This piece is the second in a four-part series covering recovery economics in the Southern Cone.
Despite Uruguay and Argentina’s parallel economic successes and failures during the five-year period after the 2002 Financial Crisis, the two riparian countries’ economic patterns began to diverge by the 2008 global economic downturn. In Argentina, the inflation rate rose due to indifferent tax collection policies that allowed public spending to outpace available tax revenues and forced the government to resort to printing money. Despite Argentine goods being attractive on the international market—due to Chinese demand for agricultural commodities as well as other Southern Cone countries’ demands for Argentina’s manufactured goods—Buenos Aires remains cut off from international financial markets. Across the Río de la Plata, Uruguay’s investment in its institutions as well as its targeted industrial policy have encouraged more consistent growth. Montevideo’s economic policy has contributed to de-dollarization because of a growing trust in the Uruguayan peso, a phenomenon that Argentina still strives to achieve. Nevertheless, as a small, open economy geographically linking two emerging nations, Uruguay is significantly affected persistently by economic volatility coming from Argentina and often finds its trade policy restricted by policies put into effect by the Southern Cone’s Mercosur trade bloc. After Uruguay and Argentina both grew considerably for the first five years of their respective recovery efforts, the cracks in Argentina’s populist economic policies undeniably began to emerge. These cracks highlight the diverging policies that have gained Argentina little trust in the world marketplace while Uruguay enjoys an increasingly favorable global reputation.
The 2008 Financial Crisis and De-Dollarization
The global downturn in 2008 retarded growth in both Argentina and Uruguay, but neither country fell into a recession. The GDP growth rate dipped to .8 percent in Argentina and 3 percent in Uruguay, mostly due to contracting global demand, resulting in a steep reduction in current accounts.  However, the 2008 downturn combined with relaxed tax collection policies led to mounting inflation in Argentina. For the first time since the 2002 crisis, the government reduced the growth of the Argentine money supply to below 10 percent in an attempt to curb inflation. Although Buenos Aires officially claimed an inflation rate of 10 percent, unofficial estimates placed it somewhere around 25 percent. The government resorted to draconian policies such as jailing economists who publish these unofficial statistics, demonstrating the Kirchner administration’s fear of any depreciation based on speculation.  Nevertheless, even with the global economic cool-down, the Argentine economy still somewhat grew during the worst years and quickly recovered to a pre-crisis level of growth.
Commodity prices crashed in 2009, resulting in a reduction in export value and thereby revealing the largest difference between the two recovery models. In the post-2002 era, the Uruguayan Central Bank instituted wide-sweeping reforms that sought the advantage of social institutions to help rekindle trust between the constituencies and the government. Thus, Uruguay’s economy has seen relative de-dollarization in recent years, as the citizenry begins to trust the Uruguayan peso once again. Deposit dollarization declined by 10.5 percentage points between 2001 and 2010 and credit dollarization decreased by nearly 30 percentage points, demonstrating strong financial fundamentals and macroeconomic stability.  Such figures indicate that Uruguayans began using the peso for consumption and investment rather than relying on the steadiness of the dollar. Moreover, the transparency of the Central Bank in its foreign capital purchases and interactions with the private sector provided sufficient incentives for the internalization of currency risks while at the same time inducing peso investment. Finally, a developing domestic capital market encouraged trade in pesos rather than mainly in dollars. Thus, the Uruguayan Central Bank’s recovery policies relieved the rapid dollarization seen before the 2002 crisis, thereby bringing stability and investment.
While Uruguay enjoyed relative de-dollarization, Argentina experienced a rapid dollarization due to the currency controls on the Argentine peso. The peso remained largely undervalued for much of the mid-2000s due to the Kirchner policy of hording foreign reserves. Mimicking East Asian policies following the 1997 financial collapse, Argentina hoped to accrue enough reserves to protect itself from default; by the 2008 crisis, Argentina had easily fulfilled this aim. The forcibly low exchange rate in relation with the U.S. dollar raised domestic prices due to heightened global demand for Argentine products. However, because the Central Bank failed to de-dollarize the economy, Argentines tended to spend their wages before an expected depreciation. This trend expanded demand, which, in turn, pushed prices up even further. For a country with a history of hyperinflation and little trust in its domestic currency, the Argentine exchange policy only made the recovery more precarious.
Furthermore, corruption in the Argentine government has hindered economic development in many industries where tax evasion is prevalent and the government commonly colludes with domestic and foreign businesses. According to WikiLeaks, in September 2007, the U.S. ambassador to Argentina, Earl Anthony Wayne commented that “when Argentine officials argue ‘there is money to be done in Argentina,’ maybe the true message is that yes, there’s money to be done as long as you know how and with whom you can really make business deals.”  In a sad scandal, President Cristina Fernández de Kirchner became entwined in corruption allegations surrounding the human rights group Madres de Plaza de Mayo and its housing-construction arm Shared Dreams. Shared Dreams used its many ties to the Kirchner family to win 45 million USD in public funds from Kirchner’s late husband Néstor toward this project, in which price hikes appeared to hide embezzlement by the company.  Such corruption funnels government funds to favored businesses, inducing the Central Bank to print more money. Further, the corruption drains resources from many already suffering Argentine social institutions such as the educational system, only adding to distrust of the government.
Debt Restructuring and International Financial Markets
While defaulted loans and extended debt restructuring has prevented Argentina from gaining access to international financial markets, Uruguay quickly restructured its sovereign debt and was able to deepen its connections to such markets. Nevertheless, Argentina’s status as an international pariah also allowed Buenos Aires to focus on reducing its debt rather than incurring further debt through an IMF Stand-By-Agreement (SBA). According to Argentine Finance Minister Hernán Lorenzino, after its default, the Kirchner administrations made attempting to lower the numerator in its debt to GDP ratio a pillar of reform.  In this sense, Argentina has succeeded, reducing its debt to GDP ratio from 153.2 percent in 2002 to 37.2 percent in 2008. By 2006, directly after a mandatory debt exchange program that helped save the government an estimated 1 billion USD in interest from defaulted bonds, the government had reduced public debt by 76.5 percent. With an additional restructuring in 2010, the total amount of debt restructured totaled 92.6 percent. Argentina cannot return to international markets, however, until settling its 7.5 billion USD owed to Paris Club countries. Nearly a quarter of those with Argentine debt still refuse to restructure their bonds under such harsh conditions imposed by Buenos Aires.  Argentina tried to force debt holders to exchange their principles; therefore, the Argentine scheme can be categorized as a hard debt restructuring. Using similar policies, countries such as Greece could restructure their sovereign bonds and alleviate some economic concerns. The Argentine recovery proves that even after a massive default, it is possible for a country to repay its debtors without completely sacrificing its budgetary policy or national dignity.
The hard restructuring scheme undertaken by Argentina directly counters the soft policy pursued by Montevideo. Utilizing a collaborative effort between the Central Bank and its creditors, Uruguay underwent a voluntary debt exchange in 2003 that lengthened maturities while keeping coupons and principles constant, thereby easing pressure on the Central Bank to repay their foreign-owned bonds.  Even with the additional debt burden brought on by the IMF’s SBA, Uruguay was able to reduce its debt to GDP ratio to only 25 percent by 2011, a level that can be sustained well into the future with further macroeconomic stability. At the same time, Uruguay has protected itself from a similar financial crisis by building up foreign reserves without inducing major inflationary concerns. The soft approach likely would not work in country such a post-Eurozone Greece; however, Uruguay’s approach to debt restructuring could buy time for further recovery policies to take effect in larger economies with debt worries, such as Italy, while maintaining a favorable position with international financial institutions.
Protectionism and Mercosur
Along with debt restructuring and de-dollarization, Argentina and Uruguay are also beginning to diverge in their trade policy. Mercosur, with a combined population totaling 270 million and a GDP nearing 3 trillion USD, currently stands as the fifth-largest economy in the world and the fourth-largest trading block behind the EU.  Although this group possesses sizable markets for Uruguayan and Argentine products, nationalism has largely prevented integration. Argentina and Brazil have long dominated the trade bloc, leaving Uruguay vulnerable to the two regional powers’ semi-protectionist policies. As a large and emerging economy, Argentina wants to protect its domestic industries and therefore has raised its common external tariff in recent years.  Global Trade Alerts, a database that monitors restrictions on international commercial activity, reports that Argentine imposes more “harmful” trade restrictions than any country in the world aside from Russia.  Because Buenos Aires cannot raise import tariffs without Mercosur’s consent, it resorts to informal tools such as non-automatic licensing to delay imports by as much as 60 days. As The Economist reports, “Argentina has made no pretense of honoring that time period,” and continuously expands the list of goods encompassed by this non-tariff barrier to trade.  Argentina’s protectionism stands in stark contrast to Uruguay’s internationalization approach and has brought on tension between the two nations on trade policy.
Moreover, internal trade disputes between Brazil and Argentina have further destabilized a unified regional trade policy. In response to and in light of Argentina’s protectionism, Brazil has implemented a plan that would require approval for shipments of automobiles, with a two-month waiting time for each application.  The new policy harms both its neighbors as Argentina sells over 80 percent of its cars to Brazil, an industry that accounts for nearly 7 billion USD annually. With the non-tariff barriers, this automobile trade will decline. Further, growing protectionism already is harming Uruguay, which relies on Argentina and Brazil as its two largest trade partners. As a small, open economy, Uruguay has sought to diversify its trading partners and has even initiated negotiations on FTAs with European and North American countries. However, Mercosur has consistently blocked Montevideo’s progress. The Argentine government, in particular, has made it clear that Uruguay cannot sign a FTA with the United States while still inside Mercosur.  These cracks inside the trade bloc only appeared after the 2002 Financial Crisis weakened the region’s economies, and have intensified in recent years.
The divergence between the Argentine and Uruguayan economies became very apparent after the first five years of recovery. The Argentine default cut Buenos Aires out of all international monetary institutions, leading to a hard debt-restructuring scheme, maintenance of the dollarized economy, and a protectionist trade policy. Nevertheless, while a growing number of questions regarding the long-term sustainability of Argentina’s recovery remain, Buenos Aires reduced its debt to GDP ratio and fostered growth in the trade sector, providing validity for its unorthodox approach. Uruguay, with a soft debt-restructuring policy, a growing internationalization of the economy, and greater transparency leading to de-dollarization, has continued its astounding recovery, leaving few questions as to the sustainability of the growth. The divergence between the two countries’ recovery paths can be attributed to the differences between a large and small economy. But together, the Argentine and Uruguayan recovery efforts prove that the fiscal austerity and monetary conservatism are not the only economic tools to induce growth and emerge from a financial crisis with an internationally viable and impressively expanding economy.
Eric Stadius, Research Associate at Council on Hemispheric Affairs
Originally published on September 11, 2012
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