Debt Management: Some Reflections Based on Argentina

A good liability management strategy is one that helps minimize the cost of borrowing over the medium and long term. The objective is not to save the last basis point in each transaction, but rather to bring down the overall borrowing cost. This paper uses Argentina`s experience to illustrate some important elements in the design of a liability management strategy. It takes into account the specific characteristics of the Argentine capital market and of the debt instruments that are available.

The Argentine Currency Board

This paper evaluates the usefulness of a currency board regime based on Argentina’s experience. Argentina adopted the currency board in March 1991 to put an end to a long history of large macroeconomic imbalances and high inflation that culminated in the hyperinflation process of 1989-91. The regime has been extremely successful in restoring macroeconomic stability and ensuring low inflation. The adoption of a tight fiscal stance, and of sound polices to strengthen the financial system were critical to ensure the resilience of the economy to respond to adverse external shocks. The paper will argue that a strict exchange rate rule like the one used in Argentina can be a strong alternative to other exchange rate regimes to ensure macroeconomic stability in a globalized world with highly integrated capital markets.

Inflationary rigidities and stabilization policies

Latin American countries provide the best living laboratory to study inflationary processes and stabilization programs. The purpose of this paper is to analyze the experience with orthodox stabilization policies, which are based on a tight fiscal stance and not supported by a system of price controls. The analysis of these policies is structured as follows. Part I analyzes in detail the question of why purely orthodox policies were especially effective in stopping hyperinflation as opposed to chronic inflation processes. Part II turns to chronic inflation countries and analyzes three basic types of stabilization. The first type is based almost exclusively on fiscal adjustment. The second considers programs which employ nominal anchors in conjunction with fiscal adjustments. The third type examines the exchange rate based stabilizations which often evolve out of a monetary-fiscal package. In the final part of the paper, the authors consider the long run view which extends beyond specific programs and emphasizes the importance of persistence in fiscal discipline and in adherence to nominal anchors.Environmental Economics&Policies,Inflation,Banks&Banking Reform,Economic Stabilization,Economic Theory&Research

Lessons from the heterodox stabilization programs

This paper draws lessons from the advantages and disadvantages of the heterodox stabilization approach in chronic high inflation countries. Heterodox stabilization programs make temporary use of some income policies - price and wage controls - to support orthodox policies. Heterodox programs were successfully tried in two chronic high inflation countries, Israel and Mexico. In both cases these programs were followed by a second, more orthodox stage and included the use of the exchange rate as the nominal anchor. While the programs succeeded, both experienced costs in the form of an appreciation of the real exchange rate and high real interest rates. The main lessons from the experiences as analyzed by the authors are : 1) the initial, rapid reduction in inflation at the beginning of heterodox programs is the easy part; the difficult part is to maintain price stability over time; 2) income policies in heterodox stabilization programs are only justified in high chronic inflation countries (with annual rates of inflation above 100 percent) where inflationary persistence is more pervasive and problematic; 3) there is a case for a larger fiscal adjustment in heterodox programs because of the risk that a government that starts with price controls could be confused with one that tries to achieve price stability without adjusting; and 4) a heterodox program that fails is likely to lead to a large amount of inflation instability.Economic Theory&Research,Environmental Economics&Policies,Economic Stabilization,Insurance&Risk Mitigation,Insurance Law

Dual and multiple exchange rate systems in developing countries : some empirical evidence

The authors examine the determinants of the parallel exchange rate for a cross-country sample of developing countries. The sample includes countries in which the parallel exchange rate is official (dual exchange rate systems) as well as those in which it is unofficial (black market). They base their empirical analysis on a portfolio macroeconomic model in which the parallel exchange rate is determined by expectations and equilibrium asset considerations in the short run, but depends on the evolution of key policy variables (such as stock of money, budget deficits, and trade policy) in the long run. The results indicate that macroeconomic variables explain more than 70 percent of the variation in the spread between the official and parallel exchange rates. The authors cannot reject the hypothesis that there are no differences in the determinants of the spread when the parallel rate is official and unofficial. Also, they cannot reject the hypothesis that restrictions on the capital account affect the spread. These results are consistent with prior findings that portfolio considerations dominate the determination of the parallel rate in the short run. There is evidence that the adoption of dual exchange rate systems only partly insulates domestic prices. This insulation may be limited by : 1) a leakage of transactions from the official to the parallel market; and 2) depreciation of the parallel exchange rate.Fiscal&Monetary Policy,Financial Economics,Economic Stabilization,Economic Theory&Research,Macroeconomic Management

Exchange-rate-based stabilization in Argentina and Chile : a fresh look

Exchange-rate-based stabilization is designed to reduce inflation by using the exchange rate as the main nominal anchor. This does not necessarily mean a fixed exchange rate. A crawling peg with a low rate of depreciation or a pre-announced gradual reduction in the rate of devaluation are alternative ways to use the exchange rate as a nominal anchor. Exchange-rate-based stabilization (ERBS) has been widely used in the high-inflation economies of Latin America. Argentina, Chile, and Uruguay adopted a pre-announced crawling peg in the late 1970s (the famous tablitas) to bring down inflation, with mixed results. Israel and Mexico used the exchange rate as a nominal anchor, and inflation came down significantly. More recently, Argentina relied on a fixed and convertible exchange rate (the convertibility plan) to bring to an end four decades of inflation. So far, the outcomes have been good. The authors find that ERBS have generally been more effective than money-based programs in bringing down inflation in the high inflation economies. But when inflation was reduced gradually, the process resulted in continuous (sometimes significant) real appreciation. Even fixing the exchange rate in Chile in 1979 did not reduce the underlying rate of inflation. Argentina's recent convertibility plan has been more successful in bringing inflation down significantly than previous money-based programs (from monthly rates of about 10 percent to just 1.5 percent in a few months). One could argue that this is a special case, since Argentina was coming from full-blown hyperinflation, so the authors compared the fixed-exchange-rate periods in Argentina and Chile, and came up with useful insights. Argentina's greater success cannot be explained only by fiscal arguments. When Chile fixed its exchange rate in 1979, it wasalready enjoying a budget surplus. Argentina in 1991 was running a small deficit - smaller than in previous years, but a deficit. Perhaps a better explanation is the government's perceived strong commitment to the fixed exchange rate and the potential large costs of reneging on it. The convertibility law made devaluation far more difficult (requiring congressional approval) and reduced the chances of discretionary devaluation. And the government tied its own hands further by legalizing the use of the dollar as a unit of account and means of exchange. The costs of abandoning the fixed exchange rate were also perceived to be greater in Argentina. Devaluation was (and is) perceived as opening the door for renewed hyperinflation, a dreadful scenario. Chile did not face this threat so it was more difficult - and took longer - to convince the public that the government was determined to maintain the parity. Governments tend to stick to the fixed exchange rate longer than is prudent. It is now apparent that some flexibility at an earlier stage would have reduced the costs of the final failure of the tablitas. Why do governments find it so difficult to make exchange-rate policy more flexible? Why do they wait for a balance of payments crisis rather than anticipate it? Perhaps because they fear the public will equate flexibility with failure and a loss of credibility. The authors found, however - in the experience of Israel and Mexico - that inflation does not necessarily go up when the exchange rate is made more flexible. Countries must balance the need to maintain an exchange rate rule (for credibility) with the need to keep external balance.Economic Stabilization,Economic Theory&Research,Environmental Economics&Policies,Macroeconomic Management,Fiscal&Monetary Policy

Some implications of policy games for high inflation economies

The authors used the policy game approach to gain insight into a problem that has puzzled analysts of high inflation economies. Why are programs based on tight fiscal and monetary policies slow at reducing inflation in high inflation countries? Distinguishing between regimes of rule and discretion the authors explain that governments that cannot abide by policy rules and tend to use surprise inflation in a discretionary manner to achieve short term goals ( e.g. eroding the real wage or the real value of domestic debt ), raising the rational public's inflationary expectations. If policy makers can convince the public that they will not resort to surprise inflation tactics, the long term level of inflation may be reduced considerably. Another problem addressed is how should policymakers who are genuinely interested in disinflation react to adverse public expectations? The policymakers are faced with the dilemna of sticking to their announced policy and paying immediate costs in terms of unemployment and capital flight, or compromising their initial targets at the cost of renewed inflationary expectations. They conclude that lack of credibility generates disinflation costs. And if the source of a credibility problem is the inability of weak policymakers to honor their committment, strong policymakers may need to compromise to some extent.Environmental Economics&Policies,Economic Theory&Research,ICT Policy and Strategies,Inflation,Banks&Banking Reform

Parallel exchange rates in developing countries : lessons from eight case studies

In parallel (dual) foreign-exchange markets - extremely common in developing countries - a market-determined exchange rate coexists with one or more pegged exchange rates. The authors report the main lessons from a World Bank research project on how these systems work, based mainly on case studies in Argentina, Ghana, Mexico, Sudan, Tanzania, Turkey, Venezuela, and Zambia. On the whole, the experiences were disappointing. Most countriestolerated high premiums for long periods, which harmed the allocation of resources and growth. The studies indicate no clear gains from prolonging a dual system. The case for a dual foreign exchange system is stronger when the system is adopted as a temporary option to deal with a severe balance of payments crisis. Argentina, Mexico, and Venezuela resorted to a dual system at the time of the debt crisis, to smooth out the devaluation in the exchange rate to achieve the needed real depreciation. This helped to maintain limited control over domestic inflation, and avoided a sharp drop in real wages while protecting the balance of payments. In the longer term, not much was gained. In the cases studied, the dual system was misused more often than not: it was used too long and the premium was higher than is should have been. Venezuela, for example, used the system for six years with an average 120 percent premium, Mexico for five years (average 30 percent), and Argentina for eight years (average 44 percent). In Argentina and Venezuela, the dual system was used to avoid macroeconomic adjustment while protecting international reserves. It is doubtful the macroeconomic gains (in terms of keeping equilibrium in the balance of payments and lower inflation) were greater than the costs in terms of misallocation of resources. In Ghana and Tanzania, the dual exchange rate system was prolonged to maintain overvalued real exchange rates and expansionary macroeconomic policies. The large premium in those countries (at times more than 1,000 percent) shows the dramatic inconsistency between exchange rate policy and monetary and fiscal policies. On determinants of the parallel exchange rate, the evidence indicates that macroeconomic fundaments (such as fiscal deficit, credit policies, and so on) matter most. In the short run the premium is driven by expectation about the evolution of these macroeconomic factors. Overall, in the countries examined in the project, the existence of a parallel foreign exchange market generated fiscal losses. These losses resulted because the public sector was a net seller of foreign exchange rate. This means that unification has some pleasant fiscal arithmetic. The experience with unification indicates that it usually takes place at the parallel exchange rate. Most countries unified to a crawling peg system, though some opted for floating exchange rates. Successful unification to a fixed exchange rate was less frequent, and it required strong adjustment in fiscal and monetary policies. Regarding speed, unification was quick in countries where the parallel system was used temporarily, and gradual in those where the system existed for long periods and with a tradition of widespread foreign exchange controls.Financial Economics,Economic Theory&Research,Economic Stabilization,Fiscal&Monetary Policy,Macroeconomic Management

Devaluation in low-inflation economies

In the current period of devaluation pessimism, devaluation is often seen as an instrument to accommodate inflation instead of one to change the real exchange rate and support external balance. The authors argue that such pessimism has in some cases gone too far. The real exchange rate is an endogenous variable, and whether devaluation can change the real exchange rate depends on other factors. But devaluation is not always evil, say the authors, and in some cases it can improve macroeconomic performance. It is most effective if it corrects an initial situation where the currency is clearly overvalued. In low-inflation countries, devaluation is less likely to destabilize prices because there is less indexing. The authors examine the effect of maxi-devaluation in low-inflation countries on the real exchange rate, inflation, and growth. They use a sample of 33 maxi-devaluations (20 percent or larger) in economies that had low inflation before the devaluation and where the exchange rate had remained fixed for at least three years before the devaluation. Not surprisingly, most of these episodes occurred in the 1950s and 1960s, when fixed exchange rates and inflation were the norm. The results indicate room for devaluation optimism. The authors find that devaluation is more effective in low-inflation economies where devaluation is a sporadic event - typically, effecting a real depreciation twice as large as that in inflationary economies. In low-inflation countries, a 50-percent devaluation typically succeeds in depreciating the real exchange rate by about 30 percent in the long run, without leading to a permanent increase in inflation. The authors also find that growth and exports increase after devaluation. Other findings include the following. Countries determined to maintain price stability after devaluation can do so. In countries with low inflation that have not devalued for three years, a maxi-devaluation is not likely to move the economy into high inflation. Under most of the most likely scenarios, inflation will increase around 3 percentage points (or 35 percent of the original rate of inflation). Under the best scenarios, there is an increase in inflation the year before and the year of devaluation, but inflation then falls to a level slightly higher than the level before devaluation. Devaluation has a favorable impact on exports. The shift to a more flexible exchange-rate regime was not associated with complete loss of control of inflation. In most cases, inflation went up slightly - and in only a few cases (Ecuador, Israel, Mexico, and Zaire) dramatically.But the movement toward greater exchange-rate flexibility was not associated with complete loss of control of inflation. In Pakistan and Rwanda, inflation fell, and in most countries it averaged less than 20 percent.Environmental Economics&Policies,Economic Stabilization,Economic Theory&Research,Macroeconomic Management,Fiscal&Monetary Policy