1991–2001

The IMF and A

rgentina,1991–2001

IMF 20

04

The IMF and Argentina, 1991–2001

IEO

The IMF and Argentina,1991–2001

I n t e r n a t i o n a l M o n e t a r y F u n d • 2 0 0 4

Evaluation Report

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© 2004 International Monetary Fund

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The IMF and Argentina, 1991–2001 / [prepared by a team headed by ShinjiTakagi] — [Washington, D.C.] : International Monetary Fund, Indepen-dent Evaluation Office, 2004.

p. cm. — [Evaluation report]Includes bibliographical references.ISBN 1-58906-380-5

1. International Monetary Fund — Argentina. 2. Argentina — Economicpolicy. 3. Crisis management — Argentina. I. Takagi, Shinji, 1953– II. Evalu-ation report (International Monetary Fund. Independent Evaluation Office).

HC125.I53 2004

Preface vii

Abbreviations and Acronyms viii

THE IMF AND ARGENTINA, 1991–2001

Executive Summary 3

1 Introduction 8

Overview of Economic Developments, 1991–2001 11Factors Contributing to the Crisis 14

2 Surveillance and Program Design, 1991–2000 17

Exchange Rate Policy 17Fiscal Policy 23Structural Reforms in Macro-Critical Areas 29The Manner of Engagement with Argentina 36

3 Crisis Management, 2000–01 39

Second Review and Augmentation, January 2001 39Completion of Third Review, May 2001 46Fourth Review and Augmentation, September 2001 50Noncompletion of Fifth Review, December 2001 56The Decision-Making Process 58

4 Lessons from the Argentine Crisis 64

Major Findings 64Lessons for the IMF 68Recommendations 73

Boxes

1.1. The IMF and Argentina, 1991–2001 91.2. Was the Convertibility Regime Viable? 151.3. The Politics of the Convertibility Regime 162.1. Economic Characteristics of Hard Peg Economies 182.2. Measuring the Equilibrium Real Exchange Rate 233.1. Framework and Implementation of Private Sector Involvement 433.2. Financial Instruments Used During the Crisis 543.3. Measures Announced or Taken During 2001 Without Prior

Consultation With the IMF 614.1. How and When Could an Alternative Approach Have Been

Attempted? 694.2. Experience with Catalytic Finance 72

Contents

iii

CONTENTS

Figures

1.1. Inflation 111.2. Capital Flows 121.3. Real Quarterly GDP Growth 121.4. Interest Rate Spreads over U.S. Treasuries 132.1. Monthly Real Effective Exchange Rate 192.2. Trade and Current Account Balances 192.3. Comparison of Fiscal Targets and Actuals 242.4. Projected Overall Fiscal Balances and Their Outturns 252.5. Public Sector Debt Targets and Actuals 272.6. Public Sector Debt and General Government Overall Balances 282.7. Real GDP Growth and Unemployment 313.1. IMF and Private Sector (Consensus) Forecasts for Key Program

Variables 453.2. Bank Deposits, January 3, 2000–December 31, 2001 473.3. Evolution of Fiscal Deficit Targets and Outcomes 483.4. International Reserves, January 3, 2000–December 31, 2001 51

Tables

1.1. Key Economic Indicators 103.1. Program Projections and Targets for 2001 413.2. Fiscal Performance Under the Stand-By Arrangement in 2001 48

Appendixes

1 The IMF’s Financing Arrangements with Argentina, 1991–2002 772 Argentina and the IMF Prior to 1991 783 A Retrospective on Argentina’s Fiscal Policy, 1991–2001 804 Selected Program Conditionality, 1991–2001 835 Economic Characteristics of Major Emerging Market Economies 856 Debt Sustainability Analysis 877 A Preliminary Analysis of the 2001 Mega-Swap 908 Financial Instruments Used by Argentina During the Crisis 959 Timeline of Selected Events, 1991–2002 98

10 List of Interviewees 101

Appendix Figures

A5.1. General Government Fiscal Balance in Crisis Countries 85A6.1. External Debt Sustainability 88A6.2. Public Debt Sustainability 89A7.1. Exchange Options 90

Appendix Tables

A3.1. Public Sector Balance, 1961–2000 81A3.2. Consolidated Public Sector 81A3.3. Adjusted Fiscal Balance 81A3.4. Social Security Balance 81A3.5. Federal and Provincial Fiscal Accounts 82A5.1. Indicators of Economic Structure in Selected Emerging Market

Economies 86A7.1. An Overview of the Mega-Swap 91A7.2. Details of Old and New Bonds 92

iv

Contents

Bibliography 103

STATEMENT BY THE MANAGING DIRECTOR, IMF STAFF RESPONSE,IEO COMMENTS ON MANAGEMENT/STAFF RESPONSE,STATEMENT BY THE GOVERNOR FOR ARGENTINA,ANDSUMMING UP OF IMF EXECUTIVE BOARD DISCUSSION

BY THE CHAIRMAN

Statement by the Managing Director 109

IMF Staff Response 110

IEO Comments on Management/Staff Response 114

Statement to Executive Board Members from the Governor for Argentina, His Excellency Roberto Lavagna 115

Summing Up of IMF Executive Board Discussion by the Chairman 120

v

The following symbols have been used throughout this report:

– between years or months (e.g. 2003–04 or January–June) to indicate the years ormonths covered, including the beginning and ending years or months;

/ between years (e.g. 2003/04) to indicate a fiscal (financial) year.

“Billion” means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

Some of the documents cited and referenced in this report were not available to the publicat the time of publication of this report. Under the current policy on public access to theIMF’s archives, some of these documents will become available five years after their is-suance. They may be referenced as EBS/YY/NN and SM/YY/NN, where EBS and SMindicate the series and YY indicates the year of issue. Certain other documents are to be-come available ten or twenty years after their issuance depending on the series.

This report evaluates the role of the IMF in Argentina during 1991–2001, focus-ing particularly on the period of crisis management from 2000 until early 2002. It was prepared by a team headed by Shinji Takagi and including Benjamin Cohen,Isabelle Mateos y Lago, Misa Takebe, and Ricardo Martin. It also benefited fromsubstantive contributions from Nouriel Roubini and Miguel Broda. The report wasapproved by Montek S. Ahluwalia, then Director of the Independent Evaluation Of-fice (IEO). Research assistance and logistical support in Argentina from Nicolas Arregui; administrative support by Annette Canizares, Arun Bhatnagar, MariaGutierrez, and Florence Conteh; and editorial work by Ian McDonald and Esha Rayare gratefully acknowledged.

In keeping with standard IEO procedures, parties whose actions and decisionswere evaluated, including IMF staff and previous Argentine authorities, were given achance to comment on a draft of the report, but the final judgments are the responsi-bility of the IEO alone. The final version of the report was submitted to IMF manage-ment for comments, and also circulated simultaneously to Executive Directors. Thereport, with management and staff comments and the IEO response, was discussed bythe Executive Board on July 26, 2004. The report is being published as discussed bythe Board, along with a statement to the Executive Board by the Governor of the IMFfor Argentina and the Chairman’s Summing Up of the Board discussion.

The IEO was created in 2001 to provide objective and independent evaluations onissues relevant to the IMF. It operates independently of IMF management, and atarms’ length from the IMF Executive Board.

Preface

vii

CBA Currency board arrangementCET Common external tariffDSA Debt sustainability analysisEFF Extended Fund Facility (IMF)FAD Fiscal Affairs Department (IMF)FIN Finance Department (IMF)G-7 Group of Seven countriesG-10 Group of Ten countriesICM International Capital Markets Department (IMF)IDB Inter-American Development BankIEO Independent Evaluation Office (IMF)IFI International financial institutionIMF International Monetary FundIMFC International Monetary and Financial Committee (IMF)LIBOR London interbank offered rateLOI Letter of intent (IMF)MAE Monetary and Exchange Affairs Department (IMF)1

MERCOSUR Mercado Común del SurNDA Net domestic assetsNFPS Nonfinancial public sectorNIR Net international reservesNPV Net present valuePAYG Pay-as-you-goPBG Policy-based guarantee (World Bank)PDR Policy Development and Review Department (IMF)PSI Private sector involvementREER Real effective exchange rateRES Research Department (IMF)SBA Stand-By Arrangement (IMF)SDR Special drawing right (IMF)SRF Supplemental Reserve Facility (IMF)TRE Treasurer’s Department (IMF)2

VAT Value-added taxWEO World Economic Outlook (IMF)WHD Western Hemisphere Department (IMF)

1Effective May 1, 2003, name was changed to Monetary and Financial Systems Department.2Effective May 1, 2003, name was changed to Finance Department.

Abbreviations and Acronyms

viii

The IMF and Argentina, 1991–2001

The Argentine crisis of 2000–02 was among themost severe of recent currency crises. With the

economy in a third year of recession, in December2001, Argentina defaulted on its sovereign debt and,in early January 2002, the government abandoned theconvertibility regime, under which the peso had beenpegged at parity with the U.S. dollar since 1991. Thecrisis had a devastating economic and social impact,causing many observers to question the role playedby the IMF over the preceding decade when it was al-most continuously engaged in the country throughfive successive financing arrangements.

Overview

The convertibility regime was a stabilization de-vice to deal with the hyperinflation that existed at thebeginning of the 1990s, and in this it was very suc-cessful. It was also part of a larger Convertibility Plan,which included a broader agenda of market-orientedstructural reforms designed to promote efficiency andproductivity in the economy. Under the ConvertibilityPlan, Argentina saw a marked improvement in its eco-nomic performance, particularly during the earlyyears. Inflation, which was raging at a monthly rate of27 percent in early 1991, declined to single digits in1993 and remained low. Growth was solid throughearly 1998, except for a brief setback associated withthe Mexican crisis, and averaged nearly 6 percent dur-ing 1991–98. Attracted by a more investment-friendlyclimate, there were large capital inflows in the form ofportfolio and direct investments.

These impressive gains, however, masked theemerging vulnerabilities, which came to the surfacewhen a series of external shocks began to hit Ar-gentina and caused growth to slow down in the sec-ond half of 1998. Fiscal policy, though much im-proved from the previous decades, remained weakand led to a steady increase in the stock of debt,much of which was foreign currency denominatedand externally held. The convertibility regime ruledout nominal depreciation when a depreciation of thereal exchange rate was warranted by, among otherthings, the sustained appreciation of the U.S. dollar

and the devaluation of the Brazilian real in early1999. Deflation and output contraction set in, whileArgentina faced increasingly tighter financing con-straints amid investor concerns over fiscal solvency.

The crisis resulted from the failure of Argentinepolicymakers to take necessary corrective measuressufficiently early, particularly in the consistency offiscal policy with their choice of exchange rateregime. The IMF on its part erred in the precrisis pe-riod by supporting the country’s weak policies toolong, even after it had become evident in the late1990s that the political ability to deliver the necessaryfiscal discipline and structural reforms was lacking.By the time the crisis hit Argentina in late 2000, therewere grave concerns about the country’s exchangerate and debt sustainability, but there was no easy so-lution. Given the extensive dollarization of the econ-omy, the costs of exiting the convertibility regimewere already very large. The IMF supported Ar-gentina’s efforts to preserve the exchange rate regimewith a substantial commitment of resources, whichwas subsequently augmented on two occasions. Thissupport was justifiable initially, but the IMF contin-ued to provide support through 2001 despite repeatedpolicy inadequacies. In retrospect, the resources usedin an attempt to preserve the existing policy regimeduring 2001 could have been better used to mitigateat least some of the inevitable costs of exit, if the IMFhad called an earlier halt to support for a strategy that,as implemented, was not sustainable and had pushedinstead for an alternative approach.

Surveillance and Program Design,1991–2000

Exchange rate policy

The convertibility regime was enormously suc-cessful in achieving price stability quickly. Althoughthe IMF was initially skeptical of its medium-term vi-ability, its internal views as well as public statementsbecame much more upbeat when Argentina—with fi-nancial support from the IMF—successfully weath-ered the aftermath of the Mexican crisis, endorsing

Executive Summary

3

EXECUTIVE SUMMARY

the convertibility regime as essential to price stabilityand fundamentally viable. Little substantive discus-sion took place with the authorities on whether or notthe exchange rate peg was appropriate for Argentinaover the medium term, and the issue received scantanalysis within the IMF.

Following the devaluation of the Brazilian realin early 1999, IMF staff began to consider more se-riously the viability of the peg and possible exitstrategies. However, consistent with establishedpractice, but contrary to recent Executive Boardguidelines, the issue was not raised with the author-ities in deference to the country’s prerogative tochoose an exchange rate regime of its own liking.Neither was the issue brought to the attention of theExecutive Board. Not only was the staff concernedthat discussion of exchange rate policy, if leaked tothe public, might cause a self-fulfilling speculativeattack on the currency, but it also knew from its an-alytical work that the risks and costs associatedwith any exit from convertibility were already veryhigh.

Fiscal policy

The choice of the convertibility regime made fis-cal policy especially important. Given the restric-tions on use of monetary policy, debt needed to bekept sufficiently low in order to maintain the effec-tiveness of fiscal policy as the only tool of macro-economic management and the ability of the govern-ment to serve as the lender of last resort. Fiscaldiscipline was also essential to the credibility of theguarantee that pesos would be exchanged for U.S.dollars at par. Fiscal policy was thus rightly thefocus of discussion between the IMF and the author-ities throughout the period. While fiscal policy im-proved substantially from previous decades, the ini-tial gains were not sustained, and the election-drivenincrease in public spending led to a sharp deteriora-tion in fiscal discipline in 1999. As a result, the stockof public debt steadily increased, diminishing theability of the authorities to use countercyclical fiscalpolicy when the recession deepened.

The IMF’s surveillance and program condition-ality were handicapped by analytical weaknessesand data limitations. The IMF’s focus remained onannual fiscal deficits, when off-budget operations,notably the court-ordered recognition of old debt,were raising the stock of debt. Insufficient attentionwas paid to the provincial finances, the sustainablelevel of public debt for a country with Argentina’seconomic characteristics was overestimated, anddebt sustainability issues received limited attention.These deficiencies were understandable, given theexisting professional knowledge, available analyti-cal tools, and data limitations, but the IMF’s high

stake in Argentina should have prompted the staffto explore in greater depth the risks that might arisefrom considerably less favorable economic devel-opments. The more critical error of the IMF, how-ever, was its weak enforcement of fiscal condition-ality, which admittedly was inadequate. The deficittargets involved only moderate adjustments, evenwhen growth was higher than expected, while theywere eased to accommodate growth shortfalls.Even though the annual deficit targets were missedevery year from 1994, financing arrangements withArgentina were maintained by repeatedly grantingwaivers.

Structural reforms

The IMF correctly identified structural fiscal re-forms, social security reform, labor market reform,and financial sector reform as essential to enhancingthe medium-term viability of the convertibilityregime, by promoting fiscal discipline, flexibility,and investment. These views were broadly shared bythe authorities. In fact, most of the initiatives for re-form in these areas came from the authorities; therole of the IMF was largely limited to providingtechnical assistance in the fiscal areas, particularlytax administration. Some gains were made in theearly years, but the long-standing political obstaclesto deeper reforms proved formidable. Little progresswas made in later years, and the earlier reforms wereeven reversed in some cases.

The remarkable feature of the successive IMF-supported programs with Argentina was the paucityof formal structural conditionality. Despite therhetoric about the importance of structural reformsin program documents, only two performance crite-ria (covering tax and social security reforms) wereset in the first three IMF arrangements; in the subse-quent arrangements, not a single performance crite-rion was set, though a number of structural bench-marks were included. Staff consistently expressedreservations over the weak structural content of thesuccessive arrangements, but management, sup-ported by the Executive Board, overruled the staffobjections to approve programs with weak structuralconditionality. As it turned out, the lack of strongstructural conditionality had the unfortunate out-come of obliging the IMF to remain engaged withArgentina when the evident lack of substantiveprogress in structural reform should have called foran end to the program relationship.

Crisis Management, 2000–2001

In the fall of 2000, Argentina effectively lost access to voluntary sources of financing. The authori-

4

Executive Summary

ties approached the IMF for a substantial augmenta-tion of financial support under the Stand-By Arrange-ment approved in March 2000, which up to that timehad been treated as precautionary. In response, fromJanuary to September 2001, the IMF made three de-cisions to provide exceptional financial support toArgentina, raising its total commitments to $22 bil-lion. In December, however, the fifth review of theprogram was not completed, which marked the effec-tive cutoff of IMF financial support.

The augmentation decision in January 2001

The decision to augment the existing arrange-ment, approved by the Executive Board in January2001, was based on the diagnosis that Argentinafaced primarily a liquidity crisis and that any ex-change rate or debt sustainability problem wasmanageable with strong action on the fiscal andstructural fronts. The protracted recession wasthought to have resulted from a combination of ad-verse but temporary shocks, and it was assumedthat external economic conditions would improvein 2001. The IMF was also well aware that thecosts of a fundamental change in the policy frame-work would be very large and wished to give theauthorities the benefit of the doubt, when they wereevidently committed to making strong policy cor-rections. Exceptional IMF financing was thusdeemed justified on catalytic grounds. Given theprobabilistic nature of any such decision, the cho-sen strategy may well have proved successful if theassumptions had turned out to be correct (whichthey were not) and if the agreed program had beenimpeccably executed by the authorities (which itwas not). The critical error was not so much withthe decision itself as with the failure to have an exitstrategy, including a contingency plan, in place,inasmuch as the strategy was known to be risky. Noserious discussion of alternative strategies tookplace, as the authorities refused to engage in suchdiscussions and the IMF did not insist.

The decisions to complete the third review inMay and to further augment the arrangementin September 2001

While these decisions still involved uncertainty,the weak implementation of the program in early2001 and the adoption—without consultation withthe IMF—of a series of controversial and market-shaking measures by the authorities after March2001 should have provided ample ground for con-cluding that the initial strategy had failed. In fact,even within the IMF, there was an increasing recog-nition that Argentina had an unsustainable debt pro-file, an unsustainable exchange rate peg, or both. Yet

no alternative course of action was presented to theBoard, and the decisions were made to continue dis-bursing funds to Argentina under the existing policyframework, on the basis of largely noneconomicconsiderations and in hopes of seeing a turnaroundin market confidence and buying time until the ex-ternal economic situation improved.

The decision not to complete the review inDecember 2001

After the September augmentation, economicactivity and market confidence continued to col-lapse, making the achievement of the program’stargets and the salvage of convertibility virtuallyimpossible. While aware of this predicament, theIMF did not press the authorities for a fundamentalchange in the policy regime and announced in earlyDecember that the pending review under the Stand-By Arrangement could not be completed under thecircumstances. Within a month of this announce-ment, economic, social, and political dislocationoccurred simultaneously, leading to the resignationof the President, default on Argentina’s sovereigndebt, and the abandonment of convertibility, soonfollowed by government decisions that further am-plified the costs of the collapse of convertibility. Inthose circumstances, the IMF was unable to pro-vide much help and largely stood by as the crisisunraveled.

The decision-making process

The IMF’s management of the Argentine crisisreveals several weaknesses in its decision-makingprocess. First, contingency planning efforts by thestaff were insufficient. Too much attention wasgiven to determining—inconclusively—which al-ternative policy framework should be recom-mended to the authorities, while little effort wasmade to determine what practical steps the IMFshould take if the chosen strategy failed. Second,from March 2001 on, the relationship between theIMF and the authorities became less cooperative,with the authorities taking multiple policy initia-tives that the IMF viewed as misguided but feltcompelled to endorse. Third, little attention waspaid to the risks of giving the authorities the benefitof the doubt beyond the point where sustainabilitywas clearly in question. Fourth, the ExecutiveBoard did not fully perform its oversight responsi-bility, exploring the potential trade-offs between al-ternative options. To some extent, this appears tohave reflected the fact that some key decisions tookplace outside the Board and that some critical is-sues were judged by management to be too sensi-tive for open discussion in the full Board.

5

EXECUTIVE SUMMARY

Lessons from the Argentine CrisisThe Argentine crisis yields a number of lessons

for the IMF, some of which have already beenlearned and incorporated into revised policies andprocedures. This evaluation suggests ten lessons, inthe areas of surveillance and program design, crisismanagement, and the decision-making process.

Surveillance and program design

• Lesson 1. While the choice of exchange rateregime is one that belongs to country authori-ties, the IMF must exercise firm surveillance toensure that the choice is consistent with otherpolicies and constraints. Candid discussion ofexchange rate policy, particularly when a fixedpeg is involved, must become a routine exerciseduring IMF surveillance.

• Lesson 2. The level of sustainable debt foremerging market economies may be lower thanhad been thought, depending on a country’s eco-nomic characteristics. The conduct of fiscal pol-icy should therefore be sensitive not only toyear-to-year fiscal imbalances, but also to theoverall stock of public debt.

• Lesson 3. The authorities’ decision to treat anarrangement as precautionary should not, but inpractice may, involve a risk of weakened stan-dards for IMF support. Weak program design andweak implementation in the context of arrange-ments being treated as precautionary do not helpa country address its potential vulnerabilities.When there is no balance of payments need, itmay be better not to agree to an arrangement,thus subjecting the country to market disciplinerather than to program reviews by the IMF.

• Lesson 4. Emphasis on country ownership inIMF-supported programs can lead to an undesir-able outcome, if ownership means misguided orexcessively weak policies. The IMF should beprepared not to support strongly owned policiesif it judges they are inadequate to generate a de-sired outcome, while providing the rationale andevidence behind such decisions.

• Lesson 5. Favorable macroeconomic perfor-mance, even if sustained over some period oftime, can mask underlying institutional weak-nesses that may become insuperable obstacles toany quick restoration of confidence, if growth isdisrupted by unfavorable external develop-ments. The IMF may have only a limited role toplay when institutional weaknesses are deeplyrooted in the political system, and structuralconditionality cannot substitute for domesticownership of the underlying reforms.

Crisis management

• Lesson 6. Decisions to support a given policyframework necessarily involve a probabilisticjudgment, but it is important to make this judg-ment as rigorously as possible, and to have afallback strategy in place from the outset in casesome critical assumptions do not materialize.

• Lesson 7. The catalytic approach to the resolu-tion of a capital account crisis works only underquite stringent conditions. When there are well-founded concerns over debt and exchange ratesustainability, it is unreasonable to expect a vol-untary reversal of capital flows.

• Lesson 8. Financial engineering in the form ofvoluntary, market-based debt restructuring iscostly and unlikely to improve debt sustainabil-ity if it is undertaken under crisis conditions andwithout a credible, comprehensive economicstrategy. Only a form of debt restructuring thatleads to a reduction of the net present value(NPV) of debt payments or, if the debt is be-lieved to be sustainable, a large financing pack-age by the official sector has a chance to reverseunfavorable debt dynamics.

• Lesson 9. Delaying the action required to re-solve a crisis can significantly raise its eventualcost, as delayed action can inevitably lead tofurther output loss, additional capital flight, anderosion of asset quality in the banking system.To minimize the costs of any crisis, the IMFmust take a proactive approach to crisis resolu-tion, including providing financial support to apolicy shift, which is bound to be costly regard-less of when it is made.


• Lesson 10. In order to minimize error and in-crease effectiveness, the IMF’s decision-makingprocess must be improved in terms of riskanalysis, accountability, and predictability. Amore rule-based decision-making procedure,with greater ex ante specification of the circum-stances in which financial support will be avail-able, may facilitate a faster resolution of a crisis,though the outcome may not always be opti-mum. Recent modifications to the exceptionalaccess policy have already moved some way inthis direction.

Recommendations

On the basis of these lessons, the evaluation offers six sets of recommendations to improve

6

Executive Summary

the effectiveness of IMF policies and procedures,in the areas of crisis management, surveillance,program relationship, and the decision-makingprocess.

Crisis management

• Recommendation 1. The IMF should have acontingency strategy from the outset of a crisis,including in particular “stop-loss rules”—thatis, a set of criteria to determine if the initialstrategy is working and to guide the decisionon when a change in approach is needed.

• Recommendation 2. Where the sustainabilityof debt or the exchange rate is in question, theIMF should indicate that its support is condi-tional upon a meaningful shift in the country’spolicy while it remains actively engaged to fos-ter such a shift. High priority should be givento defining the role of the IMF when a countryseeking exceptional access has a solvencyproblem.

Surveillance

• Recommendation 3. Medium-term exchangerate and debt sustainability should form the corefocus of IMF surveillance. To fulfill these objec-tives (which are already current policy), the IMFneeds to improve tools for assessing the equilib-rium real exchange rate that are more forward-looking and rely on a variety of criteria, exam-ine debt profiles from the perspective of “debtintolerance,” and take a longer-term perspectiveon vulnerabilities that could surface over themedium term.

Program relationship

• Recommendation 4. The IMF should refrainfrom entering or maintaining a program rela-tionship with a member country when there isno immediate balance of payments need andthere are serious political obstacles to neededpolicy adjustment or structural reform.

• Recommendation 5. Exceptional access shouldentail a presumption of close cooperation be-tween the authorities and the IMF, and specialincentives to forge such close collaborationshould be adopted, including mandatory disclo-sure to the Board of any critical issue or infor-mation that the authorities refuse to discuss with(or disclose to) staff or management.


• Recommendation 6. In order to strengthen therole of the Executive Board, procedures shouldbe adopted to encourage: (i) effective Boardoversight of decisions under management’spurview; (ii) provision of candid and full infor-mation to the Board on all issues relevant to de-cision making; and (iii) open exchanges of viewsbetween management and the Board on all top-ics, including the most sensitive ones. These ini-tiatives will be successful only insofar as IMFshareholders—especially the largest ones—col-lectively uphold the role of the Board as theprime locus of decision making in the IMF.While a number of approaches to modifyingBoard procedures to strengthen governance arepossible, and the issue goes beyond the scope ofthe evaluation, some possible steps are discussedin the concluding section of Chapter 4.

7

The Argentine crisis of 2000–02 was among the most severe of recent currency crises. The

currency-board-like arrangement, under which the peso had been pegged at parity with the U.S.dollar since 1991, collapsed in January 2002 and,by the end of 2002, the peso was trading at Arg$3.4to the U.S. dollar. Coming after three years of re-cession, the crisis had a devastating impact. Theeconomy contracted by 11 percent in 2002, bring-ing the cumulative output decline since 1998 tonearly 20 percent. Unemployment rose to over 20percent, and the incidence of poverty worseneddramatically.

The role played by the International MonetaryFund (IMF) deserves special attention for at leastthree reasons. First, unlike the cases of Indonesiaand Korea, where the IMF had no program involve-ment for several years preceding the crisis, in Ar-gentina the IMF had been almost continuously en-gaged through programs since 1991 (Box 1.1).Second, again unlike the other cases, the crisis inArgentina did not explode suddenly. Signs of possi-ble problems were evident at least by 1999, whichled the government to seek a new Stand-ByArrangement (SBA) with the IMF in early 2000.Third, IMF resources were provided in support ofArgentina’s fixed exchange rate regime, which hadlong been stated by the IMF as both essential toprice stability and fundamentally viable. Indeed, inthe debates on fixed versus flexible rates that fol-lowed the East Asian crisis, Argentina’s currency-board-like regime was often held up as an exampleof the kind of credible fixed rate regime that is fun-damentally viable.

This evaluation examines the role of the IMF inArgentina during 1991–2001, with a special focuson the period of crisis management from 2000 up tothe first few days of 2002.1 While the principal focus

of the evaluation is on the crisis period, it is neces-sary to review experience in the preceding decade inorder to shed light on why and how, despite its ex-tensive involvement with the country, the IMF wasnot able to help Argentina prevent and better managethe crisis.

In keeping with the terms of reference of the In-dependent Evaluation Office (IEO), the primary pur-pose of the evaluation is to draw lessons for the IMFin its future operational work. The following qualifi-cations apply:

(1) Any evaluation necessarily benefits fromhindsight. While hindsight can be useful indrawing lessons for the future, in evaluatingthe past, and especially in determining ac-countability, it must be kept in mind that muchof what we know now may not have beenknown to those who had to make the relevantdecisions.

(2) The behavior of an economy is always subjectto uncertainty, and uncertainties increase incrises. Decisions taken in the face of uncer-tainty cannot be judged to represent mistakenjudgment ex ante just because they failed toachieve the results envisaged. It is necessaryto take a probabilistic approach: were the exante probabilities of success high enough tojustify the decision, given the expected benefitof success and the potential costs of an evenmore aggravated crisis if the strategy eventu-ally failed?

(3) To be meaningful, evaluation of a particularstrategy must imply comparison with an alter-native that may have produced better results.However, it is extremely difficult rigorously toestablish such a counterfactual.

(4) The IMF is only one of the actors involved. Inpractice, the country itself is ultimately re-sponsible for its policy decisions. This is espe-cially important when the underlying policychoices are strongly owned by the country—as they were in Argentina.

Introduction

8

CHAPTER

1

1The choice of this period leaves out issues related to the role ofthe IMF in Argentina’s subsequent economic reconstruction andrecovery. The IEO’s terms of reference do not allow it to evaluateissues that have a direct bearing on the IMF’s ongoing operations.

Chapter 1 • Introduction

The evaluation makes extensive use of IMF doc-uments made available to the IEO.2 The IEO, how-ever, is not given automatic access to documentsthat are purely internal to management or thatcover management’s exchanges with national au-thorities, except when such documents were sharedwith staff.3 Since there is often close consultationbetween management and the IMF’s major share-holder governments, and the records available to us

do not cover these consultations, our judgments oncertain policy matters are based on limited infor-mation. This is acknowledged where relevant.

The evaluation team has extensively intervieweda number of those involved in decision making in theIMF as well as some current and former officials ofArgentina and other member countries. The teamhas also benefited from consulting with the exten-sive academic literature on the Argentine crisis andinteracted with a number of individuals who haveexpressed views on the IMF’s role in it.

The report is organized as follows. The rest ofthis chapter provides a brief overview of economicdevelopments from 1991 to early 2002 and dis-cusses factors that contributed to the crisis. Chap-ter 2 evaluates the content and effectiveness of sur-veillance and program design in the precrisis pe-riod, from 1991 to early 2000. The focus is placed on three areas of critical relevance to the IMF,namely (i) exchange rate policy, (ii) fiscal policy,and (iii) macro-critical structural reforms. Chap-ter 3 discusses major issues and procedures associ-ated with the key decisions made by the IMF

9

Box 1.1.The IMF and Argentina, 1991–2001

From 1991 through 2001, the IMF maintained fivesuccessive financing arrangements with Argentina.These included two extended arrangements under theExtended Fund Facility (EFF) approved in 1992 and1998, and three SBAs approved in 1991, 1996, and2000 (see Appendix 1 for details). Of these, the 1998extended arrangement was treated as precautionary,and no drawings were made under it. As a result, thebalance of outstanding IMF credit to Argentina actuallydeclined during 1997–99. It was only in late 2000 thatthe IMF’s exposure to Argentina rose sharply (see fig-ure). In addition, the IMF provided extensive technicalassistance to Argentina, dispatching some 50 missionsduring this period, mainly in the fiscal and bankingareas, in order to support the objectives of the IMF-sup-ported programs.

From early 2000 onward, the IMF-supported pro-grams attempted to address the worsening recession aswell as, from late 2000, Argentina’s inability to accessinternational capital markets. In March 2000, a three-year SBA for SDR 5.4 billion ($7.2 billion) was agreedto and, in January 2001, this was augmented by SDR 5.2billion to SDR 10.6 billion ($13.7 billion). At the sametime, additional financing was arranged from officialand private sources. The total amount of financing wasannounced to be $39 billion, prompting the governmentto use the word “blindaje” (shield) in characterizing thepackage. In September 2001, the arrangement was further augmented by SDR 6.4 billion ($8 billion) toSDR 17 billion ($22 billion), with up to $3 billion setaside to be used in support of a possible debt-restructur-

ing operation. In December 2001, with the hoped-for re-turn of confidence nowhere to be seen and the fiscal pro-gram seriously off track, the scheduled program reviewwas not completed, and IMF support of Argentina waseffectively cut off.

2They include staff reports for Article IV consultations and useof IMF resources, technical assistance reports, briefing papersand back-to-office reports for staff missions and visits, internalmemorandums and technical notes exchanged among staff or be-tween staff and management, minutes or summaries of formaland informal Executive Board meetings, comments by manage-ment and staff on briefing papers, and policy papers prepared bystaff for the Board. Some of these Board policy papers have beenpublished, including on the IMF’s website. Full citations for thesepapers are made in footnotes and not in the bibliography, exceptwhen they are available in print form.

3Management refers to the group of senior IMF officials con-sisting of the Managing Director, the First Deputy Managing Di-rector, and two Deputy Managing Directors.

Financial Transactions Between Argentina and the IMF(In millions of SDRs)

Source: IMF database.

1991 92 93 94 95 96 97 98 99 2000 01 02–2000

0

2000

4000

6000

8000

10000

12000Disbursements

Net flowCredit outstanding

Repayments and charges

CHAPTER 1 • INTRODUCTION

10

Tabl

e 1.

1.K

ey E

cono

mic

Ind

icat

ors

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Rea

l GD

P gr

owth

(pe

rcen

t)10

.510

.36.

35.

8–2

.85.

58.

13.

8–3

.4–0

.8–4

.4–1

0.9

Rea

l pri

vate

con

sum

ptio

n gr

owth

(pe

rcen

t)15

.012

.17.

15.

4–4

.07.

38.

72.

5–4

.00.

3–4

.9–1

3.3

Rea

l pub

lic c

onsu

mpt

ion

grow

th (

perc

ent)

–13.

122

.712

.12.

7–1

.6–0

.93.

87.

15.

6–0

.1–1

.9–1

3.5

Rea

l fix

ed in

vest

men

t gr

owth

(pe

rcen

t)31

.533

.516

.013

.7–1

3.0

8.8

17.7

6.5

–12.

6–6

.8–1

5.7

–36.

4

Infla

tion

(CPI

,Dec

./Dec

.,pe

rcen

t)84

.017

.57.

43.

91.

60.

10.

30.

7–1

.8–0

.7–1

.541

.0M

oney

(M

1,D

ec./D

ec.,

perc

ent,

in p

esos

)14

8.6

49.0

33.0

8.2

1.6

14.6

12.8

0.0

1.6

–9.1

–20.

178

.4Br

oad

mon

ey (

Dec

./Dec

.,pe

rcen

t,in

pes

os)

167.

963

.055

.914

.9–4

.320

.026

.910

.32.

34.

4–1

9.7

18.3

Cur

rent

acc

ount

bal

ance

(bi

llion

U.S

.dol

lars

)–0

.4–6

.5–8

.0–1

1.1

–5.2

–6.8

–12.

2–1

4.5

–11.

9–8

.8–4

.59.

6(In

per

cent

of G

DP)

–0.2

–2.9

–3.4

–4.3

–2.0

–2.5

–4.2

–4.9

–4.2

–3.1

–1.7

3.1

Expo

rt o

f goo

ds a

nd s

ervi

ces

(U.S

.dol

lars

,per

cent

gro

wth

)–2

.13.

48.

517

.828

.913

.69.

00.

7–1

0.5

11.6

–0.5

–7.4

Impo

rt o

f goo

ds a

nd s

ervi

ces

(U.S

.dol

lars

,per

cent

gro

wth

)68

.358

.830

.311

.3–4

.615

.824

.13.

4–1

5.3

0.5

–16.

6–5

2.6

Publ

ic s

ecto

r de

bt (

perc

ent

of G

DP)

34.8

28.3

30.6

33.7

36.7

39.1

37.7

40.9

47.6

50.9

62.2

...

Exte

rnal

deb

t (p

erce

nt o

f GD

P)34

.527

.730

.533

.338

.440

.642

.747

.551

.251

.652

.242

.9D

ebt

serv

ice

ratio

(pe

rcen

t)33

.627

.530

.925

.230

.239

.450

.057

.675

.470

.866

.3..

.

Inte

rnat

iona

l res

erve

s m

inus

gol

d (b

illio

n U

.S.d

olla

rs)

6.2

10.2

14.0

14.6

14.5

18.3

22.3

24.8

26.3

25.1

14.6

10.5

Exch

ange

rat

e (p

eso/

U.S

.dol

lar,

end-

peri

od)

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

3.4

Rea

l effe

ctiv

e ex

chan

ge r

ate

(end

-per

iod)

114

0.5

165.

417

7.8

169.

316

2.9

163.

317

5.8

170.

617

7.6

184.

818

4.7

71.6

Term

s of

tra

de (

good

s an

d se

rvic

es,

perc

ent

chan

ge)

7.6

6.1

–7.7

14.4

–4.5

9.9

0.2

–5.1

–8.4

7.2

–5.7

–10.

8

Cen

tral

gov

ernm

ent

prim

ary

bala

nce

(per

cent

of G

DP)

...

1.3

2.1

0.8

0.1

–0.5

0.4

0.9

0.4

1.0

0.1

0.7

Gen

eral

gov

ernm

ent

prim

ary

bala

nce

(per

cent

of G

DP)

...

1.3

1.5

0.1

–1.3

–0.7

0.3

0.5

–0.8

0.5

–1.4

0.3

Cen

tral

gov

ernm

ent

over

all b

alan

ce

(per

cent

of G

DP)

...

–0.2

0.9

–0.5

–1.5

–2.2

–1.6

–1.3

–2.5

–2.4

–3.8

–11.

9G

ener

al g

over

nmen

t ov

eral

l bal

ance

(p

erce

nt o

f GD

P)..

.–0

.40.

1–1

.4–3

.2–2

.9–2

.1–2

.1–4

.2–3

.6–6

.2–1

2.8

Sour

ces:

IMF

data

base

;and

Wor

ld B

ank,

Glo

bal D

evel

opm

ent F

inan

ce.

1 Ave

rage

of 1

990

= 1

00.


during the crisis period, from late 2000 through theend of 2001. These decisions include (i) the com-pletion of the second review and augmentation ofthe SBA (January 2001); (ii) the completion of thethird review (May 2001); (iii) the completion of thefourth review and augmentation (September 2001);and (iv) the noncompletion of the fifth review (De-cember 2001), which was effectively the cutoff ofIMF financial support. Chapter 4 summarizesmajor findings of the evaluation, draws lessons forthe IMF from the Argentine experience, and pre-sents six sets of recommendations. Finally, ten ac-companying appendixes provide more detailed in-formation and analyses on some of the issuesdiscussed in the report, including a timeline ofmajor events and a list of interviewees.

Overview of Economic Developments, 1991–2001

The Convertibility Law, which pegged the Ar-gentine currency to the U.S. dollar in April 1991,was a response to Argentina’s dire economic situa-tion at the beginning of the 1990s. Following morethan a decade of high inflation and economic stag-nation, and after several failed attempts to stabilizethe economy, in late 1989 Argentina had fallen intohyperinflation and a virtual economic collapse (seeAppendix 2). The new exchange rate regime, whichoperated like a currency board, was designed to sta-bilize the economy by establishing a hard nominalpeg with credible assurances of nonreversibility.The new peso (set equal to 10,000 australes) wasfixed at par with the U.S. dollar and autonomousmoney creation by the central bank was severelyconstrained, though less rigidly than in a classicalcurrency board.4 The exchange rate arrangementwas part of a larger Convertibility Plan, which included a broader agenda of market-orientedstructural reforms to promote efficiency and pro-ductivity in the economy. Various service sectorswere deregulated, trade was liberalized, and anti-competitive price-fixing schemes were removed;privatization proceeded vigorously, notably in oil,

power, and telecommunications, yielding large cap-ital revenues.

There was a marked improvement in Argentina’seconomic performance under the ConvertibilityPlan, particularly during its early years (Table 1.1).Inflation, which was raging at a monthly rate of 27percent in February 1991, declined to 2.8 percent inMay 1991; on an annual basis, inflation fell to singledigits in the summer of 1993 and remained low (oreven negative) from 1994 to the end of the convert-ibility regime in early 2002 (Figure 1.1). The overallfiscal balance of the federal government improvedsignificantly from the previous years, with an aver-age budgeted deficit of less than 1 percent of GDPduring 1991–98.

Growth performance was impressive throughearly 1998, except for a brief setback in 1995 whenArgentina was adversely affected by the Mexicancrisis. For 1991–98, GDP growth averaged nearly 6percent a year, vindicating the market-oriented re-forms introduced in the early 1990s. Attracted by amore investment-friendly climate, there were largecapital inflows in the form of portfolio and direct in-vestments. During 1992–99, Argentina receivedmore than $100 billion in net capital inflows, includ-ing over $60 billion in gross foreign direct invest-ments (Figure 1.2).

The resilience of the convertibility regime wasseverely tested by the Mexican crisis in 1995. In re-sponse, Argentina launched a rigorous adjustmentprogram under IMF financial support, consisting ofstrong fiscal action and structural reform. When the

11

4The Convertibility Law was approved by Congress on March27, 1991, establishing full convertibility of the austral at A10,000per U.S. dollar (or the new peso created in January 1992 at Arg$1per U.S. dollar), requiring the central bank in principle to backfully the monetary base with foreign exchange reserves, and pro-hibiting indexation of local-currency-denominated contracts. Un-like a “classical” currency board, however, the central bank wasallowed to hold U.S. dollar-denominated domestic debt as a coverfor part of base money, and was also not required to intervene tosupport the dollar (i.e., the peso technically could appreciateabove parity). See, for example, Baliño and others (1997) andHanke and Schuler (2002).

1992 93 94 95 96 97 98 99 2000 01 02–10

0

10

20

30

40

50

Figure 1.1. Inflation1

(In percent)

Source: IMF, International Financial Statistics.1Year-on-year change in CPI.


peg survived and a V-shaped recovery ensued, thiswas widely interpreted as evidence of the convert-ibility regime’s robustness and credibility. Favor-able external circumstances also contributed to thisoutcome. This was a period in which the U.S. dol-lar was relatively weak, so the peg did not entail a

loss of competitiveness, particularly given the im-provements in productivity. Tariff reductionsachieved under MERCOSUR also helped promoteexports, particularly to Brazil, Argentina’s largesttrading partner. Capital flows to emerging marketswere strong in the mid-1990s and Argentina was amajor beneficiary. Argentina was relatively unaf-fected by the outbreak of the East Asian crisis in1997; it quickly returned to the international capitalmarkets in December of that year.

In October 1998, the performance of Argentinareceived the attention of the world when PresidentCarlos Menem shared the podium of the AnnualMeetings with the IMF Managing Director, whocharacterized “the experience of Argentina in recentyears” as “exemplary.” The Managing Director fur-ther remarked: “Argentina has a story to tell theworld: a story which is about the importance of fis-cal discipline, of structural change, and of monetarypolicy rigorously maintained.”5

As it happened, Argentina’s performance deteri-orated from the second half of 1998, owing to ad-verse external shocks, including a reversal in capi-tal flows to emerging markets following theRussian default in August 1998; weakening of de-mand in major trading partners, notably in Brazil; afall in oil and other commodity prices; generalstrengthening of the U.S. dollar against the euro;and the 70 percent devaluation of the Brazilian realagainst the U.S. dollar in early 1999. Real GDP fellby over 3 percent in the second half of 1998. Therewas a mild pickup in economic activity in the sec-ond half of 1999, spurred by increased governmentspending in the run-up to the October presidentialelections, but this was not sustained and GDP de-clined by 3!/2 percent for 1999 as a whole. Theeconomy never recovered through the end of theconvertibility regime (Figure 1.3).

The economic slowdown, coupled with the elec-tion-driven surge in public spending in 1999, hadimportant implications for fiscal solvency. Ar-gentina’s consolidated fiscal balance had been indeficit throughout the 1990s except in 1993, but themagnitude was not large. Consolidated public sectordebt, however, increased more rapidly because of theperiodic recognition of off-budget liabilities, includ-ing the court-ordered payments of past pension ben-efits, which averaged over 2 percent of GDP a yearduring 1993–99. Even so, the rise in the debt-to-GDP ratio was modest as long as growth remainedhigh, and there was even a small decline in the ratio

12

Figure 1.3. Real Quarterly GDP Growth1

(In percent)

Source: IMF, International Financial Statistics.1Year-on-year.

–20

–15

–10

–5

0

5

10

15

1988 90 92 94 96 98 2000 02

5Transcript of the press conference, October 1, 1998. A numberof staff members interviewed told the evaluation team that theyhad considered such a sanguine assessment of Argentina to be notwarranted in the fall of 1998.

Figure 1.2. Capital Flows(In billions of U.S. dollars)

Source: IMF, International Financial Statistics.

1991 92 93 94 95 96 97 98 99 2000 01 02–30

–20

–10

0

10

20

30

40

Others (including loans and deposits)Net portfolio investmentNet direct investment

Financial account balance


from 1996 to 1997. The situation changed in 1999,when growth decelerated and the public finances de-teriorated sharply. The debt-to-GDP ratio rose from37.7 percent of GDP at end-1997 to 47.6 percent atend-1999, an increase of 10 percentage points in justtwo years. The ratio would eventually reach 62 per-cent at the end of 2001.

Argentina’s problems intensified in 2000, whengrowing solvency concerns over the cumulative in-crease in public debt were exacerbated by the con-tinued appreciation of the U.S. dollar and a furtherdrying up of capital flows to emerging marketeconomies. These developments would normally re-quire a smaller current account deficit and a depreci-ation of the real exchange rate, but the convertibilityregime placed severe limitations on the ability of Ar-gentina to achieve this adjustment in a manner thatcould avoid recession. Argentina initially sought torestore market confidence by negotiating an SBAwith the IMF, which it indicated would be treated asprecautionary.6

Market confidence did not recover as expectedand market access was effectively lost later in theyear, leading Argentina to seek an augmentation ofIMF support. From December 2000 to September2001, the IMF made a series of decisions to provideexceptional financial support to Argentina, whichultimately amounted to SDR 17 billion, includ-ing the undrawn balance under the existingarrangement (see Box 1.1 for details). However,stabilization proved elusive. The augmentation an-nounced in December 2000 and formally approvedin January 2001 had a favorable effect, but it wasshort-lived. Pressure built up again as it became ev-ident that political support for the agreed measureswas lacking and program targets were unlikely tobe met.

From the spring of 2001, the authorities took a se-ries of measures in quick succession, including: anannounced plan to change the anchor of the convert-ibility regime from the U.S. dollar to an equallyweighted basket of the dollar and the euro (theswitch to take effect only when the two currenciesreached parity); a series of heterodox industrial or protectionist policies (called “competitivenessplans”), involving various tax-exemption measuresin sectors most adversely affected by the recession;and an exchange of outstanding government bondstotaling $30 billion in face value for longer maturity

instruments (the so-called mega-swap).7 Many ofthese measures, which were taken without consulta-tion with the IMF, were perceived by the markets asdesperate or impractical, and served to damage mar-ket confidence.

Despite these initiatives and the financial supportof the IMF, market access could not be restored, andspreads on Argentine bonds rose sharply in the thirdquarter of 2001 (Figure 1.4). Amid intensified capi-tal flight and deposit runs, capital controls and a par-tial deposit freeze were introduced in December2001. With Argentina failing to comply with the fis-cal targets, the IMF indicated that it could not clearthe disbursement scheduled for December. At theend of December, following the resignation of Presi-dent Fernando De La Rúa, the country partially de-faulted on its international obligations. In early Janu-ary 2002, Argentina formally abandoned theconvertibility regime and replaced it with a dual ex-change rate system.

13

Figure 1.4. Interest Rate Spreads over U.S. Treasuries1

(In basis points)

Source: Datastream.1JP Morgan Emerging Market Bond Index (EMBI)—Global Stripped Spreads.

1994 95 96 97 98 99 2000 010

1000

2000

3000

4000

5000

6000EMBI Global Argentina

EMBI Global BradyEMBI Global Composite

6In IMF terminology, a financing arrangement is considered as“precautionary” if the authorities indicate an intention not to drawon the resources provided. However, there is no legal distinction between precautionary and regular arrangements, as the authori-ties have the right to use the resources made available under thearrangement, should circumstances change.

7Other measures included: (i) a transitional compensationmechanism (called the convergence factor) to mimic the basketpeg through fiscal means, by paying exporters a subsidy andcharging importers a duty equivalent to the difference between theprevailing exchange rate and the exchange rate calculated by thebasket; and (ii) the zero deficit plan (which subsequently becamelaw), mandating the government, in the event of a prospectivedeficit, to introduce across-the-board proportional cuts in primaryexpenditures, which revealed the dire liquidity position of thegovernment and was generally perceived as impractical. See Box3.3 for the chronology of these and other additional measures.


Factors Contributing to the Crisis

The causes of the Argentine crisis have beenstudied extensively, and a considerable literaturehas emerged on the subject (see, for example,Mussa, 2002; Hausman and Velasco, 2002; de laTorre and others, 2002; and Perry and Servén,2002). The IMF also conducted its own internal re-view and drew a number of lessons from the crisis.8There is a general agreement that a combination ofdomestic and external factors contributed to the cri-sis, but different authors have emphasized differentfactors as relatively more important. Most have em-phasized one or more of the following three factorsas critically important: (i) weak fiscal policy(Mussa, 2002); (ii) the rigid exchange rate regime(Gonzales Fraga, 2002); and (iii) adverse externalshocks (Calvo and others, 2002). Some havestressed a combination of these factors as critical(Feldstein, 2002; Krueger, 2002).9

It is difficult to isolate, from the many factors in-volved, those that were fundamentally more impor-tant. It is possible, however, to distinguish betweenthe underlying factors that generated vulnerabilityand the immediate factors that triggered the crisis. Inthe absence of triggering events, a crisis may nothave occurred when it did, but the underlying vul-nerability would have continued and a crisis couldhave been triggered later by other adverse shocks. Inthe absence of the underlying vulnerability, however,the same adverse developments would not have hadthe catastrophic effects that were associated with thecrisis, though they may well have produced somenegative effects.

It is clear that Argentina’s vulnerability arosefrom the inconsistency between the weakness offiscal policy and its choice of the convertibilityregime. The weak fiscal policy created serious liq-uidity problems for the government when marketconditions tightened and led to the eruption of afunding crisis in early 2001. If Argentina’s publicsector had generated surpluses in its fiscal accountduring the precrisis years, it could have avoided thetightening liquidity constraints in 2000 and the all-out funding crisis of the public sector in 2001.

Argentina also would have enjoyed greater flexibil-ity in using fiscal policy to cope with the impact ofadverse shocks, and would have been spared fromthe need to contract fiscal policy when output wasalready declining.

Underlying this poor fiscal performance were Ar-gentina’s weak political institutions, which persis-tently pushed the political system to commit morefiscal resources than it was capable of mobilizing.Public expenditure could not be controlled becausespending was often used as an instrument of politicalfavor. Tax administration was also weak, leading towidespread tax avoidance and evasion, and efforts toimprove tax compliance were not successful. Furthercomplicating fiscal management were certain fea-tures of Argentina’s federal structure. The system ofrepresentation gave power to the provinces, which inturn relied on the federal government for much oftheir tax revenue. Provincial politicians enjoyed alarge share of the political benefit of spending withlittle of the cost of taxation, creating poor incentivesfor fiscal responsibility. On the federal level, the revenue-sharing (“coparticipation”) arrangements,under which the proceeds of some taxes (but not oth-ers) were shared with the provinces, led to highlydistortionary tax policies (by creating incentives touse nonshared taxes, such as payroll and financialtransactions taxes).10 Under these circumstances, in-centives to collect tax remained weak both in theprovinces and at the federal level (Tommasi, 2002;Spiller and Tommasi, 2003).

Though extremely effective initially as a stabi-lization tool, the convertibility regime was a riskychoice for Argentina over the medium term (Box1.2). By all but eliminating money creation as asource of revenue, it raised the required level of fis-cal discipline. While this was extremely positive interms of its impact on inflation, it also increased thepotential long-term disruptive effect if the fiscal dis-cipline was not fully delivered. It also made adjust-ment to adverse shocks more difficult by eliminatingnominal depreciation as an instrument of policy. Hadwages and prices been sufficiently flexible down-ward, the required real exchange rate depreciationcould have been achieved through price deflation. In

14

10As another aspect of the coparticipation scheme, there was atendency for excessive spending cuts to be made at the federallevel when fiscal adjustment was required, because any effort toincrease shared tax would lose a large share to the provinces. Itwas for this reason that Economy Minister José Luis Machinea in1999 negotiated a temporary arrangement with the provinces,whereby the federal government would transfer a fixed amount tothe provinces regardless of the amount of tax collected. SeeCuevas (2003). Coming at a time of deepening recession, how-ever, the fixed transfer scheme did not help the federal govern-ment improve its finances.

8Policy Development and Review Department, “Lessons fromthe Crisis in Argentina,” SM/03/345, October 2003. Henceforthreferred to as PDR (2003). See also Collyns and Kincaid (2003)for broader lessons on Latin America.

9There are studies that emphasize “structural” factors, such aseconomic liberalization and the volatility and procyclicality of in-ternational capital flows (Frenkel, 2003; Damill and Frenkel,2003) and political factors (Corrales, 2002). As early as 1997, theinsightful political analyses of Gibson (1997) and Starr (1997)predicted an eventual collapse of the convertibility regime basedon political factors existing at that time. For a more complete listof studies on the Argentine crisis, see the bibliography.


the absence of downward wage flexibility, the im-provement in the current account required by the se-ries of adverse shocks that hit Argentina from late1998 could only be achieved through a prolongeddemand contraction.

Compounding these vulnerabilities was Argen-tina’s limited market for domestic borrowing andits limited ability to issue long-term debt denomi-nated in its own currency. As a result, the govern-ment relied heavily on external borrowing in for-eign currencies. The combination of a weak fiscalpolicy and heavy reliance on external borrowingwithin the constraint of the convertibility regimebecame a recipe for disaster, when the country washit by the prolonged adverse shocks. In particular, asharp reduction, or “sudden stop” in the terminol-

ogy of Calvo and others (2002), in global capitalflows to emerging market economies increasinglyraised the cost of external financing, and worsenedthe fiscal situation. Thanks to careful managementof maturity structure, the impact of the sudden stopon the public sector’s immediate financing needwas not as great as it would have been had more ofthe debt been contracted at shorter maturities, butthis only meant that the crisis took a few years todevelop.

Political factors also played a prominent role inArgentina (Box 1.3). The new government of Fer-nando De La Rúa, who took office in December1999 in the midst of growing signs of economic dif-ficulties, was a coalition (Alianza) of the centristRadical party and the center-left FREPASO party,

15

Box 1.2.Was the Convertibility Regime Viable?

Some authors have argued that the convertibilityregime (a hard peg to the U.S. dollar) was fundamen-tally unviable and thus doomed to fail from the incep-tion (Curia, 1999; and Gonzales Fraga, 2002). Issuesrelated to a choice of exchange rate regime are com-plex. Here, we will only consider one aspect of thechoice, namely, the ability of an exchange rate regimeto accommodate shocks that require a change in thereal exchange rate.

In considering the viability of the convertibilityregime for Argentina, there are three relevant questionsto ask:

• How frequent and large are required real exchangerate changes?

• How effectively can a required real exchange ratechange be accommodated in the absence of nomi-nal exchange rate flexibility?

• Assuming that the impact of a relevant shock is ad-verse and prolonged, how resilient is the economyagainst sustained deflation (when nominal flexibil-ity is sufficient) or sustained output contraction(when insufficient)?

Several of Argentina’s real characteristics were notideal for supporting a peg to the U.S. dollar: (i) exportswere predominantly homogeneous goods subject to fre-quent global shocks; (ii) Argentina’s small total trade-to-GDP ratio (about 16 percent) required a large real ex-change rate change to generate a given size of externaladjustment; (iii) the U.S. share of trade was relativelysmall (about 15 percent); and (iv) Argentina and theUnited States did not share closely correlated businesscycles. These were factors that could require frequentand possibly large real exchange rate changes, particu-larly with a fixed peg to the U.S. dollar, although there isno presumption that those changes would be necessarilylarge relative to the capacity of the country.

A country’s ability to respond to a required change inthe real exchange rate depends on the flexibility of itsmarkets and institutions. In Argentina, at the inceptionof the convertibility regime, its institutional rigidities inthe product and labor markets limited this ability. Butthese rigidities were an outcome of policy, and it wasfor this reason that a series of structural reforms werepursued in these areas in the early 1990s. Much rigidityremained, particularly in the labor market, but, giventhe magnitude and number of adverse shocks that hitArgentina in the late 1990s, it probably would havebeen unrealistic to expect that the country’s nominaland real flexibility alone could deliver the required ad-justment quickly.

Likewise, much of what makes up the resilience ofan economy—such as financial sector soundness andfiscal discipline—is also policy-driven. In terms of fi-nancial sector soundness, Argentina had a strong bank-ing system as measured by conventional prudential cri-teria, and the banking system did withstand the adverseimpact of the crisis for some time. What weakened theresilience of the Argentine economy was the lack of fis-cal discipline, in an environment where the public sec-tor relied on external borrowing. If Argentina had per-sistently generated fiscal surpluses throughout the1990s, the government would have retained capacity tofinance the economy out of recession; if it had less ex-ternal borrowing, the impact of the adverse shockswould have been less immediate. With a large real ex-change rate shock, prolonged output contraction mayhave been unavoidable, but the country could have usedits borrowing capacity to remain afloat until many ofthe shocks inevitably reversed themselves.

More fundamentally, the longer-term viability of anyfixed exchange rate regime depends on the degree ofpolitical support—in this case, the understanding of thetough policies needed to keep the convertibility regimeviable and the willingness to accept them.


which represented divergent views of priorities ineconomic policy. The Alianza enjoyed a workingmajority in the Lower House of Congress, but theSenate and the majority of the provinces, includingthe three largest ones, remained under the control ofthe main Justicialist (Peronist) opposition. Internaldifferences within the government and its inability toreceive broad support within the larger political es-tablishment undermined the credibility of many gov-ernment initiatives. The fragile state of the coalition,as well as the lack of broader political support, led to

the resignation of Vice President Carlos Álvarez inOctober 2000 and the successive resignations of twoMinisters of Economy (José Luis Machinea and Ricardo López Murphy) within 20 days in March2001, with a devastating impact on market confi-dence at a critical stage. Political developments inthe later months of 2001, including the defeat of theruling coalition in congressional elections, also con-tributed to the perception that the government wouldnot be able to take the very difficult steps needed toresolve the crisis.

16

Box 1.3.The Politics of the Convertibility Regime

As with most major economic policy measures, theconvertibility regime had important political dimen-sions, including:

• With the early success of the Convertibility Plan,President Carlos Menem, who had been elected to asix-year term, decided to seek a second term bychanging the constitution. In January 1994, the twomain political parties agreed on a framework forconstitutional reform that would allow PresidentMenem to serve a second term of four years, withthe elections set for mid-1995. This led to politicaldeals with opposition, provincial, and labor leaders,which weakened commitment to fiscal disciplineand stalling—even rolling back in some cases—thepace of structural reforms. However, despite thepressure of the upcoming elections, the authoritieswere able to take decisive action on the fiscal andstructural fronts in response to the Mexican crisis inearly 1995.

• From early 1997, President Menem began to seeka third term, despite the constitutional injunction.His attempt was eventually not successful, but itcreated a prolonged period of political competi-tion in which Peronist leaders at the federal andprovincial levels tried to use public spending towin the nomination.

• Beset by bribery scandals, the Peronist party lost itsmajority in Congress after elections in October1997. This made it difficult for the executive to se-cure congressional approval for its fiscal and struc-tural policy agendas.

• In the presidential elections of 1999, the convert-ibility regime was so popular with the public thateven the main opposition Radical party ran on theplatform to maintain the fixed exchange rateregime. With the help of the FREPASO party, theRadical party won the elections and, on December10, 1999, the new coalition (Alianza) governmentof Fernando De La Rúa took office, with José LuisMachinea as Minister of Economy.

• There was some—though marginal— opposition tothe convertibility regime, because it was perceivedas a symbol of the economic dislocation and unem-ployment that accompanied the radical deregula-tion, liberalization, and privatization initiatives ofthe early 1990s. Once the vulnerabilities of the con-vertibility regime had become apparent after late1998, opposition became more vocal. During thepresidential elections of 1999, some major candi-dates made remarks suggesting the need for achange in the convertibility regime, but they failedto receive broad public support.

• The Alianza turned out to be fragile. In October2000, Vice President Carlos Álvarez resigned as aprotest over lack of action by the Cabinet on al-leged corruption charges. Lack of support withinthe coalition for strong fiscal adjustment led to theresignation of Minister Machinea on March 2, 2001and that of his successor Ricardo López Murphy inthe evening of March 19, the very day when he re-ceived public support from President De la Rúa andpresented his economic agenda to the Annual Meet-ings of the Inter-American Development Bank(IDB) in Santiago.

This chapter reviews the IMF’s prolonged in-volvement in Argentina from the introduction

of the convertibility regime in 1991 until the onset ofcrisis in late 2000. The purpose is to determine theextent to which IMF surveillance helped to identifythe vulnerabilities that led to the crisis and how ef-fectively the IMF used the program relationship withArgentina during much of the period to addressthese vulnerabilities. We focus on three areas of crit-ical relevance to the IMF: (i) exchange rate policy;(ii) fiscal policy; and (iii) macro-critical structuralreforms in the fiscal system, the labor market, the so-cial security system, and the financial system. Foreach of these areas, two sets of issues will be ad-dressed: first, whether the IMF’s diagnosis of whatneeded to be done at various stages was correct, andwhether it could have been improved; second, theIMF’s impact on the policies actually chosen, andwhat determined the strength or weakness of thatimpact.

Exchange Rate Policy

Argentina was one of the handful of countries thatmaintained a “hard peg” in the 1990s and early2000s (Box 2.1). It is well known that the sustain-ability of such an exchange rate regime critically de-pends on certain stringent conditions being fulfilled.One of the central issues in evaluating surveillanceand program design in this area during the precrisisphase is how the IMF perceived the convertibilityregime’s medium-term viability over time; how ef-fectively it advocated the requisite supporting poli-cies; and whether it provided timely advice on exitstrategy if and when supporting policies were judgedto be insufficient.

Early success of the convertibility regime

As pointed out in Chapter 1, the convertibilityregime, with a rigid peg to the U.S. dollar, was ini-tially adopted as an instrument of price stabilization,and this objective was achieved. The IMF was ini-tially reluctant to support the system (see Cavallo

and Cottani, 1997), and remained for some time con-cerned that it might not deliver the permanent stabi-lization that was needed. The staff report that accom-panied Argentina’s request for a new SBA in July1991 commented: “The convertibility scheme canassist the authorities in their search for a rapid decel-eration of inflation, but it is also evident that infla-tion must decline quickly and stay at very low levelsif the economy’s competitiveness is not to be im-paired. This in turn requires that the fiscal objectivesof the program be fully met.”

Because convertibility was initially viewed as astabilization device, little attention was paid towhether the arrangement was appropriate as a basisfor long-term growth. There was little analysis ofwhether the exchange rate regime was viable over themedium term, including the issue of whether theUnited States and Argentina formed an optimum cur-rency area in terms of synchronization of businesscycles, geographical trade structure, or common ex-posure to external shocks. Instead, attention was fo-cused on whether the fixed rate was overvalued at themoment the peg was introduced and whether the pegmight lead to a real appreciation in the near future.

Once the economy had stabilized and started togrow, the focus of the IMF shifted to the risk of over-heating. Partly because the rate of inflation initiallyremained higher than that in the United States, theArgentine currency appreciated in real effectiveterms by over 50 percent from March 1991 through1993 (Figure 2.1). Concerns were expressed over thecurrent account deficit, which widened to 3 percentof GDP in 1992 (Figure 2.2). Internal staff docu-ments occasionally expressed concern that the deteri-orating current account might undermine the sustain-ability of the exchange rate regime and suggestedthat fiscal policy be moved toward surplus and re-serve requirements on banks be tightened. The au-thorities generally disagreed with this assessment,though the fiscal balance improved in 1992–93 andreserve requirements were tightened somewhat inAugust 1993.

The worries over the current account deficit sub-sided in early 1994, as inflation continued to fall andthe real effective exchange rate (REER) began to de-

17

CHAPTER

2 Surveillance and ProgramDesign, 1991–2000

CHAPTER 2 • SURVEILLANCE AND PROGRAM DESIGN, 1991–2000

preciate, reflecting the U.S. dollar’s depreciationagainst Argentina’s main trading partners. The staff,while still advocating fiscal adjustment, no longerexpressed strong concerns over the sustainability ofthe exchange rate regime. In retrospect, this mighthave been an opportune time to exit the peg, al-though the memory of hyperinflation was still freshand argued against such a possibility at that time.Some Board members did raise the issue, but thestaff hardly discussed it with the authorities and ap-pears to have accepted their view that a significant

portion of the real appreciation had been offset byimprovements in competitiveness resulting fromderegulation and privatization.

The Mexican crisis and subsequent recovery

The Mexican crisis of 1994–95 represented aturning point in the IMF staff’s view of the peg. Ear-lier reports had noted the effectiveness of the peg incontrolling inflation, and had outlined the policies

18

Box 2.1. Economic Characteristics of Hard Peg Economies

Argentina was one of the handful of countries thatmaintained a “hard peg” during the 1990s and early2000s. Other economies with hard pegs during someor all of this period included Bulgaria, Hong KongSAR, Estonia, Lithuania, Ecuador, and Panama. Ofthese, the first four economies maintained currency-board-like arrangements, while the other two weredollarized economies in which the U.S. dollar func-tioned as legal tender.

Comparison of Argentina with the other economiesin some pertinent economic characteristics revealsthree important facts (see table below):

• Argentina’s external debt was particularly largerelative to the value of exports, with the debt-to-exports ratio at 438 percent for 1992–2001.

• Argentina had a particularly small external sector.Total trade accounted for only 16 percent of GDP

during 1992–2001, far smaller than the average of96 percent for the group.

• Along with Hong Kong SAR, Argentina had only asmall share of its total trade (about 15 percent) ac-counted for by the anchor currency country (that is,the United States), whereas the other countries con-ducted at least 33 percent of their trade with anchorcurrency countries.

In terms of other macroeconomic characteristics, Ar-gentina did not differ much from, or perform muchworse than, its comparators. Argentina’s governmentdebt did not seem particularly high relative to that ofother countries, indicating that debt became an issuelargely because it was mostly foreign currency denomi-nated and the country had a small export base. As mea-sured by general government balance relative to GDP,Argentina’s fiscal policy was worse than most, but betterthan Lithuania’s.

Economic Characteristics of Selected Hard Peg Economies(In percent; period averages)

Hong KongArgentina Bulgaria SAR Ecuador1 Estonia Lithuania Panama1992–2001 1998–2003 1990–2003 2000–03 1993–2003 1995–2003 1990–2003 Average

Total external debt/exports of goods and services 438.4 150.6 . . . 240.7 52.2 77.1 80.9 173.3

Current account balance/GDP –3.3 –5.0 3.0 –1.1 –7.6 –7.8 –3.6 –3.6

International reserves/central bank reserve money 120.1 195.7 472.4 136.6 127.8 136.2 . . . 198.1

Total trade/GDP 16.4 84.3 239.2 53.4 144.5 90.4 45.6 96.3

Share of trade with anchor currency country2 15.2 51.4 14.6 33.0 57.6 43.3 34.2 35.6

General government balance/GDP –2.5 –0.4 0.2 0.8 –0.3 –3.6 –0.9 –1.0

General government net debt/GDP3 42.3 74.2 . . . 68.8 2.4 23.0 64.6 45.9

Sources: IMF database, and Bankscope.1Total external debt/exports of goods and services is the average between 2000 and 2002.2Anchor currency economies are the EU for Estonia and Lithuania and the United States for the rest of the economies.3Gross debt for Ecuador.

Chapter 2 • Surveillance and Program Design, 1991–2000

that staff judged to be necessary for sustaining thepeg. Not until 1995 did a formal staff report state aposition as to whether the peg should be maintained.The staff report of March 1995 took a clear positionin favor of the peg:

The pegging of the Argentine peso to the U.S. dollarsince April 1991 has been critical to the successful per-formance of the economy in recent years, providing thenecessary discipline to keep inflation under control. . . .Argentina’s economic history during the 1980s sug-gests that it would be very difficult to keep inflation ex-pectations under control in the event that exchange ratediscipline were to be lost. For this reason, and in viewof the strengthening of policies by the Argentine au-thorities, the staff supports the maintenance of the fixedexchange rate.

These views were echoed in public statements. Thepress release following the Board approval of the ex-tension request, dated April 6, 1995, said: “The deci-sive measures taken by the authorities, shortly aheadof national elections, demonstrate their full commit-ment to the basic objective of maintaining the Con-vertibility Plan that has served the country well.”

The staff was impressed by Argentina’s ability towithstand the pressures that followed the Mexican cri-sis, and particularly the authorities’ willingness totake tough measures in support of the peg.1 These in-cluded a fiscal adjustment of some 2 percent of GDP(mostly through an increase in the value-added tax(VAT) rate from 18 percent to 21 percent and a reduc-tion in public sector wages) and a set of structural re-forms, most notably measures to improve labor mar-ket flexibility for small and medium-sized enterprises.The fact that these politically painful decisions weretaken on the eve of presidential elections was espe-cially notable.

Subsequent staff reports and public statements re-iterated the IMF’s support for the peg. In a speech inBuenos Aires in May 1996, the Managing Directorcommented:

The recovery in output, which is just now beginning totake hold, depends mainly on continued strengtheningof private sector confidence, and continued macroeco-nomic policy discipline is essential to achieve this. Inthis regard, the Convertibility Law has served an essen-tial function over the last five years in reinforcing Ar-gentina’s commitment to fiscal discipline and price sta-bility; accordingly, it is continuing to play a critical rolein restoring confidence.

There were, however, some internal differences inperception. While IMF management and staff in the

Western Hemisphere Department (WHD) moved to-ward a more explicit stance in support of the ex-change rate peg, other departments and some Execu-tive Directors started to wonder if the peg should bereexamined. Given the “very weak growth prospect”envisaged for Argentina, a memorandum by the Pol-icy Development and Review Department (PDR) inJanuary 1996 questioned the appropriateness of the

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Figure 2.1. Monthly Real Effective Exchange Rate(1990 = 100)


1991 92 93 94 95 96 97 98 99 2000 01 0250

75

100

125

150

175

200

Figure 2.2. Trade and Current Account Balances(In percent of GDP)


1991 9392 94 95 96 97 98 99 2000 01–6

–5

–4

–3

–2

–1

0

1

2

3

4

Trade balance

Current account balance

1How the markets reacted to some of the actions of the authori-ties taken in early 1995 is analyzed in Ganapolsky and Schmukler(1998).


exchange rate arrangement in view of the need tostimulate domestic demand. While some ExecutiveDirectors had raised this issue from time to time, thequestions became more frequent in the aftermath ofthe Mexican crisis. Nevertheless, management con-sistently supported WHD’s position in favor of thepeg, and whenever the issue was raised at Boardmeetings, the majority of Executive Directors alsoconcluded that grounds for encouraging an exit werelacking.

From mid-1996 through 1998, there was virtuallyno substantive discussion of the peg within the staffor between the staff and the Argentine authorities,although the issue was raised from time to time atBoard meetings. The topic did not seem especiallypressing, largely because the REER based on con-sumer or wholesale prices showed only mild appre-ciation, if any, over most of this period. Concernsabout competitiveness were never far from the sur-face, but staff reports dismissed these by citing therapid growth of exports (exports grew over 30 per-cent annually in volume terms and 11 percent invalue terms from 1995 through 1999). As evidenceof the positive impact of structural reforms on laborcosts, the staff produced an estimate of the real peso-dollar exchange rate based on unit labor costs, whichshowed a steady cumulative “depreciation” of al-most 50 percent from 1991 through the third quarterof 1998.

In retrospect, the years 1996–97 may well havebeen the last opportunity for Argentina to exit fromthe peg without facing very high costs. Spreads, ifany, between peso and dollar interest rates weresmall, suggesting that the market did not expect anybreak in the peg to involve a large depreciation.2Moreover, the strength of capital flows to emergingmarkets in that period and the widespread optimismabout Argentina’s growth potential would have actedto stabilize the currency. The authorities’ strong re-sponse to the Mexican crisis had produced a greatdeal of confidence in the ability of the Argentine po-litical system to keep the country’s debt under con-trol and to implement a new wave of structural re-forms, all of which created favorable circumstancesfor exit.

It should be noted, however, that exit was neveran easy option, either politically or economically. Inthe first place, the design of the convertibility regimemade any exit costly, a feature that was necessary aspart of the strategy of ensuring its initial credibility,and the costs increased over time as the fixed peg de-

termined behavior that was reflected in balancesheets and other aspects of economic life. Moreover,President Menem’s prestige was closely linked tothe convertibility regime, which commanded widepublic support. The legal consequences of any exitwould also have been just as significant, given theextensive dollarization of contracts and the fact thatit would have meant the breach of a social contractbetween the state and the public. Nevertheless, theIMF could have played a valuable role in encourag-ing serious consideration of the exit option throughpolicy advice and an offer of financial support if theauthorities were interested.

Staff clearly believed that a strong program basedon fiscal consolidation and structural reform wouldfacilitate a possible switch to a floating exchangerate in the future. A briefing paper prepared in April1997 stated: “the discussions on a program to besupported by an extended arrangement will be basedon the assumption that convertibility will be main-tained, . . . with the expectation that successful im-plementation of the program may create the condi-tions for orderly exit from this strategy, if such exitwere to be desired.” Unfortunately, this idea was notdeveloped, and no further effort was made to deter-mine more precisely what “the conditions for or-derly exit” might be. From 1995 to 1999, the staffdevoted few analytical resources to the question andhardly raised the issue with the authorities.

Responses to adverse shocks

From 1998 to 2000, Argentina underwent a seriesof adverse shocks and, in consequence, unfavorableeconomic developments. These included: (i) a sharpreduction of capital flows to emerging markets afterthe East Asian and Russian crises of 1997–98; (ii) acorresponding increase in the risk aversion of inter-national investors; (iii) a terms of trade shock deriv-ing from the fall in the relative price of commoditiesexported by Argentina; (iv) the Brazilian devaluationof early 1999 and the ensuing loss of market share inBrazil; (v) a secular appreciation of the U.S. dollarrelative to the euro that eroded the competitivenessof Argentina in third markets; (vi) a sharp increase—by 175 basis points—in the U.S. federal funds ratebetween mid-1999 and mid-2000; (vii) prolongedrecession in Argentina; and (viii) the structural andworsening current account deficit. As pointed out byCalvo and others (2002), under these circumstances,Argentina’s relatively small tradable goods sectorwould have required a large real exchange rate ad-justment to restore external balance.

The evolving crisis in Brazil toward the end of1998 should have presented an occasion for staff toresume internal discussion of the convertibilityregime, but this did not happen. The staff report of

20

2Spreads between peso and dollar interest rates on similar do-mestic instruments began to decline substantially in late 1995 andremained relatively small from early 1996 to the third quarter of1997, ranging from near zero (or even negative in some cases) toless than 200 basis points.


September 1998 did not mention the risks to Ar-gentina of a possible devaluation of the Brazilianreal.3 A briefing paper in November included a foot-note suggesting that a worsening of the situation inBrazil might lead to lower capital market access and“slightly negative” growth in 1999, but did not evendiscuss its implications for the convertibility regime.When Brazil abandoned its crawling peg in January1999, causing a sharp appreciation in the REER ofthe Argentine peso, the staff responded by reaffirm-ing its support. The staff report for the 1999 ArticleIV consultation, written shortly after Brazil’s devalu-ation, declared:

The authorities and the staff agree that the most appro-priate response to recent events in Brazil is to reaffirm,indeed reinforce, the strong commitment to the policyframework that has served Argentina well, includingthe automatic adjustment mechanism implied by thecurrency board, prudent fiscal and debt policies cast ina medium term framework, and significant structuralreform to bolster banking soundness and flexibility inthe economy.

The staff’s positive appraisal of the “automaticadjustment mechanism” was new.4 In late 1997, theauthorities had offered this argument to justify theirposition that strong action to address the current ac-count deficit was not necessary. While not explicitlyrejecting this view, the staff had been careful not tomake the same argument in its own appraisal. In-stead of relying on any automatic adjustment mecha-nism, the staff had urged that the current account gapbe reduced through fiscal adjustment combined withstructural reforms to improve competitiveness. Inearly 1999, however, it apparently shifted to a posi-tion more accommodating of the automatic adjust-ment view, while continuing to emphasize the needfor prudent fiscal policies and structural reform. ByAugust 1999, however, the staff again emphasizedthe need for aggressive action without mentioningthe automatic adjustment mechanism, suggestingthat skepticism about the efficacy of “automatic ad-justment” had returned.

The initial response of the Argentine authoritiesto the Brazilian devaluation was to announce theirintention to pursue full dollarization of the economy,that is, moving to an even harder peg. Technical dis-cussions on this matter with the U.S. authorities hadstarted in 1998. The issue assumed a higher profilein 1999, but the discussions slowed ahead of the Oc-tober 1999 elections. The new De La Rúa adminis-tration that took office in December 1999 did notpursue the matter. The mere announcement in early1999 that the Argentine authorities were seriouslyconsidering full dollarization had a positive impactof reassuring investors that the authorities were notconsidering a break in the peg.

Despite being aware of the authorities’ interest infull dollarization and of their discussions with theUnited States, and despite the urging of managementand reviewing departments, WHD did not take astrong position on the dollarization issue. The reportprepared for the May 1999 review noted that thestaff shared the authorities’ view that full dollariza-tion would improve growth prospects by reducingthe high interest rates paid by Argentine borrowers.The report, however, provided no supporting analy-sis, beyond noting that full dollarization would needto be supported by “further reforms to increase theflexibility of the economy and its resilience to asym-metric shocks within the dollar area.”5 Within thestaff, as well as in the wider policymaking commu-nity, there was an understandable lack of consensuson the benefits of full dollarization, particularly foran economy like Argentina with a relatively diversi-fied geographical pattern of trade.

When the recession deepened in the course of1999, and prospects for a rapid recovery in 2000faded, WHD staff began to engage in a comprehen-sive analysis of the issues surrounding possible exitstrategies. A memorandum prepared for managementin August 1999 outlined two scenarios for 2000. Inone scenario, the “current” policies were assumed tobe maintained despite falling tax revenue, resulting ina sharp rise in the fiscal deficit, a fall in confidence,and a tightening of external financing conditions, as aresult of which unemployment was projected to riseand the sustainability of the convertibility regime tocome into question. The second scenario identified “aset of policies that could help restore confidence andensure the sustainability of the convertibility regimeover time,” including a sharp fiscal adjustment of upto 1.5 percent of GDP and structural reforms de-signed to shore up competitiveness, possibly withaugmented official support. Dollarization is men-

21

3The issue was raised, however, at the Board discussion of thereview. In response to questions from a few Executive Directors,the staff representative downplayed the risks to Argentina of a cri-sis in Brazil, noting the diversification of Argentina’s exports in1998, its ability to resist an outflow of deposits as demonstratedduring the Mexican crisis, the strength of the banking system, andthe contingent repurchase agreements with commercial banks.

4According to this view, any balance of payments difficultiesunder a currency board arrangement would result in a contractionof base money, leading to a rise in domestic interest rates and afall in domestic prices. These developments are in turn expectedto bring about the needed adjustment of the balance of paymentsthrough a combination of a fall in domestic demand, a real ex-change rate depreciation, and an increase in capital inflows.

5The Argentine proposal, however, did lead to further researchwithin the IMF into issues related to full dollarization in the gen-eral case. See Berg and Borensztein (2000).


tioned as a measure that might further boost confi-dence, provided that it is accompanied by firm poli-cies such as those described.

The staff noted that, if a package of the type de-scribed in the second scenario did not prove to befeasible, then “[a]n exit strategy would need to beconsidered.” But exit “would be extremely difficult,if not chaotic,” for a number of reasons, includingthe memory of hyperinflation, the likelihood of capi-tal flight, and the impact on the banking system. Thememorandum concluded that, while a move to afloating regime “could lead to a stronger economicperformance over the medium term” because itwould enable a more rapid adjustment of relativeprices, the risks of a return to the pre-1991 instabilityand the costs of the transition “are too high to allowcontemplation of such a possibility on a voluntarybasis.” Staff therefore recommended implementingthe fiscal adjustment and structural reforms needed“to restore viability to convertibility.”

The August 1999 memorandum proved to be onlythe start of a lengthy process of analysis by staff ofthe costs, benefits, and modalities of an exit from thepeg. The different analyses all reached the same con-clusion: that an exit would be extremely costly andwould bear a high risk of leading to hyperinflation, asevere shock to the banking system, and a sovereigndefault. Subsequent decisions by the IMF can be un-derstood in the light of the assessment that, given thelarge up-front costs, it was not appropriate to forcean exit from the peg. But this was valid only on theassumption that appropriate corrective steps wouldbe taken to preserve the peg.

The political environment after 2000 was particu-larly unfavorable to considering an exit from the pegas a policy option. The De La Rúa administrationhad been elected on a pledge to maintain the con-vertibility regime, and needed to demonstrate that itwould not repeat the hyperinflation of the late 1980sthat had brought down the Radical government. Theauthorities were highly reluctant even to discuss theissue, given the risk that news or rumors that suchdiscussions were under way would lead to a marketpanic, but they were receptive to the staff’s adviceon the need for policy action to support the exchangerate regime. Measures to this end were built into theSBA approved in March 2000, although they provedto be largely ineffective.

The IMF and exchange rate policy:an assessment

In assessing the effectiveness of IMF advice inthis area, it is important to recognize that the choiceof exchange rate regime is a member country’s pre-rogative. However, the IMF has an obligation to ex-ercise firm surveillance over members’ exchange

rate policies, and this is normally understood tomean that the IMF must examine the consistency ofthe authorities’ choice of exchange rate regime withother policy choices, given the institutional con-straints. The views of the Executive Board reiterat-ing this broad understanding were clearly expressedduring a discussion on “Exchange Rate Regimes inan Increasingly Integrated World Economy” held onSeptember 31, 1999.6 Yet, IMF staff devoted onlylimited resources to determining whether the ex-change rate regime adopted in Argentina was consis-tent with other policies and institutional constraintsand, if not, what possible exit strategies Argentinashould consider. Until the very last minute, manage-ment and staff did not discuss alternatives to Ar-gentina’s exchange rate policy at the ExecutiveBoard, even though the issue was raised on occasionby Executive Directors.

The reluctance to analyze and discuss fundamen-tal issues of the convertibility regime can be ex-plained by four factors:

• First and perhaps most important, there was afear that discussion of the convertibility regime,particularly when markets were jittery, mightundermine its viability in a self-fulfilling man-ner. But even if this was a legitimate considera-tion constraining the scope of discussion in theBoard, it does not explain the failure to discussthe issue with the authorities.

• Second, the IMF lacked objective tools to evalu-ate the appropriateness or sustainability of acountry’s exchange rate arrangement. In largepart, this reflected the absence of consensuswithin the economics profession (Box 2.2), butavailable analytical tools were also not suffi-ciently deployed. The exchange rate was typi-cally analyzed in terms of historical movementsof the REER, but such analysis was not based onthe forward-looking concept of sustainability.

• Third, there was an institutional culture that dis-couraged open discussion of such issues, basedon a particular (and in our view incorrect) inter-pretation of the Articles of Agreement. It is truethat IMF staff quickly learned that the authori-

22

6The Chair’s Summing Up of the Board discussion stated that“the Fund should offer its own views to assist national authoritiesin their policy deliberations [on exchange rate policy]. In particu-lar, the Fund should seek to ensure that countries’ policies andcircumstances are consistent with their choice of exchange rateregime. In some cases where the issue arose, this would requirethe Fund to offer advice on an appropriate strategy for exiting afixed exchange rate regime.” It further stated: “Directors agreedthat the Fund should not provide large scale assistance to coun-tries intervening heavily to support an exchange rate if this peg isinconsistent with the underlying policies.”


ties were not interested in discussing alterna-tives, which is understandable in view of thecentrality of the peg to their overall economicstrategy. However, the prerogative of a membercountry to choose an exchange rate regime of itsliking, and even its unwillingness to discuss theissue, did not exonerate the IMF from its obliga-tion to exercise firm surveillance over members’exchange rate policies.

• Fourth, repeated public statements by the IMFsupportive of Argentina’s convertibility regimesubsequently made it difficult for managementand staff to credibly propose alternatives to the Executive Board and to the Argentine authorities.

Whatever the reason may be, the IMF’s failure toaddress the viability of the exchange rate systemearly in the process must be read as a weakness of itssurveillance over exchange rate arrangements, asmandated by the Articles of Agreement and reaf-firmed by subsequent Executive Board statementsand policy guidelines. In the event, very little analy-sis was done, let alone discussed with the authori-ties. By the time staff and management began toconsider substantive issues related to the convertibil-ity regime, the cost of any exit was already so highthat it could only be implemented with strong politi-cal leadership, something that would prove lackingin Argentina.

Fiscal Policy

Fiscal policy was the single most prominent topicof discussion between the IMF and the Argentine au-thorities for virtually the entire period of convertibil-ity. While fiscal policy often dominates the IMF’s in-teractions with member countries, it assumed aparticular importance in the case of Argentina. Forone thing, there was a history of fiscal irresponsibil-ity that had in the past contributed to repeated cyclesof defaults and hyperinflation.7 Moreover, the choiceof the convertibility regime made fiscal policy espe-cially important.

There were three reasons why convertibilitymade fiscal policy especially important. First, fiscalpolicy was effectively the only tool of macroeco-nomic management, because the reserve backingrule of the currency-board-like regime imposed re-strictions on the use of monetary policy. For fiscal

policy to perform this role, debt needed to be keptlow enough to allow deficit financing during adownturn without creating fears of insolvency. Sec-ond, the same restrictions on monetary policy de-prived the central bank of the ability to act as thelender of last resort in the event of a banking crisis.This reinforced the need to maintain a sufficientlylow level of public debt to ensure that the govern-ment had adequate borrowing capacity to supportthe banking sector, if necessary.8 Third, the long-run viability of the convertibility regime depended

23

Box 2.2. Measuring the EquilibriumReal Exchange Rate

There is now a consensus that the Argentine pesowas increasingly overvalued during the immediateprecrisis period, but assessing the degree of overval-uation is not easy.

A wide range of views exist even today onwhether the peso was overvalued before the seriesof external shocks hit Argentina during 1998–2000.Some consider that the improvement in productivityin the 1990s was sufficient to compensate for (asubstantial portion of) any nominal effective appre-ciation of the peso (e.g., PDR, 2003). Others chal-lenge this view by appealing to the fact that thesurge in productivity had tapered off in the secondhalf of the 1990s (e.g., Perry and Servén, 2002). Ar-gentina’s export growth in the 1990s is difficult tointerpret, given the low initial base, the eliminationof export taxes and other trade liberalization mea-sures, and the impact of trade diversion associatedwith MERCOSUR. The fact that imports grewmuch faster (at 25 percent a year) than exports (at 8percent) during 1990–98 may have indicated a lossof competitiveness.

In the spring of 2000, before the further worsen-ing of economic and financial conditions in Ar-gentina and before the further weakening of the eurorelative to the U.S. dollar, there were equally dividedviews of the peso’s overvaluation. For example, theovervaluation was estimated to be 7 percent byGoldman Sachs, 13 percent by JP Morgan, and 17percent by Deutsche Bank. There were many otherestimates, ranging from a single digit to over 20 per-cent. Irrespective of the difficulty of quantifying theexact amount of overvaluation, however, the seriesof adverse shocks within the context of Argentina’seconomic characteristics should have led to an un-ambiguous qualitative judgment that the peso wassignificantly overvalued as the country entered thesecond year of recession.

7In July 1991, the Argentine representative at the ExecutiveBoard noted: “The chronic fiscal imbalance is recognized as the main contributing factor to the past stagnation and price instability.”

8In a heavily dollarized economy, however, there is a limit tothe public sector’s ability to perform this role regardless of thechoice of exchange rate regime.


on the credibility of the government guarantee thatlocal currency would be exchanged for U.S. dollarsat par. This credibility required that the markets didnot question the ability of the government to bor-row in foreign currencies, which in turn dependedon fiscal solvency.

The convertibility regime, coupled with centralbank independence, was expected to contribute tofiscal discipline by eliminating money creation as asource of deficit financing. This strategy seemed towork in the first few years, when the authorities suc-ceeded in substantially reducing fiscal deficits andthere was even a small surplus in 1993. The earlyachievements in fiscal consolidation were inter-preted by the IMF (as well as others) as a vindicationof the disciplining role of a currency-board-like

arrangement.9 Yet, Argentina still regularly fell shortof the targets agreed under the IMF-supported pro-grams. The fiscal balance remained in deficit (exceptin 1993) even when growth was high (Figure 2.3).Relative to the program targets set at the beginningof the year, annual targets were missed every yearfrom 1994 through 2001. The margins were some-times substantial, amounting to as much as 2 percentof GDP. The shortfalls are especially notable consid-ering that GDP growth exceeded forecasts in severalof these years. Despite this poor record, the IMFmaintained financing arrangements with Argentinaby relaxing targets or replacing the existing arrange-ment with a new one.

The IMF’s analysis of fiscal policy

The IMF’s analysis of fiscal policy, particularlyduring the second half of the 1990s, can be faultedon three grounds. It focused too much on the flowaspect reflected in the fiscal deficit and not enoughon the stock aspect reflected in the size of publicdebt, which was arguably critical for market confi-dence. It also underplayed the role of provincial fi-nances, which were an important source of fiscalweakness. Finally, it overestimated the sustainablelevel of debt for a country with Argentina’s eco-nomic characteristics.

Focus on flow variables

The focus of the staff’s analysis and discussionwith the authorities was primarily on the fiscaldeficit as a flow variable. Although total public sec-tor debt was included as a performance criterionfrom the beginning, an assumption of overdue oblig-ations was routinely accommodated. The staff didnot produce a table providing a convincing connec-tion between fiscal flow variables and the year-to-year change in the debt stock until July 1997. Thedebt stock per se became the main focus of briefingpapers and policy discussions only in late 1999 orearly 2000, when the debt-to-GDP ratio began to ap-proach 50 percent. By then, the economy was in re-cession, and efforts to reduce the debt by running afiscal surplus were difficult and possibly also coun-terproductive.

The focus on the deficit had two consequences.First, a failure to meet fiscal targets in a given yearwas followed merely by a renewed insistence thatthe authorities meet the flow targets for the follow-

24

9For example, a staff study published in 1997 concluded that,in Argentina, the “[currency board arrangement] contributed in animportant way to enforcing fiscal discipline (at the federal level).”Baliño and others (1997), p. 7.

Figure 2.3. Comparison of Fiscal Targets and Actuals

Source: IMF staff reports.

1999

1999

1995

1995

2000

2000

1998

1998

1996

1996

1994

1994

1997

1997

1992

1992

1993

1993

–3.0 –2.5 –2.0 –1.5 –1.0 –0.5 0 0.5–8–7–6–5–4–3–2–101234

–5 –4 –3 –2 –1 0 1–6

–4

–2

0

2

4

6

8

10

12

Real

GD

P G

row

th (i

n pe

rcen

t)

Fiscal balance (in percent of GDP)

Fiscal balance (in percent of GDP)

Real

GD

P G

row

th (i

n pe

rcen

t)

Actual

Difference(Actual minus target)


ing year; the targets were never recalibrated to cor-rect for the deviation of the debt stock from the de-sired path as a result of earlier underperformance(Figure 2.4). A full compensation for a shortfall inthe previous year may not have been appropriate, butfiscal deficits should have been explicitly related tothe objective of reducing debt ratios over time. Sec-ond, the focus on flow variables weakened the fiscalposition over time because of asymmetric responseto growth shocks. There was a tendency to loosenfiscal targets and grant waivers for the nonobser-vance of performance criteria when growth fellbelow forecasts (for example, in 1995, 1999, or2000), but not to strengthen targets when growth ex-ceeded forecasts (for example, in 1993 or 1997).10

The need for a tighter fiscal policy in Argentinawas not fully appreciated within the IMF duringmuch of the precrisis period. Despite the tendency torelax targets in years of weak economic perfor-mance, WHD’s fiscal policy stance was at times crit-icized for being too contractionary, both by reviewdepartments and by some Executive Directors. Forexample, PDR remarked in August 1996 that, giventhe high level of unemployment, the delay in recov-ery, the lack of inflationary pressure, the govern-ment’s waning political support, and the fact that fis-cal policy was still tight in a cyclically adjustedsense, “the wisdom of pushing too hard for signifi-cantly more stringent fiscal measures is subject toquestion.”11 As late as February 1999, the ResearchDepartment (RES) warned that caution “should betaken not to aggravate the economic downturnthrough a further tightening of the fiscal position.Given Argentina’s low fiscal deficit, the sound trackrecord of fiscal responsibility established in recentyears, and the experience following the Mexican cri-sis, the ‘market confidence’ effects of a policy re-sponse of fiscal tightening are likely to be modest.”

The emphasis on the deficit as a flow variableserved to understate the seriousness of Argentina’s fis-cal position, because sovereign debt was growingmuch more quickly than would be expected from theyear-to-year deficit figures (see Appendix 3 for de-tails). One reason for this was the (often court-ordered) assumption of old debts, including overdueobligations to pensioners, government suppliers, andprovincial governments. The authorities were alsoprone to issue off-budget debt to settle governmentobligations, through such means as the capitalizationof interest payments.12 While such increases in debtwere not given due recognition, the deficit-relatedperformance criteria for the program supported by the1992–94 extended arrangement included privatizationreceipts.13 In other words, the performance criteriacould be met with nonrecurring debt-reducing opera-tions but were unaffected by nonrecurring debt-increasing operations.

The emphasis on flows in part reflected the factthat the IMF’s financial programming was based on flow relationships. A similar approach informedthe authorities’ attempt to legislate fiscal disciplinethrough the enactment of a “Fiscal ResponsibilityLaw” in September 1999. This law set a timetable

25

Figure 2.4. Projected Overall Fiscal Balances and Their Outturns(In percent of GDP)

Source: IMF staff reports.

1991 9392 94 95 96 97 98 99 2000 01–3

–2

–1

0

1

2

3

Second review

SBA 2000

Second review

EFF 1998

Second review

SBA 1996

Seventh reviewFourth

review

EFF1992

Actual

Actual

10This tendency was noted in the IEO’s evaluation of fiscal ad-justment in IMF-supported programs (IEO, 2003b). When growthwas robust, staff did sometimes try to argue for tightening the fis-cal targets, but to no avail. In March 1993, for example, the staffadvised the authorities “that a strengthening of the public finances,perhaps even beyond the programmed level, would restrain ab-sorption and reduce the risks to the program.” The authorities re-sponded that, in their view, demand pressures were subsiding andadditional restraint was not necessary. In the end, the targets thathad been set at the beginning of the year were not adjusted andwere met only with a small margin. Likewise in April 1998, seniorstaff wrote a letter to the authorities stressing the need to tightenfiscal policy in view of a large current account deficit. It should benoted, however, that the staff’s approach to fiscal policy in theseinstances was motivated by cyclical demand management consid-erations, and not by debt sustainability concerns.

11A Wall Street Journal commentary written around this timeby a prominent academic expert took a position even more lenienttoward fiscal policy than that of the IMF, by recommending that anew IMF-supported program should focus on structural reformsrather than short-term fiscal targets. See Edwards (1996).

12An unofficial estimate by Teijeiro ( 2001) puts the figure at$31 billion during the 1990s.

13Privatization revenues, however, were later treated as financing.


under which the federal deficit would be reducedgradually and then eliminated entirely by 2003, andlimited the growth rate of real expenditures to that ofreal GDP. The accumulation of a small “fiscal stabi-lization fund” was envisaged, which would smoothcyclical fluctuations in the fiscal accounts, but debt re-duction per se was not a primary goal of the law. In in-ternal discussions and in discussions with the authori-ties, staff did not consider the pace of fiscalconsolidation specified in the law to be fast enough,and was disappointed that the law covered only thefederal government (attempts were made in 2000 toenact similar laws in the provinces). Nevertheless, theIMF publicly endorsed the law as providing an impor-tant signal of the authorities’ commitment to soundfiscal policies, and urged the presidential candidatesto declare their support for it. In the event, even therelatively weak prescriptions of the law could not bemet in the recessionary climate of 2000.

Insufficient attention to provincial finances

The provincial governments constitute a significantcomponent of the public sector in Argentina, with acombined spending comparable to that of the federalgovernment once transfers to the provinces are ex-cluded from federal expenditures (see Appendix 3,Table A3.5). From the very beginning, the IMF waswell aware that poor tax administration and weak fis-cal control at the provincial level had contributed tothe country’s historically poor fiscal performance, andthis posed challenges for strengthening the overall fis-cal discipline of the public sector. As a result, the re-form of the provincial finances, including the rev-enue-sharing arrangements, was rightly made an areaof structural reform under the successive financingarrangements with Argentina (see the section “Struc-tural fiscal reforms”). Yet, the focus of formal fiscalconditionality in the earlier years remained exclu-sively on the federal government budget, and it wasonly in 1998 that the combined federal and provincialdeficits were explicitly included as an indicative targetin the EFF (see Appendix 4).

An attempt to address weaknesses in provincialfinances was made in response to the Mexican cri-sis. One-time revenue sources that had financedprovincial deficits, such as privatization receiptsand the settlement of the federal government’s ear-lier obligations to the provinces, had fallen sharplyfrom their levels of the early 1990s, and there was adanger that the provincial deficits would rise veryquickly. The strategy adopted then was for Ar-gentina’s Treasury and central bank to restrict bor-rowing by the provinces in order to encourage a re-turn to fiscal discipline. However, the ability and thewillingness of the federal authorities to controlprovincial borrowing proved limited, with some of

the provinces successfully floating large bond is-sues (which required at least tacit approval at thefederal level) on international capital markets.

The effort to get the authorities to focus on theneed for greater fiscal discipline at the provinciallevel was clearly not successful. The federal authori-ties on their part cited constitutional limitations ontheir ability to make commitments on behalf of theprovinces. To make matters worse, the ability evento monitor the provincial finances was constrainedinitially by the lack of reliable and timely data, al-though staff efforts did help to improve the capacityto monitor these developments over time. Neverthe-less, the federal government’s repeated attempts tobail out provincial governments or programs meantthat much of the provincial deficits ended up beingexplicitly recognized as federal deficits.14 Moreover,part of the provincial deficit reflected the transfers ofsome of the responsibility for spending programsfrom the federal government to the provinces thattook place throughout the 1990s.

Overestimating the sustainable level of debt

One reason why there was less focus on debt thannecessary was that the public debt-to-GDP ratio (inthe range of 30 percent during much of the 1990s)did not seem excessive for quite some time, and Ar-gentina had little difficulty financing its deficitsthrough foreign borrowing. In retrospect, it is evi-dent that the staff’s analysis missed a number of im-portant economic characteristics of Argentina thatmade the situation especially vulnerable (see Appen-dix 5). First, Argentina’s public debt was almost en-tirely denominated in foreign currencies, reflectingits limited ability to issue long-term debt in its owncurrency, itself a reflection of the fact that the con-vertibility regime tended to encourage dollar-de-nominated debt. The apparent public debt-to-GDPratio was therefore potentially understated because adepreciation of the peso, a possibility that was ig-nored because of the assumed stability of the ex-change rate regime, would immediately translateinto a jump in the debt ratio. Second, much of thedebt was held by external creditors (who tend to bemuch more susceptible to swings in market senti-ment than domestic creditors), making debt servic-ing conditional on export receipts, and Argentinahad a relatively small ratio of exports to GDP. This

26

14For example, a briefing paper expressed concern over the fis-cal pact negotiated between the federal and provincial govern-ments in August 1993, in which the federal government took overa number of heavily indebted provincial pension systems and in-creased revenue transfers in exchange for the provinces’ agree-ment to support social security reform and to implement deregu-lation and tax reform at the provincial level.


meant a large external debt-service ratio, whichcould trigger a run on the currency. Third, Argentinasuffered from weak tax administration, and revenuecollection did not show an improvement commensu-rate with economic growth (see the section “Struc-tural fiscal reforms”). Fourth, as with other emergingmarket economies, Argentina could borrow only atsizable spreads over U.S. treasuries, and a shift inmarket sentiment could lead to very high interestrates, creating potentially explosive debt dynamics.

These problems did not surface as long as growthwas robust and capital market conditions were rela-tively favorable, as in the 1990s. The rise in the debtratio was modest during much of the 1990s and, in1992 and 1997, the ratio even declined because ofstrong GDP growth. Staff projections assumed thatthis outturn would be the norm in future years, butafter 1997 debt accumulation consistently exceededGDP growth, which was compounded by a jump inthe stock of debt associated with the election-drivenincrease in public spending in 1999 (Figure 2.5). Asnoted by the staff’s recent analysis of the Argentinecrisis (PDR, 2003), overoptimistic growth projec-tions led to an overestimation of Argentina’s abilityto accumulate a larger stock of debt. Nor did thestaff explore the implications of less optimistic pro-jections. While staff reports regularly mentioned therisks faced by Argentina, and particularly the riskthat a fall in confidence would lead to a temporaryloss of market access, little was done in the way ofrigorously exploring the implications of these risksfor fiscal solvency.15

It is relevant to ask whether diagnostic tools devel-oped in the IMF since the Argentine crisis would havegenerated stronger warning signals, had they beenavailable earlier. Our analysis shows that debt sustain-ability analysis would have consistently projected theexternal debt-to-GDP ratio to exceed the suggestedbenchmark of 40 percent during 1998–2000 even inthe baseline scenario (see Appendix 6).16 In this

sense, external debt sustainability would clearly havebeen questioned by 1998. The public debt-to-GDPratio, however, would have been projected to exceed50 percent only in 2001 even under the most extremescenario. It is not clear if staff would have taken thisas a sufficiently alarming signal. As noted by Krueger(2002), even with the best available methodology,debt sustainability analysis remains “fundamentally amatter of judgment.” To trace what actually happened,debt sustainability analysis would have required un-usually adverse assumptions on the exchange rate.17

The IMF and fiscal policy: an assessment

Our assessment of Argentine fiscal policy is thatit was too weak given the exceptional standards re-quired by the convertibility regime.18 While the IMF

27

15The staff’s analyses typically assumed relatively mild shocks,such as slower export growth or a rise in global interest rates. Forexample, the staff report of January 1998 forecast growth of 4percent, followed by a gradual return to potential growth of 5 per-cent by 2000. The consolidated public sector deficit was pro-jected to narrow from 1.4 percent of GDP in 1998 to 0.4 percentin 2000 and 0.1 percent by 2004, while the public sector debt-to-GDP ratio would steadily fall by one or two percentage points ayear from 36.3 percent at end-1997.

16PDR suggests the 40 percent benchmark as implying the con-ditional crisis probability of about 15–20 percent. “SustainabilityAssessments—Review of Applications and Methodological Re-finements,” SM/03/206, June 2003. Reinhart and others (2003),however, suggest a much smaller threshold (of perhaps as low as15–20 percent) for some highly debt-intolerant emerging marketeconomies. Recent RES analysis argues that the sustainable pub-lic debt level for a typical emerging market economy may beabout 25 percent of GDP. See IMF (2003), p. 142.

Figure 2.5. Public Sector Debt Targets and Actuals(In percent of GDP)

Source: IMF documents.Note: There was a break of actual data series in 1999 owing to a change of

the GDP definition.

1995 96 97 98 99 2000 01 02 0330

35

40

45

50

55

60

65

SBA 2000 Third review (5/01)

SBA 2000 (3/00)

EFF 1998Third review (5/99)

EFF 1998 (2/98)

SBA 1996 Third review (7/97)

SBA1996 (4/96)

Actual

17Empirical evidence suggests that, if a currency crisis doesoccur, short-run real depreciation is typically far in excess of anyinitial fundamental real overvaluation and, in most cases, lasts fortwo years (Cavallo and others, 2003).

18We are not making a judgment on the relative size of the pub-lic sector compared with other countries, but on the country’swillingness to generate tax revenues on a sustainable basis to sup-port choices on the level of public expenditures. However,Krueger (2002) notes that the average Argentine federal em-ployee was paid much more than the average Argentine privatesector employee (as much as 45 percent in 1998) and that Ar-gentina’s size of the public sector was large by international stan-dards, with its public sector employment comparable to that ofsome industrial countries.


was always aware of fiscal weaknesses and calledfor corrective steps, it did not anticipate the extraor-dinary vulnerability that could arise from theseweaknesses. Argentina did achieve greater fiscal dis-cipline in the 1990s, compared with previousdecades, but the fiscal balance remained weaker thannecessary, and the numbers hid the true picture. Withoccasional bailouts of provincial liabilities, recogni-tion of off-budget obligations, and the unintendedfiscal consequence of social security reform, debtaccumulated steadily throughout the period (Figure2.6). While the deficiencies in the IMF’s analysis offiscal policy were understandable, given the existingprofessional knowledge, available analytical toolsand data limitations, the IMF’s high stake in Ar-gentina should have prompted the staff to explore in

greater depth the risks that might arise from consid-erably less favorable economic developments.

Not only did fiscal policy remain weak, structuralobstacles to effecting a rapid turnaround in the fiscalbalance (such as the federal-provincial revenue-shar-ing rules) were not removed. As a result, whengrowth slowed in 1999–2001, the authorities wereunable to respond with a fiscal stimulus; to the con-trary, the government’s solvency had deteriorated andits borrowing needs had grown to such an extent thata fiscal contraction was thought necessary to restoremarket confidence. This created adverse debt dynam-ics—a process in which an excessive fiscal contrac-tion caused the recession to deepen, the sovereignborrowing spread to widen, and debt to increase stillfurther. This is not to say that the authorities had analternative course of action available at the time. Therestrictions imposed by the convertibility regimemade it impossible to resort to expansionary fiscalpolicy once the markets had closed. Such procyclicalfiscal policy and vulnerability to self-reinforcing debtdynamics are typical of heavily indebted countries,particularly in Latin America, but in the case of Ar-gentina, the convertibility regime compounded theseproblems.

Despite its awareness of the steady increase indebt, the IMF did not adequately incorporate debtdynamics into conditionality. The IMF’s approachwas based on a belief that, if the deficit was consis-tently small and declining, the market would be will-ing to finance both the deficits and the investmentneeded to generate high levels of growth. This ap-proach, however, ignored the very real possibilitythat conditions would at some point deteriorate—growth would falter, the terms of trade would shift,or capital flows would reverse. At each point, devia-tions may have seemed small or well justified, andeach decision to accommodate the deviation in-volved a judgment call. But a series of these mar-ginal decisions, when combined and accumulated,proved fatal for Argentina during the crisis of2000–01, when the combination of high interest pay-ments, low growth, and worsening credit quality cre-ated “debt dynamics” that caused the country’s debtratios to spiral out of control.

In sum, the IMF’s fiscal analysis underestimatedthe vulnerabilities created by Argentina’s particularcombination of economic policy choices in threeareas. First, the convertibility regime, in an environ-ment of limited wage flexibility, meant that anyneeded adjustment in the real exchange rate in re-sponse to an adverse shock was likely to involve pro-longed periods of recession, which would make itdifficult to achieve fiscal discipline. Second, theheavy reliance on external borrowing in foreign cur-rencies increased the exposure to swings in marketsentiment and hence pressures on the balance of

28

Figure 2.6. Public Sector Debt and General Government Overall Balances


40

60

80

100

120

140

160

180

0120009998979695949392199125

30

35

40

45

50

55

60

65

70

Public sector debt(In billions of pesos,

left-hand scale)

General government overall balance (In billions of pesos,

left-hand scale)

Public sector debt(In percent of GDP,

right-hand scale)

–18

–16

–14

–12

–10

–8

–6

–4

–2

0

2

01200099989796959493921991


payments and the real exchange rate. While under afixed exchange rate all domestic financial assetscould in principle be the source of similar pressuresif domestic agents sought to exit during a crisis, inpractice external creditors are much more suscepti-ble to such swings. Third, fiscal policy was weak,given the exchange rate regime and the reliance onexternal borrowing, and the political ability to de-liver the required fiscal discipline weakened furtherin the late 1990s against the background of electoralpolitics. This left the economy vulnerable to adversedebt dynamics and limited the scope for counter-cyclical fiscal policy. These three elements provedhighly toxic when the country faced a series of ad-verse external shocks.

Structural Reforms in Macro-CriticalAreas

Starting in 1990, the Argentine authorities em-barked on a program of comprehensive market-ori-ented reforms, reversing a decades-long policy ofheavy state intervention. The reforms consisted ofprivatization of state-owned enterprises, deregula-tion of product and labor markets, and liberalizationof foreign trade. Of the many reforms implemented,this section does not deal with the efficiency-ori-ented reforms in the real economy. It focuses insteadon the “macro-critical” areas of structural reformthat were of particular relevance to the IMF, namely,structural fiscal reforms, labor market reform, socialsecurity reform, and measures to improve financialsystem soundness. The implementation of reform inthese areas was seen as critical to the success of theconvertibility regime, by promoting fiscal discipline,flexibility of the economy, and national savings. Inmany of these areas, the IMF worked side by sidewith the World Bank and the IDB.19 (Details of thestructural reforms associated with each program,whether in the form of performance criteria or struc-tural benchmarks, are given in Appendix 4.)

Structural fiscal reforms

Structural fiscal reforms were rightly consideredcritical to improving fiscal discipline, and coveredfederal-provincial fiscal relations, tax policy, and taxadministration. We review below reforms in each ofthese areas and assess the role the IMF played.

Federal-provincial fiscal relations

The importance of reforming the provincial fi-nances, including the federal-provincial revenue-shar-ing arrangements, was well recognized by IMF stafffrom the very beginning.20 Argentina had a complexrevenue-sharing (“coparticipation”) scheme whichgenerated perverse incentives. An increase in sharedfederal taxes implemented for fiscal adjustment pur-poses at the federal level, for example, would create anew provincial revenue entitlement and lead to a per-manent increase in provincial spending. Provinceshad an incentive to press for new transfers, rather thangenerating their own revenues or reallocating existingspending.21

Following the Mexican crisis, successive IMFarrangements sought to promote reform of theprovincial finances, while the World Bank and theIDB provided financing and technical assistance toassist in reforming provincial administrations andprivatizing provincial banks. Progress was made insome areas, but a permanent reform of the copartici-pation scheme was extensively discussed but neverconcluded. This reflected the largely “zero-sum” na-ture of any reform, given the conflicting interests ofthe federal and provincial governments. In the past,revenue-sharing rules were often changed as a quidpro quo between the two parties, but the federal gov-ernment’s ability to strike a compromise became in-creasingly limited by tightening constraints on fiscalresources and by the political gridlock of the late1990s.22

Subsequently, the fiscal compulsions of the fed-eral government necessitated temporary changes inthe coparticipation scheme. The 1998 tax reform(see below), which increased shared taxes, compen-sated the federal government for the lost revenueshare by allowing a fixed deduction (of up toArg$2,154 million a year) from the collected rev-enue until the end of 2000. The fiscal pact of De-cember 2000 extended the validity of this deductionfor the federal government until 2005. At the sametime, it replaced revenue-based transfers by a fixedtransfer of Arg$1,364 million a month for 2001–02

29

19The World Bank made financial commitments to Argentinatotaling $12.6 billion during FY1991–99 and provided technicalassistance in such areas as public sector reform (increasingly tar-geted at the provinces), privatization, labor market and financialsector reforms, and the social sectors. See OED (1996, 2000).

20See Schwartz and Liuksila (1997) and Cuevas (2003) for acomprehensive analysis of fiscal federalism in Argentina.

21The unusual degree of complexity, under which differentsharing rules applied to different taxes, was an outcome of politi-cal bargaining. Likewise, rigidity reflected the provincial govern-ments’ preference for a set of agreed rules as a protection againstpossible acts of federal opportunism (such as unilateral cuts intransfers). See Tommasi (2002).

22The constitution stipulated that a new tax-sharing agreementbe sanctioned by Congress by the end of 1996. However, the pro-vision that any new revenue-sharing law be also authorized byeach provincial legislature ensured that no such law would be en-acted (Tommasi, 2002).


and, for 2003–05, by a predetermined but increasingamount of transfers. Additional changes were intro-duced during the crisis in early 2002, but a perma-nent reform of the revenue-sharing scheme was notmade.23

Tax reform

Tax reform efforts in the 1990s aimed at reducingthe distortionary impact of the tax system on em-ployment and investment, improving its flexibilityand effectiveness as a fiscal policy tool, and improv-ing tax compliance (see below). There were twomajor phases of tax reform at the federal level. In theearly 1990s, some 21 distortionary federal taxeswere abolished; the bases of the VAT, corporate, andpersonal income taxes were broadened; and the pay-roll tax for employer contributions to the social secu-rity system was reduced for certain provinces andsectors. Tax reform enacted in 1992 fulfilled a struc-tural performance criterion of the program supportedby the 1992 EFF—in fact, this was one of the onlytwo structural performance criteria included in anyIMF-supported program during the precrisis period.

Various tax reform measures were included asstructural benchmarks under the program supportedby the 1998 EFF (see Appendix 4). In 1997, at therequest of the authorities, the IMF had dispatched amission to prepare a blueprint for tax reform thatcould be submitted to Congress after the Octoberelections. Many of the mission’s recommendationsfound their way into the reform of 1998. It reducedemployer social security contributions further in ex-change for an increase in existing taxes and the in-troduction of new ones. The bases of the VAT andincome taxes were broadened further, taxes were in-troduced on interest payments and on the gross assets of businesses, some excise taxes were in-creased, and a “single presumptive tax” was intro-duced to cover the business tax obligations for smallenterprises and self-employed individuals. An over-riding concern of the IMF throughout this periodwas that any tax reform be at least revenue-neutral,and preferably revenue-enhancing. In 1998, IMFmissions consistently stressed the link between re-ducing the payroll tax and increasing the yield ofother taxes.24

Tax compliance

Widespread tax evasion and noncompliance, andthe ineffectiveness of the judicial system that en-courages such behavior, lie at the roots of Ar-gentina’s chronic fiscal problems. The IMF was wellaware of this, and improvement of tax administrationreceived focused attention during the 1990s. TheIMF staffed a number of technical assistance mis-sions on tax administration with some of the bestqualified experts, complementing parallel efforts byother international financial institutions (IFIs). Threefull-fledged technical assistance missions were sentby the Fiscal Affairs Department (FAD) to cover allaspects of tax administration, while many short andfollow-up visits addressed specific areas, includingcustoms administration.

Efforts to improve tax compliance involved com-puterizing the operations of the tax-collectionagency, systematizing the audit process, applyingspecial scrutiny to the returns of large taxpayers, andrequiring retailers to use cash registers that would fa-cilitate VAT enforcement. From 1992, IMF technicalassistance helped formulate work plans and trackprogress in such areas as the monitoring of large tax-payers and improving the audit process. In 1995, amission stressed the need to intensify VAT audit pro-grams and to improve control of basic VAT filingand payment obligations. A technical assistance mis-sion on tax administration even visited the Provinceof Buenos Aires in 1996, in what the staff describedat the time as “one of the first instances in whichtechnical assistance has been provided to a sub-national level of government by the Fund.”25 Thesemeasures should have been supported by reform ofthe judicial system, but this area received much lessattention than it deserved.

Despite these efforts, tax compliance in Argentinadid not improve noticeably. Successive FAD mis-sions noted that weak revenue administration wasassociated with frequent changes in tax law and se-nior management in tax administration, politiciza-tion of the tax administration, lack of a computer-based accounting system that consolidates differentpayments and tax liabilities of each taxpayer into asingle account, insufficient audit coverage, numer-ous payment facilitation schemes, frequent use oftax amnesties, and lengthy and inefficient appealsprocedures. As a tangible reflection of these weak-nesses, from 1993–96 to 1997–2000, total net taxcollection remained essentially unchanged at 21 per-cent of GDP. Notably, there was no change in net re-ceipts from the VAT (at 6.8 percent of GDP), despite

30

23In view of the federal government’s inability to pay the guar-anteed levels of transfers to the provinces, the pact of February2002 abolished the deduction of Arg$2,154 million and made 30percent of revenues collected from the financial transactions taxsubject to revenue sharing.

24The provisions of the reform were to be phased in such a waythat the revenue-increasing aspects would take effect before thereductions in the payroll tax, so that the revenue yield in 1999would be (temporarily) enhanced.

25Another mission visited the Province of Cordoba in late 1999to give advice on tax administration.


the fact that the VAT rate was raised to 21 percentfrom 18 percent in 1995.26

The role of the IMF

The IMF understood from the very beginning thatstructural fiscal reforms were critical for ensuringfiscal discipline and thereby contributing to themedium-term viability of the convertibility regime.It consistently raised the issue with the authoritiesand included some specific measures in successiveprograms. It also frequently provided technical as-sistance to give advice on tax reform and improvingtax compliance. However, its overall impact was dis-appointing.

The inability of the IMF to have a meaningful im-pact on changing Argentina’s federal-provincial fis-cal relations is understandable, given political reali-ties. Likewise, the deep-rooted culture of tax evasionmade it difficult for the IMF to single-handedlyforce a dramatic improvement in compliance, how-ever competent and sound the technical advice mighthave been.27 That said, it can be argued that the IMFdid not employ all the available tools to bring aboutreforms in some critical areas. Despite the rhetoricabout the importance of structural fiscal reforms,there was only one structural performance criterion(on tax reform) included in all of the successiveIMF-supported programs in this area. More bindingconditionality may not have yielded the desired re-sult, but it would have at least forced a more substan-tive debate and possibly also allowed the IMF to dis-engage itself more easily when it saw thatmeaningful reforms were not forthcoming. Thethreat of disengagement may well have been themost effective leverage that the IMF had.

Labor market reform

In the early 1990s, the IMF, the Argentine author-ities, and most outside observers were in broadagreement that, for convertibility to remain viable,the restrictive labor market practices that hadevolved over the previous half-century would haveto be revised. For one thing, the rigidity of the nomi-nal exchange rate meant that, in the event of a largeshock, a rapid adjustment of the REER to a new

equilibrium level could only be achieved if nominalprices in Argentina, including wages, were flexibleenough. The privatization and deregulation pro-grams of the early 1990s, and particularly the set ofderegulation measures enacted in November 1991,ensured that prices of most goods and services werereasonably flexible, but downward price flexibilitycould only be achieved if wages were flexible down-ward. Labor market reforms would have helped inthis process. It was also hoped that increased labormarket flexibility would help to increase productiv-ity and reduce unemployment at a time when the Ar-gentine economy was undergoing rapid structuralchange.

The links between labor market reform and theexchange rate regime were clearly drawn by a staffreport in early 1998, which stated: “The authoritiesagreed with the staff that, especially in view of theexchange rate regime, labor market flexibility is cru-cial to ensure the simultaneous achievement of asteady improvement in competitiveness and a furthersustained decline in unemployment.” However,progress in this critical area was negligible. The factthat rapid growth in Argentina did not translate intoreduced unemployment in the 1990s suggested thatlabor market inefficiencies remained (Figure 2.7).

The principal reason for limited progress, despitethe authorities’ repeated commitment to labor marketreform, both in their public statements and in theirletters of intent (LOIs), was the lack of political sup-port, given the labor union base of the Peronist party.Labor reform was intended to be a central element of

31

26These figures come from Fiscal Affairs Department, “Ar-gentina: Identifying Priorities for Comprehensive Tax Reform,”August 2003, Table 2, p. 22. VAT efficiency, defined as the sum ofgross collection and nominal consumption divided by the VATrate, would show that tax compliance significantly deterioratedfrom the early 1990s to the late 1990s.

27The experience in this area is another example of the diffi-culty of addressing fundamental distortions through a series ofshort-term programs, as noted by the IEO’s evaluation of fiscaladjustment in IMF-supported programs (IEO, 2003b).

Figure 2.7. Real GDP Growth and Unemployment

Source: IMF staff reports.Re

al G

DP

grow

th (i

n pe

rcen

t)

Unemployment (in percent)5 7 9 11 13 15 17 19

–6

–4

–2

0

2

4

6

8

10

12

19991995

2000

1998

19961994

1997

1992

1993


the program supported by the extended arrangementof 1992, but no action was taken that year. In the pol-icy memorandum setting forth their commitmentsunder the program for the year 1993, the authoritiesindicated their intention to introduce measures in thefirst half of that year to decentralize collective bar-gaining agreements, liberalize conditions for tempo-rary employment, and allow more flexible workinghours. This agenda broadly coincided with what IMFstaff thought was necessary. A draft labor market re-form bill was duly submitted to Congress in Novem-ber, but faced strong political opposition.

Under the pressure of the Mexican crisis in early1995, a relatively limited labor reform bill was intro-duced and passed by Congress. The legislation ex-empted small and medium-sized enterprises frommany restrictions on the use of temporary contractsand flexible working hours. Though limited, this ini-tiative, along with the simultaneous fiscal adjust-ment, gave a significant boost to market confidence,because it was seen as a signal that the Argentine po-litical system was capable of supporting the politi-cally painful policies that were necessary for con-vertibility to remain viable under adverse shocks.However, as with the fiscal measures, its signifi-cance lay in the fact that it could be viewed as acredible signal that more substantial action was im-minent. As it happened, efforts at labor market re-form faltered over the next several years.

The IMF pressed the economic team that took of-fice in July 1996 to submit legislation to reform col-lective bargaining agreements as a prior action forthe approval of the revised SBA. This set off whatstaff characterized as a “national debate” over laborreform issues. In May 1997, the government reachedagreement with labor unions on a legislative packagethat, in the view of the staff, represented only a lim-ited improvement on existing legislation and even areversal of some earlier reforms. While the packageincluded a reduction in severance payments and thegradual elimination of the automatic extension ofcollective bargaining agreements (a practice givingexcessive bargaining power to labor unions), it alsodiscouraged temporary labor contracts by eliminat-ing their exemption from social charges. The lattersteps seemed to go against the authorities’ statedgoal of reducing unemployment, especially giventhat temporary positions had been an important com-ponent of recent job growth. Furthermore, the pack-age did not eliminate restrictive aspects of the labormarket, such as the predominance of sectoral collec-tive bargaining agreements over those reached at theenterprise level, the favored status enjoyed by someworkers under “special labor statutes,” and the shel-tering of union-run health plans from competition.

A staff mission that visited Buenos Aires shortlyafter the May 1997 agreement “indicated to the au-

thorities that, in its view, the proposed reforms fallwell short of what is needed to ensure adequate flexi-bility in the labor market, and would not appear, intheir present form, to deserve support” under the ex-tended arrangement then being negotiated. Reviewdepartments strongly supported WHD’s position. InSeptember 1997, however, the staff agreed with theauthorities on a formula under which further labor re-form at least comparable to the May 1997 agreementwould be a structural benchmark for the first reviewof the extended arrangement in mid-1998. This com-mitment was included in the LOI signed in December,but even this weak package failed to clear Congress.

In February 1998, the government proposed alabor reform package that staff judged to be evenweaker than that agreed with the unions the previousMay. The plan to phase out the automatic extensionof collective bargaining agreements had beendropped, and the centralization of collective bargain-ing was actually to be increased. In July, during amission to prepare the first review of the program,the staff proposed three specific changes to the draftlabor law—a longer probation period for new em-ployees; further reductions in severance pay; and alimited decentralization of collective bargaining—and “made it clear that they would recommend theconclusion of this review only after they had beenintroduced into the bill and approved by Congress.”The government proposed a modified law, but couldnot get congressional approval.

Staff continued to raise labor reform issues in1999, but the authorities chose not to take actionahead of the elections. Enactment of labor reform wasa structural benchmark for the first review of the SBAnegotiated in early 2000 with the Alianza government,and the new authorities duly secured the passage of alabor reform law by Congress in May 2000. This lawfinally enacted several of the measures that the IMFhad been urging since the mid-1990s, including ex-tending the probation period of new workers, limitingthe automatic extension of collective bargainingagreements, and decentralizing the collective bargain-ing process. The controversy surrounding this law,however, revealed deep fissures in the ruling coalitionand raised doubts as to whether the substance of thelaw would indeed be put into practice.28

The role of the IMF

Our evaluation suggests that the IMF rightly em-phasized labor market reforms, particularly in theearly years of the convertibility regime, but whenpolitical obstacles surfaced, it was reluctant to jeop-

32

28It was later alleged that bribes had been paid to oppositionpoliticians to secure the passage of the legislation by Congress.


ardize its relationship with Argentina over labormarket matters. Internal memorandums suggest thatthe softening of the WHD’s position from May toSeptember 1997 was a response to management’sperceptions. In the fall of 1998, following the con-gressional rejection of a labor reform law, the stafftook a position that the Board discussion of the re-view be postponed until the authorities had taken ap-propriate measures, such as implementing the law bydecree. This position, however, was overruled bymanagement and, in its report to the Board, the staffonly stated its “regret” at the outcome. It should benoted that most Executive Directors, when they meton September 23, 1998, did not share the staff’s con-cerns; some accepted the arguments of the authori-ties that the new law was not as regressive as alleged,while others merely encouraged the authorities tofollow through on their promises of introducingcomplementary legislation.

The turbulence in world financial markets in 1997and 1998 undoubtedly weighed heavily on the mindsof management and Executive Directors. These con-siderations argued against disrupting the IMF’s rela-tionship with Argentina at a time when the countrywas one of the few major emerging marketeconomies that seemed relatively unscathed by theglobal flight to safety. Understandably, any concernsthe IMF may have had were not aired publicly. Atwo-sentence press release issued after the September1998 meeting simply stated: “substantial progresshas been made in the implementation of the structuralreforms included in the program.” However, this for-bearance on an issue that was ultimately central tothe viability of the convertibility regime had its costs,because policies that a few months earlier weremeant to be at the core of the IMF-supported pro-gram would be delayed to the point where theywould have little impact on the economy’s ability torespond to the shocks of 1999–2000.

Social security reform

The pay-as-you-go (PAYG) social security systemof Argentina was reformed in 1994 with a partial“privatization” that created a fully funded pillar in thesystem. Younger workers were allowed to choose be-tween the state-run system and approved private pen-sion funds. IMF staff had long recognized that the ex-isting PAYG system was headed for insolvency andthat a serious reform of some kind was needed. So-cial security reform was made a structural perfor-mance criterion for the program supported by the ex-tended arrangement approved in March 1992. Thepolicy memorandum specified that the reform wouldinvolve “[f]inancial equilibrium of the existing pay-as-you-go system on both a cost and accrual basis” aswell as “a new mandatory, capitalized, privately ad-

ministered system, and a voluntary private supple-mentary system.” The reform was to be completed bythe end of 1992 but was delayed until late 1993 bythe protracted political debate, which resulted in acompromise that allowed participation in the funded,privately administered system to be voluntary.

In principle, the switch from a PAYG system toone that is fully funded can lead to a higher level ofnational savings and investment, higher capital accu-mulation, and higher long-run per capita income.This follows from the fact that, instead of paymentsfrom contributors to the system going directly tobeneficiaries, contributors invest in a mix of publicand private assets (usually through privately run,publicly regulated pension funds), while retireesdraw on the income from the assets they had accu-mulated during their working lives to pay for theirretirement. If the population is growing and the pen-sion funds are well run, this creates a pool of savingsentrusted to private managers who compete in searchof high returns, a setup which should improve the ef-ficiency of capital allocation.

For these long-run benefits to obtain, however, thetransition costs from one regime to the other must befinanced through taxation rather than public borrow-ing.29 Tax on the “old” generation (the current benefi-ciaries and those who have accumulated substantialrights under the old system)—either through an ex-plicit tax, an increase in contributions, or a cut in ben-efits—would seem unfair, since this generation al-ready has made contributions under the old system,which went to support the previous generation of re-tirees. But if instead the transition is financed via a taxon the current “young” generation (those whose pen-sions will be based on rights accumulated under thenew system), the young will be taxed twice: once fortheir contributions to the new regime and once for thetransition payments to the current beneficiaries. Be-cause taxing either the old or the young is politicallycostly, some countries have tried to smooth the transi-tion costs by issuing debt. But debt-financed privati-zation is no different from taxing the young.30

33

29The staff was aware of the importance of how the transitionfrom a PAYG system to a funded one is financed in determiningthe effect on saving. A staff study published in 1997 stated that“the public sector deficit created as workers stop paying payrolltaxes and start making contributions to the new system shouldbe financed as much as possible through fiscal consolidation” ifthe impact on saving was to be maximized (Mackenzie and oth-ers, 1997).

30If debt is issued at the time of the reform to cover the implicitpension wealth of the current beneficiaries, this would requireraising taxes equal to the interest costs required to service thisdebt. If new debt is issued each year to cover the annual revenueloss from contributions now going to the privatized accounts, thistoo would lead to an accumulation over time of public debt thatneeds to be financed. For this reason, Kotlikoff (2001) has calleddebt-financed privatization a “shell game.”


The strategy chosen in Argentina resembled thesecond, debt-financed model. Political resistance toreform resulted in a compromise that allowed thepublic system to coexist side by side with the private,funded system. Not only were the contributions ofthose who moved to the private system transferredout of the public system, the payroll tax that was des-ignated as the employer’s contribution to the pensionsystem, was progressively lowered as a way to reducelabor costs and improve competitiveness. Additionalliabilities were created when the federal system tookover the obligations of some of the bankrupt provin-cial systems. Both the year-to-year loss of revenuesfrom reduced contributions to the PAYG system andthe increased liabilities from the takeover of theprovincial systems were financed with debt, whichcontributed to the growing fiscal imbalance.31

The fiscal imbalance created by the social securityreform was significant. From 1994 on, governmentrevenues from social security payroll taxes graduallydeclined, with the revenue gap in 2001 estimated at2.9 percent of GDP. Of this, 1.5 percent was due to thetransfer of workers’ contributions from the social se-curity system to individual accounts in the new privatepension funds, a direct effect of the reform, and the re-maining 1.4 percent resulted from the reductions inpayroll tax rates. On top of this, the federal assump-tion of the liabilities of the provincial systems addedanother 0.9 percent of GDP annually to expendituresby 2001. Against this, there were offsetting reductionsin social security expenditures as a result of the re-form; an estimate by Rofman (2002), which may beoptimistic, is that annual expenditures were smallerby 1.1 percent of GDP in 2001. Taken together, the re-form and accompanying policy changes worsened theannual overall fiscal balance of the federal govern-ment by at least 2.7 percent of GDP.32

The role of the IMF

The social security reform was initiated and inlarge part designed by the Argentine authorities,

with the World Bank providing some technical assis-tance. In retrospect, most observers (the IMF, theWorld Bank, local commentators, and the adminis-trators of the new private funds) overemphasized thepotential benefits of the new system and failed fullyto anticipate its severe fiscal consequences.33 Part ofthe problem was that it overestimated the self-financing component of the reform, without recog-nizing the imperfections of capital markets thatwould create an immediate burden on the govern-ment’s borrowing requirements.34 The increase infiscal deficits arising from the reform was consid-ered simply as an explicit recognition of already ex-isting implicit debt, which the markets should bewilling to finance.35 This was perfectly true, but for acountry subject to severe financing constraints, theconsequence of the reform on the government’s cashposition should have received greater consideration,and should have argued for a transition financed byeither taxes or expenditure cuts. To achieve the de-sired impact on saving, moreover, much of that bur-den needed to fall on the old.

Initially, staff tried to press for a transition fi-nanced by taxes or expenditure cuts. In May 1993,when the reform passed by Congress incorporated acompromise that allowed participation in the priva-tized system to be voluntary, the staff secured a com-mitment from the authorities that the contributionsof workers who chose to remain in the state systemwould be treated as if they were part of a fully priva-tized system, and not be applicable to fiscal perfor-mance criteria. Unfortunately, the commitment toexclude social security contributions when assessingfiscal performance was rapidly weakened and thendropped.36 After 1994, program documents did notidentify the share of the primary surplus accounted

34

31Some authors (e.g., Hausmann and Velasco, 2002) have un-derplayed the role of the social security reform in exacerbatingthe fiscal problems of Argentina in the 1990s. According to theirinterpretation, the reform only made explicit the implicit pensionliabilities of the PAYG system and reduced long-term social secu-rity wealth by partially phasing out the PAYG system. But the re-form and related policy changes did not just make explicit im-plicit liabilities; they rather sharply increased the flow and stockimbalance of the regime.

32All the figures in this paragraph come from Rofman (2002),Table 1, p. 1. See also Table A3.4 in Appendix 3 for the estimatesof social security balances by Cetrángolo and Jiménez (2003).Comparison of the two sets of figures suggests that almost all ofthe social security deficits during 1994–2001 resulted from thereform and the associated changes.

33The staff report for the 1994 Article IV consultation, for ex-ample, commented: “Structural reforms such as ... reform of thesocial security system ... have helped to reduce domestic costsand promote higher saving and investment.”

34Based on Latin American experience, Artana and others(2003) argue that the financing of the transition cost is not guar-anteed in an emerging market economy “simply because the actu-arial balance has improved with reform.”

35In the words of an October 1996 background paper, the tran-sition costs, then estimated at about 1 percent of GDP annually,were “an investment in an improved pension system.”

36In August 1993, staff pressed for a primary surplus target of2.7 percent of GDP in 1994, a figure based on the assumption thatsocial security contributions of 1 percent of GDP would be madeto the public system. After negotiations with the authorities, theprogram targeted a primary surplus of 2 percent of GDP, or 1 per-cent if social security contributions were excluded. In the staff re-port outlining the 1994 program, this 2 percent figure was de-scribed as an improvement over the 1.7 percent outturn from1993, implying that the staff no longer favored excluding em-ployee contributions to the state system from fiscal targets. Theprimary surplus actually achieved in 1994 was 0.8 percent ofGDP.


for by contributions to the public system. The steadyreduction in employer contribution rates may wellhave been a desirable public policy measure, as theywere meant to reduce unemployment and increasecompetitiveness by cutting labor costs. The problemwas that there was no compensating effort to ensurethat the overall fiscal position was strengthened to fi-nance the transition.37 The IMF, among others, didnot fully grasp early on the conceptual weaknessesof the way the transition to the new system was fi-nanced, which together with other accompanyingpolicy changes implied a flawed reform with seriouslong-term consequences.

Financial system soundness

The convertibility regime called for an especiallystrong financial system because restrictions onmonetary policy prevented the central bank fromacting as a lender of last resort through money cre-ation. The Argentine authorities, understanding thisimperative, took several initiatives—particularlyafter the Mexican crisis—to foster the developmentof a liberalized financial system with extensive in-volvement by foreign institutions and strong pru-dential safeguards. By the end of the 1990s, Ar-gentina was considered a model for other emergingmarket economies in the area of banking supervi-sion and prudential policy.38 Banking system assetsgrew from a post-hyperinflation level of 20 percentof GDP in 1991 to 40 percent of GDP in 1999. Cap-ital adequacy, measured according to the standardsof the Basel Committee on Banking Supervision,stood at 21 percent in 1999.

The banking system was strong enough to with-stand for many months the impact of the deepeningcrisis during 2000–01, but the crisis revealed that thesystem had contained vulnerabilities that were notfully recognized. For one thing, holdings of govern-ment debt became a serious risk factor when thegovernment developed solvency problems, leadingto bank runs and capital flight in 2001.39 This vul-nerability resulted directly from the government’sdeliberate policy to seize the banking system’s liq-

uidity in a desperate attempt to finance its deficitswhen there was no other source.40

The banking system was also heavily exposed toa devaluation of the peso against the U.S. dollar.While most of banks’ assets and liabilities werematched in terms of their currency of denomination,many dollar-denominated bank loans went to Argen-tine companies and households that had earnings inpesos, and devaluation would compromise theseloans. The authorities were reluctant even to mea-sure this risk, in keeping with their policy of portray-ing devaluation as unthinkable.41

The large public sector banks were particularlyvulnerable to a crisis of confidence in the govern-ment. In particular, the federally owned Banco de laNación, the Banco de la Provincia de Buenos Aires,and several other provincial banks remained in statehands, despite the privatization efforts. In 2001, theperception that these institutions had weak balancesheets because of politically motivated lending deci-sions (particularly large public debt holding) wouldshake public confidence in the banking system as awhole and thereby help trigger the banking crisis.

The role of the IMF

The initiatives for financial sector reform camefrom the Argentine authorities themselves, withsome financial and technical support from the WorldBank and the IDB. The IMF’s role in the financialsector was limited, though the Monetary and Ex-change Affairs Department (MAE) provided techni-cal assistance on a few occasions, in such areas asthe central bank’s accounting system, payments sys-tem reform, and risk-based supervision. It was onlyin March 2001 (when the crisis was already underway) that, at the request of the Argentine authorities,the IMF became deeply involved in an assessment ofthe Argentine banking system as part of jointIMF/World Bank Financial Sector Assessment Pro-gram missions. At this time, the missions found thatthe most serious short-term risk came, not from in-stitutional or regulatory weaknesses, but from themacroeconomic environment characterized by threeyears of recession and high interest rates.42

35

37In August 1997, a FAD technical assistance team advised theauthorities “that the abolition of the employer contribution to thepension component of the social security tax should, pari passuwith it, involve an alternative financing mechanism for the pen-sion scheme given the existence of a social contract.” But this rec-ommendation was not included in the staff reports.

38The World Bank (1998) ranked Argentina second, after Sin-gapore and tied with Hong Kong SAR, in the quality of its regula-tory environment.

39There are several estimates. According to Lagos (2002), thebanking sector’s exposure to the public sector rose from 17.9 per-cent of total assets at end-2000 to 27.2 percent at end-2001. Ex-posure had been less than 10 percent at end-1994.

40A historical analysis of how the banking system succumbedto government pressure in 2001 is offered by Della Paolera andTaylor (2003).

41The banking system was equally exposed to a fall in the equi-librium real exchange rate, because likely deflationary adjust-ment would have forced some borrowers with earnings in non-tradable goods and services into bankruptcy through what IrvingFisher (1933) called “debt-deflation.”

42The missions identified the banking sector’s exposure to thepublic sector only as a “medium-term vulnerability.” The IMFmaintained close monitoring of the banking sector throughout2001, but the Financial Sector Assessment Program for Argentinawas not formally completed.


The IMF staff was very well aware of the exten-sive liability dollarization of the financial systemand hence its exposure to a devaluation. However, itwas only when economic conditions began toworsen toward the end of 1999 that the staff began toanalyze these vulnerabilities in detail. Until then, thestaff deferred to the authorities’ insistence that therewas no point in contemplating a devaluation, even ata purely analytical level. By the time the vulnerabili-ties began to be examined, and it became clear that adevaluation would cause significant damage to thefinancial system, there was not much anyone coulddo to avert or minimize such damage.

The weaknesses of the state-owned portions ofthe financial system were never an important themeof staff documents or Board discussions. The IMFsupported the privatization of the remaining state-owned financial institutions, just as it supported pri-vatization in other sectors, and staff raised the issuefrom time to time in consultations with the authori-ties. The staff was conscious of the political con-straints involved and chose not to press the matterstrongly. The conversion of the Banco de la Naciónfrom a public agency to a publicly owned corpora-tion, which would facilitate its eventual privatiza-tion, was a structural benchmark under the programsupported by the 1998–99 extended arrangementand, after it failed to be achieved in that program,under the 2000 SBA. Congress rejected a formalconversion in 2000 but it approved measures to in-crease the bank’s autonomy and transparency, stepsthat the staff viewed as having met “the intent of theoriginal proposal.”

The IMF and structural reforms: anassessment

Until 1998, the IMF rightly focused on a verynarrow range of structural issues. Performance crite-ria (covering tax and social security reforms) wereincluded only in the EFF of 1992. The IMF pressedthe authorities for labor market reform and reformsof provincial finances (including intergovernmentalfiscal relations), but this was done without formalstructural conditionality in a program context. In fi-nancial sector reforms, the key decisions were takenby the authorities themselves with little or no prod-ding from the IMF.

This approach changed somewhat from 1998. Anumber of benchmarks began to be set in such areasas labor reform, tax reform, reform of tax adminis-tration, social security and health care reforms, theconversion of the Banco de la Nación from a stateagency to a state-owned enterprise, and even theleasing of airports and telecommunications frequen-cies. However, in all these cases conditionality tookthe form of structural benchmarks (which do not

govern disbursement), and no performance criteriawere included. Staff’s discussions with the authori-ties and Executive Board discussions continued tofocus on a small number of areas, labor reform inparticular. Many other reforms were repeatedly post-poned or quietly dropped, perhaps in an implicit ac-knowledgment of the obstacles that hindered effec-tive action by the federal authorities.

As noted by Allen (2003), the remarkable featureof the programs with Argentina was the paucity offormal structural conditionality, particularly in theform of performance criteria. Internal documentssuggest that staff in review departments was oftencritical of the weak structural content of the pro-grams, particularly those supported by extendedarrangements, but management consistently over-ruled such objections. This may have reflected, par-ticularly after 1998, the institution’s response to theincreasing criticism of the excessive structural con-ditionality it had allegedly imposed on the EastAsian crisis countries.

What little conditionality the programs containedwas not vigorously enforced. Delays were allowedin meeting the performance criteria; repeated slip-pages in meeting the benchmarks were a rule. Evenin the area of labor reform, where the IMF’s involve-ment was direct and persistent, the measures ulti-mately enacted either were limited in nature, re-versed earlier reforms, or came too late to helpmoderate the impact of the 1998–2001 recession onunemployment. Undoubtedly, the required reformsfaced enormous political obstacles and, in the caseof measures to improve tax compliance, wentagainst the deep-rooted culture of evasion. Strongerconditionality would be unlikely to have broughtabout greater change in the absence of domesticownership, but the IMF did not adequately identifythe structural measures that were key to longer-termsuccess and then make adequate progress in thoseareas a prerequisite for its continued program rela-tionship with the country.

The Manner of Engagement withArgentina

The IMF rightly supported Argentina’s broad pro-gram of stabilization and structural reform in theearly 1990s, but by late 1993, policy differenceswith the authorities had emerged in a number ofareas, particularly fiscal policy and the slow pace ofstructural reform. By the end of 1994, Argentina hadceased to draw under the extended arrangement, andit appeared unlikely that the arrangement would berenewed. However, the IMF’s relationship with Ar-gentina underwent a fundamental shift with theMexican crisis in 1995, when it added a year to the

36


extended arrangement that was off track. Thisproved to be the beginning of a prolonged involve-ment with some special features.

Two aspects of this engagement of the IMF afterthe Mexican crisis deserve particular note:

• First, the IMF in its public statements and inter-nal reports moved from a stance of evaluatingthe authorities’ policies given their choice of aspecific exchange rate regime to one of endors-ing that regime. Interviews with staff indicatethat the IMF was sometimes pressed by the au-thorities to express such endorsements, withsupport from major shareholders. The credibil-ity of the IMF became closely linked to the sur-vival of the exchange rate regime, at least in in-ternational public opinion.

• Second, the IMF continued to provide access toits resources even though the balance of pay-ments need was no longer as pressing, and evenafter it had become clear that the political abilityto implement policies needed to sustain the ex-change rate regime was breaking down. TheIMF repeatedly accommodated Argentina’s slip-pages in meeting fiscal performance criteriafrom mid-1996 onwards, either to give the au-thorities credibility or in view of their good-faith efforts in the face of political constraints.

As it happened, Argentina enjoyed reasonablylow-cost access to international capital markets inthe post-Mexican-crisis period, and this had two ef-fects on the IMF’s ability to influence policy in thedesired direction. First, the availability of privatesector finance was seen as weakening the IMF’sleverage with the authorities, particularly when thearrangement was being treated as precautionary.43

Second, easy market access reduced the sense of ur-gency concerning the policy adjustment that wasjudged to be necessary, reflecting a misjudgmentabout the persistence of capital inflows. The generalbuoyancy of portfolio flows to emerging marketeconomies in the mid-1990s turned out to be a re-versible phenomenon, but while it lasted, it created agreat deal of complacency.

There were differences of view between manage-ment and staff on policy toward Argentina, particu-

larly regarding the extended arrangement that wasapproved in February 1998. As early as the fall of1996, staff was surprised to learn that managementhad “acquiesced” to a request by the Argentine au-thorities to have the SBA succeeded by an EFF.WHD’s misgivings about the arrangement, given theauthorities’ backsliding on labor market reform,have already been mentioned. From mid-1997through the end of the year, internal staff memoran-dums were almost unanimous in opposing the pro-posed EFF with Argentina, at least on the termsbeing finalized. In October, for example, the Trea-surer’s Department (TRE) questioned the authori-ties’ ability to achieve the required structural re-forms, given their past performance and the presentpolitical environment. Likewise, in November, REScommented on the draft LOI: “We maintain the viewthat the program outlined in this . . . letter of intent isnot ambitious enough to warrant Fund support in theform of a high-access extended arrangement.” How-ever, these concerns were downplayed or absentfrom the staff report on the 1998 EFF-supported pro-gram presented to the Executive Board.

The lack of candor in staff reports might havebeen a factor influencing the Executive Board’s as-sessment, but the record suggests that the staff’sgenerally upbeat public assessments were shared bymost on the Executive Board. For example, the deci-sion not to discuss Argentina in a formal settingfrom October 1996 to February 1998 (two programreviews in 1997 were approved on a “lapse of time”basis) indicates that Executive Directors werebroadly satisfied with developments during that pe-riod and no Director considered formal discussionnecessary. Although Directors, when they did chooseto discuss Argentina, expressed a range of views asto whether they found the authorities’ actions to because for concern, there was almost universal confi-dence expressed in the authorities’ ability and will-ingness to implement the appropriate policies.Voices expressing serious doubt about the overalllogic of the actions of the IMF or the authorities be-came rarer as the decade wore on.

In retrospect, the rationale for maintaining a pro-gram relationship with Argentina appears question-able. From at least 1994 until early 2000, except dur-ing the immediate aftermath of the Mexican crisis,Argentina was able to raise large amounts of financ-ing at relatively low cost. During this period, and par-ticularly after 1999, the earlier political consensus insupport of fiscal adjustment and structural reformsweakened considerably and the authorities were un-able to deliver on their commitments in IMF-sup-ported programs. Nevertheless, the IMF continued toremain engaged even after Argentina had recoveredfrom the impact of the Mexican crisis. The informa-tion available at the time—the authorities’ poor com-

37

43A deeper analysis, however, would have suggested a contraryview. First, the exposure of the World Bank to Argentina duringthis period was sharply increasing, so that the declining exposureof the IMF was simply the reflection of a shift in burden sharingbetween the two institutions, not of a successful reduction in Ar-gentina’s borrowing needs. Second, Argentina critically neededthe IMF’s seal of approval in order to receive World Bank loansand to enjoy large access to the international capital markets, sothat the IMF did in fact maintain considerable leverage, had itbeen willing to exercise it.


pliance record with earlier programs, the unravelingof the political consensus that had backed the reformprogram of the early 1990s, the absence of a clearbalance of payments need—would have been suffi-cient reason to end the program relationship. The de-cision to approve an EFF in early 1998—despitestrong staff misgivings—effectively weakened mar-ket discipline on Argentina’s economic policies. This

said, it has to be recognized that even at this timemarket pressure on Argentina to modify its policiesmay not have been very strong, since the market per-ception of the sustainability of policies was initiallyfavorable and reacted only slowly to events. It is notpossible to say whether a stronger signal from theIMF, in the form of refusal to approve the EFF, wouldhave made a fundamental difference.

38

This chapter presents an evaluation of the IMF’scrisis management strategy from late 2000

through the collapse of convertibility during the firstfew days of 2002, focusing on issues and develop-ments relevant at key decision points, namely: (i) thesecond review and augmentation of the March 2000SBA in January 2001; (ii) the third review in May2001; (iii) the fourth review and augmentation inSeptember 2001; and (iv) the noncompletion of thefifth review in December 2001, which effectively cutoff IMF financial support. It then examines sepa-rately the decision-making process, including theIMF’s contingency planning efforts. For each ofthese decision points, we examine successively: pro-gram design and the case made in the staff report tothe Board; additional elements considered by staffand management, but not conveyed formally to theBoard; and the basis for the Board decision. We thenappraise the decision made, focusing on whether thediagnosis was reasonable, given the facts known atthe time, and whether the decisions made were con-sistent with that diagnosis.

Second Review and Augmentation,January 2001

Background

In early 2000, the new Argentine government ne-gotiated a three-year SBA to replace the extendedarrangement that had fallen off track. The newarrangement, approved in March, provided SDR 5.4billion ($7.2 billion) and was aimed at buttressinginvestor confidence and facilitating a sustainable re-covery of the economy. The program design empha-sized tax and expenditure measures to stem a furtherdeterioration of the fiscal balance and renewed ef-forts at structural reform, on the basis of which con-fidence would be boosted, contributing to lowercosts of financing for Argentine borrowers. The re-cession was believed to have bottomed out and, withthe projected more favorable external environment,GDP growth in 2000 was expected to rebound to 3.4percent. External financing requirements, although

large, were expected to remain manageable if theprogram was fully implemented. For these reasons,the authorities announced their intention to treat thearrangement as precautionary.

In the event, the expected recovery failed to mate-rialize, program implementation wavered, and thecoalition government visibly weakened with the res-ignation of Vice President Carlos Álvarez in earlyOctober. Amid these unfavorable economic and polit-ical developments, Argentina effectively lost accessto international capital markets. Although thearrangement had been treated as precautionary up tothis time, the authorities recognized the gravity of thesituation and requested exceptional support from theIMF. Unlike other major economies in the region,which had slowed in the aftermath of the 1997–99emerging market crises but had then begun to re-cover, Argentina had remained trapped in recessionfor two years; the overall fiscal deficit was projectedto reach 3.6 percent of GDP for 2000, with the publicdebt-to-GDP ratio rising to nearly 50 percent.

At this time, two diagnoses were possible regard-ing Argentina’s protracted recession and loss of mar-ket access. One was to view them primarily as a li-quidity crisis resulting from adverse but temporaryshocks. According to this interpretation, growthcould return shortly, if some confidence-enhancingpolicy adjustments were implemented, including ap-propriate fiscal adjustment and measures to improvecompetitiveness, but no fundamental changes wereneeded in the exchange rate regime or the structure ofdebt. In support of this view, a tentative recovery incompetitiveness did appear to be under way. Reflect-ing strong growth in global commodity prices, Ar-gentina’s terms of trade had experienced a sharp re-bound in 2000, after a steady decline over 1997–99,and there was a shift in the trade balance from adeficit to a modest surplus in 2000. The banking sys-tem remained well capitalized, with high levels ofliquidity.

An alternative diagnosis would have been to viewthe slowdown in economic activity as resulting froman exchange rate that had become significantly over-valued because of a series of adverse shocks. Accord-ing to this interpretation, adjustment would call for

Crisis Management, 2000–01

CHAPTER

3

39

CHAPTER 3 • CRISIS MANAGEMENT, 2000–01

either a nominal devaluation or a substantial price de-flation, each with adverse implications for (publicand external) debt sustainability. Indeed, Argentina’sexternal debt was then projected to reach 488 percentof exports at end-2000, with total external debt ser-vice (excluding the rollover of short-term debt)amounting to 94 percent of export receipts. While thepublic debt-to-GDP ratio, at just under 50 percent atend-2000, did not appear particularly large, most of itwas dollar-denominated, which implied that if thepeso were indeed devalued to reflect its real equilib-rium level, the debt-to-GDP ratio would shoot up tolevels where sustainability would come into question,if this were not already the case.

The appropriate response to Argentina’s requestfor IMF support depended critically on which diag-nosis was correct. If the country were indeed facinga liquidity crisis, and had good prospects for regain-ing market access on appropriate terms in the nearfuture, the provision of large IMF financing, com-bined with some adjustment, was warranted on cat-alytic grounds. On the other hand, if there were alarge misalignment of the real exchange rate or if thedebt were unsustainable, the IMF should not providelarge access without requiring a fundamental changein the policy regime, possibly involving devaluation,debt restructuring, or most likely both.1

The IMF adopted the liquidity crisis view of Ar-gentina’s loss of market access.2 Its response there-fore involved the following elements: (i) agreeingwith the authorities on a strengthened program em-phasizing growth, competitiveness, and medium-term fiscal discipline; (ii) allowing them to purchasethe undrawn amount under the SBA immediately;and (iii) more than doubling the access under the ex-isting SBA to SDR 10.6 billion (500 percent ofquota), equivalent to about $13.7 billion. In combina-tion with commitments of other IFIs and the Govern-

ment of Spain, and with financing assurances fromthe private sector, the total headline figure of the“blindaje” was advertised to be almost $40 billion.3

The key elements of this response were negoti-ated between IMF staff and the Argentine authoritiesfrom September to the first half of December 2000,with periodic involvement of the Board.4 The pack-age was announced to the public in substantial detailon December 18, 2000 and was soon followed by thedisbursement of the undrawn amount of $2 billionaccumulated during the first nine months of thearrangement. This paved the way for a marked eas-ing of market conditions by the time the augmenta-tion was formally approved by the Board on January12, 2001.

Program design and strategy

The program was based on the diagnosis that sus-tainability of both the public debt and the current ac-count was achievable, with sufficient policy adjust-ments within the existing regime. In particular, thestaff report noted that Argentina’s competitivenesshad been improving quickly in recent months, atrend that was expected to continue. It was also ar-gued that a collapse of the convertibility regime, aswell as a debt default, would have tremendous ad-verse implications for Argentina and also for emerg-ing markets as a whole. The exchange rate peg stillappeared to enjoy strong and broad support withinArgentina, making any move against it politicallyunthinkable. The main risk to the program was seento come from weak implementation.

The main features of program design were: (i) asmall relaxation of the fiscal deficit and debt targets,so as to limit the contractionary impulse of fiscalpolicy, while preserving the objective of stabilizingpublic debt dynamics in the near term (Table 3.1);5and (ii) acceleration of structural reforms deemedcritical both to ensure long-run fiscal sustainabilityand to strengthen competitiveness, in particular fis-cal, social security, and health care reforms andother measures aimed at promoting investment. Theprogram assumed that these measures, if vigorously

40

1Board decisions governing the use of IMF resources mandatethat financing not be provided in support of unsustainable poli-cies. Decisions related to the Supplemental Reserve Facility(which is intended to be the principal instrument of large accessin a capital account crisis) state: “The Fund will be prepared toprovide financial assistance . . . to a member that is experiencingexceptional balance of payments difficulties due to a large short-term financing need resulting from a sudden and disruptive lossof market confidence . . . if there is a reasonable expectation thatthe implementation of strong adjustment policies and adequate fi-nancing will result, within a short period of time, in an early cor-rection of these difficulties” (emphasis added). They further notethat “this facility is likely to be utilized in cases where the magni-tude of outflows may create a risk of contagion that could pose apotential threat to the international monetary system.” See Se-lected Decisions and Selected Documents of the InternationalMonetary Fund, 2002, pp. 325–26.

2Management used the expressions “a liquidity need” and “arollover problem” in describing Argentina’s difficulty to the Ex-ecutive Board in November.

3The sum included the loan commitments of $2.4 billion eachover the next two years from the World Bank and the IDB. The$2.4 billion from the World Bank, however, did not represent newmoney but the loans already committed.

4Informal Board meetings were convened on October 30, No-vember 11, and December 18, 2000. IMF management main-tained close and frequent contact with G-7 treasuries and financeministries during this period.

5The program endorsed the actions already taken by the author-ities in November, including the relaxation of the federal deficittarget for 2001 to $6.5 billion from $4.1 billion and the extensionof the target year for eliminating the deficit under the Fiscal Re-sponsibility Law from 2003 to 2005.

Chapter 3 • Crisis Management, 2000–01

implemented, would bring about a virtuous circle ofimproved confidence, resumption of growth, and im-proved prospects for public and external debt sus-tainability. GDP growth, which was –0.8 percent in2000 and had been projected to rebound to 3.7 per-cent in 2001, was scaled down to a projected 2.5 per-cent. Real investment was expected to grow by 5.8percent, following a decline of 6.8 percent in 2000.The program envisaged export growth of 11 percentover the medium term, and a general continuation ofthe improvement in the external environment, in-cluding a further decline in U.S. interest rates, fur-ther depreciation of the U.S. dollar, and further im-provements in the country’s terms of trade.

The critical issue related to the recovery of con-fidence. The official financing provided did notcover the full financing needs of the coming year.The strategy therefore relied on the catalytic role ofIMF financing, assuming a quick recovery of mar-ket confidence and a resumption of private capitalinflows.6 This imposed a “market test” of the pro-gram’s effectiveness: if market access could not be

41

Table 3.1. Program Projections and Targets for 2001

2001 Projections________________________________________________2000 March September January May September 2001

Outcome 2000 2000 2001 2001 2001 Outcome

Real GDP growth (in percent) –0.8 3.7 3.7 2.5 2.0 –1.4 –4.4Real investment growth (in percent) –6.8 . . . . . . 5.8 –0.3 –7.7 –15.7

Terms of trade change (year on year, in percent) . . . –0.2 1.0 0.5 –0.6 –0.6 –0.6

REER appreciation (+) (12-month basis, in percent)1 1.6 . . . . . . . . . 1.4 8.62 2.9

Export growth(In terms of U.S. dollars, in percent) 13.3 10.6 11.2 9.1 7.6 3.7 0.8(Volume, in percent) 2.7 10.0 9.0 7.2 7.4 4.8 4.6

External balance (in billions of U.S. dollars)Current account balance –8.8 –14.5 –11.0 –9.8 –10.0 –8.2 –4.3Capital account balance 7.7 . . . 13.3 6.0 3.5 –5.7 –15.1

Nonfinancial public sector . . . . . . 3.9 0.0 –1.4 –2.6 . . .Nonfinancial private sector . . . . . . 9.0 5.2 3.9 –4.0 . . .Financial system . . . . . . 0.8 0.4 0.7 1.4 . . .

Consolidated public sector fiscal balance3

Revenues (in percent of GDP) 24.6 . . . . . . 24.7 25.0 24.7 23.7(In billions of pesos) 70 73 73 69 64

Noninterest expenditures(In percent of GDP) 24.2 . . . . . . 23.1 23.4 23.2 25.0(In billions of pesos) 69 68 68 65 67

Primary balance (in percent of GDP) 0.5 . . . 2.4 1.5 1.6 1.5 –1.4Overall balance (in percent of GDP) –3.6 . . . –2.0 –3.1 –3.2 –3.7 –6.2

Public sector debt(In percent of GDP) 50.9 47.3 49.6 52.5 53.5 56.9 62.2(In billions of U.S. dollars) 145 154 157 160 167

Memorandum item:4Nominal private investment growth

(in percent) –8.1 6.6 9.1 . . . 2.4 –9.8 –18.1

Source: IMF staff reports.1Based on 1996 trade weights.2Actual through September 2001.3Including the indexation of government bonds and interest capitalization associated with the debt exchange in 2001 and excluding bonds issued to banks in con-

nection with the banking crisis, and the reinstatement of wage and pension cuts implemented in July 2001.4World Economic Outlook projections made in May 2000, October 2000, May 2001, and October 2001.

6Official financing is considered catalytic if it is sufficientlylarge to build confidence, but not large enough to cover all pro-jected outflows. For a recent study of the effectiveness of cat-alytic official finance, see Cottarelli and Giannini (2002).


restored soon (effectively by the end of the firstquarter), it would be a sign that the program wasnot working.7 The financing provided was front-loaded, with 106 percent of quota disbursed imme-diately and three more installments of 46 percent ofquota disbursed over the remaining quarters of2001. A controversial aspect was the proposal toprovide only one-fifth of total access under theSupplemental Reserve Facility (SRF), which in-volves a higher rate of charge and a shorter repay-ment period than under an SBA, and to invoke ex-ceptional circumstances to provide the rest underconventional SBA terms.8

The program’s policy emphasis remained on fis-cal adjustment, with five out of six performance cri-teria targeting fiscal variables (see Appendix 4 fordetails). One of the performance criteria and an in-dicative target were included specifically to monitorthe provincial finances. In addition, there were twoprior actions requiring the authorities to rescind bydecree the actions of Congress that had added un-wanted items in the 2001 budget and deadlocked thepassage of legislation to reform the pension andhealth care systems.9 Structural reforms, althoughpresented as critical to the success of the program,were subject only to benchmarks.

In the report accompanying the request, the staffcharacterized the risks faced by the program as“significant,” emphasizing developments in the ex-ternal environment and the degree of support pro-vided by the political class to the government’sstrategy. However, an alternative scenario pre-sented in a supplemental note right before theBoard meeting, reflecting the revised World Eco-nomic Outlook (WEO) projections, was more opti-mistic than the baseline of the staff report. Thissuggested that, in the staff’s view, the baseline wasessentially conservative and actual risks were prob-ably lower.

Additional considerations

The staff’s analytical efforts focused on how torestart growth, which was viewed as critical for debtsustainability. However, the staff also recognized thatthere was little that structural reforms could achievein terms of improving the supply side of the economyin the short run. It was primarily in this context thatthe staff examined possible alternative strategies. Thestaff analysis, as of October 2000, indicated that (i) given the high degree of dollarization of the econ-omy, a shift to a floating exchange rate regime wouldlikely be very disruptive, at least in the initial phase,unless it were possible substantially to contain theinitial overshooting of the currency; (ii) dollarizationat par would likely have modest benefits as well asrelatively modest costs; and (iii) dollarization at amore depreciated rate could help improve competi-tiveness and moderate the initial effects of the deval-uation, but it was uncertain whether it would be cred-ible and therefore sustainable. In presenting theanalysis of these issues, the staff did not state eitherthe overvaluation of the exchange rate or debt sus-tainability as the fundamental problem.

Comments offered by review departments on thebriefing paper for the negotiating mission in mid-November generally expressed concerns on severalpoints, including: (i) the limited credibility of thegovernment’s commitment to fiscal consolidationwhen the effort was effectively being pushed back intime; (ii) the crowding out of private investment im-plied by the financing plan, which relied heavily ondomestic sources of finance (Box 3.1); and (iii) thepossibility that market access could not be restoredas quickly as necessary. It is noteworthy that RES,which was then in charge of monitoring internationalcapital markets, even suggested that it was time tostart working on a comprehensive debt restructuring.Much the same level of concern was expressed inter-nally by reviewing departments when the programdesign was finalized.

The Board decision

Several issues were raised at the informal meetingconvened in late December by the Managing Direc-tor to inform the Board of his recommendation.Some Directors urged the staff to explore alternativesolutions, including modifying the exchange rateregime and restructuring debt. Executive Directorsindicated that they would have preferred a blend ofresources with a larger SRF component, and a fewDirectors also pointed out the need for the IMF tohave an exit strategy. In response, the Managing Di-rector indicated that (i) the staff had been asked toproduce two scenarios, with and without the “cur-rency board” and had concluded that the risks in-

42

7Programmed financing requirements for the first two quartersexceeded identified (official and domestic) financing sources by$703 million and $1,726 million, respectively. The $2 billion bal-ance accumulated under the SBA meant that Argentina could af-ford to delay new placements in international capital marketsuntil after the end of the first quarter. In effect, the program as-sumed new placements of $500 million in the first quarter and $2billion in the second quarter.

8Access under an SBA is normally capped at 300 percent ofquota. It was argued that Argentina faced both a short-term bal-ance of payments need (which the SRF was meant to address) anda medium-term one, as was clear from the large humps in debtamortization in 2002 and 2003 that a larger recourse to the SRFwould have implied.

9These prior actions were not explicitly spelled out in the pro-gram documents, although there were clear understandings be-tween the IMF staff and the authorities.


volved in modifying the exchange rate regime wereoverwhelmingly larger; and (ii) he was thinkingabout an exit strategy for the IMF, but preferred notto discuss it in that setting.

On January 12, 2001, the Executive Board unani-mously approved management’s recommendation tosupport the authorities’ request. The statementsmade by Directors at the meeting, however, indi-cated that there were in fact three distinct groups:

• A small group was of the view that the programcontained all the ingredients of success andwould get Argentina out of trouble soon.

• At the other extreme, a small minority of indus-trial country chairs (including the representa-tives of two G-7 countries) articulated the viewthat, under realistic assumptions, the debt dy-namics were unsustainable and therefore the

program was very unlikely to succeed. Theywere nevertheless willing to give it the benefit ofthe doubt, based on three considerations: (i) thetheoretical possibility that a return of confi-dence, brought about by determined implemen-tation of the program, would make the staff’sbaseline scenario come true; (ii) the perception(in part influenced by the staff’s generally posi-tive surveillance assessments) that Argentinahad built a stellar track record over the 1990sand therefore deserved to be given a chance; and(iii) the large costs of failing to support thecountry at this juncture.

• In between, a large group saw substantial risksin the program and was unconvinced that it pro-vided a durable solution. This group consideredthat the program was built on excessively opti-

43

Box 3.1. Framework and Implementation of Private Sector Involvement

Following the series of capital account crises in thelate 1990s, the international community intensified itsefforts to agree on a framework for involving the pri-vate sector in crisis resolution. The IMF’s InternationalMonetary and Financial Committee (IMFC), in its Sep-tember 2000 meetings held in Prague, outlined a frame-work for taking due account of PSI when making IMFfinancing available.

The IMFC communiqué read in part: “In some cases,the combination of catalytic official financing and pol-icy adjustment should allow the country to regain fullmarket access quickly. . . . Reliance on the catalytic ap-proach at high levels of access presumes substantialjustification, both in terms of its effectiveness and therisks of alternative approaches. In other cases, empha-sis should be placed on encouraging voluntary ap-proaches, as needed, to overcome creditor coordinationproblems. In yet other cases, the early restoration offull market access on terms consistent with medium-term external sustainability may be judged to be unreal-istic, and a broader spectrum of actions by private cred-itors, including comprehensive debt restructuring,might be warranted to provide for an adequately fi-nanced program and a viable medium-term paymentsprofile.”

At the time the blindaje was being discussed, imple-mentation of the “Prague Framework” was an impor-tant consideration and, in the absence of proven modal-ities, the announcement by the Argentine authoritiesthat they had secured significant commitments from theprivate sector was taken as a sign that the new ap-proach—based on the provision of incentives to en-courage countries to take strong steps at the earlystages of their financial difficulties to prevent a deepen-ing crisis—was working. It appeared to be a concreteimplementation of the first ladders of the “tool kit” de-fined by G-7 Finance Ministers at the Köln summit,

and broadly endorsed by the IMF, namely “linking theprovision of official support to efforts by the country toseek voluntary commitments of support and/or to com-mit to raise new funds from private markets” and/or “toseek specific commitments by private creditors tomaintain exposure levels.”

Specifically, the private sector component of theblindaje—about $20 billion over the next five years—involved an agreement with the 12 market-making in-stitutions in Argentina to roll over maturing bonds andto purchase new public issues for $10 billion, under-standings with private pension funds to purchase newpublic issues for $3 billion, and liability managementoperations on international bonds for $7 billion. Be-cause these agreements were premised on the transac-tions being conducted at market prices, they repre-sented only loose commitments. As the table belowindicates, financing projections for 2001, made at dif-ferent times throughout the year, assumed a dispropor-tionate reliance on domestic (and largely captive) cred-itors rather than on the international private sector.

Projected Federal Government Financing, 2001(In billions of U.S. dollars)

January May August December

Official creditors 9.7 9.6 10.21 10.2Resident bondholders 8.2 11.8 9.3 15.82

Nonresident bondholders 3.9 0.5 0.8 0.8

Total 21.8 21.9 20.3 26.8

Source: IMF staff reports.1Excludes $4 billion in purchases from the IMF to be retained in central

bank reserves.2Includes unidentified sources, broadly covering the “captive” market.


mistic GDP and export growth assumptions andfurthermore that the two objectives of the pro-gram (restarting growth to stabilize the publicdebt dynamics and ensuring external sustain-ability) were potentially inconsistent. Neverthe-less, the program was thought to present the bestalternative, provided that it was used by the Ar-gentine political system as a window of oppor-tunity to tackle the needed fiscal adjustment andstructural reforms. They were impressed by theamount of private sector involvement (PSI)—animportant consideration in view of the Interna-tional Monetary and Financial Committee’s(IMFC) communiqué issued in September2000—although the nature of the commitmentssecured by the authorities was not clear (seeBox 3.1).

Concern about the viability of the program and theuncertainties associated with it was reflected in thefact that some Directors called on the staff to workout contingency measures and alternative solutions,including a change in the exchange rate regime and arestructuring of debt. Most, however, only indicatedthe need for close monitoring, without specifyingwhat should be done in case monitoring revealed dif-ficulties. Many considered that the extent and natureof PSI effectively achieved, as well as the price atwhich it could be obtained, would be the litmus testof the program’s success. All Directors emphasizedthat the key to success was a return of confidence,which could only be brought about by strict adher-ence to the program; this would in turn require fullsupport from the whole spectrum of Argentine soci-ety, including Congress, provincial officials, the bu-reaucracy, and labor unions. While the behavior ofthe political establishment on key elements of theprogram in the last months of 2000 did not bode wellin this connection, Directors were impressed by thedetermination of the authorities (as demonstratedamong others by their compliance with the prior ac-tions) and were also mindful of the cohesion and de-cisiveness with which the country had reacted at thetime of the Mexican crisis in 1995.

Overall assessment

It can be argued that from late 2000 to early 2001there were several compelling reasons to support Argentina:

• Argentina had not drawn on the resources madeavailable under successive IMF arrangementsover the previous three years. This meant thatthe country was effectively coming to the IMFfor financial assistance for the first time in along while and that the IMF’s exposure to Ar-gentina was relatively low.

• The decisiveness with which the country’s es-tablishment had dealt with the Mexican crisisoffered hope that a similarly strong responsewas possible on this occasion and provided le-gitimate grounds for giving Argentina the bene-fit of the doubt.10

• There were genuine concerns about contagionfrom an all-out crisis in Argentina at the time,when there was nervousness elsewhere in theworld, including in Turkey and Brazil. Therewas also a more specific concern that othercountries with currency boards might comeunder pressure if a crisis in Argentina revealedthat such exchange rate regimes were not crisis-proof.

• The increase in the IMF’s exposure to Argentinatied to this review was large (about $2.8 billion)but it left ample room for further support in caseof need.

• The cost of any alternative strategy (for example,abandoning the peg) was certain to be large.

Program design was highly optimistic. If the keyassumptions made under the program about exoge-nous factors had materialized and the agreed policymeasures had been implemented, the strategy maywell have succeeded in creating breathing space forArgentina, if not in providing a permanent solu-tion.11 However, the assumptions were overly opti-mistic, given what the staff and the Board knew atthe time and relative to the market’s “consensus”forecast (Figure 3.1). In addition, the program suf-fered from the following shortcomings:

• Sensitivity analysis failed to explore the impactof significantly less favorable external condi-tions and policy slippages, in particular on debtsustainability. In addition, no serious analysis ofexchange rate sustainability was made.12

44

10Based on extensive exchanges with political experts, the eval-uation team is of the view that the political situation in late 2000was much more divisive than in 1995, and that to think that thesame decisiveness could be repeated misunderstood Argentinepolitics.

11In the event, at least three critical assumptions turned out tobe incorrect. First, the political system proved unable to deliverthe required fiscal adjustment. Second, the terms of trade fellslightly instead of retaining the upward trend of 2000. Third, thepeso appreciated further in real effective terms, driven by the riseof the U.S. dollar against the euro and the weakening of theBrazilian real. As a result, exports grew by 0.9 percent instead ofthe large increase of 9 percent that was assumed. U.S. interestrates did decline, but Argentina benefited from this only tem-porarily, as confidence failed to recover, leading to a further out-put decline instead of the expected pickup.

12Sensitivity analysis in the staff report examined both publicdebt sustainability and external sector dynamics, but each sce-


• There was an inconsistency in the program, asnoted by some Executive Directors. Even withthe rather optimistic assumptions made in theWEO projections, the IMF’s standard templateof external debt sustainability analysis, if avail-able in late 2000, would have indicated that Ar-gentina needed to generate a noninterest cur-rent account surplus of 0.5 percent of GDP in2001 in order to stabilize the external debt toGDP ratio at over 50 percent of GDP. This wasinconsistent with the large projected currentaccount deficit (see Appendix 6).

• Although the restoration of fiscal stability was akey objective, program design in practiceamounted to easing fiscal policy in the short runwhile affirming the commitment to fiscal disci-pline over the medium term. This was a continu-ation of the policies that had already been pur-sued by the authorities and had proved to havefailed in restoring confidence. The relaxation offiscal policy in the short run was justifiable oncountercyclical grounds but medium-term com-mitments lacked credibility. The implicit as-sumption that the fiscal design of the programwould suffice to restore confidence was highlydoubtful.

• The justification given for the limited recourseto the SRF (to avoid a hump in debt service in2002 and 2003) was inconsistent with thepremise that normal market access would be re-stored in the near term.

• The prior actions agreed to by the authorities—which involved an executive decree to overrulethe legal action of Congress that contradictedthe program—confirmed the commitment of theauthorities, but not that of the rest of the politi-cal system. A broad political consensus, vital forthe restoration of Argentina’s fiscal heath, waslacking.13

Although not all indicators of market accessprospects were signaling alarm,14 there were worri-some signs. Projected financing requirements, forexample, exceeded $30 billion a year for the foresee-able future. Total external debt service was projectedto amount to 100 percent of export receipts in 2001.

45

nario considered only the impact of a modest shock (for example,GDP growth lower by one percentage point, interest rates higherby 100 basis points, or foreign demand lower by half a percentagepoint). None of the three scenarios included in the report (in addi-tion to the baseline) explored the impact of either a large shock ora combination of shocks.

13This was well understood by at least some in the IMF. A staffmemorandum to management in early December 2000 stated:“the track record of the government in its first year of office [has]been relatively poor in terms of implementation of announcedmeasures.” Furthermore, in a memorandum to management datedDecember 29, 2000, the staff noted that its “concerns about own-ership of the program by the political class have been confirmedby the attitude of Congress, which in the end refused to supportthe government in some of the essential, but politically more dif-ficult elements of the program.”

Figure 3.1. IMF and Private Sector (Consensus)Forecasts for Key Program Variables

Sources: IMF staff reports; and Consensus Economics, Inc.

–2

–1

0

1

2

3

4

5

6

Consensus(2002)

IMF (2002)

Consensus(2001)

Consensus(2001)

Consensus(2002)

IMF (2001)

IMF (2001)

IMF (2002)

Aug. 2001

Aug. 2001

May 2001

May 2001

Dec. 2000

Dec. 200025

26

27

28

29

30

31

32

33

Annual GDP Growth Projections(In percent)

Export Projections(In billions of U.S. dollars)

14These indicators are: (i) characteristics of the economy thathave a bearing on its ability to service additional external debt; (ii) previous levels of market access and market indicators; (iii) strength of the macroeconomic and structural policy frame-work; (iv) authorities’ commitment to sustain the implementationof the reform program; (v) level of reserves and availability of fi-nancing; (vi) stage of the crisis; and (vii) shifts in portfolio de-mand (such as those caused by an anticipation of devaluation).See, for instance, the Managing Director’s statement in “StatusReport on Private Sector Involvement in Resolving FinancialCrises,” June 2000.


Gross international reserves only covered an esti-mated 80 percent of short-term external debt. Whilestaff did not have an estimate of the extent of over-valuation of the REER, its sharp appreciation in theprevious three years, along with the impact of otherrecent shocks on the equilibrium exchange rate,made it likely that it was in fact significantly over-valued. Furthermore, the unwillingness of Congressto support key elements of the policy package alsocast doubt on the authorities’ ability to adherestrictly to the program.

In assessing the decision of January 2001, it isnecessary to recognize that the decision involvedconsiderable uncertainty and cannot be judged tohave been wrong ex ante just because it failed toyield the intended result. We must instead considerwhether the decision had a reasonable chance of suc-cess ex ante, keeping in mind that the costs of any al-ternative strategy would have been high. With allthese caveats, the evaluation suggests that an objec-tive assessment of Argentina’s difficult economicand political situation at the time would have re-vealed that the probability of success of the catalyticapproach was indeed low, if all the risk elements hadbeen fully taken into account.

Nevertheless, it could be argued that, despite allthe odds against it, there was a case for giving acountry with an otherwise reasonable record thebenefit of the doubt. In view of the considerable riskinvolved, however, the decision to support Argentinain January 2001 should have been accompanied by abetter anticipation of unfavorable outcomes and aclearer understanding of an exit strategy in case thechosen strategy did not work. The failure to do this,rather than the decision itself, represents the criticalerror in the second review. In keeping with the spiritof the policy on exceptional access, the program ef-fectively incorporated a market test, but the condi-tions for judging success or failure were not madeexplicit, and there was no discussion of what thenext steps would be in the event that the catalytic ap-proach failed.15

Completion of Third Review, May 2001

Background

The January 2001 augmentation appeared to suc-ceed initially, at least in the sense of reducingspreads below their precrisis level and allowing Ar-

gentina to regain market access for a short period.16

Policies agreed in the program, however, were notfully implemented. In late February 2001, it becameevident that fiscal performance had slipped signifi-cantly, and that with unchanged policies the federaldeficit for the year would reach $10 billion (insteadof the targeted $6.5 billion).17 On the structural side,the two decrees reforming the pension and healthcare systems, which had been issued as prior actionsfor the January augmentation, were challenged in thecourts and suspended. Spreads rose again to crisislevels. Three major credit rating agencies down-graded Argentina’s sovereign debt.

In early March, José Luis Machinea was obligedto resign as Minister of Economy, and his successor,Ricardo López Murphy, proposed a fiscal adjust-ment that would have narrowed the deficit by about1 percent of GDP, mostly through spending cuts.The program provoked strong political oppositionand, after an initial show of support, the presidentforced his resignation only two weeks after he hadbeen appointed. This was a significant blow to mar-ket confidence, because it seemed to show that, evenunder conditions of extreme economic crisis, the Ar-gentine political system was incapable of supportingeven a relatively modest step toward the implemen-tation of a sound fiscal policy. It led to an accelera-tion of deposit withdrawal (Figure 3.2).

The appointment, in late March, of DomingoCavallo as Minister of Economy initially succeededin calming the fears of depositors and market partic-ipants, as he brought with him a high degree of pop-ular support and international credibility. In an un-usual show of unity and recognition of the urgencyof the situation, Congress granted special quasi-leg-islative powers to the executive by enacting the Eco-nomic Emergency Law and agreed to institute a fi-nancial transactions tax, leaving the government freeto set the tax rate. These developments temporarilyboosted expectations that strong fiscal adjustmentcould be rapidly put in place.

As it turned out, the appointment of MinisterCavallo heralded a radical departure from the moreorthodox policy stance of the previous two ministersand the generally cooperative relationship that had

46

15In a January 2001 memorandum, WHD expressed the viewthat “if activity were to continue to stagnate over the next sixmonths, and market concerns were to intensify, the whole strat-egy should be rethought.” However, this stance was never explic-itly endorsed by management or even by review departments, letalone implemented.

16Following the approval of the augmentation, the governmentwas able to implement its financing plan at interest rates substan-tially lower than those assumed in the program. These develop-ments led staff to comment in memorandums to management inmid-February that there had been a “marked change in percep-tions about the country’s prospects,” and to suggest that the au-thorities might wish to discuss returning to a precautionary treat-ment of the arrangement at a forthcoming meeting.

17The outturn for March 2001 would show that the federaldeficit target was missed by Arg$1 billion (or 30 percent) over theprogram ceiling, of which about a third was due to expenditureoverruns.


existed between the IMF and the Argentine authori-ties.18 The new minister soon announced a series ofmeasures that modified substantively the nature ofthe economic program to be supported by the IMF,while reaffirming commitments to the convertibilityregime and to the fiscal targets of the original pro-gram. Further announcements of dramatic policyshifts followed, all with little or no prior consultationwith the IMF (see Box 3.3 for details). Many ofthese measures were counterproductive in restoringmarket confidence, especially the proposal to alterthe convertibility regime, the dismissal of the centralbank governor, and the relaxations of bank liquidityrequirements. These actions seriously underminedten years’ worth of policies toward establishing cen-tral bank independence and strengthening the capitaland liquidity position of the banking sector.

With no signs that growth was picking up anytime soon, a drop in tax compliance, and paralysis atthe political level, all the fiscal targets for the firstquarter were breached by large margins (Table 3.2).Seven out of the 10 structural benchmarks set in Jan-uary were observed, but the critical measures envis-aged in the areas of provincial finances, pension andhealth care reforms, and tax amnesties had not beentaken. Despite evident underperformance on theseimportant dimensions, the IMF Executive Board onMay 21 unanimously approved management’s rec-ommendation to complete the third review of theSBA by granting waivers for the substantial slippagein compliance with the end-March performance cri-teria, thus allowing the disbursement of the $1.2 bil-lion tranche.


The economic program needed to be revised tocompensate for the fiscal slippages recorded in thefirst quarter (Figure 3.3), and to find additional or al-ternative policies to rekindle growth, as the expectedpickup had failed to materialize. The revised pro-gram had three pillars: (i) putting fiscal adjustmentback on track, in particular by introducing a high-yield financial transactions tax (so that the original year-end targets would be observed);19

(ii) boosting competitiveness (through the competi-tiveness plans previously announced by Mr. Ca-vallo); and (iii) implementing a voluntary, market-

based, “mega-swap” of government bonds to reducethe near-term financing needs of the federal govern-ment, though very little information was available onits nature, its cost, and its impact on the debt dynam-ics. The main assumptions were that GDP growthwould gradually build up to 5 percent in the lastquarter, achieving an annual average of 2 percent, in-vestment would pick up to 7 percent in the fourthquarter, and exports would grow at 11 percent in2001 as a whole.

The staff report advanced three main reasons forsupporting the completion of the review: (i) thestrength of the new measures that had been an-nounced by Mr. Cavallo (although the staff was alsocritical of several of them, especially the competi-tiveness plans and the timing of the proposed modi-fication of the convertibility law); (ii) the authorities’demonstrated commitment to the program (backedby a show of support from Congress, which hadgranted exceptional powers to the executive); and(iii) the importance of Argentina’s stability for theregion and emerging market economies in general.Equally important, the staff initially felt compelledto give the benefit of the doubt to the new Ministerof Economy, and was concerned not to force anabrupt and hence disorderly collapse of the policyregime. The staff report noted that “a change in the[convertibility] regime would likely have large ad-verse consequences on the balance sheets of the non-financial private sector, the banking system and thepublic sector, with a generalized disruption and dis-location of the economy.”

47

Figure 3.2. Bank Deposits, January 3, 2000–December 31, 2001(In billions of pesos)

Source: Bloomberg.

2000 2001Jan. Mar. May July Sep. Nov. Mar. May July Sep. Nov.Jan.

60

62

64

66

68

70

72

74

76

78Mar. 19 July 5 Oct. 26

18The IMF continued to maintain a cooperative relationship atthe technical level, but its impact on Argentina’s decision makingbecame increasingly limited.

19The proceeds from the financial transactions tax were notsubject to revenue sharing with the provinces and could havegone a long way toward closing the fiscal gap, had the proceedsnot been used to support the competitiveness plans and the con-vergence factor.


The staff noted that, with the new measures out-lined by the authorities (combined with the provi-sions of the previously enacted Fiscal ResponsibilityLaw) and on the basis of conservative growth and in-terest rate assumptions, the debt dynamics would besustainable. On the scale of exposure of the IMF, Ar-gentina’s debt-service indicators were recognized tobe “relatively high compared to other members,” butthe country was believed to “be able to meet fully itsobligations to the Fund based on its impeccable

track record.”20 Although the staff noted that “theprogram [faced] significant risks,” it identified onlya few in terms that did not suggest a high probability(such as, “growth may take longer to recover thannow envisaged,” “interest spreads may not decline asfast as needed,” and “tax compliance is difficult toenforce and improve in the short term”). The staff re-port added that the process of placing the debt-to-GDP ratio on a declining path, assumed to be the keyto a virtuous circle out of the crisis, “[depended] cru-cially on firm implementation,” thereby suggestingthat whatever risks existed could be handled by deci-sive action.


Internal memorandums suggest that staff wasmuch more concerned about the viability of the pro-gram than indicated in the staff report.21 In particular,a note sent to management in March 2001 indicatedthat Argentine society was showing signs of “adjust-ment fatigue,” which would make it difficult to sustainthe adjustments and fiscal discipline needed to ensureexternal viability. It further referred to indications ofwavering support for the convertibility regime, notingthat “some well-connected commentators and ana-lysts have recently started calling for changes to thecurrency board regime.” In early May, staff contacts

48

Table 3.2. Fiscal Performance Under the Stand-By Arrangement in 2001(In millions of pesos)

Target (As Set at Adjusted Margin Relative toPrevious Review) Target Outcome Margin1 Original Target1

January–March 2001Overall fiscal balance of federal government –2,100 . . . –3,122 –1,022Primary expenditure of federal government 13,313 . . . 13,684 –371Change in federal stock of debt 2,150 1,311 1,791 –480 359Change in stock of debt of consolidated

government 2,750 1,903 2,457 –554 294

January–June 2001Overall fiscal balance of federal government –4,939 –5,469 –5,339 130 –400Primary expenditure of federal government 26,657 . . . 26,429 228Change in federal stock of debt 5,039 7,025 6,973 –1,934Change in stock of debt of consolidated

government 6,639 8,762 8,394 368 –1,755

Source: IMF staff reports.1A negative sign indicates a shortfall.

Figure 3.3. Evolution of Fiscal Deficit Targets and Outcomes(In billions of pesos)

Source: IMF staff reports.Note: Targets refer to the overall cumulative deficit of the federal

government.

0

2

4

6

8

10

12OutcomeSBA fourth review (Aug. 2001)SBA third review (May 2001)SBA second review (Dec. 2000)SBA first review (Sep. 2000)SBA request (Feb. 2000)

Jan.–Dec.2001

Jan.–Sep.2001

Jan.–Jun.2001

Jan.–Mar.2001

Jan.–Dec. 2000

20This statement was factually incorrect, as Argentina had pre-viously incurred arrears to the IMF, most recently in the late1980s.

21Management shared these concerns, asking staff to consideralternative scenarios for Argentina. Management also advised Mr. Cavallo to prepare a contingency plan, but no substantive dis-cussion with the authorities took place on possible options.


with major New York-based investment banks re-vealed that market participants were skeptical of thepolicy plans outlined in the just released LOI, notleast because they perceived the authorities as lackingcredibility to implement them. Even more explicitly, anote from the “Argentina Task Force”22 in late April(about two weeks prior to the issuance of the staff re-port to the Board) conveyed to management its judg-ment that “the probability of a full-blown crisis in Ar-gentina has increased. Avoidance of such an outcomeseems unlikely, though not impossible.”

Analytical work on contingency scenarios byIMF staff continued, with two key messages emerg-ing. One involved consideration of two possiblepaths to the outbreak of a full-blown crisis if marketsentiment failed to improve: (i) a passive scenario inwhich the current strategy was maintained until thevery end and (ii) a proactive scenario in which dras-tic preemptive actions were taken on the debt anddeposit fronts (for example, a debt standstill, a tem-porary freeze on deposits, or a temporary suspensionof convertibility). Although the proactive approachwas the staff’s preferred choice, the passive ap-proach was seen as more likely to be adopted by theauthorities, given the politics of the situation. In thatcase, the staff pointed out that “its eventual unravel-ing, after reserves have been eroded, will be cata-strophic for the Argentine economy.”23 The othermessage that came out of the analysis was that thebanking system posed the greatest challenge in thedebt restructuring and devaluation scenarios (evenunder relatively mild assumptions). Even if an inten-sification of the ongoing run on deposits could beaverted, which appeared doubtful, very large injec-tions of public funds would be needed to avert thebanking system’s complete collapse in either case.

The Board decision

The Board accepted management’s recommenda-tion to complete the review, but not because of confi-dence that the program was sustainable. The Sum-ming Up makes it clear that Directors’ assessment ofthe economic outlook and the program’s prospectswas bleak. It noted that the recent crisis had beenbrought about, not by exogenous shocks, but by theauthorities themselves through “an unexpected re-laxation of the fiscal stance”; that several of the mea-sures taken in recent weeks by the authorities werevery questionable in substance (such as the tariff in-

crease, the financial transaction tax, and compro-mises made with central bank independence and theliquidity requirements of the banking system) or intiming (as in the announcement of a modification inthe convertibility regime), and even more so as theyhad been taken against the advice of the IMF.

The only positive remark the Board could makeabout the proposed program was regarding the au-thorities’ commitment to adhere to the year-end fis-cal targets for 2001 and to advance the agenda ofstructural reforms, particularly in the fiscal area, andtheir reaffirmation to preserve the independence ofthe central bank and the high capital and liquiditypositions of the banking system despite the contraryactions already taken. While most Directors tookpositive note of the statement of the Argentine repre-sentative on the Board affirming that “the politicalclass understands what is at stake and, once again, issupportive of decisive actions,” several Directorsnoted that similar statements had been made at thetime of the blindaje but were followed by poor pro-gram implementation.

The Board’s assessment of the forthcoming debtswap was guarded. While all Directors welcomed itin principle, they also deplored the lack of detailsabout its terms and conditions. They noted that, de-pending on these, the debt swap could either en-hance or jeopardize debt sustainability. In fact, sev-eral Directors even expressed the view that, atcurrent spreads, going ahead with the swap wouldlock in interest rates that would prove unsustainablein the medium term but recognized that, the an-nouncement having been made, delaying or cancel-ing it would be likely to have dramatic adverse ef-fects. A few Directors made it clear that this was thelast chance before a more coercive debt restructuringwould need to be made in order to reduce the netpresent value (NPV) of the debt. Last but not least,several Directors questioned the feasibility of thepromised fiscal adjustment, noting that once again itwas predicated upon optimistic growth assumptionsand that the same structural problems (particularly inthe area of tax collection) that had proved to be ahindrance in the first quarter remained unaddressed.

Why, then, did the Board agree to the completionof the review? The Chairman’s Summing Up of theBoard meeting noted that “in sum, Directors felt thatthe authorities have responded promptly and effec-tively and that the new measures merit the strongsupport of the international community.” Accordingto the statements of individual Directors, many ofthem were concerned that withholding support atthis juncture would be tantamount to “shying away”from the mandate of the IMF and to effectively sur-rendering to the same “procyclical influences thatare driving market behavior.” Several justified theirsupport, in spite of serious reservations, by the im-

49

22An interdepartmental team assembled in mid-1999 to under-take analytical work on Argentina, parallel to the process of pro-gram negotiations and reviews in which WHD took the lead. Seethe section “The Decision-Making Process” for details.

23“Argentina—Possible Crisis Scenarios,” sent to managementon April 14, 2001.


portance of Argentina’s stability for the region andemerging markets in general. In the words of aBoard member representing a large shareholder, themain rationale for the Board’s support of a programthat Directors viewed as deeply flawed was that “noone has proposed a different strategy that, risk ad-justed, promises a less costly alternative.”

Overall assessment

The decision to complete the third review in Mayis much more difficult to justify than the January de-cision. All the indicators for gauging market accessprospects were now sending negative signals, exceptfor those regarding the authorities’ commitment. Therevised program design offered no reasonableprospect of making Argentina’s situation sustainable.The assumptions on growth and interest rates mayhave been conservative when compared with the V-shaped recovery that followed the Mexican crisis, butwere in fact quite optimistic relative to the contempo-rary consensus forecast (see Figure 3.1), especiallyregarding GDP growth. Fiscal slippages were to becorrected by a sharp adjustment that would be heav-ily concentrated in the fourth quarter (as indicated bythe slope of the cumulative deficit target lines in Fig-ure 3.3), which was neither realistic nor helpful to thecredibility of the program. The announced mega-swap had every characteristic of “gambling for re-demption” by the authorities (see Appendix 7). In ad-dition, the new policy measures taken by theauthorities were misguided in many respects and in-sufficient to ensure compliance with the programmedfiscal adjustment path. It is doubtful, at this point,that any program could have achieved a sufficientturnaround in confidence to spur the expected re-bound in growth, but the measures on which this onewas based could even make things worse.

The decision required a difficult balancing ofjudgments of (i) a low probability that completingthe review would succeed in staving off a crisis and(ii) recognition that such a crisis would be verycostly. As pointed out earlier, it is important to avoidconcluding that the decision was wrong just becauseit failed, but our assessment is that it had very littlechance of success, taking into account what wasknown at the time:

• The program was effectively off track and sev-eral of the measures designed by the authoritiesin response—such as the competitiveness plansin particular—contradicted IMF advice.

• Even with optimistic assumptions, a return tosustainability looked doubtful.

• Market spreads remained at prohibitive levels.According to the logic of the catalytic approach

that underlay the January augmentation, this factalone should have provided ample reason for re-fusing to complete the review on the terms re-quested by the authorities.

• The desire to help a member country understress was entirely commendable, but the keyconsideration should have been whether thestrategy proposed was sustainable under realis-tic assumptions and, if not, whether the coun-try’s interests (as well as those of the interna-tional community) would be better served byproposing alternative solutions to its problems.24

It was simply assumed that keeping Argentinaafloat for however long the $1.2 billion wouldbuy was the best strategy.

At this point, at least two other options could havebeen considered: (i) helping Argentina undergo adrastic change in the macroeconomic policy frame-work immediately (involving a change in the ex-change rate regime and debt restructuring, embed-ded in a broader, coherent economic reform plan);and (ii) explicitly using the time “bought” by theaugmentation to make a transition to an alternativeregime while giving the catalytic approach a lastchance, by negotiating a fully credible policy pack-age combined with debt restructuring. But the IMFhad no viable alternative plan to offer, and the au-thorities refused to discuss such alternatives. Thisbecame a reason for continuing to support a strategywith a low probability of success.

Fourth Review and Augmentation,September 2001

Background

After the completion of the third review, the eco-nomic situation deteriorated even further. The mega-swap, completed in early June 2001 at spreads ofjust under 1,000 basis points (compared to around800 assumed as a working hypothesis at the time ofthe third review), entailed substantial costs for thecash flow savings obtained. The operation received amixed appraisal from market participants, but what-ever positive effect it may have had on spreads wasquickly erased by the confidence-shaking impact ofa new set of measures announced by the Minister ofEconomy in mid-June without prior consultation

50

24This is not to suggest that a fully quantitative analysis of theexpected costs and benefits of various options could have beenundertaken. It would have been a tall order to fill under the cir-cumstances. The Board discussion, however, was not informed byany systematic analysis of different options going beyond thevery near term.


with the IMF. These included the so-called “conver-gence factor,” which amounted to a devaluation forthe nonenergy tradable goods sector by mimickingthe proposed basket peg announced earlier throughfiscal means.25 Contrary to the intention of boostingcompetitiveness, the signal it gave to the marketswas an admission that the exchange rate regime wasno longer viable.

In early July 2001, faced with the refusal of thedomestic financial sector to provide any more creditto the government, the Minister announced a “zerodeficit policy,” which was passed into law by Con-gress later that month. The law mandated the gov-ernment, in the event of a prospective deficit, to in-troduce across-the-board proportional cuts inprimary expenditures. There was considerable skep-ticism that the wage and pension cuts implied by thelaw would be politically sustainable, but more thananything it confirmed the dire liquidity situation ofthe government. Meanwhile, deposit runs intensified(see Figure 3.2), accompanied by a sharp reductionin international reserves (Figure 3.4). Spreads con-tinued to climb, reaching 1,600 basis points by lateJuly.

In late July, facing the prospect of a banking crisisif deposit runs could not be stopped, the authoritiesrequested the IMF for the rapid disbursement of alarge amount of support. In response, the IMF ini-tially announced that it would consider acceleratingdisbursements under the existing arrangement, but acouple of weeks then passed without any confirma-tion of this move, leading to great uncertainty as towhat the next step would be. In the meantime, the Ar-gentine authorities fed assurances of internationalsupport to the media, and nuanced statements of sup-port were expressed by various world leaders, includ-ing from France, Spain, the United Kingdom, theUnited States, and many Latin American countries.

Internal documents and interviews with key offi-cials indicate that decision making in the summer of2001 was particularly arduous. In August alone, nofewer than six informal Board meetings were heldon Argentina, not to mention the daily meetings ofmanagement and senior staff and regular contactswith the treasuries and finance ministries of majorshareholder governments. Several options were con-sidered by management, but when Executive Direc-

tors returned from the summer recess on August 20,they were only presented with three:

• Option 1. Augmenting the existing arrangementby $8 billion in support of an enhanced versionof the existing strategy;

• Option 2. Putting together a program (of un-specified design) with large amounts of money($30–40 billion) from the official sector; and

• Option 3. “Rethinking the entire strategy” (i.e.,changing the exchange rate regime, restructur-ing the debt, or both).

They were then told in no uncertain terms that fail-ure to act quickly would precipitate default and acollapse of the exchange rate regime.

After some initial hesitation, on August 21, theManaging Director recommended a version of op-tion 1 that included a “creative element” in the formof a possible use of $3 billion as an enhancement insupport of a debt restructuring operation.26 Accord-ing to participants in the meeting, the reaction of theBoard was largely positive, but several Directors, in-cluding some from G-7 countries, wished to reservetheir positions at that point.27 In a press release is-

51

25A subsidy was to be paid to exporters and a duty charged toimporters, with the amount equivalent to the difference betweenthe prevailing exchange rate and the exchange rate calculated bythe basket. Although this was effectively a dual exchange rate, itwas determined by IMF staff that, from a legal standpoint, it didnot constitute a multiple currency practice (use of which is re-stricted by the Articles of Agreement), because the system oper-ated through the budgetary process, and not through the foreignexchange market.

Figure 3.4. International Reserves, January 3, 2000–December 31, 2001(In billions of U.S. dollars)

Sources: Bloomberg; and IMF database.

Jan. Mar. May Jul. Sep. Nov. Jan. Mar. May Jul. Sep. Nov.2000 2001

0

5

10

15

20

25

30

35

40

International reserves net of IMF position

Gross international reserves

26It appears that this idea, a surprise to most Directors, hadbeen raised by senior U.S. Treasury officials over the precedingdays in direct conversations with the Managing Director.

27As a result, the press release only announced the ManagingDirector’s intention to recommend that decision to the Board, in-stead of stating that the Board supported that decision (as hadbeen done in the case of the blindaje announcement in December2000).


sued on that day, the Managing Director made publichis intention to recommend to the Board an augmen-tation of the existing SBA by $8 billion in support ofan essentially unchanged program, though with anoption for debt restructuring.


The main pillar of the revised program was thezero-deficit policy, which had been enacted into lawby Congress in late July. It was hoped that restoringa viable fiscal position would help halt the outflowof deposits and ease domestic financing conditions.This was expected to help create conditions for a re-covery of demand and output, beginning in thefourth quarter of 2001, combined with trade and taxmeasures removing impediments to investment,“competitiveness plans” aimed at improving prof-itability in the sectors most affected by the recession,and the introduction of the “convergence factor” (seeTable 3.1 for details of the macroeconomic frame-work). In order to give credibility to the authorities’commitment to fiscal adjustment, two prior actionswere set, involving a public announcement ahead ofthe Board meeting that cuts in guaranteed transfersto the provinces might be implemented if required tomeet the zero deficit target and that a reform of rev-enue-sharing arrangements would be presented toCongress before year-end.28

The staff report was unusually candid in spellingout the risks to the program, which were “all thegreater in light of the Fund’s increased exposure toArgentina.” It noted the likelihood of strong politicalresistance to key components of the program, thevulnerability of the banking sector to further depositruns, the worsening of several external vulnerabilityindicators, and the fact that the authorities had only afew months to reestablish the credibility required tomeet their large financing needs for the followingyear.

The staff report also used guarded language topronounce on debt and current account sustainabil-ity. Remarkably, the relevant paragraph of the reportdid not include the usual expression of staff confi-dence in the authorities’ ability to repay the IMF.While it concluded that “overall, the staff is of theview that Argentina’s program deserves Fund sup-port,” the reasons invoked to support that view es-sentially boiled down to the authorities’ resolve andhad little to do with the likelihood of being able torestore sustainability. Mitigating somewhat thisguarded appraisal, in comments made at the Boardmeeting, the staff further asserted that the risks and

costs of alternatives, involving a debt standstill, de-valuation or both, would be far greater.


Looking beyond Argentina, the staff consideredpotential contagion both within and outside the re-gion, and outlined tentative policy responses for thecountries most likely to be affected. Notes producedby the staff throughout the summer of 2001 revealuncertainties as to whether contagion would begreater in the event of a preemptive debt restructur-ing (possibly leading to a generalized withdrawal ofcapital from emerging markets) or in the event of adevaluation forced by markets. RES concluded thatthe potential for contagion from an Argentine defaultwould likely be limited because a “credit event” wasalready widely anticipated and had been partly dis-counted by markets for some time, while contagioncould be worse if the IMF tried to stall it.29

Starting in July, internal discussions within staffand with management became more focused onwhat the stop-loss rule should be for the IMF. Bymid-July, staff communicated to management theview that unless credibility was gained quickly,which was considered possible though unlikely to besustained beyond a few months,30 “it would be ad-visable to adopt alternative measures before the re-serves are depleted and major damage is done to thebanking system. . . . If and when problems reemerge,it will not be advisable to seek to maintain the situa-tion much longer.” At the same time, the staff feltthat the authorities would probably hold on to theirstrategy until liquidity constraints became insur-mountable.

By end-July, notes to management further ex-pressed the staff’s view that a reduction in the NPVof the debt was likely to be needed under all scenar-ios. It was estimated that, under the current exchangerate regime an annual primary surplus of 4!/2 percentof GDP would be needed through 2006 to make thedebt sustainable, an unlikely development given thatthe primary surplus never reached 2 percent in theprevious decade.31 One of the memorandums drafted

52

28These prior actions were discussed, but not explicitly charac-terized as such in program documents.

29Similar views were expressed to the Board by the Director ofthe International Capital Markets Department (ICM) in an infor-mal meeting in late August.

30An informal report on an interdepartmental staff meeting onvulnerabilities held on July 12, 2001, noted: “There was consen-sus that the situation in Argentina was not sustainable [in view ofthe level of international spreads and domestic interest rates] anda strategy that lacks political credibility and support.”

31The debt dynamics simulation presented by staff in January2001 had assumed that the primary surplus of a similar magnitudecould be achieved in 2005, but it was envisaged that the reductionwould be made gradually against the background of strong GDPgrowth.


by the Argentina Task Force around this time evensuggested that “if, at some point, the program agreedwith the authorities were to go irremediably offtrack, [it would] quickly bring about a collapse ofthe current policy regime.” It then predicted withstriking accuracy how the crisis would unfold.32

Despite these reservations, by mid-August 2001,the staff came to the view that completing the re-view without augmentation was effectively ruledout by expectations formed in the markets; the au-thorities had made statements during the previousweeks—without any denial from IMF or G-7 offi-cials—that they received concrete commitments foran additional $9 billion of financing. Staff felt thatnot fulfilling these expectations would almost cer-tainly trigger a speculative attack on the peso, lead-ing to a depletion of foreign exchange reserves anda debt default.33 In order to justify the augmenta-tion, the staff tried to commit the authorities to a se-ries of measures, mostly on the fiscal front, which itthought would strengthen the credibility and feasi-bility of the required fiscal adjustment. But the staffwas unable to obtain the authorities’ agreement onmore than a few of these measures.34 On its part,management secured a commitment from the au-

thorities to engage in discussions with the IMF onan alternative policy framework in the event interna-tional reserves fell below a critical threshold (effec-tively set just above the balance of outstanding IMFcredit).

In a meeting of selected senior staff called by theManaging Director, about a week before the final de-cision was made, the chance of success of the pro-gram was estimated at most as 20–30 percent.35 Thestaff was divided as to whether it was still significantenough to complete the review, given the enormouscosts of withholding support. Those who were infavor argued that the augmentation would buy time(four to five months at most) and ensure that the au-thorities, not the IMF, took responsibility for the crit-ical decisions needed (that is, a change in the ex-change rate regime and debt restructuring). It wasalso argued that the costs to the Argentine people,neighboring countries, and the IMF itself would beless if the authorities were given a last chance todemonstrate the viability of their strategy.36 However,a clear majority of those present disagreed, sayingthat the IMF might not be spared from blame in anycase. The additional few billion dollars would notbuy enough time to make a difference, but would bemore likely to disappear in capital flight, leaving Ar-gentina more indebted to the IMF. According to somepresent at the meeting, a key element in manage-ment’s eventual decision was concern about a politi-cal backlash against IMF policy advice, especially inLatin America, if it was perceived to withhold sup-port from a country that had been under IMF-sup-ported programs for the last decade and was ostensi-bly committed to implementing its agreement.

Right before the formal Board meeting, manage-ment was informed of the findings of a just-com-pleted staff visit to Buenos Aires. In the staff’sview, given the recession-induced fall in tax rev-enue and tax compliance, the (already relaxed) fis-cal targets for end-September would likely be metonly through unsustainable measures (for example,payment arrears) and accounting maneuvers, andthe authorities would likely not comply with theirpromise to cut guaranteed transfers to theprovinces, which had been a key condition to en-sure short-term fiscal sustainability.

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32The memorandum described the evolution of the crisis as fol-lows. “During the first few weeks of traumatic adjustment to-wards a more sustainable position, a number of events will likelytake place in rapid succession, including: a default on governmentdebt; the abandonment of the currency peg; a sharp decline in ac-tivity and spike in unemployment; a deterioration of banks’ bal-ance sheets; political dislocation. . . . In the event, steps could betaken to make the transition process somewhat less chaotic [and]the Fund could offer a number of short-term recommendations:(i) the announcement of the debt moratorium should be followedby a combination of defensive legal actions and the governmentshould organize a preliminary meeting as rapidly as possible withdomestic and external creditors; (ii) any bank holiday must beshort and should be used only to provide the authorities time todevelop a credible policy package; for the same reasons, the au-thorities should not try to impose a deposit freeze; (iii) the newexchange rate regime will need to be perceived as part of a sus-tainable policy mix; (iv) the government will need to strengthenthe Central Bank; (v) [it] will need to start working immediatelyon a set of policies that will achieve a fiscal position that is credi-ble and visibly consistent with a quick resumption of fiscal viabil-ity, including debt service payments.”

33Interestingly, providing support of that magnitude was seenby many market participants at best as a “middle of the road” so-lution, likely to be insufficient to buy Argentina more than a fewweeks of respite. Market views of what it would take to “bail out”Argentina ran in excess of $30 billion, a figure corresponding to option 2 considered by management. See, for instance, “Ar-gentina’s Final Crisis Resolution,” BNP Paribas Emerging Mar-kets Trade and Sovereign Strategy, August 14, 2001.

34The measures refused by the authorities included various pro-visions to safeguard the existing tax revenues, abolishing thecompetitiveness plans and associated tax exemptions, speedingup progress in pension and health care reforms, obtaining writtencommitments from all provincial governors on fiscal disciplineunder the zero-deficit law, and strengthening the state-ownedbanks.

35The minutes of the meeting state that those who were moreoptimistic considered the “chance of success” to be “20–30 per-cent,” while at the same time acknowledging that “precise quan-tification was not really meaningful.” Management may well haveheld a somewhat more optimistic view, as a member of manage-ment has indicated to the IEO, but it was generally recognizedthat the probability of success was low.

36Obviously, this argument assumed that the strategy chosenwould work.


The Board decision

On September 7, 2001, the Executive Board ap-proved the recommendation of management to com-plete the fourth review of the SBA and to augmentthe arrangement by SDR 6.3 billion ($8 billion), ofwhich SDR 3.97 billion ($5 billion) were to be dis-bursed immediately and $3 billion set aside to bemade available in support of a possible debt restruc-turing operation (Box 3.2). In a move that is rare inthe IMF’s consensus-based decision-making process,two Directors abstained. The decision brought totalcommitments under the arrangement to SDR 17.5billion ($22 billion). Unlike the announcement of theblindaje in late 2000, the advance announcement ofthe IMF’s decision to support Argentina brought only

a short-lived relief in market conditions, and spreadshad quickly returned to reach 1,400 basis points bythe time of formal Board approval.

At the informal Board meeting of August 20, Di-rectors were told by management that augmenting thearrangement in support of enhanced policies withinthe same framework had a low probability of success.As noted, on the next day, the same option, enhancedby the possibility of using IMF resources in support ofan unspecified market-based debt restructuring opera-tion, was presented by management as the least costlyand risky of various alternatives under the prevailingcircumstances. At the same time, management sharedwith Board members notes prepared by the Directorsof RES and ICM, each expressing skepticism as to theadvisability of using IMF resources in support of avoluntary debt restructuring operation, even leavingaside the intricate legal issues involved.37

According to the minutes of the Board meeting ofSeptember 7, 2001, a number of Directors felt thatthe situation was not sustainable and that the pro-gram did not offer satisfactory remedies. Neverthe-less, with the exception of two Directors, the Boardexpressed its willingness to support the program, os-tensibly to buy the authorities (and the internationalcommunity) time to put together a solution thatwould be both less disorderly and less costly than animmediate collapse of the regime. Many Directorswere particularly concerned with the impact that adefault in Argentina would have on the world econ-omy, at a time when the global outlook was worri-some.38 All Directors appeared impressed by thestrength of what they saw as the authorities’ resolve,and some wished to give them the benefit of thedoubt on their ability to implement the measuresthey had announced. A handful of Directors eventhought that the program had a good chance to work,provided that it was perfectly implemented and re-ceived the enthusiastic support of the IMF.

Overall assessment

The September 2001 augmentation suffered from anumber of weaknesses in program design, whichwere evident at the time. If the debt were indeed un-

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Box 3.2. Financial Instruments UsedDuring the Crisis

During 1999–2001, Argentina made use of variousmarket-based financial tools to manage its financialneeds. These included: (i) voluntary debt restructur-ing operations without official enhancements; (ii) public guarantees and other enhancements to in-duce the provision of private financing; and (iii) pri-vate contingent credit lines.

First, a voluntary debt restructuring operation wasdone without official enhancements in the mega-swap of June 2001, in which 52 old bonds totalingabout $30 billion (in face value) were exchanged forfive new bonds with longer maturities.

Second, a public guarantee and an official en-hancement were provided, respectively, by the WorldBank’s policy-based guarantee (PBG) loan and theproposal to use $3 billion of IMF money for debt op-erations in the September 2001 augmentation. Ar-gentina, however, eventually defaulted on the PBGloan when it opted not to pay the Bank for the guar-antee the Bank had exercised. The $3 billion madeavailable in September 2001 was not used for debtoperations, as it became evident very quickly thatthere was no effective way of using this relativelysmall sum to reduce the debt burden of Argentina.

Third, credit lines with a group of internationalbanks were maintained by the central bank in orderto provide liquidity support to the domestic bankingsystem, through guaranteed sales (with a promise torepurchase) of Argentina’s international bonds inbank portfolios for cash. The mega-swap of June2001, however, reduced the amount of eligiblebonds, and effectively reduced the size of the facil-ity. Argentina did draw on the facility in September2001, but the credit line was too small to provide thesums the country needed.

For further details, see Appendix 7 on the mega-swap and Appendix 8 on public guarantees, officialenhancements, and private contingent credit lines.

37Specifically, the note from the RES Director concluded that “asa rule, financial engineering can dissipate our resources but cannotenhance them,” while the note from the ICM Director further ex-plained that “it is very hard to see how a voluntary exchange, ac-companied by a relatively small amount (compared to total debt) ofcredit enhancement via Fund finance for interest payments, can re-sult in a significant improvement in Argentina’s debt service pro-file, no matter what financial engineering is involved.”

38Further evidence of such concerns is provided by the min-utes of the Board discussion on the WEO, which coincidentallywas concluded on the same day that the Argentina program wasapproved.


sustainable, as by then well recognized by IMFstaff,39 the program offered no solution to that prob-lem. While implicitly acknowledging the need fordebt restructuring by including a component for thatpurpose, the program provided no information on thenature or scale of this operation. In any case, it wascertain that the debt operation could not, in and of it-self, offer much by way of achieving debt sustainabil-ity, unless much larger amounts of financing could bemobilized.40 The way the operation was presented, itmight even be perceived as signaling that a coercivedebt restructuring was imminent and thereby riskedfurther undermining market confidence.

The program was also based on policies that wereeither known to be counterproductive (such as theso-called convergence factor) or that had proven tobe “ineffective and unsustainable everywhere theyhad been tried” (as was the case with the zero deficitlaw).41 Nor did the program address the now clearovervaluation of the exchange rate, which had appre-ciated by an additional 7.7 percent by September2001.42 The fiscal component of the program re-mained weak or unconvincing. The fiscal targets forthe current quarter had to be relaxed preemptively,and all the adjustment effort was therefore concen-trated in the last quarter.43

At best, the amount provided offered Argentinabreathing space, perhaps until the end of the year,but it was simply not possible to expect Argentina toregain market access within such a short amount oftime, given the prevailing market sentiment.44 This

meant that, unless the public sector’s financing re-quirements could be reduced to zero, continuation ofthe strategy would require large amounts of addi-tional financing to prevent a default, in violation ofthe terms of the SRF under which over half of theadditional financing was provided. More signifi-cantly, it put at risk a considerable amount of IMFresources.

Although staff and management, in their reportsto and communications with the Board, were for themost part candid in spelling out the risks to the pro-gram and to the IMF itself, the staff report did notdiscuss the following issues:

• The implications for future IMF financing of con-tinued adherence to the strategy that was beingrecommended. These included the question ofhow much more “bridge” financing would be re-quired from the official sector if the internationalcommunity were to help Argentina until confi-dence returned and growth finally resumed.

• The risks and costs of the various alternatives.There was no analysis of what the next stepwould be, even though it was certain that contin-uing the program, with scheduled disburse-ments, was the least probable scenario. As a re-sult, the Board could not assess if therecommended strategy was indeed the leastcostly and least risky one, and had only thechoice between supporting a program with alow probability of success and withdrawing sup-port entirely, thereby triggering an immediatecollapse, with high costs and little idea of whatstrategy would follow. As in May 2001, thecosts of providing further support to postpone adefault and devaluation were not discussed.

• The findings of the staff visit that had occurredshortly before the Board meeting, which con-firmed that the recommended strategy was al-ready headed for a likely failure.

The Board was also not proactive in performing itsoversight responsibility to safeguard the IMF’s re-

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39A memorandum to management dated July 26, 2001 noted:“While the results are highly sensitive to the assumptions, thestaff estimates that a haircut of between 15 and 40 percent is re-quired, depending on the policy choice.”

40This was the conclusion of analytical work done inside theIMF, as well as of parallel work done by some U.S. Treasurystaff. The Argentine authorities were aware of this, and the debtrestructuring scenario on which they were working in fact in-volved enhancement in the order of $20 billion to 30 billion.Those outside the IMF supporting the idea of “earmarking” $3billion for a debt operation seem to have hoped that this sumcould work as seed money for further contributions from the offi-cial sector. However, the Argentine authorities were not success-ful in their attempts to secure additional official financing frombilateral sources during the fall.

41As expressed by FAD at the time.42In the same July 26 memorandum, the staff stated that the

peso was overvalued by as much as 15 percent.43One review department put it as follows: “The realization of

the medium-term debt scenario presented would represent a radi-cal departure from this track record of slippages, optimisticmacroeconomic assumptions, and inability of successive pro-grams since January to arrest the growth of public debt.”

44New York-based market participants interviewed by the IEOindicated that, by August 2001, all but a few international in-vestors had eliminated or reduced their exposure to Argentina sig-nificantly in their expectation that a crisis was inevitable. That thissense of inevitability did not lead to a sharp increase in market

spreads until the last months of the year likely reflects a combina-tion of factors. First, it was widely expected that the official com-munity would provide further support to Argentina, thereby de-laying the explosion of the crisis for an uncertain amount of time.Second, while much larger spreads have been experienced byother countries that avoided a crisis (for example, Brazil in 2002),these episodes are generally associated with a special event thatincreases uncertainty, such as elections, against the backgroundof otherwise sound economic fundamentals. In contrast, Ar-gentina’s spreads had remained high for a sustained period oftime. Third, spreads cannot readily be translated into an impliedprobability of default, as they also incorporate expectations aboutthe magnitude of the default. It is thus important to consider notonly spreads but also other indicators in order to ascertain marketviews.


sources. The staff report made it plain that accordingto a variety of indicators the disbursement of the $5billion tranche would make the IMF’s exposure to Ar-gentina among the riskiest in its history.45 It did notinclude the usual expression of staff confidence in theauthorities’ ability to repay the IMF. Yet, only a fewDirectors expressed concerns about safeguards to theIMF’s resources in their Board statements, despite thefact that none of them knew of the understandingreached between management and Mr. Cavallo on Argentina’s need to consider an alternative strategyand discuss it with the IMF when international re-serves fell below IMF exposure. A specific questionasked by one of the two abstaining Directors on thispoint was left unanswered and not picked up by theBoard.

Noncompletion of Fifth Review,December 2001

Background

By late October 2001, it had become clear that theaugmentation of the SBA and the zero deficit policyhad failed to bring about the hoped-for virtuous cir-cle of stronger public finances, lower interest rates,and economic recovery. Argentina’s economic per-formance continued to deteriorate in almost everyrespect, with GDP expected to drop by 4!/2 percent in2001 and the fiscal position at end-September wasweaker than originally programmed by 3 percent ofGDP. Spreads had widened to unusually high levels,reaching 2,000 basis points at end-October. Yet, evenat this late stage, staff continued to defer to the au-thorities’ unwillingness to engage in an open discus-sion of alternative policy frameworks.46

On November 1, 2001, the Argentine authoritiesannounced—again without prior consultation withthe IMF—a new package of measures intended togive a decisive boost to competitiveness through tax

incentives47 and to make further progress in ensuringfiscal solvency, including a two-phase debt ex-change, which was characterized as “orderly” as op-posed to “voluntary.” Phase I of the debt exchangewas aimed mainly at domestic creditors and entailedan exchange of old credit for guaranteed loans to thefederal government at substantially lower interestrates and longer maturities, collateralized by revenuefrom the financial transactions tax, while Phase IIwas to be directed at international creditors under in-ternational conventions.48

On the same day, responding to a request frommanagement, staff outlined its own “preferred strat-egy” consisting of (i) further fiscal adjustment to en-sure adherence to the zero deficit policy; (ii) a suit-ably comprehensive debt restructuring involving areduction in the NPV of around 40 percent; (iii) dol-larization at par (assuming it would be the authori-ties’ preference); and (iv) repayment of SRF dis-bursements on an obligation basis and fulldisbursement of the balances undrawn under theSBA (i.e., $9 billion). This approach was made ef-fectively irrelevant by the unexpected announcementof the authorities.

On November 2, 2001, in its communication tothe Board, staff characterized the package of mea-sures announced by the authorities on the previousday as being “not consistent with fiscal reality.” Itviewed the proposed debt exchange, unclear as it wasat this stage, as running a major risk of being rejectedby the markets and causing a bank run. Staff furthernoted that sustainability could not be ensured unlessthe provinces and the federal government could reachagreement on a new revenue-sharing mechanism,which they had so far failed to do in breach of pro-gram conditionality (let alone the requirements of theconstitution). Board members asked questions butdid not provide specific guidance as to the strategy to

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45The staff report noted that projected debt service to the IMFwould reach 34 percent of total public sector debt service in 2002(20 percent in 2003), and 23 percent of exports in 2002 (12 per-cent in 2003). The ratios of debt service to exports dwarfed thoseattained in any other previous capital account crisis case. Theshares of debt service to the IMF in total public sector debt ser-vice were exceeded only in the cases of Korea and Russia, wheredebt service to the IMF never exceeded 7 percent of exports.

46In late October, when review departments were generally “ofthe view that the authorities were unlikely to be able to commit toa credible set of measures that would be sufficient,” WHD fearedthe consequence of a possible leak and did not consider it prudentto include in a briefing paper explicit instructions for the missionchief to engage with the authorities in a discussion of alternativepolicy frameworks. Against the advice of review departments (es-pecially FAD and PDR), management supported WHD’s circum-spect stance.

47By then, there was little doubt that the REER had appreciatedsince the start of the year, but to our knowledge no effort wasmade by either IMF staff or the authorities to calibrate the com-petitiveness plans to assess the extent to which they offset the ex-change rate appreciation. Staff rightly criticized these measuresfor their fiscal cost, but to the extent that these measures were tan-tamount to admitting that Argentina had a competitiveness prob-lem, it is likely that they also undermined confidence in the ex-change rate peg.

48The two-phase approach was adopted for two reasons. First, adebt exchange under international conventions would take amuch longer time. Second, the domestic banking system and pen-sion funds needed to be protected from a possible capital loss re-sulting from coercive debt restructuring. In the event, phase I wascompleted on December 13, involving about $42 billion (or 34percent) of federal government bonds, but phase II, which was tobe completed in mid-January 2002, was overtaken by events andnever executed. IMF staff had serious reservations about thisstructure because of the inter-creditor equity issues it raised andthe likelihood that it would lead to a further erosion of investorconfidence.


be followed, other than implicitly endorsing manage-ment’s stance, as communicated to the authorities,that the next IMF disbursement would be dependenton a successful completion of the fifth review andfull agreement on a program for 2002 and the 2002budget.

In late November 2001, there was a renewedbank run in which more than $3.6 billion in depositswas lost over three days, bringing the cumulativedecline since the beginning of the year to $15 bil-lion (or 20 percent of total deposits). On Decem-ber 1, the government introduced wide-ranging con-trols on banking and foreign exchange transactions,placing limitations on deposit withdrawals and pur-chases of foreign exchange for travel and transfersabroad. Meanwhile, a staff mission had arrived inBuenos Aires toward the end of November for nego-tiations relating to the completion of the fifth re-view. During those negotiations, it was evident thatthe staff’s assessment differed considerably fromthat of the authorities on the prospects for achievingthe fiscal targets.

The decision and its aftermath

On December 5, 2001, shortly after Minister Cav-allo had made a statement that negotiations with theIMF were “going well,” the IMF issued a press re-lease indicating that the mission returning to head-quarters on that day had concluded that the fifth re-view under the SBA could not be completed at thispoint, which also meant that the scheduled trancheof $1.3 billion would not be released. On the sameday, management informed the Board that it couldnot recommend completion of the fifth review, be-cause the fiscal deficit target of $6.5 billion for 2001was likely to be breached by $2.6 billion, and pro-jections for 2002 showed a large financing gap, inspite of the successful conclusion of phase I of thedebt exchange. According to informal records of themeeting, Directors emphasized that the IMF shouldnot be abandoning Argentina. Responding to Direc-tors’ questions about next steps, management indi-cated that the IMF would continue to work with theauthorities on a sustainable program within the ex-isting policy framework.

On December 8, 2001, staff met with the Argen-tine economic team in Washington “to advance inthe specification of the size of the fiscal effort re-quired to provide the basis” for completing the re-view “under the current SBA” and discussed a set ofrevenue-enhancing and expenditure-cutting mea-sures that would reduce the financing gap to $10 bil-lion for 2002–04. WHD staff commented to manage-ment that “[garnering] the support required to put inplace the necessary fiscal measures would be a tallorder under any circumstances, let alone the very

difficult present ones.” In a note to managementdated December 10, FAD expressed, with broad en-dorsement from PDR and RES, serious concernsabout the quality and credibility of that fiscal pro-gram,49 and advised against the completion of the re-view on that basis, while also recognizing that fur-ther fiscal adjustment was probably not feasible.

Meanwhile, in Argentina, the flight to qualitywithin the banking system intensified and massdemonstrations started in protest against the eco-nomic policies of the government, the deposit freezein particular. This led to the declaration of state ofemergency on December 19, and the subsequent res-ignations of Minister Cavallo and President De LaRúa, who would be followed by four presidents inquick succession over a period of about 10 days (seethe timeline of events in Appendix 9). Managementsought guidance from Directors representing the G-10 countries. A consensus emerged that the IMFwould have to wait until there was a new govern-ment with whom talks could be initiated towardfinding a comprehensive medium-term solution, in-cluding a plan to recapitalize the banking system. Nospecific proposals appear to have been discussed re-garding key policy options, although there was ageneral debate on exchange rate regime options fac-ing the authorities, namely, floating or devaluationaccompanied by dollarization.

On its part, staff had begun outlining in some de-tail the main elements of a program that could besupported by a new three-year SBA, which involvedfurther financial support from the official commu-nity. The main elements of the envisaged programincluded: a changed exchange rate regime (devalua-tion and dollarization or float); a combination of per-manent fiscal adjustment and debt relief to make thepublic finances sustainable over the medium term;an agreed strategy to strengthen the banking sector,including phasing out withdrawal restrictions; struc-tural reforms to support fiscal adjustment; and finan-cial assistance from the international community toaugment international reserves, restore confidenceand, in the event of dollarization, provide liquidityassistance to the banking system. Specific measureswere spelled out in each of these areas.

On December 23, President Rodríguez Saá, thesecond president to follow Fernando De La Rúa, de-clared partial default on Argentina’s external debt. Inearly January 2002, President Eduardo Duhalde, thefourth president, terminated the convertibilityregime and replaced it with a dual exchange rateregime consisting of a fixed rate of 1.40 pesos to the

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49FAD noted in particular that the program being negotiated in-cluded ambitious assumptions about GDP growth, tax administra-tion gains, revenue elasticity, and the sustainability of the drasticcuts in wages and pensions over the medium term.


dollar for foreign trade and a free market exchangerate. Immediately thereafter, the IMF dispatched asenior staff member to Buenos Aires to inquire aboutthe authorities’ immediate intentions and to commu-nicate to them that, in order to start discussions on anew IMF-supported program, more work and betterdefinitions would be needed in four areas: the newexchange rate regime (emphasizing that the IMFcould not support the dual exchange rate system),the budget, the cost of bank restructuring, and themodality and status of phase II of the debt exchange.These elements were then refined in a confidentialletter from the First Deputy Managing Director,which subsequently appeared in the Argentinepress.50

These developments were discussed at an infor-mal meeting of the Board on January 11, 2002, whenDirectors endorsed—ex post—management’s initia-tives and expressed a strong willingness to supportArgentina. Several Directors encouraged staff to getinto negotiating mode immediately, in order to avoida vicious circle of waiting, seeing the economic situ-ation deteriorate further, and chasing a moving targetin designing a new program. Notes from staff tomanagement indicate a keen awareness of that risk,emphasizing the authorities’ lack of preparedness todeal with the situation, their general overoptimism,and the fact that they appeared to be “thinking theirway through issues as they came along.” In practice,however, the political reality left little choice but towait for the authorities to make their own decisions.As it turned out, the policy decisions made in thetwo weeks that followed, without consultation withthe IMF, including especially that of converting dol-lar-denominated bank assets and liabilities intopesos at asymmetric rates, inflicted irreversible dam-age to the banking sector and practically ensuredthat the worst possible scenario would materialize,as no new program could be agreed upon until a yearlater.

Overall assessment

By December 2001, it was clear to most ob-servers that a devaluation of the peso and a compre-hensive—NPV-reducing—debt restructuring couldnot be avoided, and no program could be sustainable

as long as the Argentine authorities were unwillingto consider these options. Under these circum-stances, the decision not to complete the review waswell founded. However, it is relevant to ask whetherthe disengagement could have been managed betterto contain the ultimate impact of the crisis.

As noted earlier, the analytical work done by theArgentina Task Force in July 2001 had predictedwith striking accuracy how the crisis would unfold.Staff knew well that, unless the incumbent authori-ties could somehow be persuaded to handle the crisispreemptively, an all-out crisis would unfold in an en-vironment of political dislocation and might lead topolicy missteps that could aggravate the costs evenfurther. Yet, in the face of intensifying social and po-litical instability, the IMF did not develop an alterna-tive approach and insist that such options be dis-cussed with the authorities. Discussions with amember of the management team reveal that theIMF repeatedly informed the Argentine authoritiesthat they should develop an alternative, but it did notitself produce a comprehensive alternative that couldbe supported with additional financing.

The result was that the crisis eventually devel-oped as predicted. Frank assessments in internalmemorandums clearly indicate that, by the end ofOctober 2001, management and staff were con-vinced that completion of the fifth review would behighly unlikely under the existing terms. However,this view was not communicated clearly to the au-thorities, allowing them to engage in desperate at-tempts to save what was by then clearly unsustain-able, instead of facing reality and working with theIMF toward addressing the problem in the least dam-aging way. Following the decision not to completethe review, the IMF did not have a meaningful im-pact on the critical choices made in the immediateaftermath of the termination of the convertibilityregime. A workable contingency plan that could beused in support of Argentina during the painfulregime shift might have produced a less traumaticoutcome. The costs of the crisis would still havebeen huge, but earlier discussions of various exit op-tions might have reduced the risks of policy choicesthat made a bad situation worse.

The Decision-Making Process

Our review of the IMF’s decisions on Argentinain 2001 reveals certain features of decision makingunder uncertainty which, although specific to thisparticular episode, are also capable of generatinglessons for the IMF’s decision-making process. Weconsider below five aspects of this process: (i) inter-nal staff organization for crisis management,(ii) contingency planning, (iii) relationship with the

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50According to the press reports (as well as the reference made inan informal Board meeting), the letter appears to have emphasizedfive prerequisites for successful program negotiations: (i) a unifiedexchange rate in place or, alternatively, a road map toward unifyingthe exchange rate regime; (ii) a credible anchor for monetary pol-icy; (iii) a credible fiscal policy—including a reform of fiscal rela-tions between the federal government and the provinces; (iv) aclear road map with regard to bank and corporate restructuring; and(v) an agreement with a majority of the creditors about debt re-structuring, bearing in mind the need for equity of treatment.


authorities, (iv) management of financial risk, and(v) Executive Board involvement.

Internal staff organization for crisismanagement

In the second half of 1999, the IMF geared up tocrisis management mode by setting up an “ArgentinaTask Force,” consisting of senior staff from key de-partments (WHD, PDR, FAD, MAE, and RES)charged with the task of overseeing the productionof all relevant analytical work related to Argentina.Between July 1999 and December 2001, the taskforce oversaw the production of more than 40 ana-lytical notes, largely focused on exploring the impli-cations of alternative policy frameworks for Ar-gentina. Late in 2000, a daily reporting process wasinitiated to monitor key economic and financial indi-cators. This was initially staffed by PDR personnelfor internal departmental purposes, but was subse-quently broadened to incorporate inputs from WHDstaff, with output disseminated to senior staff acrossdepartments. Moreover, the First Deputy ManagingDirector was closely involved in all work related toArgentina.

These arrangements ensured that (i) relevant ex-pertise from throughout the institution was broughtto bear on the critical issues at stake and (ii) a livelyinterdepartmental debate took place on all issues,with differences of view being aired and brought tomanagement’s attention in a transparent manner.51

While the setup of these arrangements was fully ap-propriate, the process nevertheless failed in two im-portant ways. First, some critical issues only re-ceived limited attention, including whether thecountry faced a liquidity or a solvency crisis,whether the exchange rate was sustainable, and mostimportantly what practical steps to take should thepreferred strategy fail. Second, the IMF never cameto closure on issues that were subject to heated inter-nal debate, such as the assessment of the merits ofthe mega-swap or, more critically, the type of ex-change rate regime to promote as a replacement tothe currency-board-like arrangement.

Contingency planning

Contingency planning, namely planning on an al-ternative course of action in case the current strategyfailed, should be a critical element in crisis manage-

ment. Such contingency planning, in a crisis context,must involve four components: (i) determining the al-ternative policy framework that should be adopted bythe authorities if the current strategy is to fail; (ii) de-termining the practical steps that should be taken bythe IMF and the international community in supportof that strategy to maximize its chance of success andminimize its costs to the country; (iii) determiningthe basis upon which failure of the existing strategyand a need for change in approach should be identi-fied before a full-blown crisis materializes; and (iv) effectively conveying this assessment to the au-thorities. The IMF devoted significant analytical re-sources to considering different contingencies (focus-ing for the most part on the first component), but theother, more practical elements of contingency plan-ning were not undertaken in a meaningful way untilvery late in the process.

The analytical work that was done in identifyingalternative courses of action for the authorities didproduce an increasingly rigorous and insightful outputfrom late 2000, but it had limited operational value fordecision making for three reasons. First, the most im-portant component of contingency planning—deter-mining the practical steps that the IMF and the inter-national community should take in the event thecurrent strategy failed—was not undertaken until De-cember 2001, when the outbreak of a full-blown crisiswas all but certain. Second, even when the staff begana rigorous analysis of the viability of the current strat-egy and how the crisis might unfold, it did not explorepossible “stop-loss rules” for the IMF sufficientlyahead of time. Third, most critically, these analyseswere not shared with the authorities nor, for the mostpart, with the Board. In the case of the authorities, thisreflected a natural reluctance to discuss any alterna-tive strategy involving debt restructuring or a changeto the exchange rate regime. In the case of the Board,it appears to have reflected concerns that candid dis-cussions of alternative strategies might leak and hencetrigger a self-fulfilling crisis.

The IMF’s analytical efforts appear to have beenhampered by excessive deference to the strong own-ership by the authorities of the exchange rate regimeand the conclusion, known even from preliminaryanalyses undertaken as early as 1999, that the risksand costs of abandoning the convertibility regimewould be enormous. Likewise, reflections on mean-ingful debt restructuring scenarios were to a largeextent hindered, until the late spring of 2001, by therecognition that any “coordinated” operation wouldlikely trigger a run on banks and force a change inthe exchange rate regime.52 Despite the Prague

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51While opposing views were sometimes held along depart-mental lines on some issues (e.g., the mega-swap of June 2001),the dividing line on the most fundamental aspects of diagnosis(e.g., currency overvaluation) and actions required (e.g., comple-tion or noncompletion of a review) more frequently ran betweenindividual staff members within each department.

52The experience in Uruguay in 2002 would later show that thispremise was not necessarily correct.


framework of September 2000, little progress had infact been made in suggesting a practical modality forinvoluntary PSI and the role the IMF should play inthe process. There were some precedents—Russia,Ukraine, and Pakistan—but a majority of IMF staffat the time believed—perhaps with some justifica-tion—that the Argentine situation was so unique be-cause of the magnitudes involved as to make previ-ous experience inapplicable. More important, theabsence of a clear modality to make the Pragueframework operational meant that the IMF did nottake a proactive role. While each debt crisis isunique and none of the precedents provided a ready-made modality for Argentina, the magnitude of thestake in Argentina would seem to have warrantedgreater creative thinking and proactivity on the partof the IMF using previous experience as a point ofdeparture (as indeed was subsequently done in thecase of Uruguay in 2002).

Relationship with the authorities

Whereas in the first year of the SBA the authoritieshad designed economic policies in close coordinationwith IMF staff, the relationship became somewhat un-cooperative from May 2001 onward. First, the Minis-ter of Economy developed a pattern of taking policyinitiatives unforeseen by—and often incompatible inspirit with—the program negotiated with the IMF,without prior consultation (Box 3.3). Second, stafffound it all but impossible to have a substantive inter-action with the authorities regarding contingencyplans until the late summer or fall of 2001.53

Three factors seem to explain why the IMF ac-cepted such an ineffective relationship with thecountry authorities.

• First, the IMF, after being widely criticized inthe aftermath of the East Asian crisis for impos-ing its will on member countries, was keen topromote country ownership of programs inevery possible way. The Argentine program wasunquestionably fully owned by the authorities54

and in the climate of the time, this was per-ceived as a source of strength. Mindful of thecredibility of its general pro-ownership mes-sage, the IMF thought that it could ill afford tocriticize such a highly owned program.

• Second, both management and the Board fearedabove all that lack of public endorsement for themeasures announced by the authorities might, initself, trigger a confidence crisis. This implies abelief that the markets would see the measuresunder a less negative light if the IMF appearedto endorse them. However, feedback obtainedfrom market participants in the course of inter-views conducted by the evaluation team foundno evidence that this was indeed the case. Onthe contrary, market participants were puzzledby the IMF’s reaction.

• Third, management and Directors seemed tohave entertained the hope that strongly wordedstatements at the Board or in occasional directexchanges with the authorities would suffice topersuade them to mend their ways. While thishope was not inconsistent with standard Boardpractice, it clearly lacked realism in this case.

Management of financial risk

By January 2001, the IMF had increased its expo-sure to levels where Argentina’s capacity to repaywas clearly in question.55 Nevertheless, the IMFcontinued to make decisions to commit additionalresources to the point where exposure to Argentinabecame alarmingly large, without regard for the fi-nancial risk it was assuming. Concentration of creditrisk is to some extent inevitable for a crisis lendersuch as the IMF, and part of this risk is protected bythe seniority of IMF credit. Even so, there was ageneral lack of focus on financial risk within theIMF,56 which resulted in a failure to bring relevantexpertise to bear on the critical decisions beingmade. In particular, no staff from the Treasurer’s

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53It was only after September 2001 that some exchange ofviews on alternative strategies began to take place at the workinglevel. The Minister of Economy himself, however, did not be-come involved in such discussion until November, by which timethe quality of the dialogue had deteriorated even more. A goodamount of communication was thus effected through formal let-ters, with the Minister of Economy repeatedly urging the Manag-ing Director to send a staff mission and the Managing Directorwriting to the Argentine President to explain why he would not doso. The deterioration in the quality of dialogue between the twoparties in part reflected the widening perception gap as to whatconstituted the next steps.

54Strong country ownership, however, masked increasinglysharp dissentions within the Argentine economic team as the cri-sis intensified.

55In comments written earlier in January 2000 on the programdesign for the March 2000 SBA, TRE had noted that “Argentina’scapacity to repay the Fund is of primary concern, given the pro-jected increase in external borrowing requirements and the highlevel of external debt service (in percent of exports).” This com-ment applied to the commitment of only SDR 5.4 billion (com-pared with SDR 17.5 billion following the second augmentation).

56There was a sharp increase in the number and volume of ar-rears to the IMF in the second half of the 1980s, leading to theadoption, in the early 1990s, of strengthened due diligence proce-dures in assessing members’ capacity to repay the IMF. Theseprocedures contributed to a sharp decline in both the number andvolume of arrears by the late 1990s when, as noted in the IEO re-port on prolonged use of IMF resources (IEO, 2002), assessmentsof capacity to repay became pro forma exercises.


(now Finance) Department was included in the workof the Argentina Task Force.57

Risk analysis, if undertaken ahead of the January2001 augmentation, would have indicated that theIMF’s overall liquidity position would for an ex-tended period of time remain highly exposed to Ar-gentina, in terms of both outstanding credit and pro-jected charges. In the event of a nonpayment ofprincipal, the IMF’s precautionary balances wouldnot be sufficient to cover the total amount of arrearsthat could arise, with concerns for the capacity of thecurrent burden-sharing mechanism to make up forthe resulting loss of income. Argentina’s risk was ex-ceptional, not only in the size of the amounts in-volved, but also in the length of time the IMF’s ex-posure would be likely to remain high.58

The fact that risk analysis was not prepared bystaff, much less shared with the Board, probablycontributed to the lack of noticeable concern on the

part of many Directors about the financial risks thatgreater exposure to Argentina would pose. It is stillstriking how few Directors raised this issue as a con-cern during Board discussions, especially given thelack of conditionality on net international reserves(in view of what was considered to be a functioningcurrency board arrangement) and, in September2001, the absence of standard assurances in the staffreport concerning Argentina’s ability to repay theIMF.

Executive Board involvement

The Executive Board was extensively involved indealing with the Argentine situation. In addition toformal Board meetings to approve program reviews,the Board met informally to discuss Argentina on 16occasions from December 2000 to January 2002.Yet, in practice, the Board as an institution played alimited role in providing inputs, not just into thespecifics of program design (as is customary), butalso in the overall strategy on Argentina. This assess-ment, however, may not apply to some individualDirectors or subgroups of Directors, as they mayhave been privy to exchanges between managementand their authorities outside the established internalchannels. The focus here is on the formal role of theBoard within the established decision-making proce-dures of the IMF.

There were several reasons for the limited role theExecutive Board played in considering alternative

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Box 3.3. Measures Announced or Taken During 2001 Without Prior Consultation With the IMF

March 28. Minister Cavallo announced an economicprogram consisting of a tax on financial transactions,changes in other taxes and tariffs, and sectoral “com-petitiveness plans.”

April 9. Banks were allowed to include governmentsecurities up to Arg$2 billion to meet the liquidity requirements.

April 16. Minister Cavallo sent to Congress a bill tomodify the convertibility law to change the anchor toan equally weighted basket of the euro and the dollar.

May 2. Minister Cavallo proposed a “mega-swap,”under which investors would exchange maturing bondsfor new bonds with longer maturities.

June 15. Minister Cavallo announced a package oftax and trade measures, including a trade compensationmechanism for exporters and importers of nonenergygoods, which effectively amounted to a devaluation ofthe peso through fiscal means.

July 11. Minister Cavallo announced a “zero-deficitplan,” aimed at eliminating the federal governmentdeficit from August 2001 onwards.

November 1. The authorities announced a new pack-age, including a debt exchange, a new batch of compet-itiveness plans, a rebate of VAT payments on debit cardtransactions, and a temporary reduction in employeesocial security contributions.

November 23. The central bank introduced an effec-tive cap on deposit rates, by imposing a 100 percentliquidity requirement on deposits paying an interestrate more than 1 percentage point above the average ofall local banks.

December 1. The authorities introduced wide-rang-ing controls on banking and foreign exchange transac-tions, including setting a weekly limit of US$250 onwithdrawals from individual bank accounts, prohibitingbanks from granting loans in pesos, and introducingforeign exchange restrictions on travel and transfersabroad.

57TRE had an opportunity to express any reservations it mighthave had on financial risk grounds through the normal reviewprocess. Until very recently, however, its concurrence was not re-quired for briefing papers, LOIs, and other documents to be sub-mitted to management, so that any reservations it might have ex-pressed could have been of limited force. In any event, no suchreservations were expressed by TRE in 2001 through the estab-lished procedure.

58Such analysis was made in September 2003 in a report to theBoard prepared jointly by PDR and the Finance Department(FIN). This analysis reached broadly the same conclusion as ex-pressed here.


strategies when faced with decisions concerning Ar-gentina. First, the Board generally had very limitedlead time, if any, to consider matters subject to itsdecision, in part because of the fluidity of the situa-tion, but also because management in most casesconvened a Board meeting only at a late stage of thedecision-making process and insisted that a publicstatement indicating the broad thrust of the decisionbe released immediately after the meeting. This wasthe case in both augmentation decisions (in Decem-ber 2000 and August 2001), as well as on several oc-casions when management felt compelled to take astance on a particular policy announcement of theauthorities in the spring and summer of 2001. Direc-tors expressed reservations about the process butwent along with it. In the critical decision not tocomplete the fifth review under the existing terms,although the decision was taking shape through themonth of November, the Board was only informedon December 5, the same day as the public, havingreceived only scant indications before that day thatthis decision was in the making.

Second, a majority of the Board appeared willingto accept a “take it or leave it” decision process,whereby the only choice available was to endorsemanagement’s proposal or take responsibility fortriggering a financial crisis. Such a setting inevitablytilts the decision in favor of supporting the countryalmost irrespective of the odds of success of the pro-posed strategy. A process whereby the Board isgiven a choice among several strategies for support-ing a country would have likely yielded a more bal-anced outcome. The only occasion where such achoice was presented was in August 2001 when theManaging Director indicated that the Board had tochoose between three options. However, the prosand cons of these options were not analyzed in anydepth and the only option presented in some detailwas management’s preferred option.

Third, a majority of the Board also appeared will-ing to leave important questions unanswered. Execu-tive Directors, for example, seldom asked such criti-cal questions as “What would be the exit strategy forthe IMF?” or “Is there a contingency plan if the cur-rent strategy does not work?” Notably, Directors didnot take advantage of the usual lapse of time be-tween public announcement and formal Board ap-proval in order to improve the robustness of the deci-sion, for example, by requesting greater safeguardsto IMF resources or further analytical work fromstaff. It is true that at each formal Board meetingseveral Directors did inquire about contingencyplans. But each time, management’s response wasthat work was ongoing at the staff level and that, inview of the sensitivity of the matter, it would be bestnot to discuss such options at the Board. As it turnedout, the work under way only partially addressed the

relevant issues, but when the Board learned of thework, it was already too late.59

Fourth, when staff reports were less than fullycandid about the prospects and risks involved, aswas the case for most of the decisions taken in 2001,Executive Directors inevitably had less than a firmbasis for demanding answers to the most criticalquestions.

Finally, inherent asymmetry in the process neces-sarily limited the ability of the Board to exercisestrict oversight in the December 2001 decision:when the Managing Director decides not to com-plete a program review, Board acquiescence is notformally required.60 As noted above, in the Argen-tine case, management did not involve the Board inthe process of coming to this decision.61

Some have argued that these weaknesses in theBoard oversight of management decisions reflect aninherent conflict of interest for most Executive Di-rectors. Those representing borrowing countries tendto show solidarity with other borrowers and are re-luctant to challenge management lest it jeopardizetheir chance of receiving its support should it beneeded. Those representing major industrial coun-tries necessarily work within the parameters deter-mined by the positions taken by their authorities out-side the Board in their direct interaction withmanagement. Reluctance to discuss highly sensitiveissues in the Board, where there is a risk of leaks, isunderstandable. Nevertheless, bypassing the Boardundermines its governance function, and weakensthe transparency and accountability of the decision-making process in the IMF.

The extent to which decisions on critical programissues are taken solely within the Board, and on thebasis of full information and participation by allBoard members, is one of the key governance issuesof the IMF. The IMF’s shareholders are sovereigngovernments and it is inevitable, and also not im-proper, that they will make their views known tomanagement. This is bound to condition manage-ment decisions when the shareholders concernedrepresent or can mobilize a majority. Documents

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59At the Board meeting on the third review of the SBA, in May2001, no Director reacted even when the staff representative ad-mitted that “within the present monetary and exchange rate sys-tem, there is no contingency plan.”

60Legally, the Board may decide to complete a program revieweven if the Managing Director does not recommend it, and Boardmembers could in theory take the initiative to place the decisionon the Board’s agenda and put it to a vote. In practice, this hasnever happened.

61An “informal restricted Board meeting” was held to discussArgentina on November 2, 2001, while the decision was still inthe making. Informal minutes of the meeting indicate that man-agement’s view on whether or not to complete the fifth reviewwas not discussed.


available to the IEO provide no indication of the ex-tent to which this happened in the case of Argentina.However, a wide range of staff members and othersinterviewed believe that decisions on Argentina wereinfluenced by external pressures.62 But it is not easyto determine what constitutes such pressure or

whether it is inappropriate. As noted above, expecta-tions that had formed among market participants didconstrain decision making in the IMF. As to politicalpressure, it is difficult to define. Certainly, the mereexpression by a shareholder government of its pref-erences cannot be called political pressure, and thekey issue is whether management took decisions onits own responsibility. Those in management whowere involved have indicated to the IEO that theymade all critical decisions under their purview withfull responsibility whatever the wishes of the majorshareholders.

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62For instance, the internal review of the role of the IMF in theArgentine crisis states that the “IMF yielded to external politicaland market pressures to continue providing its support, despiteserious concerns over fiscal and external sustainability” (PDR,2003, p. 72).

This concluding chapter draws on the previoustwo chapters to summarize the major findings of

the evaluation, and presents ten lessons for the IMFthat are suggested by these findings. The chapter thenconcludes with six sets of recommendations.

Major Findings

The major findings of the evaluation are summa-rized below, organized by (i) overview of the crisis;(ii) surveillance and program design in the precrisisperiod; and (iii) crisis management.

Overview of the crisis

The catastrophic collapse of the Argentine econ-omy in 2001–02 represents the failure of Argentinepolicymakers to take necessary corrective measuresat a sufficiently early stage. The IMF on its part,supported by its major shareholders, also erred infailing to call an earlier halt to support for a strat-egy that, as implemented, was not sustainable. Asthe crisis deepened, the IMF was not able to engagethe authorities in evolving an alternative strategy thatmight have helped mitigate the ultimate costs of thecrisis, even though these would have been inevitablyhigh.

The convertibility regime was an effective re-sponse to the economic reality of the early 1990s,when a decade of economic mismanagement hadshattered the public’s demand for local currency.However, its success in ending hyperinflation, facili-tating a strong recovery in the early 1990s, survivingthe Mexican crisis of 1995, and promoting stronggrowth in 1996–98 masked the regime’s potentialmedium-term vulnerabilities. There were favorablefactors that allowed the exchange rate regime to sur-vive for a number of years without being severelytested. The situation changed in 1998–99 when Ar-gentina was hit by a series of adverse shocks, includ-ing the devaluation of the Brazilian real, a sharp re-duction in capital flows to emerging markets, astrengthening dollar, and a rise in international inter-est rates, which, taken together, led to a permanent

decline in Argentina’s equilibrium real exchangerate.

These shocks would have been difficult enough tohandle at any time, given the rigidity of the fixed ex-change rate and the lack of downward flexibility indomestic wages and prices. As it happened, theycame at a time when the fiscal situation had deterio-rated steadily, with a continuous rise in the balanceof public debt. What is worse, almost 90 percent ofthe debt was denominated in foreign currencies, rais-ing doubts about Argentina’s debt servicing capacityand exacerbating the vulnerability to shifts in equi-librium real exchange rates. The resulting rise insovereign spreads, in an environment where growthremained low, created highly unfavorable debt dy-namics. The domestic political situation also con-tributed to how the crisis evolved, as the election-driven rise in public spending in 1998–99 added tofiscal fragility and the divisions in the coalition gov-ernment that took office in late 1999 shook the con-fidence of domestic and international investors inArgentina’s ability to take difficult decisions.

By late 2000, when the ongoing recession and in-ternal political discord had caused Argentina effec-tively to lose access to international capital markets,Argentina had both an exchange rate problem and adebt sustainability problem, but it lacked the politi-cal cohesion to deal with the situation with decisive-ness. The IMF sought to assist Argentina through anaugmentation of the SBA in January 2001, based onthe assumption that the crisis was largely a liquiditycrisis and that any debt sustainability or exchangerate problem was still manageable. It was thoughtthat official financing, combined with sufficient ac-tion on the fiscal front, would catalyze private flowsrelatively quickly and restart economic growth.

The January 2001 program was therefore opti-mistic to begin with and, as it happened, the commit-ments made under the program were not fully imple-mented. In particular, it soon became evident thatthe fiscal targets would not be met. The willingnessof the IMF to complete a review in May 2001 de-spite Argentina’s noncompliance with fiscal targets,when there were indications that the catalytic ap-proach had failed, allowed the authorities to pursue a

Lessons from the ArgentineCrisis

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CHAPTER

4

Chapter 4 • Lessons from the Argentine Crisis

series of desperate and unorthodox measures to“gamble for redemption.” Many in the IMF inter-nally expressed disagreement with those measuresbut, in public, the IMF supported Argentina,1 fearingthat doing otherwise would mean an immediate ex-plosion of the crisis. A further augmentation of theSBA was approved in September 2001, accompa-nied by ineffective and conceptually flawed effortsto promote a voluntary debt restructuring without of-fering a sustainable policy framework. This did notrestore market confidence and only allowed the cri-sis to drag on.

In retrospect, the IMF’s efforts at crisis manage-ment suffered from a serious weakness. At each de-cision point in 2000–01, the IMF’s management andExecutive Board considered the costs of a switch,from a less sustainable policy environment to onethat would be more sustainable in the long run butthat would involve massive disturbances in the shortrun, to be too high, and chose to buy time until con-ditions improved. The costs of an exit would havebeen very large indeed, regardless of when it wasmade. As it turned out, the ultimate costs probablyrose, as Argentina’s credibility was lost, interna-tional reserves declined further, more public debtwas forced on the banking sector and more depositswere withdrawn, and the country’s debt to the IMFexpanded against the background of falling output.

The objective of the strategy followed in 2001was to minimize the costs of the crisis, not only tothe Argentine economy, but also to the internationalfinancial system and the IMF. Contagion from Ar-gentina was indeed limited, but it is impossible tostate with any certainty whether the lack of conta-gion was a direct outcome of the way in which theArgentine situation was handled by the IMF. Itseems plausible, however, that the protracted natureof the Argentine crisis—and the fact that it was inthe end widely anticipated by market participants—was the major factor explaining the lack of widercontagion. The costs to the IMF, however, were siz-able. Its financial support inevitably linked the IMFin the view of the public with the unorthodox poli-cies followed by the authorities; its repeated willing-ness to support such policies and to stretch the use ofdiscretion beyond established access limits gave riseto a perception that it lacked evenhandedness indealing with member countries.2 The concentration

of the IMF’s own credit risk also increased, althoughthis was to some extent unavoidable for a crisislender such as the IMF. Last but not least, any cat-alytic role that IMF financing might have had in thepast has been put into question, as large-scale IMFsupport can no longer be seen as signaling policysustainability.

Surveillance and program design in theprecrisis period

The IMF played a constructive role in the firsthalf of the 1990s, when its support gave credibilityto Argentina’s stabilization and structural reform ef-forts. Although the IMF was initially skeptical as towhether the convertibility plan would work, it sup-ported the authorities’ commitment to pursue sup-portive policy measures with two successive financ-ing arrangements. The IMF correctly identified thepotential vulnerabilities inherent in the convertibilityregime for a country like Argentina and the need forfiscal discipline and labor market flexibility as es-sential to the maintenance of the convertibilityregime. The IMF pushed for corrective actions inboth its surveillance activity and program design,but these efforts had mixed success and their impactdeclined over time as political commitment to thenecessary adjustment waned. The IMF also providedtechnical assistance in support of structural fiscal re-forms, including improved tax administration. Thissupport proved to be justified in the earlier years, asthe political system was able to deliver substantiallyimproved fiscal performance.

However, there were weaknesses in the IMF’sfiscal analysis during this period. Fiscal perfor-mance was overstated, because of the failure to takeproper account of off-balance expenditures, while itunderestimated the adverse fiscal implications ofthe social security reform. One of the missingpieces was the provincial finances. Data limitationsand legal constraints prevented the IMF from press-ing for greater fiscal discipline and structural fiscalreforms at the provincial level. These deficiencieswere understandable, given the existing profes-sional knowledge, available analytical tools, anddata limitations. The IMF’s high stake in Argentina,however, should have prompted the staff to explorein greater depth the consequence for debt sustain-ability that might arise from considerably less fa-vorable economic developments.

In the years following the Mexican crisis, theIMF’s approach seemed to change. While continuingto emphasize the importance of fiscal adjustmentand structural reform, the IMF repeatedly over-looked weaknesses in these areas. A number ofwaivers were granted for nonobservance of fiscalperformance criteria, and past nonperformance was

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1 At the time of the April 2001 IMFC meeting, for example, theManaging Director stated: “We do think that Minister Cavallo’sapproach, particularly with the competitiveness law, is right.” Seetranscript of the press conference, April 27, 2001.

2These views come from personal interviews, including withIMF staff and some Executive Directors who directly encoun-tered such sentiment expressed by country authorities. The evalu-ation team cannot ascertain how widely these views are held.

CHAPTER 4 • LESSONS FROM THE ARGENTINE CRISIS

accommodated by letting off-track arrangements ex-pire and replacing them with new ones, when thecorrect response should have been to end the pro-gram relationship with Argentina. Taken together,this series of decisions allowed the authorities topostpone needed policy measures, while linking thecredibility of the IMF to the policies that were inade-quate to the task at hand. Moreover, the IMF, insteadof emphasizing the policies needed to make the cho-sen exchange rate regime viable, began to endorsethe exchange rate regime itself. Indeed, the IMFpublicly lauded convertibility as an example of acurrency board, the only type of fixed exchange rateregime that is fundamentally sustainable in a worldof high capital mobility.

The Argentine experience illustrates the problemsposed by strong country ownership of weak or incon-sistent policies. All of the key economic policy deci-sions of the convertibility era were initiated by the Ar-gentine authorities. These included the choice of thecurrency-board-like arrangement, the comprehensiveprogram of deregulation and privatization, and far-reaching financial sector reforms. The problem wasthat, while all of the major political figures stated theirendorsement of the fixed exchange rate policy, the po-litical consensus behind the necessary supportingpolicies in the fiscal and structural areas became pro-gressively weaker over time. As early as 1993, politi-cal resistance had led to a significant modification ofthe social security reform, which raised fiscal deficitsinstead of eliminating them. Labor market reform wasinitiated in 1991, and then repeatedly postponed.From 1996 onward, and particularly in 1999, electoralcompetition led to a weakening of fiscal discipline atthe federal and provincial levels and the stalling—androlling back in some cases—of the pace of structuralreform. All these developments should have providedample reason for the IMF to end its program relation-ship with Argentina.

In the face of an increasingly inconsistent policymix, the IMF did not press for a modification of theexchange rate regime until it was too late. A modifi-cation of the peg was politically difficult and adviceto this effect may not have been accepted. In retro-spect, it would have been better to have pushed forsuch a change much earlier in the 1990s. A clear po-sition on the need for exit would have shaped subse-quent exchanges with the authorities. Even after theonset of the crisis in 2000, the IMF’s strategy re-mained essentially unchanged. This reflected twofactors:

• The IMF’s culture discouraged questioning amember country’s choice of exchange rateregime, despite the fact that, from the late1990s, guidance to staff increasingly stressedthe importance of providing candid advice to

member countries on exchange rate policy in thecontext of bilateral surveillance.3

• The IMF lacked a forward-looking concept ofexchange rate sustainability and failed to use thebest analytical tools. At most, staff looked atstandard measures of the real exchange ratebased on past price developments, and came tothe conclusion that the real exchange rate was atmost moderately overvalued by the end of the1990s. But a deeper and more systematic analy-sis of the conditions facing Argentina wouldhave led to the conclusion that, in 2000, Ar-gentina’s fixed exchange rate could not be sus-tained for long.4

Throughout the period, different views were artic-ulated within the IMF by different individuals andacross different parts of the institution. Some reviewdepartments, as well as some individual members ofthe staff and Executive Board, expressed concernsover Argentina’s inability to deliver the needed fiscaldiscipline and structural reforms at different pointsin time. Almost always, these dissenting views wereoverruled by such considerations as the need tomaintain influence with a member country or a de-sire to preserve the catalytic effect of the IMF’s sealof approval. Supporting a weak program whilemaintaining influence was thought better than insist-ing on a strong program that was unlikely to be im-plemented, leading to suspension of support and aneventual loss of influence.

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3An attachment to the Board document on its biennial reviewof surveillance conducted in early 2000 stated that “the Fundshould strive to provide clear advice to members on their choiceof exchange rate systems . . . and continue, in the context of Arti-cle IV consultations, to discuss with the authorities the require-ments for making a chosen exchange rate regime function reason-ably well in the particular circumstances of that country and toactively advise on the suitability of the exchange rate regime.” Itfurther noted that [Directors] “encouraged the staff to collaborateat an early stage with countries using pegs in designing [appropri-ate] exit strategies.” See “Biennial Review of the Implementationof the Fund’s Surveillance and of the 1977 Surveillance Deci-sion,” SM/00/40, February 2000, pp. 89–92.

4These conditions included: (i) the observed real appreciationover the 1990s; (ii) the series of adverse shocks that had hit theeconomy since late 1998; (iii) the small tradable goods sector (requiring a larger real depreciation for a given external shock);(iv) the large resource gap between the persistent trade deficit andthe significant surplus needed to stabilize the external debt-to-GDP ratio; (v) the large external debt-to-exports ratio; (vi) the ex-istence of a structural and persistent current account deficit (withthe current account remaining in deficit even during a deepeningrecession); (vii) the weak dynamics of exports while importswere growing faster; (viii) the deepening recession; (ix) the defla-tion required to achieve a painful change in relative prices; (x) thecontraction of the import competing sector; and (xi) the marketsignals that showed large and increasing forward premia pointingto increasing investor expectations that the exchange rate couldnot be maintained for long.


Crisis management

The January 2001 decision to augment Ar-gentina’s Stand-By Arrangement contained severalweaknesses. While the probability that Argentina’sdebt and exchange rate were sustainable was judgedsufficiently high to warrant giving the country achance to attempt the “catalytic” approach, this judg-ment was not based on rigorous debt and exchangerate sustainability analysis or a careful examinationof various indicators, many of which were indicatingworrisome signs. Program design was appropriate forthe policy challenges only under the assumption thatArgentina was facing primarily a liquidity crisis, al-beit one that required some significant policy correc-tion but within the confines of the existing policyregime. It may be argued that the decision was justi-fied as long as the probability of success was not neg-ligible—which makes it difficult to conclude that itwas clearly wrong ex ante. Even so, such a decisionshould have included an exit strategy in case the as-sumption proved wrong and therefore the preferredstrategy failed.

It is possible that the January 2001 decision, withall its flaws, may have succeeded in restoring confi-dence if the assumptions about the external economicenvironment had proved correct (which they werenot) and the agreed program had been impeccably ex-ecuted by the Argentine authorities (which it was not).However, subsequent developments should have ledto an early assessment that the approach had indeedfailed and further augmentation of IMF resourceswith essentially the same framework was unlikely toachieve much except buying a little more time. By thespring of 2001, even the modest fiscal adjustment en-visaged in the program had not been achieved. TwoMinisters of Economy had resigned and the governingcoalition was visibly weakening; the new economicteam was engaged in a number of highly controversialand increasingly desperate policy actions that wereeroding, rather than strengthening, market and in-vestor confidence; and the central bank governor hadbeen replaced ostensibly for political reasons, under-mining central bank independence.

The decisions to complete the third review in May2001 and, even more, the subsequent decision to fur-ther augment the arrangement in September 2001were questionable in view of the spirit—if not the let-ter—of IMF policies on crisis financing. In particu-lar, the IMF contravened its stated policies on privatesector involvement and the Supplemental ReserveFacility, because its support was not based on a fun-damental diagnosis of sustainability. The programdesign supported by each of these decisions was in-adequate for resolving the crisis. Several rationaleswere given for these decisions, including in particu-lar the perception of a lack of credible alternatives;

deference to the authorities’ determination to suc-ceed; and fear of contagion and concern that the IMFmight be seen to cause the demise of a member indistress.

The IMF was unduly reluctant to press for achange in the exchange rate regime because the pegwas seen to be strongly owned by the authorities andalso still commanded wide public support in Ar-gentina. External criticism of the allegedly intrusiveconditionality imposed on the East Asian crisiscountries had led the IMF to show excessive defer-ence to the authorities’ ownership of policies that itknew were misguided and counterproductive. At thesame time, the IMF failed to draw the appropriatelesson early enough from the crises in East Asia,Russia, and Brazil, namely that in these cases thecatalytic approach worked only after the fixed ex-change rate regime had been abandoned (see Lesson7 below).

Available analytical tools were not used to ex-plore potential vulnerabilities in sufficient depth. Inaddition to the already-mentioned failure to use for-ward-looking tools to assess exchange rate sustain-ability, debt sustainability analysis was not per-formed rigorously.5 The debt path should have beensubjected to stress testing for different assumptionsabout primary balances, real interest rates, growthprospects and, most importantly, the exchange rate.6The IMF thus lacked an objective basis to argue for afundamental modification of the policy frame-work—through devaluation, debt restructuring, ormost likely both—and to impress this assessment onboth the authorities and the shareholders. These fac-tors continued to tie the hands of the IMF throughthe summer of 2001, when market signals, includingforward premia that reached 40 percent, were send-ing an unambiguous message that the exchange ratewas unsustainable.

Contingency planning was inadequate, in partbecause of the authorities’ unwillingness to discussalternatives should their preferred strategy fail.While considerable staff resources were dedicatedthroughout 2001 to determining what would be thebest alternative exchange rate regime, how muchdebt relief would be desirable, and what the anatomyof an eventual crisis might look like, these efforts didnot focus on producing plans for an alternative pol-icy framework that might have involved a move to adifferent exchange rate regime and a coercive re-

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5Staff indicated to the evaluation team that it had used suchanalyses in formulating its judgments on Argentina, but no writ-ten evidence of this exists in any of the internal memorandums ornotes supplied to the IEO, let alone in the staff reports.

6A conjecture on whether tools now in place would have sentclear warning signals is offered in Appendix 6.


structuring of the debt. The alternative would havebeen costly, but the collateral damage could havebeen lowered if the switch had been attempted ear-lier and if IMF resources had been made available.Production of such operational plans would have re-quired greater in-house analyses and deeper collabo-ration with the authorities. In response to Boardmembers’ queries, management consistently indi-cated that it was working with staff on contingencyplans, but such planning never advanced very far inlight of the authorities’ consistent refusal to engagein such discussions. The authorities’ concern thatany appearance of engaging in contingency planningwould risk undermining the credibility of their com-mitment to their current strategy is understandable,but the IMF should have insisted on a confidentialdiscussion of contingencies as the price of its sup-port, including sharing with the authorities its ownanalytical work and assessments.

It must be recognized that any alternative plan formanaging the crisis would also have entailed largecosts, even in a best-case scenario, and there is noassurance that it would have received the neededbacking of a majority of shareholders and the coop-eration of the authorities. But the fact that no suchdiscussion ever took place restricted the choices fac-ing the IMF’s decision makers to either supportingan unsustainable program or abandoning a membercountry in distress. As a result, IMF resources wereused in support of a regime that was becoming in-creasingly unsustainable. Instead of financing capi-tal flight and letting Argentina endure another sixmonths of deflation and output loss, the available re-sources could have been better used to ease the in-evitable costs of transition to a new regime, by limit-ing the extent of exchange rate overshooting andminimizing the credit crunch that might result.

What might an alternative strategy have lookedlike? This is a difficult issue, and it may well go be-yond the terms of reference of this evaluation. How-ever, as an illustration, we discuss a possible approachin Box 4.1. As with all such counterfactuals, a keyquestion is whether sufficient political support couldhave been mobilized behind such a plan, especially ifit were adopted in circumstances where the IMF waslikely to be accused of pushing Argentina into a crisis.In these circumstances, any alternative strategy wouldhave had very high economic costs and was likely tohave resulted in significant political disruption. An“orderly” exit was probably impossible at this stage,and even more so given the lack of political supportfor any coherent alternative strategy.

The IMF was thus faced with choosing betweenvarious highly unpalatable—and uncertain—alterna-tives. Nevertheless, greater contingency planning(with insistence on the authorities’ cooperation as aquid pro quo for IMF support for their preferred

strategy) might have avoided a process in which theIMF continued to support an unviable strategy untilthe last possible moment. This was probably morecostly than would have been the case if a shift instrategy had been attempted at an earlier stage, al-though it is clearly not possible to predict how theArgentinean political situation would have reacted toattempts by the IMF to force such a shift. In theevent, when the eventual decision to cease supportbecame inevitable, the authorities (either incumbentor incoming) did not have a road map for handlingthe consequences of this decision. The political dis-location that ensued limited the ability of manage-ment and staff to engage in effective damage controldiscussions with the new authorities, leading to sev-eral policy decisions on the part of the authoritiesthat deepened the crisis.

While not always provided with all the elementsrequired for well-informed decisions, the ExecutiveBoard did not fully exercise oversight to prevent theIMF’s resources from being used to support an un-sustainable policy, as well as its fiduciary responsi-bility to protect their revolving character. In part,this reflected the fact that the Board—reluctantly insome cases—accepted a limited strategic involve-ment in the decisions made by management and didnot receive some critical information (despite the oc-casional requests of a few Directors). This is the re-flection of a larger problem of governance in theIMF, where important decisions are made by majorshareholders outside the Executive Board and, as po-tential borrowers, chairs representing developingcountries hardly, if ever, challenge the proposalbrought to the Board by management to support amember country.

Lessons for the IMF

The Argentine experience yields a number of use-ful lessons for the IMF. Many of these arise from Ar-gentina’s prolonged use of IMF resources and vali-date the lessons drawn by the IEO’s previousevaluation (IEO, 2002), which emphasized the needfor periodic strategic reassessments of programachievements and of the rationale for continued IMFengagement in a program relationship. We presentbelow ten additional lessons, some of which have al-ready been drawn by the IMF and have led to im-provements in its policies and procedures.7 Theseare grouped under three broad topic areas: surveil-lance and program design, crisis management, andthe decision-making process.

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7See, most notably, PDR (2003). This paper was discussed bythe IMF Executive Board on November 17, 2003.


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Box 4.1. How and When Could an Alternative Approach Have Been Attempted?

Any alternative strategy (“Plan B”) would haveneeded to include as its essential elements both deval-uation and debt restructuring.1 A debt restructuringwithout devaluation would have been neither feasiblenor credible. First, the magnitude of the adverseshocks was large and the required external and relativeprice adjustments were substantial. Second, a coercivedebt restructuring would have led to a run on the cur-rency. Third, an attempt to avoid a change in the ex-change rate regime in all recent currency crises hadfailed.

The main issue then would have been how to mini-mize the inevitable very high costs of such a strategy,including: (i) debt servicing difficulties arising from asharp exchange rate depreciation for sectors with largeforeign currency liabilities, and the resulting strains onthe banking system; and (ii) the balance sheet effectson banks arising from a devaluation and an NPV reduc-tion in the public debt. Under these circumstances,even if a standstill could stop a run on domestic debt (tobe followed by debt restructuring), there would stillhave been a run on banks and a run on the currency,which was likely to overshoot when it was floated.These developments would have led to widespreadbankruptcies, a credit crunch, and a sharp contractionof economic activity.

The order of magnitude and complications involvedin Argentina were such as to make the challenges in-volved in devising an alternative strategy much greaterthan in any other case. Moreover, the political conse-quences of the path by which Argentina arrived at analternative strategy cannot be ignored. Strong politicalleadership for such a strategy would obviously havehelped reduce potential costs, but this was unlikely tobe forthcoming in the situation then prevailing. There-fore, it is quite possible that a situation in which somegroups in Argentina viewed a devaluation/debt restruc-turing as having been “forced” by the IMF would havebeen associated with even greater political disruptionsand short-term policy choices that would have madethe situation worse. In other words, there may wellhave been no feasible actions by the IMF that wouldhave enabled the adoption of a meaningful Plan B. Butthis possibility is not an adequate justification for fail-ing to think about, let alone design and actively pro-mote, such a plan.

With these caveats in mind, such a Plan B may wellhave shared some features of the approach taken inPakistan, Uruguay, or Ukraine, where the face value ofthe debt was maintained, maturities stretched, and theinterest rate on the new debt capped at below-marketinterest rates. Even if Argentina’s problems warranted asharper debt reduction, early action would have likelyentailed a smaller haircut than required when a totaleconomic and financial meltdown had occurred. Partic-

ularly interesting as a model for Argentina is the ap-proach taken in 2002 in Uruguay, where the IMF pro-vided exceptional support (694 percent of quota) forthe government’s efforts to achieve genuine debt relieffollowing a move to a float. In the event, the debt re-structuring implemented in early 2003 achieved a 20percent reduction in the NPV of government debt, withUruguay remaining current on its debt paymentsthroughout the negotiations.2 The debt restructuringwas coordinated but voluntary, and took place againstthe background of a comprehensive, coherent programof economic reforms that was backed by the IMF.However, creditors’ willingness to adopt this approachin Uruguay was itself partly a result of developments inArgentina.

The plan should also have included a coordinatedrollover of interbank lines, because the reduction in thecross-border exposure of domestic and foreign banks in2001 was an important source of pressure on the cur-rency and international reserves—although the greatersolvency risks would have undoubtedly made such anexercise more complicated than in, say, Korea. Targeted,hence less disruptive, measures to deal with a bank runand capital flight could also have been attempted if nec-essary, including some restrictions on the conversion ofpeso deposits into dollar deposits (instead of the depositfreezes that the collapse eventually required).

Although it is impossible to test counterfactuals, thedamage could have been dampened if action had beentaken early and with the buffer provided by adequateofficial support. An earlier exit from the convertibilityregime would have been less disruptive than the freefall of the currency that followed the eventual disor-derly exit, with the associated severe balance sheet ef-fects. To contain these costs, part of the IMF resourcescould have been used to dampen an overshooting of thepeso and to support the banking system, in conjunctionwith a credible policy package, although it is very diffi-cult to avoid some overshooting in such circumstances.Some capital controls may have been unavoidable, butthe extent of these controls could have been kept to amuch smaller and less disruptive level than those actu-ally imposed in late 2001 and 2002, which led to severereal and financial disruptions.

It would have been difficult to know when the alter-native strategy of devaluation and debt restructuring

1In fact, this was also the majority view eventually reachedby IMF staff.

2It should be noted that the extent of liability dollarizationand exposure of banks to government debt were smaller inUruguay than in Argentina. A package close to 11 percent ofGDP was sufficient, in the case of Uruguay, to effectivelystop the run on the banks and to prevent a disorderly melt-down of the financial system while a coordinated debt re-structuring and a move to a float were being implemented.Uruguay suffered a sharp economic contraction, but outputbegan to recover during the same year that the debt ex-change was completed (with GDP growing 1 percent in2003), and a cooperative relationship with internationalcreditors was preserved.


Surveillance and program design

Lesson 1. While the choice of exchange rateregime is one that belongs to country authorities, theIMF must exercise firm and candid surveillance toensure that this choice is consistent with other poli-cies and constraints. This has been repeatedly en-dorsed by the Executive Board at least since 1997 butwas not observed in the case of Argentina. Recentemerging market crises have shown that fixed ex-change rate regimes are difficult to maintain underopen capital accounts. The case of Argentina clearlysuggests that this lesson may also apply to “hard”pegs, if the necessary political support is lacking forthe policies needed to make the adjustment mecha-nism palatable in the longer term. The Argentine ex-perience also suggests that domestic political consid-erations often make it difficult to change a fixedexchange rate regime, whether during good times orduring bad times.8 Therefore, exit from an unsustain-able peg is usually forced by events, entailing evengreater costs than would be the case if it occurredthrough a voluntary exit at an appropriately chosenpoint. Part of the problem is that the costs and bene-fits of alternative exchange rate regimes, especiallythe stringent requirements of sustaining a fixed peg,are typically not widely discussed in countries’ do-mestic political debate. This is where the IMF canplay a useful role by ensuring that a genuine policydebate takes place, in good times, about the costs andbenefits of the existing exchange rate regime. Thismeans that there must be regular in-depth discussionsof the issues with the authorities, as part of routine

surveillance exercises. Discussing exchange rate pol-icy when a fixed peg is involved is inherently sensi-tive and can potentially alarm the markets. It is pre-cisely for this reason that discussion should be madea routine exercise, something the markets expect tooccur as a matter of procedure.

Lesson 2. The level of sustainable debt foremerging market economies with open capital ac-counts may be lower than had been thought, de-pending on a country’s economic characteristics.Argentina’s experience exemplifies the propositionthat is now well recognized in the IMF, namely that“debt intolerance” in many emerging marketeconomies deserves special attention and that theconduct of fiscal policy should therefore be sensi-tive not only to year-to-year fiscal imbalances, butalso to the overall stock of public debt. As has beennoted by IMF staff (Reinhart and others, 2003;IMF, 2003; and PDR, 2003), a stock of debt thatotherwise looks reasonable relative to other coun-tries may be too high, when account is taken of thecurrency of denomination, the country’s opennessto trade, the revenue base, the fiscal flexibility ofthe government, its past record of default and infla-tion, and the role assigned to fiscal policy in macro-economic stabilization.

Lesson 3. The authorities’ decision to treat anarrangement as precautionary poses a risk that, inpractice, the standards for IMF support will beweakened. While it is obviously not possible todraw conclusive judgments from a single case, andthe IMF’s policies make no such distinction be-tween precautionary and other arrangements, thefact that the arrangements during 1997–99 werebeing treated as precautionary was interpreted byboth sides to imply that the IMF’s leverage with theArgentine authorities was weak. The precautionarynature of the arrangement and the fact that, as aconsequence, the IMF’s exposure to Argentina wasdeclining, were taken to justify relatively weak fis-

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8During good times, there is no incentive for politicians to riskan exit from a successful fixed exchange rate regime, particularlywhen it enjoys popular support. During bad times, if balancesheet dollarization is extensive or foreign currency exposure ishigh, the costs of exit are so high that no politician would be will-ing to take the political risk.

Box 4.1 (concluded)

needed to be attempted. In hindsight, an ideal timewould have been when there were still ample interna-tional reserves to smooth the overshoot of the ex-change rate, the balance sheets of banks and pensionfunds had not yet been weakened by forced purchasesof government bonds, and sufficiently large resourceswere still available from the IMF to shore up both re-serves and the banking system, thereby providingconfidence in the system and limiting the extent ofcapital flight. These considerations suggest that themarked—though short-lived—improvement in market

conditions that followed the approval of the first augmentation, in January 2001, provided the bestwindow of opportunity. Another opportunity wouldhave been immediately after the appointment of Mr.Cavallo as Minister of Economy, capitalizing on hisinternational credibility and strong domestic politicalleadership. Even if that window was missed, such astrategy might have remained viable until late in theyear and led to a less traumatic outcome than actuallyhappened—although the costs would still have beenvery high.


cal and structural conditionality and the regular ac-commodation of slippages. Weak program designand weak implementation in the context of arrange-ments being treated as precautionary did not servethe purpose of preventing the country from pursu-ing policies that proved to be unsustainable. Whenthere is no pressing balance of payments need, itmay be better not to agree to an arrangement, thussubjecting the country to market discipline ratherthan to program reviews by the IMF, especiallywhen there are doubts about a country’s ability toimplement a strong reform program. At a mini-mum, the precautionary nature of an arrangementshould not be used to justify weaknesses in pro-gram design or slippages in implementation.

Lesson 4. While country ownership of IMF-sup-ported programs is critical, it is not sufficient sinceownership of misguided or excessively weak poli-cies is likely to lead to an undesirable outcome.Country ownership is important, particularly inareas of economic policy that have far-reaching so-cial implications, but there are often trade-offs be-tween the extent of ownership and the strength ofthe policies embedded in an IMF-supported pro-gram. These trade-offs need to be discussed openlybetween the IMF and the authorities. An importantlesson of the Argentine experience is that strongownership should not deter the IMF from forcefullymaking its views known. The IMF should be pre-pared not to support a strongly owned program, if itis judged inadequate in generating a desired out-come, but should be prepared to explain the ratio-nale and evidence behind such decisions.

Lesson 5. Favorable macroeconomic perfor-mance, even if sustained over some period of time,can mask underlying institutional weaknesses thatmay become insuperable obstacles to any quickrestoration of confidence, if growth is disrupted byunfavorable external developments. This is particu-larly relevant in a country with a history of recur-ring crises. In Argentina, the IMF broadly identi-fied these weaknesses and sought to address themthrough structural conditionality and technical as-sistance. Despite these efforts, many of the funda-mental weaknesses in fiscal institutions remainedintact and the same weaknesses that had created arepeated cycle of debt default and hyperinflation inearlier decades again proved fatal. The lesson ofthe Argentine crisis is that institutional weaknessesthat are deeply rooted in the political system arevery difficult to change, and that the role of an ex-ternal agent, such as the IMF, in the reform processis unclear. When difficult changes are not forth-coming, even though macroeconomic performancemay be favorable, it is probably counterproductivefor the IMF to remain engaged in a long-term pro-gram relationship.

Crisis management

Lesson 6. Decisions to support a given policyframework necessarily involve a probabilistic judg-ment, but it is important to make this judgment asrigorously as possible, and to have a fallback strat-egy in place from the outset in case some critical as-sumptions do not materialize. In the absence of awell thought-out alternative strategy, and with onlyan ill-defined exit strategy, it took the IMF a longtime to change gears in the face of the demonstratedfailure of the program to achieve its stated objec-tives. This led to repeated attempts to use the samestrategy when it was evident that it had failed. Theneed for contingency planning in a program de-signed to deal with a capital account crisis has al-ready been noted in the IEO’s earlier evaluation re-port on this topic.9 The additional lesson of theArgentine experience is that contingency planningefforts should encompass not only alternative strate-gies but also “stop-loss rules”—that is, a set of crite-ria to determine if the initial strategy is working andto guide the decision on when a change in approachis needed.

Lesson 7. The catalytic approach to the resolutionof a capital account crisis works only under quitestringent conditions. The Argentine experience con-firms the lessons drawn from the experience with theother capital account crises of the last decade, as cor-roborated by two recent IMF studies (Cottarelli andGiannini, 2002; and Mody and Saravia, 2003).These studies suggest that several conditions are re-quired for the catalytic approach to work (Box 4.2).First, economic fundamentals must be sound. Sec-ond, the government must be credible in terms ofpolicy actions and past behavior to give confidenceto the markets that their concerns have been ade-quately addressed. Third, serious debt sustainabilityanalysis must suggest that, with high likelihood, thecountry is not insolvent. Fourth, the exchange rateregime must be broadly assessed to be sustainable.When there are well-founded concerns over debt andexchange rate sustainability, it is unreasonable to ex-pect a voluntary reversal of capital flows.

Lesson 8. Financial engineering in the form ofvoluntary, market-based debt restructuring is costlyand unlikely to improve debt sustainability if it isundertaken under crisis conditions without a credi-ble, comprehensive economic strategy. An importantlesson of the Argentine crisis (in particular, themega-swap of June 2001) is that market-based,NPV-neutral financial engineering operations do notwork in the midst of a crisis when risk premia signal

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9See Recommendation 3 in the evaluation report on the role ofthe IMF in recent capital account crises, IEO (2003a), p. 53.


a high probability of default. This is because suchoperations are by definition performed at interestrates that are significantly higher than in “normal”times and therefore improve short-run cash flowsonly at the cost of a higher debt service burden.Even when there is only a liquidity problem, suchoperations could turn it into a solvency problem.10

Only a form of debt restructuring that leads to a re-duction of the NPV of debt payments or, if the debtis believed to be sustainable, a large financing pack-age by the official sector, has a chance to reverseunfavorable debt dynamics. In either case, financialengineering can only be one piece of an overall pol-icy framework. The fact that these two approacheswere successfully used in 2002 in Uruguay and

Brazil, respectively, suggests that this lesson has al-ready been learned.

Lesson 9. Delaying the action required to resolvea crisis can significantly raise its eventual cost.When the required policy change has large up-frontcosts, it is understandable that the authorities of thecountry concerned will systematically resist the shiftand push for additional official financing as long aspossible. By the same token, there is a natural reluc-tance on the part of the IMF to force such a policyshift against the will of the authorities. This reluc-tance reflects the fear of being blamed for the costs ofpreemptive action, as well as the difficulty of fittingtogether the pieces of an alternative policy package.The longer the crisis drags on without its fundamen-tal causes being addressed, however, the larger wouldbe the likely costs to the economy. This is not to saythat the costs could be altogether avoided if the actionis taken early, but delayed action is likely to lead tofurther output loss, additional capital flight, andgreater deterioration of asset quality in the bankingsystem. To minimize the costs of any crisis, the IMFmust be proactive. First, it should make a realistic as-sessment of the need for a policy shift and, if such ashift is deemed necessary, provide financial supportonly when the country is able to commit credibly tothe policy changes needed to ensure viability, includ-ing, if necessary, a commitment to negotiate an NPV-reducing restructuring of the country’s obligations.Second, it should stand ready to help the countrythrough the regime shift with a package of policiesand financing to minimize the transition costs, asregime changes are typically highly disruptive andrisk triggering secondary runs on the banking systemand an overshooting of the exchange rate.

Decision-making process

Lesson 10. In order to minimize error and in-crease effectiveness, risk analysis, accountability,and predictability must be improved in the IMF’s decision-making process.

• In the case of Argentina, neither financial risks tothe IMF nor the country’s capacity to repay wereadequately discussed in a formal manner, orearly enough to affect decision making. Rulesand limits on access to IMF resources are ex-pressed as a percentage of quota. Internal discus-sions on the level of access thus tend to focus onthis metric and the impact of the proposed levelof access on the IMF’s financial position andrisks is hardly examined, even in the case oflarge borrowers like Argentina. More attention tofinancial risks in decision making would likelyraise the bar on the odds of success required tokeep supporting a questionable strategy by a rel-atively large borrower. In fact, this was one of

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Box 4.2. Experience with Catalytic Finance

In all past episodes of a financial crisis triggeredby large capital outflows, the catalytic approach hadfailed before a more flexible exchange rate regimewas forced upon the country, except in the case ofArgentina in 1995 (when the country’s overall eco-nomic fundamentals were sounder than in 2000).This was the case even when catalytic or semi-catalytic finance can be considered to have beensuccessful (including Mexico in 1995, Korea in1998, Brazil in 1999 and 2002, Turkey in 2002–03,and Uruguay in 2002); in these cases, the approachworked only after the fixed exchange rate regimehad been abandoned.

In these and other successful cases, moreover,some concerted, as opposed to purely voluntary, ele-ments of PSI were attempted in order to ensure therollover of international investors’ exposure, includ-ing in Korea (coordinated rollover and subsequenttransformation of interbank lines into medium-terminstruments), Brazil (a commitment to maintain in-terbank exposure supported by strict monitoring),and Uruguay (coordinated restructuring of the pub-lic debt). The approach taken in Argentina in 2001included very little, if any, effective PSI, as all pri-vate sector contributions were strictly market-basedand not subject to close monitoring, and in the endinvolved almost exclusively domestic agents.

10As Appendix 8 explains, variants of this voluntary debt repro-filing involving use of official resources as enhancements (eitherthrough policy-based guarantees to raise new money as in thecase of World Bank operations or through use of IMF resourcesas in the $3 billion set aside for debt restructuring operations inthe September 2001 augmentation) do not change the basic pic-ture that any voluntary debt restructuring under crisis conditionsincreases the NPV of the debt as measured using the interest ratesthat prevail during normal times. The use of official resources forsuch purposes is thus necessarily inefficient.


the first operational lessons discussed by theIMF following the Argentine crisis.

• The Argentine crisis revealed weaknesses in thedecision-making process relating to (i) the typeof information considered and (ii) lack of trans-parency regarding who is responsible for a par-ticular decision. The Executive Board, which isformally accountable for financing decisions, isnot fully informed of all the factors that staff andmanagement consider when making their recom-mendation—reflecting in part the highly sensi-tive nature of some information and concernsabout potential leaks. Critical decisions aresometimes made outside the Executive Board indirect interactions between management and theIMF’s major shareholders. While informal con-tacts with major shareholders is a normal andnecessary part of management’s responsibilities,effective crisis management requires that thelocus for decision making remain at the level ofthe Board—on the basis of candid analysis bythe staff. Otherwise, accountability will be weakand suboptimal decisions are more likely.

• There was also a lack of clarity as to why a par-ticular decision was made. The absence of clearrules led to excessive reliance on discretion,which in turn created an environment of greatuncertainty and unpredictability as to what theIMF would do next and encouraged the Argen-tine authorities to pursue questionable measuresin an attempt to gamble for redemption.11 Amore rule-based decision-making process couldlikely result in a faster resolution of a crisiswhen a solution is uncertain.12

Recommendations

Since the Argentine crisis, a number of initiativeshave been taken by the IMF to address some of theissues raised above; some changes in procedures andpolicies were even made before the staff began a sys-tematic effort to draw lessons from this crisis (seePDR, 2003). These changes include: (i) a procedureto systematize and refine debt sustainability exer-cises as a core tool of analysis; (ii) a procedure toundertake periodic, comprehensive ex post assess-ments of strategies and policies toward prolongedusers of IMF resources; and (iii) a new framework

for decisions in exceptional access cases, involvingclear criteria to assess need and sustainability,13 as-sessment of financial and liquidity risks to the IMF,capacity to repay, use of alternative metrics to deter-mine access, early and more extensive involvementof the Executive Board, and ex post evaluation bystaff. While these initiatives, if fully implemented,14

could go a long way toward ensuring that the mis-takes of the Argentine experience will not be re-peated, additional steps are necessary to furtherstrengthen these efforts. We present below six sets ofrecommendations for this purpose, covering crisismanagement, surveillance, program relationship,and the decision-making process.

Crisis management

Recommendation 1. The IMF should have a con-tingency strategy from the outset of a crisis, includ-ing in particular “stop-loss rules”—a set of criteriato determine if the initial strategy is working and tosignal whether a change in approach is needed.

• Crisis response should be part of a coherentstrategy that, from the beginning, carefully for-mulates the goals, the means for measuring theextent to which these goals are being achieved,and alternative plans (including an exit strategyin case the preferred strategy fails and a policyshift is needed). A key element would be tospecify how to trigger the exit strategy. The Ar-gentine experience suggests that, for a stop-lossrule to be effective, it must be defined early onand designed in such a way as to be activatedbefore a full-blown crisis becomes unavoidableor key options for dealing with the crisis are nolonger available.

• This and other relevant elements of the strategyshould be discussed both with the ExecutiveBoard and with the authorities (though not nec-essarily agreed in detail). Particularly when ex-ceptional access is being sought, no decisionshould be made without alternatives being ex-plicitly spelled out for the Board, along with abalanced discussion of their costs—both in theshort run and in the long run—and the respec-tive probabilities of success (see Recommenda-tion 6 below for a possible modality by which

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11Some observers have explained that undisciplined economicpolicymaking in Argentina during 2001, including by Congress,was supported by the general sense that the IMF stood ready tocome to Argentina’s rescue at all costs.

12A rule may not always lead to the best outcome. Any respon-sible decision would thus require some element of discretion.

13The criteria are: (i) exceptional balance of payments pres-sures in the capital account; (ii) rigorous and systematic debt sus-tainability analysis indicating that there is a high probability thatthe debt will remain sustainable; (iii) early expected resumptionof access to private capital markets; and (iv) reasonably strongprogram design and implementation prospects.

14A review of exceptional access policy conducted in early2004 indicated that, as of then, the new framework had not beenconsistently implemented.


this recommendation can be made operational).The authorities would naturally be reluctant todiscuss contingencies openly, fearing that publicdiscussion may undermine the credibility oftheir commitment to the current strategy. Thisshould not stop the IMF from providing the au-thorities with its analytical work underlyingsuch contingency planning efforts.

• Particular attention should be paid to financialrisks for the IMF under alternative strategies.Strengthened due diligence procedures in ana-lyzing the risks and costs of various alternativescould be considered when either absolute expo-sure or risk concentration reaches a certainthreshold.

Recommendation 2. Where the sustainability ofdebt or the exchange rate is in question, the IMFshould clearly indicate that its support is conditionalupon a meaningful shift in the country’s policy whileremaining actively engaged to foster such a shift. Inparticular:

• As mandated by the established guidelines, theIMF should firmly refuse to lend in support of apolicy framework that has a high probability ofbeing unsustainable or a low probability of beingimplemented. Equally important, at such times,the IMF should also take the lead in helping themember country in its transition to a new policyregime, including by offering advice on the tran-sition framework and by providing financing tominimize disruptions and output loss.

• In this context, high priority should be given todefining the role of the IMF when a countryseeking exceptional access has a solvency ratherthan a liquidity problem, especially with respectto its public sector debt. As long as there are un-certainties regarding the role that the IMF shouldplay in the process, it will remain impractical toimplement the principles of the Prague frame-work, which have recently been reaffirmed in thenew framework on exceptional access. Progressmade in incorporating collective action clausesin new issues of sovereign debt and in develop-ing a code of conduct for sovereign debtors andtheir creditors is a welcome development, butfurther efforts are needed to clarify the role thatthe IMF is expected to play. There may be abroad spectrum of options for the role of the IMFto be assigned by the international community,but the solution must be based on the recognitionthat, in the Argentine experience, the initial lackof a clear mandate for the IMF once it becameclear that a pure catalytic role was unlikely to besufficient led to an unduly protracted delay be-fore a cooperative solution could be found.

Surveillance

Recommendation 3. Medium-term exchange rateand debt sustainability analyses should form thecore focus of IMF surveillance. To fulfill these objec-tives (which are already current policy), the IMFshould systematize the following practices:

• When a country maintains a fixed exchangerate, the IMF should refine tools for assessingthe equilibrium real exchange rate that are moreforward-looking and rely on a variety of criteria,including market indicators, and use such toolsfor conducting a systematic analysis of the sus-tainability of the particular exchange rate, giventhe country’s macroeconomic policy and struc-tural constraints.15 On the basis of these analy-ses, the IMF should also systematically engagein a substantive policy dialogue with the author-ities on the implications of the regime for otherpolicies as well as on appropriate exit strategies.Such a dialogue should be a routine exercise inthe context of Article IV consultations. The Ex-ecutive Board must back such discussions in theface of inevitable political counterpressure.

• Surveillance should examine debt profiles fromthe perspective of “debt intolerance,” recogniz-ing that the same debt stock relative to GDPmay pose a serious problem in one case but notin another, depending on the characteristics ofthe country’s economy and the debt. In line withthis emphasis on the debt stock, the IMF shouldin its program design aim to calibrate the fiscaldeficit to achieve appropriate reductions in thedebt stock rather than merely the reduction orelimination of year-to-year fiscal deficits. Sincethe fiscal targets emerging from this exercisemust reflect the compulsions of countercyclicalpolicy, some of the focus of fiscal conditionalitymust be on medium-term improvements. An im-portant implication is that adjustments of fiscaltargets should be symmetric—a relaxation oftargets in years of unexpectedly low growth orrecession should be balanced by a willingness tostrengthen targets in years when growth exceedsexpectations.

• In all aspects of surveillance, including ex-change rate and fiscal policies, the IMF shouldnot only examine near-term vulnerabilities butalso take a longer-term perspective on vulnera-bilities that could surface over the medium term.A horizon of, say, three to five years is in prac-tice better suited for taking remedial action.

74

15Steps in this direction are already being taken.


Program relationship

Recommendation 4. The IMF should refrain fromentering or maintaining a program relationship witha member country when there is no immediate bal-ance of payments need and there are serious politi-cal obstacles to needed policy adjustment or struc-tural reform. The markets may well do a better jobof disciplining policy than a weak program that isbeing treated as precautionary. In order to provide aneffective signal on whether or not there is adequatepolitical commitment to and domestic ownership ofthe policy adjustment or structural reform judged tobe critical to longer-term sustainability, conditional-ity in macroeconomic and structural areas that aredeemed critical to the achievement of program ob-jectives should be binding, both in design and in im-plementation. The rationale and analysis underlyingany such conditionality should also be made public.

Recommendation 5. Exceptional access shouldentail a presumption of close cooperation betweenthe authorities and the IMF. While this presumptionis supposed to hold in any program, the Argentinecase suggests that there can be situations in which anexceptionally high stake for the IMF gives the bor-rowing country greater leverage. In any event, it isimportant that no issue be off the table of discus-sion—including sensitive but macro-critical is-sues—and that no policy measure or commitment ofIMF support beyond the existing terms should be an-nounced by the authorities without prior consulta-tion with the IMF. Incentives to forge such close col-laboration in exceptional circumstances couldinclude:

• Mandatory disclosure to the Executive Board ofany critical issue that the authorities refuse todiscuss with (or any critical information thatthey refuse to disclose to) staff or management;and

• A presumption that the IMF would not endorsepublicly any measure or announcement directlyrelevant to the IMF-supported program that hasnot been subject to prior consultation.


Recommendation 6. The role of the ExecutiveBoard needs to be strengthened. The new frameworkon exceptional access has reaffirmed the role of theExecutive Board as the key locus for decision mak-ing. For the Board to play this role effectively, theremust be procedures to encourage: (i) effective Boardoversight of decisions under management’s purview;(ii) provision of candid and full information to theBoard on all issues relevant to decision making; and(iii) open exchanges of views between management

and the Board on all topics, including the most sen-sitive ones. Such procedures may include:

(a) Members of the Executive Board could bemore active in their oversight function, includ-ing by exercising their right to call a Boardmeeting or to request the addition of any topicthat concerns them to the Board agenda, whenthey consider that their concern has not beenadequately addressed. Recognizing that deci-sions on exceptional access involve difficultjudgments on a variety of topics, upon whichreasonable people may disagree, the Boardcould formalize the right of Directors to re-quest from management ahead of Board dis-cussion additional staff analysis on issues theyconsider central to the success of the recom-mended strategy. This would represent an im-provement over the current practice wherebysome Directors seek additional information oranalyses through informal exchanges with se-nior staff, which are typically not shared withthe entire Board.

(b) Critical issues arise from time to time that aredeemed, by management or the Director repre-senting the country concerned, to be too sensi-tive to be discussed in a full Board meeting. Insuch cases, the Board effectively yields deci-sion-making power to management or infor-mal subgroups of larger shareholders, weaken-ing its oversight role and accountability. Toremedy this problem, the Board and manage-ment should work out a procedure to (i) recon-cile the need for confidentiality with the needfor Board decisions to be based on full andcandid information (for example, along thelines of current policy on side-letters) and (ii) ensure that management and staff exercisedue diligence to ensure prudent crisis manage-ment even when practical considerations re-quire that not all information be disclosed tothe Board. Although recent experience withearly Board involvement under the new frame-work for exceptional access suggests thatprogress has been made in this area, additionalsteps may be useful. While it is beyond thescope of this evaluation to recommend a spe-cific blueprint, possible arrangements thatcould be considered include:

• Establish guidelines whereby the Boardcould explicitly authorize management towithhold certain issues from discussion in afull Board meeting, with a presumption that,once the sensitivity is no longer present,management’s decision is ex post subjectedto Board scrutiny.

75


• Extend the heightened confidentiality proce-dures currently applicable to Board discus-sion of side-letters to other documents, suchas those on exit strategies, stop-loss rules,and other contingency matters.16

• Alternatively, assign a small group of Execu-tive Directors, on a rotating basis, to crisismanagement oversight. These representa-tives, who should broadly reflect the compo-sition of the Board, would act in their per-sonal capacity and would not havedecision-making power, but would act as“trustees” to ascertain that all relevant infor-

mation is being considered and due diligenceprocedures are being followed by manage-ment and staff.

(c) Enhanced transparency and accountability arekey to improving the prospects of full imple-mentation of policies on exceptional access.Thus, staff reports associated with exceptionalaccess cases should be published promptly,and there should be a presumption of ex postindependent evaluation of all exceptional ac-cess cases.

It goes without saying that these efforts will be suc-cessful only insofar as IMF shareholders—especiallythe largest ones—collectively uphold the role of theExecutive Board as the prime locus of decision mak-ing in the IMF and affirm their support of trans-parency and accountability as its guiding principles.

76

16Experience suggests that the policy on side-letters, while notflawless, has at least succeeded in preserving confidentiality.

77

APPENDIX

1 The IMF’s FinancingArrangements with Argentina,1991–20021

Stand-By and Extended Arrangements(In millions of SDRs)

Board Expiration or Amount Percent Amount AmountApproval Cancellation Agreed of Quota Drawn Outstanding

Stand-By Arrangement 7/29/1991 3/30/1992 780 70.1 439 0Extended Arrangement 3/31/1992 3/30/1996 4,020 361.2 4,020 683Stand-By Arrangement 4/12/1996 1/11/1998 720 46.8 613 0Extended Arrangement 2/4/1998 3/10/2000 2,080 135.3 0 0Stand-By Arrangement 3/10/2000 1/23/2003 16,937 800 9,756 9,015

Of whichSupplemental Reserve Facility 1/12/2001 1/11/2002 6,087 287.5 5,875 5,134

Yearly Disbursements and Repayments(In millions of SDRs)

Disbursements Repayments Charges Paid

1991 293 724 1741992 585 638 1271993 1,155 275 1471994 612 290 1421995 1,559 319 1811996 548 297 1861997 321 348 2011998 0 484 1951999 0 602 1442000 1,588 970 1482001 8,168 928 3272002 0 574 523

Source: IMF.

1As of March 31, 2003.

Argentina entered the decade of the 1990s havingexperienced a dismal economic performance over aprolonged period of time. From about 1975 through1990, the country was plagued by high inflation andgeneral economic stagnation. Inflation seldom fellbelow 100 percent; there were bouts of hyperinfla-tion, notably in 1985 and 1989–90. Real GDP in1990 stood 6 percent below the level in 1974. Overthis period, the general stance of economic policywas inward-looking and interventionist, althoughthere were occasional attempts to adopt more mar-ket-oriented policies.

All-out crises erupted twice during the 1980s.Early in the decade, the mounting fiscal imbalancesled to high real interest rates, a string of corporatebankruptcies, growing insolvency in the bankingsystem, and a loss of confidence. An overvalued ex-change rate had created a large cumulative balanceof payments deficit, causing a serious debt serviceproblem and an eventual loss of market access. Infla-tion accelerated, and real GDP declined by almost10 percent from 1980 to 1982.

Likewise, in early 1989, a failure to adjust the of-ficial exchange rate and public sector prices in theface of accelerating inflation led to a sharp deteriora-tion in the public finances, an attack on the currency,and a substantial loss of foreign exchange reserves.A pickup in inflation in turn created a vicious circleof soaring public sector deficits and further inflation.A suspension of the official exchange market causedexternal commercial arrears to accumulate. A deeprecession ensued, causing real GDP in 1989 to de-cline by 7 percent from the previous year. During themiddle of this crisis, the ruling Radical party lost thenational elections, and the administration of Presi-dent Raúl Alfonsín yielded power to the oppositionJusticialist (Peronist) party, five months ahead ofschedule.

Over this period, a number of attempts were madeto deal with chronic inflation and large balance ofpayments imbalances. After the mid-1980s, thegradualist approach of early attempts gave way to amore decisive, shock-therapy (“heterodox”) ap-proach, beginning with the Austral Plan of June1985, which introduced a new currency unit, the aus-

tral, initially set equivalent to 1,000 pesos. When thisfailed, additional attempts were made, notably a pol-icy package of October 1987 and the so-called PlanPrimavera of August 1988.1 A common feature ofthese later efforts was the use of wage and price con-trols, supported by a (temporary) fixing of the ex-change rate. But supportive fiscal and monetary poli-cies were not sustained, making the wage-pricefreeze and the fixed exchange rate untenable. Infla-tion returned with vengeance.

The new Peronist administration of PresidentCarlos Menem, after taking office in July 1989, im-mediately designed a package of short-run andmedium-term measures to stabilize the economy andto promote growth. The currency was devalued andthen fixed at a substantially depreciated level, sup-ported by the strengthening of the public finances. Amajor program of structural reforms was announced,consisting of an overhaul of the tax collection agen-cies, privatization of public enterprises, promotionof competition (including from foreign firms), andcentral bank independence. Two basic laws werepassed by Congress: the Law of Reform of the State(authorizing the privatization or liquidation of publicenterprises), and the Economic Emergency Law (in-cluding measures to improve public finances in theshort run and structural reforms over the mediumterm). In October 1989, the authorities requested anSBA with the IMF, which they indicated would pavethe way for a later extended arrangement.

Argentina and the IMFPrior to 1991

78

APPENDIX

2

1It was within the context of the Plan Primavera that a majordispute over Argentina emerged between the IMF and the WorldBank in the summer and fall of 1988. Resisting pressure from theU.S. Government, the IMF Managing Director chose not to lendto Argentina because he viewed Argentina’s fiscal policy as insuf-ficient to assure lasting stability. The World Bank, on the otherhand, went ahead with a package of loans totaling $1.25 billionon the basis of a “Letter of Development Policy,” which “includeda statement of the authorities’ intentions with respect to fiscal pol-icy that was more expansionary than the policy on which theFund staff was insisting as a condition for the stand-by arrange-ment.” Argentina’s subsequent failure to meet the Bank’s condi-tions, and the early collapse of the Plan Primavera in February1989, vindicated the IMF’s insistence on fiscal control. SeeBoughton (2001), pp. 520–24; also OED (1996), p. 18.

Appendix 2

There were some early impressive gains. Infla-tion, which peaked at a monthly rate of almost 200percent in July 1989, came down to 6 percent amonth, while economic activity staged a sharp re-covery. There was a marked improvement in fiscaldeficits. Capital flows reversed themselves, and thespread between the official and parallel markets allbut disappeared. Arrears to multilateral institutionswere eliminated. Toward the end of the year, how-ever, there were slippages in policy implementation.Most of the performance criteria under the IMF-sup-ported program for end-December 1989 weremissed by wide margins, and there were delays incongressional approval of the revenue measures. Theimproved economy led to large wage increases. Aspread between the official and parallel exchangerates reemerged, and the currency became subject toa speculative attack, followed by a run on the bank-ing system. Consumer prices rose by 90 percent dur-ing the final three weeks of December.

The government reacted with decisiveness. OnJanuary 1, 1990, in order to eliminate the large quasi-fiscal deficits of the central bank (arising from thesharp increase in interest rates) as a source of moneycreation, the authorities decreed that all austral-de-nominated bonds and term deposits in the bankingsystem be converted into 10-year U.S. dollar-denomi-nated government bonds (called BONEX) at LIBOR.In March, and again in September, comprehensivemeasures were introduced to strengthen the public fi-nances, including an increase in the coverage and rateof VAT. In the meantime, substantial progress was

achieved in the latter part of the year in privatization,including the sale of assets held by the state oil com-pany and the finalization of contracts to sell the publictelephone company and the national airline. Therewas some turnaround in capital flows. Inflation camedown, though it remained high relative to the UnitedStates. The currency, however, continued to depreci-ate from July to the end of the year, in line withhigher inflation and the diminished demand for aus-tral-denominated assets in the aftermath of the com-pulsory debt conversion.

All in all, between January 1983 and November1989, the IMF agreed to four SBAs with Argentina,totaling over SDR 5 billion, in support of the coun-try’s adjustment programs. Reflecting the difficultyof consistently maintaining the tight fiscal andmonetary policies, performance under the IMF-supported programs was unsatisfactory at best. Fis-cal targets were frequently violated and, despitesome early gains, stabilization was never achieved.The first of these programs was effectively inopera-tive after four months and was canceled threemonths before it was to expire. The other three pro-grams were modified, more than once in all threecases, yet the resources made available under thearrangements were never fully drawn, notwith-standing the number of waivers granted for thenonobservance of quantitative performance criteria.Total purchases made by Argentina during the pe-riod amounted to about SDR 4.4 billion, includingSDR 1.5 billion drawn under the Compensatory Financing Facility.

79

By most measures, Argentina’s fiscal discipline inthe 1990s represented a substantial improvementover the previous decades, largely reflecting in-creased tax revenue (Table A3.1). Yet, by the end ofthe decade, Argentina’s public sector had come to beperceived as having fiscal problems. There were tworeasons to explain this paradox. First, actual fiscalperformance was worse than it appeared, because ofdeficiencies in fiscal accounts. Second, despite thesignificant improvement, fiscal discipline was insuf-ficient relative to the strict constraints imposed bythe convertibility regime, particularly when thecountry was hit by a series of adverse externalshocks. In this appendix, we present four aspects ofthis explanation, by employing several alternative(and not necessarily consistent) data sources, includ-ing those provided by Argentine scholars.

Initial gains in fiscal discipline were not sus-tained. Most of the improvement in fiscal accountstook place during 1991–94, but the later years saw adeterioration (Table A3.2). In particular, the persis-tent deterioration in the overall balance of the con-solidated public sector reflected a gradual increasein interest payments and other expenditures, whilerevenue did not keep pace. It was, however, only in2001 that, with the economy in its third year of re-cession and soaring interest premia on Argentinedebt, the overall balance reached pre-1990s levels.

Issuance of debt to finance off-budget expendi-tures led to a steady increase in debt that was sub-stantially greater than the cumulative deficits. Thisexplains why the stock of public debt doubled as ashare of GDP between 1992 and 2001, when fiscaldeficits appeared moderate and the government wasreceiving significant revenue from privatization(Table A3.3). Some of the off-budget expendituresrepresented the recognition of preexisting debt (suchas overdue obligations to pensioners and suppliers),but it is said that bonds were also issued to pay forordinary expenditures.1 In any case, the treatment of

these expenditures in the budget represented the lackof fiscal transparency.

The 1994 reform of the social security system(along with associated core decisions and taxchanges) led to an increase in public debt and a dete-rioration of fiscal balance (Table A3.4). Two factorscontributed to this. First, court decisions upheld theobligation of the government to honor the overduepension payments of almost $7 billion upon which ithad remained delinquent since 1991 (see Schulthessand Demarco, 1993). Second, the reform onlyslightly reduced the benefits, while cutting the col-lection of social security tax by almost 40 percent(both through lower tax rates and through a transferof contributions to the new system). This is not tosay that the pension reform itself was ill-conceived.The system was clearly underfunded,2 and it was ap-propriate to address the problem when the economywas booming and fiscal accounts were substantiallyin better shape; moreover, a part of the loss of socialsecurity contributions had a counterpart in the re-duced future benefits to those leaving the system.3Nevertheless, the way in which the reform was donemagnified the country’s fiscal problems.

Fiscal federalism, as practiced in Argentina, madeoverall fiscal accounts less reliable and fiscal controlmore difficult. The provincial finances constitute asignificant part of the consolidated fiscal account ofthe public sector in Argentina (Table A3.5). In fact,the assignment of tax resources and spending respon-sibilities between the federal and provincial govern-

A Retrospective on Argentina’sFiscal Policy, 1991–2001

80

APPENDIX

3

1According to Teijeiro (1996, 2001), $31 billion in fiscal ex-penditure was “paid for with bonds” during the decade. Thoughhis estimates could be challenged on some grounds (including the

use of nominal value in the absence of market value), the overallnumbers are not very different from the recent estimates providedby IMF staff.

2As an indication of the magnitude of the underfunding, theratio of workers to retirees was only 1.3, and while workers paidabout 26 percent of salary to the federal social security system,pension benefits were set at 70 percent of wages. See Cetrángoloand Jiménez (2003).

3In fact, if contributions and benefits were set to match in pre-sent value, there would be no cost of transition to a funded sys-tem: a fund accumulated from earlier contributions could be usedto pay for the benefits. In Argentina, like in most PAYG systems,such a fund did not exist (because any social security surplus wasused to finance general expenditure and the benefits exceeded theamount funded by lifetime contributions).

Appendix 3

81

Table A3.1. Public Sector Balance, 1961–2000(Annual average; in percent of GDP)

Gross Revenues_______________________________Public Sector Balance Taxes on goods Social______________________

Period Overall Primary Total and services security

1991–2000 1.27 0.58 17.38 8.75 4.321981–90 6.23 4.38 12.57 6.17 2.871971–80 6.66 5.73 13.97 5.47 4.511961–70 3.46 2.9 13.86 4.85 4.20

Source: Cetrángolo and Jiménez (2003), Tables 1 and 4.

Table A3.2. Consolidated Public Sector(In percent of GDP)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Balance –0.4 0.0 –1.4 –2.3 –3.1 –2.0 –2.0 –4.1 –3.6 –6.3Revenues 23.4 24.6 24.2 23.2 22.2 23.2 23.8 24.3 24.7 23.6Expenditures 23.8 24.6 25.6 25.5 25.4 25.3 25.9 28.5 28.4 29.9Primary balance 1.4 1.4 0.2 –0.5 –1.1 0.3 0.6 –0.7 0.4 –1.4

Source: PDR (2003).

Table A3.3.Adjusted Fiscal Balance(Adjusted for off-budget expenditures; in percent of GDP)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

IMF estimate –3.1 –3.4 –3.9 –3.4 –4.0 –2.6 –2.5 –4.8 –4.2 –6.9Teijeiro (2001) –4.8 –4.8 –3.5 –4.9 –5.5 –2.1 –3.7 –6.6 –5.4 n.a.Balance implied by the

increase in public debt1 –1.2 –4.4 –1.4 –3.9 –0.9 –4.4 –4.3 –2.8 –8.8

Memorandum items:Privatization revenue 0.4 0.4 0.6 0.4 0.6 0.2 1.0 0.1 0.1Public debt (end of period) 30.7 30.6 33.7 36.7 39.1 37.7 40.9 47.6 50.9 62.2

Sources: IMF database;Teijeiro (2001); and IEO estimates.1Change in debt plus privatization receipts.

Table A3.4. Social Security Balance(In percent of GDP)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Social security contributions1 5.4 5.6 5.4 4.8 4.0 3.8 3.7 3.6 3.4 3.3Pension payments1 6.1 5.6 6.2 6.1 5.7 5.9 5.9 6.2 6.1 6.2Balance1 –0.7 . . . –0.8 –1.3 –1.7 –2.1 –2.2 –2.6 –2.7 –2.9

Memorandum items:Net effect of 1994 reform2 –0.8 –1.4 –2.2 –2.4 –2.4 –2.7 –2.9 –2.7Social security contributions1 5.4 5.6 5.4 4.8 4.0 3.8 3.7 3.6 3.4 3.3

1Cetrángolo and Jiménez (2003), Tables A.3 and A.9.2Revenue loss due to pension reform, plus assumption cost of provincial pension systems, minus savings in expenditures. Rofman (2002), Table 1.

APPENDIX 3

ments has remained one of the most contentious fis-cal issues. As a notable feature of Argentina’s fiscalfederalism, the bulk of provincial revenue comesfrom “coparticipation” of federal taxes, according torevenue-sharing criteria that have changed over timethrough various fiscal pacts (Schwartz and Liuksila,1997; and Cuevas, 2003). At the same time, startingin 1993, a program of decentralization transferred tothe provinces more and more of the responsibility for

basic social services, but without a significant reduc-tion in federal expenditures. This system has createdadverse incentives,4 and increased complexity andopacity in the true fiscal picture.

82

Table A3.5. Federal and Provincial Fiscal Accounts(In percent of GDP)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Federal governmentTotal expenditures 18.93 18.04 18.76 19.62 19.11 20.09 20.26 21.93 21.96 22.02

Of whichTransfers to provinces 6.06 5.72 5.74 5.62 5.84 6.04 6.13 6.29 6.35 5.93

Total revenues 19.55 19.19 18.73 19.09 17.18 18.63 18.9 20.25 19.57 18.78Fiscal balance 0.62 1.15 –0.03 –0.53 –1.93 –1.46 –1.36 –1.68 –2.39 –3.24

Consolidated provincial governments

Total expenditures 10.75 11.53 11.48 11.61 11.13 11.18 11.73 12.83 12.61 13.47Of which

Personnel 5.75 5.99 5.86 5.87 5.42 5.34 5.63 6.37 6.52 6.98Total revenues

Provincial taxes 3.54 3.72 3.76 3.55 3.6 3.72 3.9 3.9 3.82 3.63Coparticipation federal taxes 6.92 7.07 6.87 6.8 7.09 7.42 7.18 7.48 7.63 7.52

Fiscal balance –0.29 –0.74 –0.85 –1.26 –0.44 –0.04 –0.65 –1.45 –1.16 –2.32

Source: Cetrángolo and Jiménez (2003), Tables A.2 and A.5.

4The system allows elected officials to enjoy the political bene-fits of spending without much of the costs of tax collection; cre-ates procyclical patterns in provincial spending; and limits fiscalplanning by subjecting revenue sharing to political negotiations.

Selected Program Conditionality,1991–20011

APPENDIX

4

83

Date of Quantitative Structural Approval Arrangement Performance Criteria Performance Criteria Structural Benchmarks

7/29/91 Stand-By Arrangement 1. Overall NFPS cash balance2. Combined NFPS/CB balance3. Treasury outlays4. Cumulative NDA change5. Cumulative NIR change6. External PS arrears7. Total outstanding disbursed

external PS debt8. Cumulative net disbursements

of short-term PS debt

3/31/92 Extended Arrangement 1. Overall NFPS cash balance 1. Implement by June 30, 1992,2. Combined NFPS/CB balance tax reform aimed at replacing 3. Cumulative NDA change income tax by taxes on 4. Cumulative NIR change distributed profits and 5. External PS arrears business primary surplus.6. Total outstanding disbursed 2. Implement by December 31,

external PS debt 1992, social security reform 7. Cumulative net disbursements to achieve financial balance

of short-term PS debt on cost and accrual basis.

4/12/96 Stand-By Arrangement 1. Cumulative PS balance2. Cumulative ceiling on federal

noninterest expenditure3. Cumulative NDA change4. Cumulative change in free

international reserves5. Cumulative net disbursements

of PS debt6. Cumulative net increase in

short-term PS debt

2/4/98 Extended Arrangement 1. Cumulative federal deficit • By the first review, implement 2. Cumulative NDA change single presumptive tax, tax 3. Cumulative net disbursements administration program, and

of PS debt labor market reform; present to4. Cumulative net increase in Congress tax reform bill; and

short-term PS debt lease airports and telecom frequencies.

Indicative targets: • By the second review, obtain 1. Cumulative ceiling on federal congressional approval of tax

noninterest expenditure2 reform and new anti-trust law;2. Combined federal and implement reforms of tax

provincial deficits administration, budgetary operations, social security system,and financial system; and submit toCongress draft legislation onprivatization of Banco Nación.

APPENDIX 4

84

Date of Quantitative Structural Approval Arrangement Performance Criteria Performance Criteria Structural Benchmarks

3/10/00 Stand-By Arrangement 1. Cumulative federal balance • By the first review, implement 2. Cumulative federal primary reforms of labor market, tax

expenditure administration, and arrangements3. Cumulative change in federal debt to monitor provincial finances; and 4. Cumulative change in short-term submit to Congress reform plans

federal debt for social security, revenue 5. Cumulative NDA change sharing, and Banco Nación.6. Cumulative change in consolidated • By the second review, implement

PS debt3 social security reform; modify central bank charter and banking

Indicative target: law; and complete conversion of 1. Cumulative consolidated provincial Banco Nación into public

balance corporation.

1/12/01 Second review under 1. Cumulative federal balance • By the third review, issue Stand-By Arrangement 2. Cumulative federal primary presidential decree strengthening

expenditure and consolidating tax payments 3. Cumulative change in federal debt facilities; design national tax audit 4. Cumulative change in short-term plan; begin to set up Tax Frauds

federal debt Tribunal; issue regulations for 5. Stock of NDA proposed pension reform and 6. Cumulative change in consolidated Protection of Competition Law;

PS debt and prepare plans to restructure social security family allowances.

Indicative target: • By the fourth review, implement 1. Cumulative consolidated provincial plans to restructure family

balance allowances; issue regulatory proposal for ports system; andannounce timetable forelimination of CET surcharge.

5/21/01 Third review under 1. Cumulative federal balance • By the fourth review, implement Stand-By Arrangement 2. Cumulative federal primary plans to streamline tax payments

expenditure facilities arrangements and to 3. Cumulative change in federal debt restructure family allowances;4. Cumulative change in short-term submit to Congress draft law on

federal debt pension reform; issue regulatory 5. Stock of NDA proposal for ports system; and 6. Cumulative change in consolidated announce timetable for

PS debt elimination of CET surcharge.• By the fifth review, complete

Indicative target: 80,000 desk audits; present 1. Cumulative consolidated provincial legislation to facilitate banking

balance resolution; and implement new regulatory framework for telecomsector.

9/7/01 Fourth review under 1. Cumulative federal balance • By the fifth review, complete Stand-By Arrangement 2. Cumulative change in federal debt 80,000 desk audits; implement

3. Cumulative change in short-term plans to streamline tax payments federal debt facilities arrangements, strengthen

4. Stock of NDA tax collections, and restructure 5. Cumulative change in consolidated family allowances; submit to

PS debt Congress reform legislation onrevenue sharing; and strengthen

Indicative targets: compliance with prudential and1. Cumulative consolidated provincial reporting requirements for public

balance banks.2. Cumulative federal primary • By the sixth review, complete

expenditure 100,000 desk audits; and fully implement Tax Frauds Tribunal.

Sources:Various IMF staff reports.1Abbreviations are as follows: NFPS (nonfinancial public sector); CB (central bank); CET (common external tariff); NDA (net domestic assets); NIR (net international re-

serves); and PS (public sector).2Later converted into a performance criterion.3Binding from the fourth quarter of 2000.

Relative to other major emerging market econ-omies of Latin America and Asia during the 1990s,the following economic features of Argentina standout (Table A5.1).1

General Economic Structure

Argentina had a particularly low gross savingsrate, a particularly small market for domestic debt(comprising bank loans and debt securities) and,along with Brazil, a particularly small export sector.The small size of the domestic debt market was inpart a reflection of the low savings rate, and causedArgentina’s public sector to borrow heavily in inter-national capital markets.

External Debt Structure

Relative to GDP, Argentina’s external debt was notso high. Its ratio to exports (at 370 percent), however,was substantially higher than in other countries,though comparable to Brazil’s. An important featureof Argentina’s public debt structure was that a sub-stantial portion (about 90 percent for 1996–99) wasforeign currency denominated, compared to the aver-age of 56 percent for the comparator countries.

Fiscal Structure

The average fiscal balance of Argentina’s gen-eral government was a deficit of 2.5 percent of

GDP during 1990–2001, which was worse than thebalances in all other countries except in Brazil, butthe overall fiscal characteristics cannot be said tobe too different from its comparator countries. Ar-gentina’s fiscal balances, however, deterioratedsharply from the late 1990s. At the onset of the cri-sis in 2001, its general fiscal deficit was as large asBrazil’s (in 1998) and far larger than those of theother crisis-hit countries at the time of the crisis(Figure A5.1).

Economic Characteristics ofMajor Emerging MarketEconomies

APPENDIX

5

85

Figure A5.1. General Government Fiscal Balance in Crisis Countries(In percent of GDP)

Sources: IMF, Government Finance Statistics Yearbook; and Collyns and Kincaid (2003).

Note: Asia is Indonesia, Korea, Malaysia, Thailand, and the Philippines. Crisis time is 2002 for Colombia; 2001 for Argentina; 1998 for Brazil, Indonesia, Malaysia, and the Philippines; 1997 for Thailand and Korea; and 1995 for Mexico. Chile did not have a clear crisis. Data for Korea are the central government balance. Data for Mexico are the public sector balance.

–12

–10

–8

–6

–4

–2

0

2

Asia

Colombia

Mexico

Brazil

Argentina

t+5t+4t+3t+2t+1t=Crisist–1t–2t–3t–4t–5

1Here we consider Brazil, Chile, Colombia, Mexico (fromLatin America), Indonesia, Korea, Malaysia, the Philippines, andThailand (from Asia).

APPENDIX 5

86

Tabl

e A

5.1.

Indi

cato

rs o

f Eco

nom

ic S

truc

ture

in S

elec

ted

Em

ergi

ng M

arke

t E

cono

mie

s(In

per

cent

;per

iod

aver

age)

Peri

odA

rgen

tina

Braz

ilC

hile

Col

ombi

aIn

done

sia

Kor

eaM

alay

sia

Mex

ico

Phili

ppin

esT

haila

ndA

vera

ge

Gro

ss s

avin

gs/G

DP

1990

–200

114

.818

.621

.917

.526

.334

.134

.519

.620

.533

.024

.1

Expo

rts/

GD

P19

90–2

001

9.4

9.3

30.7

17.6

32.4

34.4

96.1

24.9

40.5

46.9

34.2

Dom

estic

deb

t m

arke

t/G

DP

1992

–200

142

.012

3.1

110.

4..

...

.12

5.4

218.

246

.991

.614

7.9

113.

2

Exte

rnal

deb

t/G

DP

1990

–200

141

.352

.745

.640

.479

.528

.444

.841

.670

.661

.050

.6

Exte

rnal

deb

t/ex

port

s19

90–2

001

368.

232

2.4

143.

319

0.6

226.

462

.143

.714

6.5

145.

211

6.0

176.

4

Shor

t-te

rm e

xter

nal d

ebt/

fore

ign

rese

rves

1992

–200

111

0.3

79.9

37.4

46.5

64.5

167.

028

.975

.699

.496

.080

.6

Fore

ign-

curr

ency

-den

omin

ated

deb

t/to

tal p

ublic

sec

tor

debt

119

96–1

999

89.2

...

26.5

51.8

98.8

...

14.2

65.9

42.4

61.6

56.3

Gen

eral

gov

ernm

ent

Ove

rall

bala

nce/

GD

P19

90–2

001

–2.5

–3.5

0.2

–2.2

–0.9

...

–0.6

–2.7

–2.4

0.7

–1.6

Tota

l rev

enue

and

gra

nts/

GD

P19

90–2

001

22.0

28.9

21.7

23.5

17.3

...

29.0

22.7

17.7

17.4

22.2

Cen

tral

gov

ernm

ent

Tota

l exp

endi

ture

and

net

lend

ing/

GD

P19

90–2

001

19.6

20.2

20.4

16.1

18.2

21.4

24.3

16.6

20.1

...

19.6

Sour

ces:

IMF

data

base

;Ban

k fo

r In

tern

atio

nal S

ettle

men

ts;W

orld

Ban

k;O

rgan

izat

ion

for

Econ

omic

Coo

pera

tion

and

Dev

elop

men

t;A

rgen

tina,

Min

istr

y of

Eco

nom

y an

d Pr

oduc

tion;

and

Braz

il,M

inis

try

of F

inan

ce.

1 Pub

lic s

ecto

r de

bt fo

r Arg

entin

a an

d ce

ntra

l gov

ernm

ent

debt

for

the

rest

of t

he c

ount

ries

.Arg

entin

a’s d

ebt

incl

udes

the

deb

t of

the

cen

tral

ban

k an

d th

e go

vern

men

t-gu

aran

teed

deb

t of

pub

lic s

ecto

r ba

nks.

Arg

entin

a’sfo

reig

n-cu

rren

cy-d

enom

inat

ed d

ebt

is t

he s

um o

f bila

tera

l and

mul

tilat

eral

loan

s,an

d fo

reig

n-cu

rren

cy-d

enom

inat

ed b

onds

and

sec

uriti

es.I

t do

es n

ot in

clud

e fo

reig

n-cu

rren

cy-d

enom

inat

ed lo

ans

from

pri

vate

ban

ks.

The IMF’s Policy Development and Review De-partment (PDR) has recently proposed a methodol-ogy to assess the fiscal and external sustainability ofa country, which has become a standard template forsuch analyses within the IMF.1 A relevant questionto ask for evaluation purposes is whether the pro-posed analytical framework, if available in late 2000,would have indicated a warning signal that Ar-gentina’s public and external debts were potentiallyunsustainable. In this appendix, we apply the WorldEconomic Outlook (WEO) projections—presum-ably reflecting the best (albeit rather optimistic) in-formation available to IMF staff—to the standardtemplates for fiscal and external sustainability analy-ses for the period 1998–2001, in order to see if theresults of such exercises would have suggested a dif-ferent course of action than the one actually chosen.

At the outset, two qualifications must be stressed.First, data requirements are quite stringent for bothfiscal and external sustainability analyses, but partic-ularly for sensitivity analysis in the fiscal sustain-ability template. Even with the benefit of several in-tervening years, it is still not possible to obtainaccurate actual data for all the variables called for bythe template. This means that considerable discre-tion and subjective judgments are involved in usingthe framework and interpreting its results. Second,the proposed methodology calibrates debt-stabiliz-ing primary balances (for public debt sustainability)and debt-stabilizing noninterest current account bal-ances (for external debt sustainability), based on agiven set of projections.2 There is, however, no con-sensus on what the sustainable level of debt wouldbe for a given country, hence what primary or nonin-terest current account surplus would be needed toprevent the debt from reaching that level. The notionof sustainability thus remains inherently subjective.

In what follows, we will present the results ofsustainability analyses, with the appropriate modifi-

cations and adjustments of WEO projections as in-puts (the basic scenario).3 Several sensitivity analy-ses were also performed, using a combination ofprojections positing an adverse shock of two stan-dard deviations from historical average for each keyvariable at t + 1 and t + 2 and a real one-time depre-ciation of 30 percent at t + 1.4 These results are notreported here because the basic scenario has yieldedsufficiently illustrative results for our purpose, butthe results of the basic scenario are compared tothose obtainable from using consensus forecasts.

The accompanying figures will show, for eachscenario, a profile of debt-stabilizing balances thatwere consistent with the projections made at WEOforecast points (i.e., May and October of each year);these balances are constant “steady-state” surplusesthat would stabilize the relevant debt to GDP ratio atits t + 5 projected value, assuming that the key vari-ables also remain at their t + 5 projected values. Asteady-state surplus can be interpreted as the adjust-ment effort required to stabilize the debt, relative tothe country’s historical performance.

External Sustainability Analysis

Figure A6.1 summarizes the results of externalsustainability analysis. Panel A indicates the eightprofiles of the external debt-to-GDP ratio that areimplied by the eight respective sets of WEO projec-tions for the key variables. It is worth noting that anearlier WEO forecast (e.g., May 1998, October1998, and May 1999) yielded a gradual rise in thedebt ratio from a relatively low level, while the laterforecasts yielded a gradual decline from a relativelyhigh level. PDR suggests a benchmark of 40 percent,at which point the conditional probability of crisis

Debt Sustainability Analysis

87

APPENDIX

6

1See “Assessing Sustainability,” SM/02/166, May 2002; and“Sustainability Assessments—Review of Applications andMethodological Refinements,” SM/03/206, June 2003.

2The template also calibrates public sector and external sectorgross financing needs consistent with the projections.

3For the modifications and adjustments made, see the annex tothis appendix.

4The key variables are: (for fiscal sustainability analysis) realGDP growth, real interest rate, and primary balance in percent ofGDP; and (for external debt analysis) real GDP growth, nominalinterest rate, dollar deflator growth, noninterest current account inpercent of GDP, and nondebt inflows in percent of GDP.

APPENDIX 6

becomes about 15–20 percent.5 According to PanelA, Argentina’s projected debt-to-GDP ratio consis-tently exceeded the critical 40 percent for most ofthe period. If we consider the actual level of 50 per-cent at the time of the crisis in 2000–01 as thebenchmark, the template would have sounded alarmfrom October 1999 onward.

Panel B depicts a profile of the debt-stabilizingnoninterest current account balances consistent withthe WEO forecasts at each forecast point. For exam-ple, the balance of about 0.5 percent of GDP in Oc-tober 2000 meant that a surplus of that magnitudewas required to stabilize the external debt to GDP

ratio at 50.7 percent of GDP (from t+5 onward). Incontrast, the historical average balance was a deficitof more than 0.5 percent of GDP. This means that aturnaround of more than 1 percent of GDP was re-quired (relative to past performance) in the noninter-est current account balance. The required surplusesderived from the WEO projections were quite simi-lar to those derived from the consensus forecast.

While the required surpluses suggested in 2000may not seem so large, at least two qualificationsmust be kept in mind in interpreting this result. First,by the fall of 2000, the WEO projections had alreadyincorporated the assumption of declining externaldebt-to-GDP ratios. If the May 2000 WEO projec-tions had been used, the template would have indi-cated a required turnaround of more 2.5 percent ofGDP. Second, the stabilizing debt level of 50 percentof GDP was high for any country, but particularly forArgentina, given the likely overvaluation of thepeso. With the sharp depreciation of the peso againstthe U.S. dollar, in the event, Argentina’s externaldebt-to-GDP ratio rose to over 140 percent in 2002.

Fiscal Sustainability Analysis

Figure A6.2 summarizes the results of fiscal sus-tainability analysis. Panel A indicates the six profilesof the public debt to GDP ratio that are implied bythe six respective sets of WEO projections for the keyvariables. It is worth noting that the earliest WEOforecast (October 1998) yielded a projection showinga steady decline in the ratio, while the next forecast(May 1999) yielded a gradual rise in the projectedratio from a relatively low level. In each projection,the debt-to-GDP ratio stabilized over the forecasthorizon (meaning that the WEO projections incorpo-rated the assumption of debt sustainability, that is,sufficiently strong fiscal action from t + 1 to t + 4),but the profile kept shifting up for each projection.

Panel B depicts a profile of the debt-stabilizingprimary balances consistent with the WEO forecastsat each forecast point. For example, the primary bal-ance of 1.6 percent of GDP in October 2000 meantthat a primary surplus of that magnitude was re-quired to stabilize the public debt-to-GDP ratio at47.6 percent of GDP (from t + 5 onward), while theprimary balance was barely in balance over the pastfive years, and the actual balance for that year turnedout to be a deficit of about 0.5 percent of GDP.

Fiscal sustainability analysis is difficult to inter-pret because the critical benchmark for sustainabilityis not known. It turns out that what exploded thedebt-to-GDP ratio in Argentina was a sharp depreci-ation of the peso associated with an exit from thepeg. As long as the sustainable level of debt wasoverestimated, and the extent of any exchange rate

88

Figure A6.1. External Debt Sustainability

Sources: IMF database; and Consensus Economics, Inc.

1997 99 2001 03 05 07

May1998 1999 2000 2001

Oct. May Oct. May Oct. May Oct.

A. External Debt/GDP(In percent)

25

30

35

40

45

50

55

60

Oct. 1998

May 1998

May 2001

May 1999

Oct. 1999 Oct. 2001

Oct. 2000

May 2000

B. Debt-Stabilizing Noninterest Current Account(In percent of GDP)

Basic scenario

Actual noninterest current account balance

Market expectations by Consensus Forecast

Historical average of noninterestcurrent account balance between t–5 and t–1

–2.0–1.5–1.0–0.5

00.51.01.52.02.53.03.5

5See “Sustainability Assessments—Review of Applicationsand Methodological Refinements,” SM/03/206, June 2003.

Appendix 6

overvaluation (or any overshooting in the event of anexit) was underestimated, debt sustainability analy-sis would have been of limited use in late 2000.

Annex on Data Modifications andAdjustments

Several modifications and adjustments were madeto the data. First, our own estimates were used whenno forecasts were available. For foreign-currency-

denominated public sector debt, amortization ofmedium- and long-term public sector debt, short-term public sector debt, and interest payments onforeign-currency-denominated debt, we used theirlatest available shares relative to total debt and ap-plied the ratios to the projected total debt. For priva-tization receipts, recognition of implicit or contin-gent liabilities, cost of bank recapitalization, andlocal-currency-denominated external debt (exclud-ing exchange-rate-linked debt), we assumed zero forthe entire period.

Second, fiscal sustainability analysis requiresgross public sector debt projections, but WEO onlyprovides net public sector debt projections. Conse-quently, we used gross debt projections as providedin the program reviews, ignoring the occasional mis-match in timing between the WEO projections andthe program reviews. When the program reviews donot provide five-year projections, the last availableprojections were used.

Third, a market consensus is taken from the Apriland October issues of the Latin American ConsensusForecast. The consensus forecasts, however, onlyprovide projections for real GDP growth, exchangerate appreciation, consumer price index (used inplace of GDP deflator), and the current account bal-ance. For the nominal external interest rate, real andnominal interest rates on public debt, and net non-debt creating capital inflows, the WEO projectionswere used. As the consensus forecasts for exchangerate appreciation are only available for two years, theprojections for subsequent years were assumed tohave zero percentage change.

Finally, our exercise yields results that are differ-ent from those of a similar exercise performed byPDR comparing early 1999 program projectionswith actual outcomes.6 The main difference is thatthe PDR exercise uses GDP data for historical yearsthat already incorporate subsequent data revisions.Our exercise, as noted, consistently uses the WEOprojections where available, supplemented by otherprojections that can be reasonably thought to havebeen available at each forecast point—consistentwith our focus on the information available to staffand the authorities at the time.

89

Figure A6.2. Public Debt Sustainability


1997 9998 2000 01 02 03 04 05 06

Oct. 98 May 99 May 2000 Oct. 2000 May 01 Oct. 01

A. Public Sector Debt/GDP(In percent)

Oct. 1998

May 2001

May 1999

Oct. 2001

Oct. 2000

May 2000

B. Debt-Stabilizing Primary Balance(In percent of GDP) Basic scenario

Actual primarybalance

Historical average ofprimary balance between t–1 and t–4

30

35

40

45

50

55

60

–1.0

–0.5

0

0.5

1.0

1.5

2.0

2.5

3.0

6As reported in “Assessing Sustainability,” SM/02/166, May2002; and “Sustainability Assessments—Review of Applicationsand Methodological Refinements,” SM/03/206, June 2003.

In this appendix, we present a preliminary analy-sis of the mega-swap of June 2001. The analysis ispreliminary in the sense that it only uses publiclyavailable information on individual bond issues, asobtained from Bloomberg, and may not fully takeaccount of possible intricacies and peculiarities ofsome specific bond issues. The analysis, however,uses latest data, as made available from the Argen-tine Ministry of Economy and Production, and uti-lizes more frequent compounding and more detailedassumptions about future floating coupons thanthose employed by the IMF’s internal assessment ofthe swap in 2001.1

The 2001 mega-swap was exercised on a marketbasis through an auction. The Argentine governmentstarted the auction on May 24 and concluded it onJune 1. The auction result was announced on June 3,and the bonds were swapped on June 19. The swapwas aimed at reducing payment obligations, particu-larly during 2001–05, by interest capitalizations andduration extensions. The government offered fivenew bonds in exchange for 52 eligible bonds. Boththe new bonds and old bonds had varied structures.The swap was designed strictly in accordance withthe government’s guidelines, as outlined in FigureA7.1. For example, long-term bonds were swappedwith long-term bonds. Fixed-coupon bonds were inprinciple swapped with fixed bonds. U.S. dollar-de-nominated bonds were only allowed to be swappedwith U.S. dollar-denominated bonds. By this struc-ture, the swap increased the amount of fixed-couponbonds, dollar-denominated bonds, and long-termbonds.

The swap achieved the government’s objectives.As Table A7.1 indicates, the (weighted) maturity ofbonds was extended by 3.73 years and the (weighted)coupon raised by 1.11 percentage points,2 while the(unweighted) discount rate over face value increasedby 2.3 percentage points (for details, see Table A7.2).The payment obligation in 2001–05 was significantly

reduced; particularly for 2001–02, the new bonds hadno principal payment obligations. The paymentobligations after 2006, however, increased substan-tially. In total, the stock of debt increased by $907million in face value. Because the swap was market-based, the market values of the old bonds and thenew bonds were the same ($23.2 billion), meaningthat the government bought back $29.5 billion of oldbonds and sold $30.4 billion of new bonds, both at$23.2 billion.

In order to see the full impact of the swap, onewould need to think in terms of net present value(NPV). One’s assessment of the actual costs andbenefits from the swap would depend on one’s as-sessment of what constitutes a normal interest ratefor Argentina. As stated in the text, an important les-son of the Argentine crisis is that market-based andvoluntary financial engineering operations, such as

A Preliminary Analysis of the2001 Mega-Swap

90

APPENDIX

7

1“Argentina—An Assessment of the Debt Exchange Opera-tion,” SM/01/204, July 2001.

2These are weighted by face value.

Figure A7.1. Exchange Options

Sources: IMF documents; and Argentina, Ministry of Economy and Production.

Old bonds

New bonds

All U.S. dollar promissory

notes (floater),

Bonte 2002 (U.S. dollar, fixed), Bonte 2002F (U.S.

dollar floater), and FRN U.S. dollar 2004

(floater)

All peso bonds

(floater and fixed)

All U.S. dollar bonds

maturing up to 2007

(floater and fixed)


maturing in 2009–17.Par bond

2023 (fixed)


maturing in 2019–31 (fixed)

U.S. dollar promissory notes 2006

(floater)

Peso global bond 2008

(fixed)

U.S. dollar global bond 2008 (fixed)



Appendix 7

91

Table A7.1. An Overview of the Mega-Swap

Basic Comparison

New Old Difference

Face value (in millions of U.S. dollars) 30,401 29,494 907Of which

Fixed 28,371 20,312 8,059(Percent of total) 93 69 24

Years to maturity (in years from 6/19/01) 16 12 4Of which

Fixed 17 16 1Coupon (fixed bonds, percent)1 12 11 1Premium/discount (in percent) –24 –21 –3

1Weighted by face value.

Present Values in June 2001(In millions of U.S. dollars, unless otherwise indicated)

Interest Payments Principal Payments Interest + Principal_______________ _______________ __________________________Discount Rate Used New Old New Old New Old New – Old

14.22 percent (6/1/01) 15,797 13,588 8,667 11,825 24,464 25,413 –949Of which

Fixed 15,059 12,190 7,278 4,858 22,337 17,048 5,289(Percent of total) 95.3 89.7 84.0 41.1 91.3 67.1

10.75 percent (12/31/99) 20,921 16,037 11,434 13,443 32,355 29,480 2,875Of which


11.92 percent (12/29/00) 18,945 15,114 10,360 12,826 29,305 27,940 1,365Of which


19.64 percent (9/28/01) 10,940 11,043 6,052 10,181 16,992 21,224 –4,232Of which


Accumulated Payment(In millions of U.S. dollars, unless otherwise indicated)

Interest Payments Principal Payments Interest + Principal_______________ _______________ __________________________New Old New Old New Old New – Old

Jun/01–Dec/02 1,604 4,210 0 5,551 1,604 9,761 –8,157Of which

Fixed 1,343 3,303 0 525 1,343 3,828 –2,485(Percent of total) 84 78 . . . 9 84 39

Jan/03–Dec/05 3,395 6,352 1,894 6,156 5,289 12,508 –7,219Of which

Fixed 2,685 5,773 0 2,952 2,685 8,725 –6,040(Percent of total) 79 91 . . . 48 51 70

Jan/06–Dec/10 17,362 7,855 12,766 3,106 30,128 10,961 19,167Of which

Fixed 17,331 7,621 12,387 2,705 29,718 10,326 19,392(Percent of total) 100 97 97 87 99 94

Jan/11– 48,306 16,911 28,783 14,681 77,089 31,592 45,497Of which

Fixed 48,306 16,411 28,783 14,130 77,089 30,541 46,548(Percent of total) 100 97 100 96 100 97

Note: For U.S. dollar LIBOR-linked floaters, the coupon rate is set equal to the U.S. dollar LIBOR forward rate. For Argentine domestic interest-rate-linkedfloaters except for FRAN 2004 and FRAN 2005, the coupon rate is set equal to the U.S. dollar LIBOR plus the spread between the U.S. dollar LIBOR and the bench-mark interest rate on 6/19/01. For FRAN 2004 and FRAN 2005, the coupon rate is the last coupon rate before 6/19/01. EMBI Global Argentina stripped yields areused as discount rates. Interest capitalization is included in the principal payment. These estimates do not consider the call schedule (even when bonds are callable),the released collateral, or the accrued interest (in the case of Brady bonds).

APPENDIX 7

92

Tabl

e A

7.2.

Det

ails

of O

ld a

nd N

ew B

ond

s

Exch

ange

Exch

ange

Issu

e A

mou

ntYe

ars

toYe

ars

toFa

ce V

alue

Am

ount

(In m

illio

nsFi

nal

Mat

urity

Mat

urity

(In m

illio

nsat

Pr

emiu

m (

+)

Rec

eive

dSe

curi

tyC

oupo

nof

U.S

.Is

sue

Mat

urity

at Is

sue

atof

U.S

.M

arke

tD

isco

unt

(–)

Offe

r (In

Stat

usN

ame

Type

Cur

renc

yC

oupo

nFr

eque

ncy

dolla

rs)

Dat

eD

ate

Dat

e6/

19/2

001

Sink

able

Floa

ter

dolla

rs)

Pric

e(In

per

cent

)m

illio

ns)

New

BP 2

006

Paga

res

USD

E+58

012

...

6/19

/200

16/

19/2

006

5.0

5.0

YY

2,03

02,

030

0.0

...

New

Nue

vo G

L 08

Glo

bal

USD

7/15

.52

...

6/19

/200

112

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2008

7.5

7.5

YN

11,4

568,

999

–21.

7..

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ewN

uevo

GL

18G

loba

lU

SD12

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2..

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001

6/19

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817

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463

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New

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vo G

L 31

Glo

bal

USD

12.0

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031

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8,52

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ewN

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08

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bal

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S10

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172

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SD..

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2,98

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Old

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3$Bo

cone

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213

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0012

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1992

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54.6

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–60.

430

4O

ldPr

o1 $

Boco

nes

AR

S..

.12

7,69

4.4

4/1/

1991

4/1/

2007

16.0

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1,42

6.3

817.

3–4

2.7

1,54

5O

ldPr

o2 U

SDBo

cone

sU

SD2.

0012

2,41

2.8

4/1/

1991

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2007

16.0

5.8

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242.

914

4.5

–40.

525

4O

ldPr

o3 $

Boco

nes

AR

S..

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5.6

12/2

8/19

9412

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2010

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31

Old

Pro4

USD

Boco

nes

USD

2.00

1291

5.2

12/2

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9412

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2010

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81.4

70.4

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597

Old

Pro5

$Bo

cone

sA

RS

...

445

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/199

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007

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378

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Pro6

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nes

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2.00

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120.

4 1/

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816

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nex

92Bo

nex

USD

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0 9/

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nte

02Bo

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APPENDIX 7

debt swaps transacted at current market yields, donot work during a crisis. This follows from the vol-untary or market-based nature of such operations,which implies that they are by definition NPV-neu-tral. But interest rates are typically higher during cri-sis, and any NPV-preserving transformation of cashflows made at higher rates would mean a muchhigher debt-service burden calculated at more nor-mal rates and serves to worsen debt sustainability.

Voluntary debt swaps (and debt buybacks) doneduring a crisis can be likened to the case of an indi-vidual who, unable to service mortgage undertakenwhen interest rates were low, decides to refinance itat a much higher interest rate in exchange for tempo-rary relief. The mega-swap involved a relief of $15billion in undiscounted cash payments for five yearsin exchange for a commitment to increase Ar-gentina’s debt payments by an undiscounted amountof $65 billion. At a more normal and sustainable dis-count rate of 12 (7) percent, this implied an increaseof about $1.3 billion ($10 billion) in the NPV valueof debt. It thus significantly worsened Argentina’salready shaky debt sustainability.

If a voluntary debt swap is expensive, why wouldany country want to do it? There are two considera-tions. First, for a country experiencing an acute li-quidity shortage, the only alternative to a market-based debt swap is either to declare an immediatedefault or to restructure its debt on nonmarket terms.If the country believes that it has no solvency prob-lem, it may be willing to pay the price to avoid theimmediate default. Second, the potential macroeco-nomic gain from improved liquidity from a swap canbe large (if the country remains solvent),3 while thecountry does not have to make a full payment on therestructured debt if it is in fact insolvent. A countryin a desperate situation thus has a strong incentive to“gamble for redemption,” by paying for an expen-sive debt swap in hopes of obtaining a high-returnoutcome that may have a low probability.

94

3Cline (2003), for example, argues that if the swap had beensuccessful and Argentina had avoided the default, the benefitwould have been at least $45 billion, an amount of lost output in2002 resulting from the default and devaluation.

Financial Instruments Used byArgentina During the Crisis

95

APPENDIX

8

As alternatives to official financing and paymentstandstills, a number of financial instruments havebeen proposed to deal with an acute liquidity needduring crisis. These include: (i) voluntary debt re-structuring operations—buybacks and swaps—without official enhancements; (ii) public guaran-tees and other enhancement to induce the provisionof private financing; and (iii) private contingentcredit lines. Argentina made use of all of these toolsduring 1999–2001. In the text, as well as in Appen-dix 7, we discuss voluntary debt swaps without offi-cial enhancements (as in the mega-swap of June2001). In this appendix, we discuss the usefulness ofofficial enhancements and guarantees to either in-duce new financing or achieve debt reduction, aswell as of private contingent credit lines to help im-prove liquidity and debt sustainability.1 We willshow that, as with voluntary debt restructuring, theseinstruments do not work under crisis conditions. Ageneral lesson is that attempts at financial engineer-ing when a country has severe debt servicing prob-lems are futile. If debt is unsustainable, debt restruc-turing with a meaningful NPV reduction can onlyrestore sustainability.

Guarantees and Enhancements

A number of proposals have been made to mobi-lize emergency liquidity from private creditors byproviding an official guarantee or by using officialresources to enhance a debt swap or buyback. Theidea is to give private creditors access to the samepreference in repayment given to official creditors,or to “enhance” private lending by using official re-sources to finance a debt buyback or a debt swap.Argentina used both forms of enhancement, the firstin the case of the World Bank policy-based guaran-tee (PBG) loan and the latter in the failed attempt toreduce its debt burden in the fall of 2001 with the $3billion set aside for debt operations in the Septemberaugmentation. We will consider each in turn.

A private loan with a partial official guarantee

Partially guaranteed instruments are typicallypriced by the market as being a combination of twocomponents: a guaranteed loan, which is valued asG-7 or World Bank risk; and an unguaranteed loan,which is valued as pure country risk. The guaranteedportion provides a financial benefit to the debtor,since the guarantee allows a risky country to borrowat a risk-free rate. But apart from this subsidy, noextra value is created by blending together a guaran-teed and an unguaranteed bond. In fact, an instrumentthat combines a guaranteed portion and an unguaran-teed portion is usually valued by the markets as beingworth slightly less than a separate World Bank bondand a separate unguaranteed country bond. A $3 bil-lion guarantee for a $6 billion bond is very similar tobeing able to borrow $3 billion from the official sec-tor and $3 billion from private creditors.

Various proposals have been made to create par-tial guarantees that produce “more bang for thebuck.” In most cases, proponents argue that whilethe guarantee formally and legally covers a portionof the cash flow, the “halo” of the guarantee from anofficial creditor will fall on the entire loan. Official“pixie dust” will lower the spread on the uncollater-alized component of the loan, since the debtor willbe less inclined to default on even the unguaranteedpayments. In practice, however, even attempts tocreate more complex structures designed to convinceinvestors that the amount of de facto protection pro-vided by the limited guarantee far exceeds the size ofthe formal guarantee have proven futile.

The most ingenious structure is a so-called rollingreinstatable guarantee, in which the World Bankguarantees the first payment of a bond. The guaran-tee is rolled to the next payment if the country hasmade the first payment. If the country cannot pay theguaranteed tranche, the World Bank would pay andthe country will have a brief period of time to repaythe World Bank. So long as the country is able tocome up with the funds to repay the World Bank, theguarantee is “reinstated” and rolled to the next pay-ment. The idea is simple: the country would notwant to default on the World Bank, so the guarantee

1This discussion relies in part on a more detailed treatment inRoubini and Setser (2004).

APPENDIX 8

would almost certainly roll over and eventuallycover the full bond. While the World Bank only for-mally guarantees the first payment, the “halo” of theguarantee would extend to the entire instrument.2 Inpractice, however, the market has priced the bondsissued with such guarantees more like a single guar-anteed bond and a series of unguaranteed bonds.This structure has never offered a realistic means ofallowing countries experiencing liquidity problemsduring a crisis to raise funds at guaranteed interestrates.

Argentina was one of the countries to experimentwith this structure. When Argentina missed the guar-anteed payment on its rolling reinstatable bond, theWorld Bank stepped in to make that payment, and Ar-gentina in turn increased its obligations to the WorldBank by the amount the World Bank had paid on theguarantee. That was the easier part. The hard part wasto decide whether or not to pay back the World Bankin time to allow the guarantee to be “reinstated” andthen “roll” on to the next payment. At the advice ofthe World Bank, Argentina opted not to pay the Bankwithin the designated period, ending any chance thatthe guarantee would be “reinstated” and the formallyunguaranteed balance would be protected. This inci-dent assured that this structure would never be viewedagain by the markets as conferring a “halo,” andserved to confirm the real risks associated with rein-statable guarantees. In a crisis, the official sector andthe country must decide if the pixie dust is real: thereis no room for ambiguity. Had the bond been honoredin full, Argentina would have ended up in the worst ofboth worlds. It would have paid a higher rate for bor-rowing through this complex structure than for bor-rowing directly from the World Bank, yet ex post itwould have treated the bond like other low-cost multi-lateral development bank debt. As it turned out, it wasthe creditors, rather than Argentina, that lost out.

Debt buybacks or swaps partially enhanced by official resources

A related issue is whether official enhancementscan be used to reduce the debt burden of a countryexperiencing liquidity and debt sustainability prob-lems. Use of official money to reduce debt burdenwas the idea behind the $3 billion set aside for debt

operations in the September 2001 augmentation forArgentina. We have already noted in the text thatmarket-based voluntary swaps during a crisis wouldmake the situation worse by increasing the real debtburden. The issue here is whether adding enhance-ments to such deals (that is, moving from a volun-tary mega-swap in June to a $3 billion enhancedswap or buyback in the fall) makes them more at-tractive. The simple answer is no. As articulated bythe classic analysis of Bulow and Rogoff (1988,1989), using official resources to buy back debt in-creases the residual value of the remaining debt anddoes not affect at all the debt burden of the debtor:all of the gains from official enhancements go to thecreditors rather than the debtor. While there is a longacademic debate on this “debt buyback boondoggle”result,3 and results on the distribution of the gain be-tween the debtor and creditors may marginallychange depending on various analytical assump-tions, it is clear that the proposal to use $3 billion ofofficial money to make the debt of Argentina sus-tainable did not make sense.

The argument is as follows. In the summer of2001, $3 billion could have bought back $4 billionof short-term debt (trading at 75 cents on the dollar)or $6 billion of long-term debt (trading at about 50cents on the dollar). In cash flow terms, the latter so-lution did not give much liquidity relief, as couponscloser to 10 percent on old long-term bonds wouldhave been exchanged with lower interest rates (say 4percent) on the $3 billion provided by the IMF,yielding a total annual saving of $180 million. Theformer solution, assuming that the IMF loan was tobe repaid four years later, would have provided acash flow relief in principal of $4 billion right awayin exchange of interest payments on the IMF loanand repayment of $3 billion four years later. So,while the short-run cash flow relief was larger, theeffect on the stock of debt of Argentina and its debtsustainability was practically nil. With a stock of ex-ternal debt around $100 billion, such an operationwould have reduced the stock by at most $3 billion.Thus, either way, use of official money would nothave affected the debt sustainability of Argentina.

In this regard, larger loans or other uses of officialmoney would have made little difference. Taking alarger short-term loan (even at subsidized rates) toreduce a larger amount of longer-term debt has littleNPV effect on debt apart from the subsidy value ofofficial money. Likewise, using the $3 billion forpartial guarantees on a debt swap instead of a buy-back would have had little or no effect on debt sus-

96

2Had this structure worked as advertised, the combined instru-ment would be worth more than the sum of its parts. But evenhere, the structure is not really creating value. Rather, the struc-ture is effectively transferring value from other unguaranteedbonds to the holders of the partially guaranteed bond. The holdersof the nonguaranteed part of the partially guaranteed bond benefitbecause their claims are being given seniority relative to othernonguaranteed claims, but it would be more efficient to provideseniority explicitly.

3See the exchange between Sachs (1988) and Bulow and Rogoff (1988, 1989). A good survey of this debate is provided inCline (1995).

Appendix 8

tainability. In all these cases, the NPV benefit is thedifference between the interest rate on the retireddebt relative to the official interest rate times theamount of official money. Even at yields of 15 per-cent, borrowing say $10 billion from the IMF at 4percent for one year implies a NPV benefit of about$1.1 billion, practically nothing compared to the ex-ternal debt of over $100 billion.

Private Contingent Credit Lines

There is another approach to obtaining liquidityduring a crisis: pay for it in advance. A country canbuy the right to borrow from a group of banks in theevent of trouble. The particular details of such a con-tingent credit line can vary, but the simplest contin-gent credit line would give the government the rightto borrow a predetermined amount at a fixed interestrate at a time and place of the government’s choos-ing. For this service, the banks would receive a fee inreturn. Contingent credit lines can be thought of as asubstitute for reserves. Instead of holding reserves“on balance sheet,” contingent credit lines provide“off balance sheet” reserves. The fee the bankscharge can be compared to the cost of paying hold-ing reserves—typically a difference between thecountry’s cost of funds and the risk-free interest ratethey earn on their reserves.

Unfortunately, actual experience with private con-tingent credit lines has been dismal, and such facilitieshardly offer a viable substitute for official financing.Back in 1997, three countries—Mexico, Indonesia,and Argentina—had access to private contingentcredit lines. All three countries eventually drew on

their credit line, and in no case was the experience ahappy one for the country or for its bankers.

Argentina’s credit line was intended to provide liq-uidity to the banking system rather than to the govern-ment. In this arrangement, the central bank bought theright to sell (with a promise to repurchase) the bank-ing system’s holdings of Argentina’s internationalbonds in return for cash. This facility, however, failedto work as designed when Argentina’s banking systemexperienced severe stress in 2001. The authoritiesfeared that drawing on the facility would trigger thebank run the facility was meant to deter. The bankswere quite keen to get out of this commitment as thepublic finances deteriorated. When the mega-swap ofJune retired many of the bonds that were eligible to be“repo’ed” for cash, it effectively reduced the size ofthe facility. Argentina did draw on the credit line inSeptember 2001, but it opted not to obtain the maxi-mum possible sum. It obtained $1.5 billion from pri-vate creditors and an additional $1.0 billion fromWorld Bank and IDB enhancements that were part ofthe facility. At any rate, the credit line was too small toprovide the sums Argentina needed.

The net amount of additional financing that thesefacilities provide in a crisis is difficult to assess: thebanks will take steps to hedge the risks associatedwith their commitment to lend to a crisis country.Some hedges—like shorting the country’s externaldebt—would put pressure on secondary market pricesbut do not directly result in pressure on the country’sreserves. Other potential hedges, such as reducing thelocal exposure of their affiliates in the debtor country,can put pressure on the country reserves. One virtue ofthe official sector is that it does not seek to hedge itscrisis lending and truly provides net new financing.

97

98

APPENDIX

9 Timeline of Selected Events,1991–2002

Date Events

1/30/91 Domingo Cavallo takes office as Minister of Economy.An exchange rate band is established, with the lower band of 10,000 australes and the upper band of 8,000 australesto the dollar.

3/27/91 Argentina, Brazil, Paraguay, and Uruguay sign treaty establishing Mercado Común del Sur (MERCOSUR).

3/28/91 The Convertibility Law is approved by Congress.

4/1/91 The Convertibility Law takes effect, with the parity of 10,000 australes per dollar.

7/29/91 IMF Executive Board approves Stand-By Arrangement with Argentina.

11/1/91 President Carlos Menem announces a broad program of economic deregulation and trade liberalization.

11/14/91 The Employment Law is approved by Congress, authorizing temporary contracts and capping indemnity.

1/1/92 The peso replaces the austral at the conversion rate of 10,000 australes per peso.

3/31/92 IMF Board approves extended arrangement with Argentina.

5/27/92 Port services are privatized by decree.

9/23/92 The new Central Bank Law is approved by Congress, establishing independence and mandating price stability as itsprimary objective.

9/24/92 Sale of State Oil Company (YPF) is authorized by law.

11/9/92 First general strike is organized by labor unions against President Menem.

11/11/92 An agreement is reached with creditor banks.

12/6/92 Argentina enters the Brady Plan. The IMF Managing Director congratulates Argentina on the agreement.

1/4/93 Use of dollars for current and checking accounts is authorized.

1/20/93 Last day to exchange australes for new pesos.

3/10/93 The Radical party, labor unions, and retirees demonstrate in protest of the pension reform.

3/16/93 Peronist governors approve the constitutional reform, allowing a second presidential term.

9/23/93 Senate approves the pension reform law.

10/3/93 Lower House elections. Peronists increase seats in Congress.

11/14/93 Olivos Pact: Carlos Menem of the Peronist party and Raúl Alfonsín of the Radical party reach agreement on theframework for constitutional reform, allowing a second presidential term of four years.

8/1/94 Constitutional Convention approves the new Constitution.

8/4/94 MERCOSUR is created, comprising Argentina, Brazil, Paraguay, and Uruguay.

11/22/94 Senate approves the privatization of Encotesa (Federal Post and Telegraph Company).

12/23/94 Mexico devalues its currency.

1/1/95 MERCOSUR comes into effect.

3/11/95 VAT rate is raised to 21 percent from 18 percent.

3/27/95 IMF Executive Board approves extension of Argentina’s extended arrangement.

4/14/95 Government suspends five banks with liquidity problems.

5/14/95 Presidential elections. Carlos Menem is reelected as President.

11/29/95 Lower House grants Minister Cavallo special powers for a year to balance federal budget.

4/12/96 IMF Executive Board approves Stand-By Arrangement with Argentina.

7/18/96 Minister Cavallo threatens to resign if his fiscal adjustment program is not approved.

7/26/96 Domingo Cavallo is replaced by Roque Fernández as Minister of Economy.

Appendix 9

99

Date Events

7/29/96 Minister Fernández formally takes office.

1/2/97 A judge declares the labor reform decree unconstitutional.

3/24/97 Postal system is privatized by decree.

4/9/97 Press reports of increasing tension between President Menem and Governor Duhalde.

4/24/97 National and provincial airports are privatized by decree.

5/9/97 A labor reform plan is agreed with unions, introducing flexibility in labor contracts, but protecting union medicalsystems from competition.

8/2/97 The Radical and FREPASO parties make an alliance, subsequently to be known as the Alianza.

8/14/97 National strike is called.

9/15/97 President Menem promises an increase in pension benefits.

9/21/97 President Menem promises an increase in teachers’ pay.

11/19/97 Alianza expresses public support for the convertibility regime.

2/4/98 IMF Board approves extended arrangement with Argentina.

2/17/98 Eduardo Duhalde relaunches his candidacy for 1999 presidential elections.

2/20/98 Press reports of accord between Governor Duhalde and President Menem.

3/28/98 Alianza launches a campaign against a second presidential reelection.

4/3/98 Fernando De La Rúa is proclaimed presidential candidate for 1999 elections in Radical party convention.

4/21/98 Eduardo Duhalde reaffirms his candidacy for 1999 presidential elections.

7/8/98 Alianza rejects the labor reform plan.

7/12/98 President Menem seeks Peronist support for a popular referendum regarding a second reelection. The idea is rejectedby both the Alianza and the Peronist party.

7/17/98 President Menem seeks Peronist support for a second reelection. Press reports of a split in the party.

7/25/98 Eduardo Duhalde launches his presidential campaign and affirms the need for a change in the economic model.

9/2/98 Labor reform is approved by Congress and becomes law.

10/1/98 The IMF Managing Director praises the Argentine economy.

10/5–7/98 President Menem attends the IMF–World Bank Annual Meetings.

10/9/98 President Menem reaffirms his desire for a second reelection term.

11/29/98 Fernando De La Rúa wins the nomination of the Alianza as presidential candidate.

12/2/98 Carlos Álvarez is chosen as the Alianza’s vice presidential candidate.

12/5/98 Press reports that President Menem seeks a constitutional reform but faces stiff opposition.

1/11/99 The court denies President Menem constitutional permission for a second reelection.

1/13/99 Brazil devalues its currency.

1/15/99 Press reports of President Menem reaffirming commitment to maintain the peso-dollar parity.

2/8/99 Press reports of President Menem proposing dollarization.

2/27/99 President Menem reportedly withdraws his bid to run for the presidential election.

4/16/99 Domingo Cavallo is reported to suggest a need to modify the convertibility regime.

5/12/99 Minister Fernández demands agreement with Congress to guarantee fiscal solvency.

7/14/99 Governor Duhalde is reported to consider debt restructuring.

10/24/99 Presidential and Lower House elections. Fernando De La Rúa and Carlos Álvarez of the Alianza win, with 48.5 percentof the votes. Alianza increases its seats to 125 (from 105), while the Peronist party retains 101 seats, a loss of 19seats.

12/10/99 De La Rúa takes office as Argentina’s president, with José Luis Machinea as Minister of Economy.

2/24/00 A strike is called against the labor market reform proposal, stipulating decentralization of collective labor contracts.

3/10/00 IMF Board approves Stand-By Arrangement with Argentina.

4/26/00 Labor reform is approved by the Senate with some modifications. Labor unions call for a national strike.

5/5/00 A national strike is called against the labor reform.

5/11/00 Labor reform is approved by the Lower House and becomes law.

6/6/00 A national strike is called.

8/17/00 Responding to public denunciations, President De La Rúa creates a special commission, chaired by Vice PresidentCarlos Álvarez, to investigate the bribery charges associated with the Senate approval of the labor reform law.

9/4/00 President De La Rúa affirms that the government has not paid bribes to get the labor reform law approved.

APPENDIX 9

100

Date Events

10/6/00 Vice President Carlos Álvarez resigns.

1/12/01 IMF Board approves augmentation of Stand-By Arrangement and completes second review.

3/2/01 Minister Machinea resigns.

3/4/01 Ricardo López Murphy is appointed Minister of Economy.

3/16/01 FREPASO members of the cabinet resign in protest over a proposed fiscal austerity program. Alliance between theFREPASO and the Radical party is broken. Labor unions call for a strike.

3/19/01 Minister López Murphy resigns.

3/20/01 Domingo Cavallo is appointed the new Minister of Economy.

3/26–28/01 International rating agencies lower Argentina’s long-term sovereign rating.

3/29/01 Minister Cavallo secures “emergency powers” from Congress.

4/14/01 Minister Cavallo announces a modification of the convertibility law, with the replacement of the dollar by an equallyweighted basket of the dollar and the euro.

4/16/01 Minister Cavallo requests major businesses to purchase “patriotic bonds” for $1 billion.

4/26/01 The Central Bank Governor is replaced over alleged money laundering charges.

5/8/01 Standard & Poor’s lowers Argentina’s long-term sovereign rating further from B+ to B.

5/21/01 IMF Board completes third review of Argentina’s Stand-By Arrangement.

6/3/01 Authorities announce the completion of the “mega-swap.”

6/15/01 Minister Cavallo announces package of tax and trade measures, including a trade compensation mechanism forexporters and importers of nonenergy goods.

6/20/01 The Senate approves the revised convertibility law.

7/11/01 A zero deficit plan is announced, with a mandatory reduction in expenditures to balance the budget.

7/30/01 The zero deficit plan becomes law.

8/10/01 Press quotes market sources to report that an IMF package will only delay the default.

8/21/01 IMF announces planned augmentation of Stand-By Arrangement by $8 billion.

9/5/01 Press reports that FREPASO is proposing an end of the convertibility regime.

9/7/01 IMF Board approves augmentation of Stand-By Arrangement and completes fourth review.

10/14/01 Upper and Lower House elections. The Peronist party controls both houses of Congress.

10/30/01 FREPASO breaks the Alianza coalition in the Lower House.

11/6/01 Standard & Poor’s lowers Argentina’s long-term sovereign rating from CC to SD (selective default).

12/1/01 The government introduces a partial deposit freeze (corralito) and capital controls.

12/6/01 Minister Cavallo travels to the United States to meet with IMF management.

12/8/01 Private pension funds are forced to buy national bonds.

12/12/01 A national strike is called, setting off a series of demonstrations against the government’s economic policies.

12/19/01 Minister Cavallo resigns.

12/20/01 President Fernando De La Rúa resigns over death of demonstrators. Ramón Puerta, President of the Senate, becomesinterim President.

12/23/01 Adolfo Rodríguez Saá is elected president by the Legislative Assembly. He announces partial default on external debt.

12/30/01 Rodríguez Saá resigns. Eduardo Camaño, head of Lower House, becomes interim president (as Ramón Puerta resignsas Senate president).

1/1/02 Eduardo Duhalde is elected President by the Legislative Assembly to serve until December 2003.

1/3/02 President Duhalde announces the end of convertibility, and the introduction of a dual foreign exchange regime.

1/6/02 The convertibility law ceases to be in effect. A dual exchange rate regime is introduced, one fixed at 1.40 pesos to adollar for foreign trade, and the other determined in the free market.

2/3/02 The government decrees the unification of the exchange rate regime and the asymmetric pesoization of bank balancesheets (assets at Arg$1/US$1, and liabilities at Arg$1.40/US$1).

2/11/02 The foreign exchange market opens for the first time under a unified regime; the peso depreciates to Arg$1.8 to thedollar.

3/8/02 The pesoization of government debt under Argentine law is decreed.

3/25/02 The peso reaches a peak of Arg$4 per dollar.

Sources: Pablo Gerchunoff and Lucas Llach, El ciclo de la ilusión y el desencanto, Ed. Ariel, 2003; Luis Alberto Romero, Breve historia contemporánea Argentina, Fondo deCultura Argentina, 2001; Luis Alberto Romero, Argentina: una crónica total del siglo XX, Ed. Aguilar, 2000; Anuario Clarín, various years, Editorial Atlántida; Clarín,1997–2002, on-line version; La Nación, 1991–2002, print version; and La Nación, 1997–2002, on-line version.

The IEO team has spoken to more than 40 currentand former members of IMF management, staff andthe Executive Board. In addition, the following indi-viduals have provided their views to the IEO, mostlythrough personal interviews but also through semi-

nars and workshops. We express our gratitude fortheir generosity in making their time available to us,and apologize for any errors or omissions. They as-sume no responsibility for any errors of fact or judg-ment that may remain in the report.

List of IntervieweesAPPENDIX

10

101

International and Regional Organizations

World Bank

Myrna Alexander Paul Levy Guillermo Perry

European Central Bank

Tommaso Padoa-Schioppa Georges Pineau Lucas Ter Braak

European Commission

Alexander Italianer José E. Leandro Heliodoro Temprano

Inter-American Development Bank

Guillermo Calvo Eduardo Cobas Alejandro IzquierdoRicardo Santiago Ernesto Talvi

Organization for Economic Cooperation and Development

Joaquim Oliveira Martins Nanno Mulder

United Nations Economic Commission for Latin America and the Caribbean

Daniel Heymann Juan Pablo Jiménez Bernardo Kosacoff Adrián H. Ramos

Member Country Officials

Argentina

Roberto Arias Daniel Artana Luis Alfredo Azpiazu Jorge BaldrichMario Blejer Darío Braun Domingo Cavallo Adolfo DizRoque Fernandez Jorge Gaggero Marcelo García Javier González FragaPablo Guidotti Ricardo Gutiérrez Alejandro Henke Miguel KiguelRoberto Lavagna Eduardo Levy-Yeyati Juan José Llach Ricardo López MurphyJosé Luis Machinea Daniel Marx Guillermo Mondino Santiago MontoyaGuillermo Nielsen Geraldo Adrián Otero Eugenio Pendas Pedro Pou Andrew Powell Alfonso Prat-Gay Jorge Remes Lenicov Carlos A. RodríguezRodolfo Rossi H. Horacio Salvador Federico Sturzenegger Mario VicensAgustín Villar

APPENDIX 9

102

Other countries

Enrique Alberola Ila Steve Backes Andrew Berg Lorenzo Bini SmaghiJasper Blom Christian Broda Terrence Checki John ClarkStephen Collins Marco Committeri Bertrand Couillault Ralf DebeliusJohn Drage Elvira Eurlings Antonio Fanna Marco Fauna Hiroshi Fujiki Alicia Garcia Herrero Stéphanie Gaudemet Giorgio GomelDoris Ellen Grimm Dietrich Hartenstein Joji Ide Hirotaka InouePierre Jaillet Yukinobu Kitamura Shuji Kobayakawa Takayuki KobayashiMichael A. P. Kuijper Haruhiko Kuroda Chris Kushlis Renaud MearyThomas Melito Jochen Metzger Isaya Muto Stéphane PallezAdrian Penalver Stephen Pickford Gonzalo Ramos Tom RogersMarc Roovers Gita Salden Tetsuya Sato Stéfan SchoenbergClaus Schollmeier Brad Setser Shigeru Shimizu Mark SobelMarc-Olivier Strauss-Kahn Wataru Takahashi John B. Taylor Gregory ThwaitesRamin Toloui Edwin Truman Jan Willem van der Kaaij Jose VinalsStephan FRHR Von Stenglin Kiyoshi Watanabe Claire Waysand Christiane WelteRolf Wenzel Dan Zelikow Vicenzo Zezza

Academics and Other Individuals

Victor Abramovich Carlos Acuna Roberto Alemann Lew AlexanderMartin Anidjar Makoto Aratake Ricardo Arriazu Santiago BausiliCosme Beccar Varela Gavin Bingham Amer Bisat Jorge Blazquez-LidoyPaul Blustein Miguel Angel Broda Mario Cafiero Gustavo CanoneroAriel Caplan Lisandro Catalan Menzie Chin Eduardo ConesaOsvaldo Cornide Eduardo Curia Eduardo de la Fuente Horacio DelguyJosé Ignacio de Mendiguren Edvardo Di Cola Rafael Di Tella Carlos DomeneCarlin Doyle Sebastian Edwards Klaus Engelen Miguel Escrig MeliaJosé Luis Fabris Roberto Favelevic Martin Feldstein Aldo Ferrer Kristin Forbes Rosendo Fraga Jeffrey Frankel Roberto FrenkelBarbara Fritz Peter Garber Américo García Guillermo GotelliGeoffrey Gottlieb Juan José Guaresti Kenji Haramiishi Eduardo Helguera Katja Hujo Hirotaka Ikeda Mika Ikeda Joseph JoyceMartin Kanenguiser Isao Kawanabe Severo Lanz Guillermo LauraAndrés Lederman Paulo Leme Fernando Daniel López Fernando LosadaFrancisco Matilla Antonio Merino García Juan Antonio Mielgo Hugo MoyanoArnaldo Musich Jujio Namiki Arturo O’Connell Federico Palacio Celedonio Paneda Arturo Porzecanski Carla Gabriela Raimondi Alberto RamosMoises Resnick Brenner Osvaldo Rial Dani Rodrik Luigi RuggeroneJosé Juan Ruiz Rodolfo Santangelo Naoki Sawaoka Miguel SebastianDennis Sertcan Takeshi Shigeoka Dante Simone Kenichi SuzukiNaoyuki Takashina Shin Takehara Masaharu Takenaka Mariano TommasiJuan Carlo Torre Gerardo Tresca Héctor Valle Andrés VelascoMotoyasu Yokota Yorikatsu Yoshida

Allen, Mark, 2003, “Some Lessons from the ArgentineCrisis: A Fund Staff View,” in The Crisis That WasNot Prevented: Lessons for Argentina, the IMF andGlobalisation, ed. by Jan Joost Teunissen and AgeAkkerman (The Hague: FONDAD).

Arriazu, Ricardo Héctor, 2003, Lecciones de la Crisis Ar-gentina (Buenos Aires: Editorial El Ateneo).

Artana, Daniel, Ricardo López Murphy, and FernandoNavajas, 2003, “A Fiscal Policy Agenda,” in After theWashington Consensus: Restarting Growth and Re-form in Latin America, ed. by Pedro-Pablo Kuczynskiand John Williamson (Washington: Institute for Inter-national Economics).

Auguste, Sebastian, Kathryn M. E. Dominguez, HermanKamil, and Linda L. Tesar, 2002, “Cross-BorderTrading As a Mechanism for Capital Flight: ADRsand the Argentine Crisis,” NBER Working Paper No.9343 (Cambridge, Massachusetts: National Bureau ofEconomic Research).

Baliño, Thomas J. T., Charles Enoch, Alain Ize, VeerathaiSantiprabhob, and Peter Stella, 1997, Currency BoardArrangements: Issues and Experiences, IMF Occa-sional Paper No. 151 (Washington: InternationalMonetary Fund).

Berg, Andrew, and Eduardo Borensztein, 2000, “TheChoice of Exchange Rate Regime and Monetary Tar-get in Highly Dollarized Economies,” IMF WorkingPaper No. 00/29 (Washington: International Mone-tary Fund).

Bordo, Michael, and Carlos A. Vegh, 1998, “What IfAlexander Hamilton Had Been Argentinean? A Com-parison of the Early Monetary Experiences of Ar-gentina and the United States,” NBER Working PaperNo. 6862 (Cambridge, Massachusetts: National Bu-reau of Economic Research).

Boughton, James M., 2001, Silent Revolution: The Inter-national Monetary Fund, 1979–1989 (Washington:International Monetary Fund).

Bulow, Jeremy, and Kenneth Rogoff, 1988, “The BuybackBoondoggle,” Brookings Papers on Economic Activ-ity:2, Brookings Institution, pp. 675–98.

———, 1989, “Sovereign Debt: Is to Forgive to Forget?”American Economic Review, Vol. 79, No. 1 (March),pp. 43–50.

Calomiris, Charles W., 2001, “The Fastest, Fairest WayOut of the Argentina Debt Crisis,” Financial Times(London), November 9.

———, and Andrew Powell, 2001, “The Argentine Finan-cial System Under the Currency Board,” April.

Calvo, Guillermo A., 1998, Capital Flows and Capital-Market Crises: The Simple Economics of SuddenStops,” Journal of Applied Economics, Vol. 1, No. 1(November), pp. 35–54.

———, and Carmen M. Reinhart, 1999, “When CapitalInflows Come to a Sudden Stop: Consequences andPolicy Options,” June.

Calvo, Guillermo A., Alejandro Izquierdo, and ErnestoTalvi, 2002, “Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina’s Lessons”(Washington: Inter-American Development Bank).

Cavallo, Domingo, 2001, Pasión por Crear: En diálogocon Juan Carlos De Pablo (Buenos Aires: Espejo dela Argentina).

———, 2002, “An Institutional Coup”; available via theInternet at www.cavallo.com.ar/papers.

———, and Joaquin A. Cottani, 1997, “Argentina’s Con-vertibility Plan and the IMF,” American EconomicReview, Papers and Proceedings, Vol. 87, No. 2(May), pp. 17–22.

Cavallo, Michele, Kate Kisselev, Fabrizio Perri, andNouriel Roubini, 2003, “Exchange Rate Overshoot-ing and the Costs of Floating” (New York: New YorkUniversity), April.

Cetrángolo, Oscar, and Juan Pablo Jiménez, 2003,“Política Fiscal en Argentina durante el Régimen deConvertibilidad” (Santiago: United Nations Eco-nomic Commission for Latin America and theCaribbean (CEPAL)).

Cibils, Alan B., Mark Weisbrot, and Debayani Kar, 2002,“Argentina Since Default: The IMF and the Depres-sion,” Briefing Paper (Washington: Center for Eco-nomic and Policy Research).

Cline, William R., 1995, International Debt Reexamined(Washington: Institute for International Economics).

———, 2003, “Restoring Economic Growth in Ar-gentina,” Center for Global Development and Insti-tute for International Economics, June.

Collyns, Charles V. and Russell G. Kincaid, 2003, Man-aging Financial Crises: Recent Experience andLessons for Latin America, IMF Occasional PaperNo. 217 (Washington: International MonetaryFund).

Corrales, Javier, 2002, “The Politics of Argentina’s Melt-down,” World Policy Journal, Vol. 19, Issue 3 (Fall),pp. 29–42.

Cottarelli, Carlo, and Curzio Giannini, 2002, “Bedfellows,Hostages, or Perfect Strangers? Global Capital Mar-kets and the Catalytic Effect of IMF Crisis Lending,”

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Statement by the Managing Director

IMF Staff Response

IEO Comments on Management/Staff Response

Statement by the Governor for Argentina

Summing Up of IMF Executive BoardDiscussion by the Chairman

In its report on Argentina, the Independent Eval-uation Office (IEO) has examined an importantcountry case to shed fresh light on the experienceof IMF-supported programs and surveillance. Thereport is thoroughly researched and insightful. It once again confirms the valuable role played bythe IEO in enhancing the learning culture of the institution.

I find most of the analysis in the report convinc-ing and generally welcome the recommendations. Ihave asked staff to prepare a statement providing amore detailed response to the report and recom-mendations. I look forward to the Board discussionof the paper, which will provide the opportunity forExecutive Directors to consider the implications ofthese recommendations for the institution.

STATEMENT BY THE MANAGING DIRECTOR ON THE EVALUATION BY THE

INDEPENDENT EVALUATION OFFICE OF THE

ROLE OF THE FUND IN ARGENTINA, 1991–2001

Executive Board MeetingJuly 26, 2004

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1. We would like to commend the IEO for thisthought-provoking report. By taking a careful lookback at the experience, this report makes a valuablecontribution to the learning culture of the Fund. Inmany respects, it also provides an independent con-firmation of our own attempts to draw lessons fromthe crisis, although we do not agree with some of itsinterpretations and conclusions. We are in agreementwith many of the recommendations and, indeed, arealready acting on some.

2. We share the report’s basic diagnosis of the cri-sis, which is very similar to our own assessment pre-sented in the October 2003 staff paper on Lessonsfrom the Crisis in Argentina.1 The IEO report notesthat “[t]he crisis resulted from the failure of Argen-tine policymakers to take necessary corrective mea-sures sufficiently early, particularly in the consis-tency of fiscal policy with their choice of exchangerate regime” [page 3]. In order to avert the crisis,stronger fiscal adjustment would have been neededduring the 1990s, when the economy was perform-ing close to its potential, to ensure the sustainabilityof public debt. Strong, sustained structural reformswould have been needed to address the weaknessesin the labor markets and the fiscal system and tobroaden and diversify the export base. Moreover, itwould have been desirable to exit from the convert-ibility regime before the other problems had becomeinsurmountable. The IEO report takes an importantstep beyond the staff paper in its detailed examina-tion of how the Fund’s decision-making processescontributed to the course of these events; by doingso, it provides a fresh perspective on the governanceof the Fund.

3. The report concludes—also in line with ouranalysis—that the Fund erred by not pushingstrongly enough for needed reforms and policy ad-justments at a time when these could have helpedprevent the crisis, and by providing financial support

for too long and when policies were increasinglyweak and inconsistent. In particular, the Fund didnot press the authorities to consider alternatives to itsquasi-currency-board regime years before the col-lapse. Clearly, while strong country ownership ofpolicies is important to ensure that they are imple-mented, ownership is not a sufficient basis for aFund-supported program when the policies them-selves are weak or inconsistent.

4. At the same time, we perceive some shortcom-ings of the IEO report. Some of its conclusions de-pend very much on hindsight. For instance, it offersUruguay’s 2002 debt restructuring as a model forArgentina (although it came later), but does notproperly acknowledge that the success of theUruguay program was due in part to the sobering ef-fect of the Argentine experience on both privatecreditors and policymakers. As the report itself notesit does not examine external influences on theFund’s decisions, nor does it consider informal chan-nels by which the Board may have been given infor-mation by the staff and management, and may there-fore understate the information on which the Board’sdecisions were based.

5. Moreover, there is an internal inconsistency inthe report’s presentation of the Fund’s decisions dur-ing late 2000 and early 2001: while the discussion inthe body of the report takes the view that the catalyticapproach had some chance of success—later im-paired by the authorities’ weak implementation—thelessons drawn appear to be based on the diagnosis ofan irretrievably unsustainable situation that staffshould have identified sooner. This inconsistency un-derscores the difficulty of making judgments on aprogram’s viability. If, as suggested in the report, theFund had drawn the line several months earlier byfailing to complete the May 2001 review, the basicfeatures of the crisis would have been the same: Ar-gentina would not have avoided a wrenching defaultand a forced exchange rate regime change, with theirdeleterious effects on private and public balancesheets and the real economy. The main—but not in-

STAFF RESPONSE TO THE EVALUATION BY THE INDEPENDENT EVALUATION OFFICE

OF THE ROLE OF THE FUND IN ARGENTINA, 1991–2001


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1See SM/03/345 and BUFF/03/206. [See PDR, 2003—Ed.]

Staff Response

consequential—difference is that the Fund wouldhave avoided increasing its exposure to Argentina byabout US$9 billion, which in the event largely fi-nanced capital flight. To have ensured a qualitativelydifferent outcome for Argentina, the Fund wouldhave had to withhold its support at least another yearor two earlier—but at that stage, it was less evidentthat the chosen strategy was unlikely to succeed.

6. An important theme of the report is that theFund should have taken a step back from the programrelationship with Argentina, to assess whether theeconomic policy strategy was on track to achieve itsobjectives. This is related to the need to strengthensurveillance in program countries, an issue stressedin the 2002 Biennial Surveillance Review. In light ofthat review, the Fund has taken steps to introducegreater freshness of perspective in Article IV surveil-lance in a program context2—taking greater care toensure that Article IV consultations with programcountries pay adequate attention to the issues that aremost important from a medium-term standpoint. The2004 Biennial Surveillance Review (SM/04/212), re-cently circulated to the Board, reviews the experiencewith implementation of these initiatives; it concludesthat the quality of surveillance in program countrieshas risen, with the main improvement relating to tak-ing stock of the economic policy strategy to date, butit notes that progress has been more limited with re-gard to the candid presentation of the short- andmedium-term outlook and candid account of the pol-icy dialogue. The IEO report’s treatment of these is-sues in the Argentine context is thus particularlytimely in view of the upcoming Board discussion ofthe 2004 Biennial Surveillance Review.

7. A key area in which a more candid assessmentof the economic policy strategy would have been de-sirable in the case of Argentina is the exchange rateregime and its consistency with other policies. TheArgentine experience indeed provides a graphic illus-tration of the need for a more pointed treatment ofexchange rate issues in the context of surveillance—notably in staff reports, but also in staff discussionswith the authorities and discussions in the Board.This issue was addressed in the more general contextin the 2002 Biennial Surveillance Review. Accordingto the 2004 Biennial Surveillance Review, it remainsa significant challenge; the Board will have the op-portunity to discuss the issue further in that context.

8. The assessment of exchange rate regimes in-evitably involves some difficult choices for the au-thorities, staff, and the Board, particularly with re-

gard to institutionally pegged exchange rates. Asnoted in the IEO paper [page 20], the costliness ofabandoning the peg was, to a considerable extent, bydesign, as it was key to its credibility: the costs ofabandoning the regime included its legal foundation,the tangled pattern of currency mismatches on pub-lic and private balance sheets, and ultimately thestrong degree of popular support for the regime. Theauthorities sought to entrench the convertibilityregime still more deeply by treating any change inregime as not just undesirable, but unthinkable.While this was the logic of the regime, it was flawedbecause the authorities were unable to garner suffi-cient domestic support to implement the strong fis-cal adjustment and structural reforms that wouldhave been needed to make it viable. Thus, while anearlier exit—preferably in the calmer times of themid-1990s—would indeed have been preferable, thecosts of such an exit even under ideal conditions orthe difficulty of engaging the authorities on the op-tions should not be underestimated.

9. The report presents a number of recommenda-tions in light of the Argentine experience. On thewhole, these are reasonable. Indeed, as noted in thereport, in many cases the proposed changes are in linewith policy changes that the Fund has already initi-ated, partly in response to the Argentine experience,although in many instances the adequacy and imple-mentation of these initiatives remain to be assessed.

10. Recommendation 1 proposes that “[t]he IMFshould have a contingency strategy from the outsetof a crisis, including in particular ‘stop-loss rules’—a set of criteria to determine if the initial strategy isworking and to signal whether a change in approachis needed.” The basic point, that the Fund should beready to stop providing additional financing if theprogram is no longer on track to achieving its objec-tives, is a sound one. The need for close and candidscrutiny of a program is particularly pressing incases of exceptional access. There is also some meritto the idea of formulating in advance how the Fundshould react to certain contingencies, although expe-rience suggests that it may be very difficult to en-gage the authorities on a contingent strategy, particu-larly at the outset of a crisis. (Indeed, the report itselfnotes that in the Argentine case, “there may wellhave been no feasible actions by the IMF that wouldhave enabled the adoption of a meaningful Plan B.”)It is also desirable for the Fund to formulate where itwould draw the line before providing further financ-ing. At some level, providing such a stop-loss rule isprecisely the purpose of the Fund’s conditionality—more specifically, of performance criteria whichspecify conditions under which the member has ac-cess to the Fund’s financing. There are, of course,questions of whether conditionality could be de-signed better to play this role in a crisis setting: for

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2See also “Enhancing the Effectiveness of Surveillance—Oper-ational Responses, the Agenda Ahead, and Next Steps”(SM/03/96 and SUR/03/38); and “Strengthening Surveillance”(SM/03/249 and BUFF/03/157). See also “Operational GuidanceNote for Staff Following the 2002 Biennial Surveillance Review.”

STAFF RESPONSE

instance, should test dates be more frequent, shoulddifferent indicators be used to monitor macroeco-nomic policies; could program reviews be used moreeffectively to assess the overall strategy; and so on.The proposed stop-loss rules would go further thanthe existing framework of conditionality by estab-lishing other, perhaps less readily quantifiable crite-ria to indicate at what point the Fund should deter-mine that the overall strategy is not working. Butconditionality also has discretionary elements, re-lated to the powers of the Executive Board, usuallyon the recommendation of management, to grantwaivers for missed performance criteria and to com-plete reviews; these elements are necessary in viewof the imperfect nature of any objective measures ofpolicy performance and, moreover, provide an op-portunity to reassess policies in relation to the over-all program objectives and strategy. A stop-loss rulewould either need to maintain this element of discre-tion—in which case, it could only serve as a guide,but would not prevent the Fund from continuing toprovide financing when events turn out differentlythan expected—or it would imply that the Boardwould, ex ante, constrain its own power to grantwaivers. We do not see the latter as appropriate,given that no quantitative indicator is likely to pro-vide a one-dimensional test of viability—and it isunlikely that it would be acceptable to the Fund’smembership. However, it would be worth giving fur-ther consideration to establishing clearer guidelinesindicating when the Fund should withdraw its sup-port in the absence of a major change in strategy.

11. Recommendation 2 is that when the sustain-ability of debt or the exchange rate is in question, theFund’s support should be predicated on a meaning-ful shift in policy. This is certainly a valid point. Inresponse to the experience of such cases, the Fundintroduced new policies on exceptional access, re-quiring an assessment that the policy program of themember country provides a reasonably strongprospect of success, including not only the member’sadjustment plans but also its institutional and politi-cal capacity to deliver that adjustment; a detailed re-view of financing assurances including market ac-cess; and a rigorous and systematic analysis of debtsustainability.3 The Board recently reviewed the ini-tial experience with the application of this frame-work and did not see a need for any changes, but itwould be desirable to give further consideration tothis issue with the benefit of the light the IEO report

sheds on the Fund’s decision-making process in acrisis situation.

12. Recommendation 3 is that the Fund shouldsystematize its practices for assessing medium-termexchange rate and debt sustainability. Exchangerates have been a major focus of analytical work bystaff, as exemplified by the two papers on exchangerate regimes discussed by the Board in 2003. Fundstaff has developed a macroeconomic balance ap-proach to exchange rate assessments; while this ap-proach is designed mainly for industrial countries, ithas also been extended to developing countries.4 Atthe same time, the 2004 Biennial Surveillance Re-view observes that, in practice, assessments of exter-nal competitiveness are often limited to an analysisof the evolution of a real exchange rate indicator;and exchange rate levels are usually found to be“about right” or in line with fundamentals. This is inline with the IEO’s recommendation that exchangerates should be assessed more systematically andmore candid conclusions drawn—with both reportspointing to a need for fresh analytical work as wellas greater candor in presenting the results.

13. As the IEO report notes, the debt sustainabil-ity framework was developed in 2002, in large partin response to the Argentine experience, althoughthere is scope for further refinements.5 In applyingthis framework, a key question is the debt level atwhich countries are likely to run into difficulties: thestaff work accompanying the debt sustainabilitytemplate, as well as the September 2003 World Eco-nomic Outlook, addressed this question by examin-ing the debt levels at which problems have emergedin the past.6 The work on “debt intolerance,” under-taken by IMF staff, implies that lower debt levelsmay be appropriate for countries that have defaultedin the past, and is part of the body of knowledge thatinforms the staff’s analysis of sustainability.7 Be-yond this, in crisis and near-crisis cases there islikely to be a need to go beyond the standard debtsustainability template, for instance by formulating

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3See “Access Policy in Capital Account Crises” (SM/02/246),the related summing up (Buff/02/159), “Access Policy in CapitalAccount Crises—Modifications to the Supplemental Reserve Fa-cility and Follow-Up Issues Related to Exceptional Access Pol-icy” (SM/03/20; and SM/03/20, Supplement 1), and the relatedsumming up (Buff/03/28).

4See Exchange Rate Assessment—Extensions of the Macroeco-nomic Balance Approach, edited by Peter Isard and HamidFaruqee, IMF Occasional Paper No. 167 (1998); and Methodol-ogy for Current Account and Exchange Rate Assessments, byPeter Isard, Hamid Faruqee, G. Russell Kincaid, and MartinFetherston, IMF Occasional Paper No. 209 (2001).

5“Assessing Sustainability” (SM/02/166). It is also worth not-ing that staff undertook analysis of medium-term debt sustain-ability for Argentina, including extreme stress tests, beginning in2000, prior to the introduction of the standardized debt sustain-ability template—although the results of this analysis were notfully shared with management and the Board.

6IMF, World Economic Outlook, September 2003, Chapter III.7Carmen Reinhart, Kenneth Rogoff, and Miguel Savastano,

“Debt Intolerance,” Brookings Papers on Economic Activity:1(2003), pp. 1–62.

Staff Response

more specific scenarios on the nature and magnitudeof shocks that may occur, by making greater use ofmarket indicators, and by undertaking a more com-prehensive cash flow analysis to assess rolloverrisks.

14. Recommendation 4 is that the Fund “shouldrefrain from entering or maintaining a program rela-tionship with a member country when there is no im-mediate balance of payments need and there are seri-ous political obstacles to needed policy adjustmentor structural reform.” We agree with the basic pointthat “[t]he markets may well do a better job of disci-plining policy than a weak program that is beingtreated as precautionary.” At the same time, giventhat Argentina retained access to the financial mar-kets, it is questionable whether following this rec-ommendation would have made much difference tothe way events unfolded there—although it is possi-ble that the markets relied unduly on the Fund pro-grams in lieu of their own due diligence. One impor-tant aspect of this issue is that a precautionaryarrangement should be subject to the same standardsas any other arrangement, given that it gives themember the same right to the use of Fund resources.The design and macroeconomic outcomes of precau-tionary arrangements will be examined in the forth-coming papers on program design.

15. Recommendation 5 is that exceptional accessshould “entail a presumption of close cooperationbetween the authorities and the IMF.” We agreestrongly with this principle, but have some doubtsabout the effectiveness of some of the specific steps

proposed. The report calls for mandatory disclosureto the Board of any issues/information that the au-thorities refuse to discuss/disclose—noting, for in-stance, the Argentine authorities’ reluctance to en-gage with the staff on exchange rate policy. We agreewith the general argument: staff has the duty to in-form the Board accurately on policy discussions (notjust in exceptional access cases but in all cases) andthis requires that when the authorities are not pre-pared to discuss key issues or provide key informa-tion staff should so inform the Board. But beyondthis principle, it is not clear what purpose the pro-posed mandatory requirement would serve. With re-gard to the proposal that the Fund not endorse poli-cies on which it was not consulted: while failing toconsult is often an indication that the policy changesare not consistent with the program, and may raisequestions about the authorities’ commitment to im-plement it—any staff assessment of policies stillneeds to be based on the merits of the policies andnot solely on whether staff was consulted.

16. Recommendation 6 is aimed at strengtheningthe role of the Executive Board. The procedures forexceptional access that were introduced after the Ar-gentine crisis and reviewed this year do provide for agreater degree of Board scrutiny in cases of excep-tional access—including the assessment of policies,debt sustainability, and financing assurances as al-ready described.

17. Staff looks forward to Board discussion ofthis report and to working with the Board in follow-ing up on its recommendations.

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We would like to offer a few points of clarifica-tion, in response to the comments made by manage-ment and staff on the IEO report, focusing on themost critical issues.

The staff suggests that the evaluation report isinconsistent between its assessment of the IMF’sdecision in late 2000/early 2001 and the lesson itdraws from this assessment (para. 5). An inconsis-tency arises only if one believes that the outcomedepended solely on economic fundamentals. This isnot the view we take. We believe that investor ex-pectations played a critical role and that, in addi-tion to serious concerns about the fundamental sus-tainability of both the exchange rate and the debt,there was a self-fulfilling aspect to the crisis. Ifthere were indeed multiple equilibria, one can thenargue that the catalytic approach, supported bystrong policy action, could have affected investorconfidence so favorably as to reverse capital out-flows. Our assessment of the IMF’s initial ap-proach—that it was worth trying in light of the veryhigh costs of the alternative—follows from this rea-soning. In the event, this strategy failed when theagreed policy correction was not made, from whichwe draw a lesson that the catalytic approach to af-fect investor expectations has a low probability ofsuccess when there are fundamental sustainabilityproblems and the political ability of the authoritiesto deliver the needed policy correction is weak. Ourassessment is a probabilistic one (based on the in-formation available at the time the decision wasmade), while the lesson necessarily benefits fromhindsight.

Regarding Recommendation 1, the staff notessome obstacles to making stop-loss rules operational(para. 10). We agree with much of this argument, butthree points deserve emphasis. First, a stop-loss ruleis meaningful only if it is part of an overall crisismanagement strategy tailored to each case. Second,discretion can be a double-edged sword. Discretioncan, for example, make it more difficult for the IMFto refuse a member country’s request for exceptionalsupport even when the situation seems irretrievable.Conversely, it may induce the country to keep post-poning the needed adjustment, in the hope that thefavor would be extended over and over again. Third,a stop-loss rule can help focus attention on sustain-ability, which goes beyond policy performance or ef-fort. In the case of Argentina, throughout the springand summer of 2001, the IMF continued to providesupport on the basis of what it perceived to be thestrength of the authorities’ resolve, when by thatpoint nothing short of a different strategy could fun-damentally solve Argentina’s economic problems.

Finally, the staff suggests that the evaluation re-port understates the informal channels of communi-cation by which information is made available to theExecutive Board (para. 4). It is worth emphasizingthat the IEO obtained, from varied sources, a largenumber of notes and reports prepared on all relevantinformal Board meetings. What the IEO lacked wasaccess to the informal exchanges that may havetaken place between management and individual orsubgroups of Executive Directors. Such exchanges,however, cannot be construed as constituting the in-formation provided to the Board.

INDEPENDENT EVALUATION OFFICE COMMENTS ON

MANAGEMENT/STAFF RESPONSE TO THE EVALUATION OF THE



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Introduction

We consider this to be a valuable and candid re-port that helps to form a more complete picture ofthe relationship of the Fund with Argentina duringthe 1991–2001 period when a currency boardarrangement (CBA) was in place. The special natureof this exchange rate system implemented during theyears of “irrational exuberance” and when the “firstcrisis of the twenty-first century” took place makesthe Argentine case an interesting one to study. Weshould remind ourselves, however, that given thespecial circumstances that surrounded the case it isnot possible to expect that the lessons to be drawnare all going to be equally useful to the Fund’s mem-bership looking forward. The report also mentionsthe belief of the majority of the staff at the time thatthe “Argentine situation was so unique . . . as tomake previous experience inapplicable.” We hopethat this is not forgotten in the present dealings ofthe Fund with Argentina, since it is of the utmost im-portance to try to avoid to the extent possible therepetition of the same mistakes, as both the Fund andArgentina are suffering, albeit unequally, the conse-quences of misguided policies.

The value of the report is, in our view, not asmuch in the area of surveillance and program de-sign, which to a large extent was covered by theNovember staff report (and its lessons alreadylearned), as in the areas of crisis management andthe decision-making process within the Fund,which can indeed offer lessons of a more generalnature that may lead to improve the working of theinstitution in the future. The way the institution re-acted to the unfolding of the crisis provided also aninteresting practical example of the limitations ofthe exceptional access policy and of private sectorinvolvement (PSI) in the particular circumstancesof Argentina, which calls for further efforts in theseareas.

Having said this, we would like to add some spe-cific comments covering the three main conceptualtopics of the report: (1) surveillance and program de-sign, (2) crisis management, and (3) the decision-making process.

Surveillance and Program Design

On surveillance and program design we believethat some further comments to those presented in thereport, including in its recommendations, are inorder. The report rightly emphasizes the constraintsimposed by the CBA and the consequent need to relyon a sound fiscal policy, as the only variable left forthe authorities to influence macroeconomic condi-tions. The most significant period from the point ofview of surveillance is the one that preceded the cri-sis. The surveillance weaknesses during that periodwere indeed many, mostly concentrated on the fiscalarea: the asymmetric treatment of fiscal targets dur-ing times of vibrant growth and recessions, the suc-cessive granting of waivers for fiscal underperfor-mance, the substantial privatization revenuesconsidered as an item above the line, the insufficientattention to provincial finances, the off-budget debtissued, and the failure to properly assess the impactof the social security reform are partially highlightedin the report. In this respect it is worth noting that thereport does not adequately assess the negative conse-quences stemming from the Fund’s endorsement ofthe social security reform, which was at the timehailed as a sound policy step in the right direction.The Fund, in spite of the very evident detrimentalimpact on fiscal revenues that this structural reformhad, pointed it out as an example to be followed. It istherefore disappointing to see that the report, in spiteof recognizing its negative fiscal consequences, stillstates that “the pension reform itself was [not] illconceived.”

In our view, the report fails to assess the extent ofstructural reforms implemented during that period.The full-fledged program of privatizations, deregula-tions, trade and financial liberalization, and fiscal andsocial security reforms contributed to give Argentinathe image of a stellar performer. Beyond the underly-ing fiscal slippages, which remained concealed forquite a long time, several other weaknesses were em-bodied in the structural reforms implemented in Ar-gentina during the 1990s. The IEO report addresses,to a certain extent, the failures implicit in the socialsecurity reforms, but it says very little as regards the

STATEMENT TO THE EXECUTIVE BOARD MEMBERS FROM THE GOVERNOR FOR

ARGENTINA, HIS EXCELLENCY ROBERTO LAVAGNA, ON THE

IEO EVALUATION OF THE ROLE OF THE FUND IN ARGENTINA, 1991–2001


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STATEMENT FROM THE GOVERNOR FOR ARGENTINA

flagship of Argentina’s structural reforms, the overar-ching privatization process. In spite of receiving fi-nancial support by IFIs, privatizations were not dulymonitored. It became evident from its earliest stagesthat the process was being carried out in a rather non-transparent manner and that its quality was at leastquestionable. Its proceeds were allowed to be countedas regular revenues, thus distorting the true nature ofthe structural fiscal situation. Perhaps more impor-tantly, monopolistic market structures were allowedto remain, coupled with a blatantly inadequate regula-tory framework; as a consequence, and notwithstand-ing the improved supply of some services, the highprices for their provision contributed to make Ar-gentina an expensive place to do business. Equallyimportant, the dealings of the government with theprivatized companies throughout the period were ob-scure, and the enforcement of contracts was veryweak. Nonetheless, as structural reforms imple-mented in Argentina during the 1990s and, very par-ticularly the privatization of all its public services,were in line with the so-called “Washington consen-sus” recommendations, Argentina’s policies werethus heralded by the Fund as an example to be fol-lowed. This was, quite evidently, an ideological prismof assessment. Also, it was—and regretfully still is—an ideological assessment unwarranted by conclusiveevidence that all structural reforms would necessarilylead to increased growth. All this clearly blurred thecapacity of the Fund to advance an objective assess-ment of Argentina’s structural reforms, and we wouldhave liked to see some more consideration of that inthe IEO report.

In fact, we could conclude that lesson 5 of the re-port should be indeed totally reversed. Rather thanstating that a good macroeconomic performancewhen not accompanied by supporting structural re-forms is not sustainable, Argentina’s experienceserves to support the opposite view that when appar-ently comprehensive structural reforms serve to con-ceal weak macroeconomic fundamentals, as it hashappened in the Argentine case, in the end thoseweaknesses surface. Argentina is at present, for thefirst time in decades, including in particular the 1990s,obtaining a fiscal primary surplus that is unprece-dented for its size and is committed to maintain it forthe foreseeable future, yet in its relationship with theinstitution is now being pressed in a way absent dur-ing the 1990s to implement structural reforms under aschedule that is oblivious to the political realities ofthe country, lest the successful performance cannot bemaintained, so runs the argument. The 1990s prove,however, that structural reforms are not a guarantee ofsustainable macroeconomic performance when thepolitical will to achieve it is not there.

The report highlights the importance of labormarket reforms as a necessary adjustment mecha-

nism for an economy with a fixed exchange rate.This is an issue on which the staff from differentdepartments presented a unified view, while man-agement and the Board, at least on some occasions,overruled that view. In fact, a package of labor mar-ket reforms was also present during the first part ofthe 1990s and again in the Stand-By program of2000. More than the regulatory framework, how-ever, market pressures on the labor market forcedsubstantial reductions in wages, particularly in theprivate sector. This is yet another instance of ideo-logical bias. Labor market reforms were constantlypressed on, on the assumption that “labor marketrigidities” were the main cause behind ever increas-ing unemployment rates, but, as we have seen,wage reduction, labor reforms, and even growth (inthe early 1990s) were coupled with increasing un-employment rates. The report itself provides mea-surements of competitiveness based on unit laborcosts that showed significant gains during the pe-riod under analysis. Thus, it could hardly be pro-posed that one relevant reason of the demise of theCBA has been labor market rigidities. The reasonwas indeed rooted in the fiscal front that repre-sented a major failure of Fund surveillance.

The report raises the issue that the staff did notmake an assessment on how suitable the CBA wasfor Argentina. The relevant consideration, however,is if the macroeconomic policies implemented wereconsistent with the CBA, which they were not. Thisis the most serious surveillance mistake. In addition,the handling of the Tequila crisis was presented as aproof of the strength of the CBA when in fact it onlyproved the shrewdness with which the authoritiesaddressed the crisis. This enhanced credibility of theCBA, endorsed and strengthened by the IFIs throughcontinued programs and explicit laudatory publicstatements, led to both abundant resources availableto the authorities and to a consequent sense of self-complacency from all the interested parties—in par-ticular from the IMF, which overlooked the risks in-volved in the continuous creeping up of the debtlevels. The impact on market behavior during thoseyears and the potential responsibilities for the Fundstemming from its reckless support for the CBA arenot, in our view, duly stressed in the report.

Argentina’s case during the 1990s offers a fertileground to analyze the issue of ownership, a key com-ponent of our surveillance exercise in the Fund, onwhich the report also offers recommendations that wedo not fully share. Practically all types of possibleownership scenarios were present in Argentina’s rela-tionship with the Fund throughout the period coveredby the study. On the part of the Fund, the CBA was atthe beginning tolerated, then accepted, then warmlysupported to the extent that even at the end there wasnever an alternative scenario developed by the staff in

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which a flexible exchange rate system was a con-stituent part.

Argentina’s ownership of policies under the pro-gram, on the other hand, was for the most part un-questionable. The report highlights, however, the ten-sion created when unquestionable ownership is atodds with what the staff considers appropriate poli-cies. We believe, in this regard, that if we expandedthe period analyzed by the report to the more recentpast we could find quite contrasting responses on thepart of the Fund to the same type of problem. In 2001the authorities implemented policies without the con-sent of the Fund, and even with its opposition, whilethe program continued until the unsustainability ofpolicies was impossible to hide any longer. Contrast-ing with the former experience, during the more re-cent experience of 2002 up until September of 2003the authorities were unable to persuade the staff on aneconomic program that could be supported on amedium-term basis, despite strong evidence that theirpolicies were producing stable and sustainablegrowth. Here we have two cases of full ownership notshared by the staff with two very different outcomesboth in terms of Fund support and economic results.

Leaving aside these two extreme cases, hopingthat they are truly exceptional, we are of the view thatin general, where ownership is clearly present, theauthorities should be given the benefit of the doubtsince they are the ones who know all the facts im-pinging on a given issue and they are the ones whorisk their own political future if they take the wrongdecisions. In addition, the view that all policy recom-mendations issued by the staff are good and reason-able in all circumstances, and that the alternativeviews brought to the table by the authorities are inprinciple wrong, is unsupported by evidence andshould be avoided. It is critical to gain acceptabilityof the Fund’s policy advice, inter alia, by presentingit as an alternative, among others, to the authoritiesand not as the only reasonable one. Also, the socialand macroeconomic costs associated with an even-tual failure of the recommended policies should beassessed, disclosed, and evaluated. Thus, we do notsee much merit in the report’s recommendation 4 thatcalls the Fund to withdraw support when the authori-ties are pursuing strongly owned policies that theFund judges inadequate. We do not believe the morerecent Argentine experience supports that claim.

Crisis Management

Turning now to crisis management, this is clearlythe most difficult problem to address given the inter-play of economic, political, and social factors in-volved. In the first place, and from a purely eco-nomic point of view, to make an assessment if amember is facing a liquidity versus solvency prob-

lem is never straightforward. At times, some dosesof brinkmanship are needed to direct a situation to-wards the best possible outcome. On other occa-sions, as in the Argentine case, an early withdrawalof support could have diminished the consequencesof a crisis. In fact, the earmarked funds of the 2001packages should have been applied to finance afaster and more efficient exit from the CBA.

The IEO report is right in pointing out that eventhough the Fund faces probabilistic scenarios and de-velopments could go as desired, when the risk is highit is important to have a fallback strategy in place ifthe preferred strategy fails. The lack of such an alter-native plan was indeed a major failure of crisis man-agement in the relationship of the Fund with Ar-gentina. We should acknowledge, however, that it isnot the practice of the institution to prepare fallbackplans, and this could become an important lessonfrom the Argentine experience. In any event, each cri-sis has its distinctive characteristics, and it is not pos-sible to pre-define a rigid set of rules to follow.

On the other hand, the Argentine crisis is not thatpeculiar from the point of view of the large amount ofresources that the Fund disbursed; in fact, it is to beexpected that in crisis situations the financial involve-ment of the Fund will be large and front-loaded, as ithas happened in most cases. Under these circum-stances, the catalytic approach to resolve a crisisused to justify the exceptional access policy losespart of its meaning. The question boils down to theinitial and evolving judgment needed as to the liquid-ity versus solvency character of a crisis and the needin the case of the latter to involve the private sector inways other than additional financing. The augmenta-tion of the Fund program in late 2000 and September2001 attempted to reassure markets that Argentinawas facing a liquidity crisis, but both the markets’thought and the reality were otherwise, and the cat-alytic approach failed to materialize.

The September 2001 augmentation contained,however, an explicit earmarking of resources fordebt restructuring. This was an unambiguous warn-ing to markets that a restructuring involving a loss ofNPV for creditors was in the offing. Notwithstand-ing the latter and the obvious risks for the Fund,fresh money was channeled to Argentina on that oc-casion. The report rightly relates the views of those,including from within the staff, that in fact thosefunds would facilitate the exit from Argentine expo-sure of the sophisticated investors that still remainedrather than to actually support the Argentine pro-gram, increasing the already huge debt of Argentinato the Fund in the process. This is indeed very seri-ous. As is evident, the Fund’s 2001 policy towardsArgentina of treating what clearly was a solvencycrisis as if it were a mere liquidity crisis had not onlythe effect of importantly increasing the debt load,

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and of aggravating the financial, economic, and so-cial problems, but also of providing the means to fa-cilitate an easily predictable capital flight.

It is noteworthy that even when the need for adebt reduction operation was publicly acknowledgedby the Fund, the need to make the exchange rate sys-tem flexible was not fully incorporated. The fact isthat in November 2001 the staff prepared a “pre-ferred strategy” involving a package of further finan-cial support that included a change of the exchangerate regime, but not in the direction of greater flexi-bility, as generally expected by markets, but in thedirection of the extreme rigidity represented by thefull dollarization of the economy. The package alsoinvolved debt restructuring representing a reductionof NPV of 40 percent.

The dollarization of the economy was a conceptused by the Menem government early in 1999 to re-assure markets during the critical months that fol-lowed the devaluation of the Brazilian real and thatpreceded the presidential elections in 1999. As thereport states, this had a positive impact on expecta-tions. However, when De La Rúa’s government tookoffice it explicitly rejected the idea of dollarization,reflecting a widespread resistance within the coun-try. Later on, the government expressed its willing-ness to go all the way, including full dollarization ofthe economy if necessary, but it was too late to reas-sure markets this time given the resistances men-tioned. All of this points to the fact that the staff’s“preferred strategy” mentioned above was out oftune with political realities.

Political factors also serve to show the complex-ity and uniqueness of the Argentine case. Althoughthe idea of full dollarization was rejected, the popu-lation at large remained largely in favor of the con-vertibility regime, to the extent that the presidentialelections of 1999 were won by the alliance of partiesthat held the maintenance of the CBA as an essentialingredient of its economic program. On the otherhand, a critical mass of political actors, includingunion leaders and some prominent leaders of thegovernment that took office in December 1999,started to be outspokenly against the CBA exchangeregime. Thus, the political backing was weakening.However, the complexity of the Argentine case, fromthe political point of view, becomes even more evi-dent when observing the overwhelming support thegovernment received in Congress to pass very de-manding laws in the spring of 2001, including thegranting of special taxation powers to the Executivebranch and the zero deficit law that gave the govern-ment ample powers to take whatever measure wasdeemed necessary to revamp confidence and avoidthe change of economic model. This was insuffi-cient, nonetheless, to reverse the self-reinforcing dy-namic unleashed during the whole of 2001, which,

as it is now clear, found its roots in the weaknessesof the model from its beginning in the early 1990s.

In closing these paragraphs on crisis managementwe have serious doubts that, notwithstanding the im-portance of having a fallback plan and of avoidingthe assumption of excessive financial risks for theFund, it would be feasible, or even beneficial, to de-velop stop-loss rules as suggested by recommenda-tion 1 that may guide decisions on when to support aprogram and when not. The staff should, however,continue refining their analytical tools so as to pro-vide the Board with a varied set of indicators of thetrue nature of country problems, in particular if it isfacing a liquidity or a solvency type of problem. Infact, we find in lesson 9 of the report a quite encour-aging statement as to crisis resolution in the frame-work of solvency problems when the relevant au-thorities are committed in an unprecedented fashionto fiscal responsibility and to taking a major shiftfrom policies that caused such solvency problems.We quote: “Delaying the action required to resolve acrisis can significantly raise its eventual cost, as de-layed action can inevitably lead to further outputloss, additional capital flight, and erosion of assetquality in the banking system. To minimize the costof any crisis, the IMF must take a proactive approachto crisis resolution, including providing financialsupport to a policy shift, which is bound to be costlyregardless of when it is made.”

The Decision-Making Process

The critical role played by management through-out transpires from the report. There are several in-stances of the staff being overruled by managementas for example in relation to labor market reforms,the many waivers granted in the fiscal area, the re-laxation of fiscal targets at the time of the “blindaje,”entailing a loosening of the fiscal responsibility lawsigned by all political parties in 1999, the decision tocontinue supporting the program during most of2001, as well as the decision to withdraw support inDecember 2001. These are all instances of the keyrole played by management. It seems only naturalthat this is the case. It is up to management to distillall the information it receives from the staff, fromthe authorities, from markets, and from civil societyand come up with a proposal to the Board. Whatmakes the job very difficult is that much of the infor-mation it receives is often conflicting, at times eventhe one coming from the staff, and the policy choicesavailable are not always the first best. It goes withoutsaying that management’s job is not merely that ofobjectively distilling information but also consists ofhandling political pressures.

Is there room for the Board to help managementhandle such difficult tasks? The report makes it evi-

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Statement from the Governor for Argentina

dent that there has been not much opportunity forthe Board, as a body, to have a meaningful partici-pation in the main decisions taken regarding Ar-gentina, which has also been the case in many otherinstances. Of course there is acknowledgment of thefact that major shareholders’ authorities let theirviews be known to management. The report doesnot see in principle any objection to that butstrongly advocates for making the Board the locusof decision making at the Fund, as it should be. Thereport calls for a broadening of the dialogue to thewhole of the Board. This is commendable alongwith the call for a greater provision of informationto the Board on all issues relevant to decision mak-ing. In fact, the practice by certain prominent share-holders of bypassing the Board raises serious trans-parency concerns in the decision-making process,not only as to the negative effect on the lack ofproper and adequate debate in the Board as the nat-ural “locus” for discussions, but also as to the“agenda”—other than finding the best possible al-ternative in specific crisis prevention or crisis reso-lution scenarios—that such shareholders might beadvancing. As to the confidentiality concerns thatwould be raised in the framework of expandedBoard discussions, we agree that the means to ad-dress them are already available through mecha-nisms similar to the use of side-letters for example.We have to note, however, that so far experiencewith the confidentiality of similar documents con-taining specific commitments has not been out-standing since it is not uncommon for these docu-ments to leak, some way or the other, into the press.

It is important, however, to analyze the interestingobservation in the report regarding the behavior ofdeveloping countries in the Board which, as the re-port says, as “potential borrowers,” usually go alongwith management proposals to support a membercountry. Reality is more complex than this, and sev-eral other factors have a bearing on developing coun-tries’ behavior at the Board. For instance, given thelimited available resources of the Fund (their relativeimportance vis-à-vis the international capital mar-kets is ever shrinking), one would expect “potentialborrower countries” to advocate limiting the grant-ing of packages to relevant competing “fellow bor-rowers.” Additionally, if the report’s view were to betaken as a premise of the analysis, then much of therecommendation presented in the report on the need

for greater Board participation in the decision-mak-ing process would be inconsequential. The outcomewould seldom be different since developing coun-tries, according to the report, would always side withmanagement, which in turn tries to incorporate theviews of major shareholders. In our view, however,developing countries are quite capable of formingindependent views from those of management, par-ticularly when provided with relevant information,and we therefore see merits in the report’s recom-mendations for a more participative decision-makingprocess on the part of developing countries as wellas others that may not have the same opportunities topresent their views directly to management.

Beyond this, it should worry all of us that the IEOreport points out shortcomings in governance andtransparency in the handling of the Argentine crisis.These shortcomings are indeed compounded by thefact that representation at the Board does not ade-quately reflect the importance of emerging economiesin the global economy.

Conclusions

As a way of conclusion, we would like to statethat whereas the concept of exceptional financingapplies fully to the Fund support received by Ar-gentina during 2001, the financial assistance Ar-gentina is currently receiving from the Fund underthe present Stand-By program is of a completely dif-ferent nature (despite that we are still calling it ex-ceptional financing). In fact, as it transpires from thereport, Argentina is not only paying for its own er-rors but also for those of the Fund. The report high-lights the risks assumed by the Fund during the trulyexceptional increase of exposure that took place in2001. Indeed, neither the Fund nor Argentina wasbenefited by those misguided policies. The differ-ence of course is that Argentina is the debtor and theFund the creditor (a preferred creditor for that mat-ter), which entails it to remain current on a huge debtfor which Argentina is not solely responsible.

Finally, it should be recognized that this institu-tion has the courage to expose and analyze its ownmistakes. This should be commended. Recognizingerrors is, however, just the first step in a healthy self-criticism exercise. The second step is bearing re-sponsibility for failures, namely sharing the burdenof redressing their consequences.

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Executive Directors commended the IndependentEvaluation Office (IEO) for preparing a balancedand comprehensive report on the Fund’s role in Ar-gentina during 1991–2001. They noted that the re-port raises important questions about the Fund’s en-gagement during that period, and seeks to drawvaluable lessons and recommendations in key areasof the Fund’s work, including surveillance, programdesign and review, and the Fund’s decision-makingprocess. Directors welcomed the opportunity to re-flect on the report’s assessment of that engagement,and agreed that it will be important to set up aprocess through which the relevant lessons and rec-ommendations could be incorporated into the Fund’soperational and policy development work.

Directors recalled that the period covered by theIEO report began with the introduction of the con-vertibility regime that pegged the Argentine peso atpar with the U.S. dollar and ended with that regime’scollapse accompanied by a default on Argentina’spublic debt. The 2001 crisis was one of the most se-vere in any country in recent years, and brought con-siderable hardship to the Argentinean people.

Directors generally agreed that the crisis stemmedfrom the prolonged inconsistency of fiscal policywith the convertibility regime. The primary responsi-bility for the choice of policies and for economic out-comes remains that of the national authorities, who inthis case failed to take the necessary measures suffi-ciently early to address this inconsistency. The Fund,for its part, erred by supporting Argentina’s weak andinconsistent policies for too long, even after it be-came evident that the political ability to deliver thesupporting fiscal discipline and structural reformswas lacking. Directors raised a number of questionsabout the Fund’s decision-making process as it con-tinued to provide support to Argentina. In this con-nection, some Directors pointed to the challenge oftaking difficult decisions in the pressured environ-ment of a rapidly developing crisis.

Directors broadly agreed with the thrust of thelessons and recommendations of the report, whichaddress important weaknesses identified by the IEOin surveillance and crisis management. They cau-tioned, however, that the applicability of some of thelessons to other crisis situations could be limited,since Argentina is a unique case in many respects.Directors noted also that a number of the report’srecommendations are in line with policies and re-forms which the Fund adopted following the crisesin Argentina and other emerging market countries,but they recognized that further additional work isneeded, including on how to ensure that the policiesadopted are, in fact, implemented.

With regard to crisis management, Directors dis-cussed the report’s recommendation that the Fundshould have a contingency strategy from the outset ofa crisis, including, in particular, “stop-loss rules” thatwould help determine if the initial strategy is workingand signal whether a change in approach is needed.Most Directors viewed contingency planning as use-ful, and a few saw merit in setting out an exit strategyif there are indications that the program could becomeunsustainable. However, many Directors noted that ina crisis or precrisis setting, it is not always possible toassess the various contingencies that might occur, andthat an element of prompt adaptation to rapidly evolv-ing events is unavoidable. Concern was also ex-pressed that any indication that the Fund was devel-oping contingency strategies could undermineconfidence in the program. Clearly further reflectionwill be needed in this area to establish what can con-structively be done in ways that enhance confidence.

As regards “stop-loss” rules, while some Direc-tors supported their consideration, most felt thatdefining and implementing such rules would be dif-ficult or impractical. These Directors considered thatdetermining whether the crisis resolution strategy isfunctioning will invariably depend on judgment anddiscretion, based on the available information at the

THE CHAIRMAN’S SUMMING UP

INDEPENDENT EVALUATION OFFICE REPORT ON THE



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Summing Up by Chairman

time. Other Directors noted that the Fund’s condi-tionality and program reviews provide a mechanismintended to ensure that the Fund continues to pro-vide its financing only so long as the policies envis-aged are being implemented and are on track toachieve their objectives.

Directors agreed with the IEO’s recommendationthat in cases where the sustainability of debt or theexchange rate is threatened, the Fund should clearlyindicate that its support is conditional upon a mean-ingful shift in the country’s policy. At the same time,they noted that assessing sustainability in these twocomplex areas, particularly in a crisis situation, willnecessarily entail judgment. It is essential that theBoard be provided with up-to-date and comprehen-sive information and analysis to make such judg-ments. Directors recognized that steps have beentaken since the Argentine crisis to strengthen thebasis on which such assessments are made: in partic-ular, the procedures on exceptional access and thedebt sustainability template. At the same time, Di-rectors looked forward to an opportunity to assesswhether further changes in the Fund’s policies andprocedures may be needed.

Directors considered that the Argentine experi-ence had important implications for the Fund’s sur-veillance, an area in which there had been markedprogress since the crisis in Argentina. They con-curred with the IEO’s recommendation thatmedium-term exchange rate and debt sustainabilityanalyses should form the core focus of IMF surveil-lance. Directors stressed that the choice of exchangerate regime must remain with the member’s authori-ties, but the Fund is obliged to exercise firm surveil-lance to ensure that other policies and constraints areconsistent with this choice. In this light, Directorscontinued to see a need—which was emphasizedagain recently in the Board discussion on the bien-nial review of surveillance—for greater candor inthe treatment of exchange rate policy in the contextof Article IV discussions, both in meetings with theauthorities and in the information presented to theBoard. Most Directors stressed, however, that re-ports on exchange rate assessments and discussionsneed to strike an appropriate balance between can-dor and confidentiality to avoid triggering a poten-tially destabilizing market reaction. In this connec-tion, it was suggested that the scope for establishingprocedures for handling sensitive topics during sur-veillance exercises should be explored by the staff.On exchange rate sustainability, Directors cautionedthat finding an appropriate operational measurewould be difficult; however, a few suggested that thedevelopment of such a measure by the staff shouldbe a priority.

Directors recognized that the Fund has intensifiedits analytical work on medium-term debt sustainabil-

ity. Recent events have led to a reassessment—notonly in the Fund, but in the economics professionmore generally—of what level of debt is sustainablefor emerging market countries, with the concept of“debt intolerance” playing an important role. Such areassessment is already reflected in the Fund’s workwith the development of the debt sustainabilityframework. Directors asked staff to continue tosharpen its analytical tools in this area, and a fewcalled for examining ways to strengthen the organi-zation and independence of DSA work.

Directors noted the possible risks associated withprecautionary Fund arrangements, especially wherethere are serious political obstacles to needed poli-cies and reforms. In cases such as Argentina, wherea member’s favorable macroeconomic indicatorsmasked underlying structural and institutional weak-nesses, it was particularly important to avoid com-placency. Most Directors did not think that precau-tionary arrangements tended to be weaker than otherarrangements, noting that in some cases precaution-ary arrangements signaled superior performance. Di-rectors agreed that there is a need to ensure that pro-gram standards and requirements for precautionaryarrangements are the same as those for all otherarrangements.

Most Directors did not support the implication inthe IEO report that the Fund should not enter into aprogram relationship with a member country whenthere is no immediate balance of payments need. Intheir view, the experience of Argentina does not pro-vide a basis for this conclusion, and they reiteratedthe value of precautionary arrangements as an im-portant tool for supporting sound policies and pro-moting crisis prevention more generally.

Directors expressed concern about the IEO re-port’s assessment of the quality of cooperation be-tween the Argentine authorities and the Fund, partic-ularly in the period leading up to the crisis. Theyviewed some of the authorities’ actions during 2001as documented in the report as not conducive to asatisfactory program relationship—particularly theirimplementation of some key measures without con-sulting the staff and their refusal to engage the staffon some key areas of policy, notably the exchangerate regime. Many Directors were also concernedthat the Board was not kept adequately informed ofsuch breakdowns of cooperation. In this light, Direc-tors stressed that all cases of the use of Fund re-sources, particularly cases of exceptional access,should entail a presumption of close cooperation,and some Directors suggested that clear guidelinesshould govern communications by both the authori-ties and the Fund on program issues. Directors en-couraged management and staff to keep the Boardfully informed of the state of policy discussions withcountry authorities in the context of financial pro-

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SUMMING UP BY CHAIRMAN

grams, including with regard to any critical issue orinformation that the authorities refuse to discusswith or disclose to staff and management. Many Di-rectors agreed with the IEO’s suggestion that thereshould be a requirement of mandatory disclosure tothe Board of any critical issues which the authoritiesrefuse to discuss.

Directors were concerned with the report’s assess-ment of the Fund’s decision-making procedures dur-ing the crisis, especially as it pertains to the role of the Board. In this regard, a number of Directorssaw a need for further discussion of approaches to

strengthen the role of the Board. Directors noted thatthe procedures for exceptional access adopted sincethe Argentine crisis have generally worked tostrengthen the Board’s involvement and ensure thatdecisions to continue program engagement under ex-ceptional access are adequately informed. At the sametime, they called for further efforts to enhance deci-sion making by the Board, including through im-provements in the provision of full information on allissues relevant to decision making, and open ex-changes of views between management and the Boardon all topics, including the most sensitive ones.

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