Oxford Analytica Brief

ARGENTINA: Economic Emergency

EVENT: The government of President Eduardo Duhalde announced a package of emergency economic measures, including devaluation of the peso

(Part 1 of 2: economic impact; Part 2 follows).

SIGNIFICANCE: The new economic measures will put an end to the eleven-year-old convertibility plan, which pegged the peso at parity with the dollar. While the changes seem inevitable and may help to generate longer-term economic recovery, their consequences will be painful and may cause new protests.

ANALYSIS: Peronist Senator Eduardo Duhalde took office as Argentina's interim president on January 2, three days after the resignation of the previous transitional leader, Adolfo Rodriguez Saa. Unlike Rodriguez Saa, Duhalde received the support of all major political parties and was named to serve out the remainder of the term of resigned President Fernando de la Rua, ending on December 10, 2003. Peronist economist Jorge Remes Lenicov was named as economy minister while Carlos Ruckauf, governor of Buenos Aires province, was appointed foreign minister. Ruckauf, rather than the economy ministry, will lead the re-negotiation of foreign debt.

ECONOMIC PLAN: Duhalde announced that the suspension of foreign debt repayments earlier imposed by Rodriguez Saa would be maintained, as would a series of austerity measures within the government; ministers and secretaries of state were ‘invited' to waive their salaries for six months.

However, Rodriguez Saa's other proposed policies, such as the creation of a third currency -- the argentino -- were scrapped. On January 4, Duhalde sent an emergency economic package to Congress, which both houses approved in a weekend session. The bill, which declares a public emergency in social, economic, administrative, financial and exchange rate matters, gives Duhalde emergency powers throughout the duration of his term to implement policies in such areas. The principal provisions, announced by Remes Lenicov on January 6, include the following:

-- The currency board will be eliminated and the peso devalued. The official rate will be 1.40 to the dollar for foreign trade and capital operations, while a parallel floating rate will be applied for tourism and other transactions. It is planned to move toward a free floating rate for all operations within six months.

--Banking controls imposed on December 1 will be maintained for an unspecified period, although restrictions on access to salaries will gradually be eased to allow withdrawals of up to 1,500 pesos per month.

--Dollar-denominated credit card debts and loans of up to $100,000 will be converted to pesos at the current one- to-one rate. Utility tariffs will also be ‘pesoised' at the one-to-one rate and will subsequently be payable in pesos, not index-linked to the future exchange rate. This will require re-negotiation of the contracts of privatized utility companies, which permitted those companies to fix tariffs in dollars.

-- A temporary tax on hydrocarbons exports will be imposed, and the revenue transferred to banks to compensate for the losses arising from the ‘pesoisation' of credit card and mortgage debts. New government loans may also be taken for that purpose.

-- Price caps will be imposed on some essential items such as medicines, fuels and utilities.

-- Staff cuts and dismissals without due cause will be suspended for a 90-day period.

-- The Central Bank will issue $3 billion worth of new peso notes in order to increase the monetary base in circulation. The bank will also be authorized in future to issue new money to be used to buy dollars.

-- The president will be authorized to carry out a reordering of the banking, financial and exchange rate systems. An ‘exchange rate holiday' will be imposed on January 7 and 8, during which banks will be able to carry out only peso operations, in order to avert a run on the dollar and an even sharper devaluation once the emergency legislation comes into force.

OPPOSITION DOUBTS. While it is hoped that devaluation will increase competitiveness and generate growth in the medium term, the new norms have already generated negative reactions in various quarters. Despite business assurances that prices will not be increased, consumer prices have risen by some 20% in recent days as retailers brace for a devaluation, and restrictions on credit card acceptance have increased. Further rises appear inevitable, and inflation -- negative in recent years -- is estimated to reach 8% in 2002. Even this figure appears optimistic, given that policies such as parallel exchange rates, capital controls and the printing of money have resulted in hyperinflation in the past.

The Spanish government and Spanish companies -- which own the majority of privatized firms -- have also criticized the measure as prejudicial to their interests. They have called on the Argentine government to respect the original privatization contract terms. France has expressed similar concerns. Spain on January 1 assumed the presidency of the EU, and it may use this position to increase pressure on the Argentine government.

Despite the ‘pesoisation' of some debts and contracts, devaluation will also generate short term balance sheet problems for both individuals and companies, leading to more bankruptcies and to a further reduction in consumer purchasing power. Both De la Rua and Rodriguez Saa were recently forced to resign by popular protests at economic measures, and Duhalde is likely to face further demonstrations against the impact of the new package.

BANKING SYSTEM. The increasing weakness of the banking system is also a source of considerable economic risk. Although banks will receive some $6 billion in funds to offset the impact of new measures – which convert assets into a devalued peso while liabilities remain in dollars -- banks claim the cost may in fact be as high as $20 billion. Most foreign-owned banks removed funds from Argentina before the December 1 controls were imposed, and banks now lack cash to cover normal transactions.

This shortage of cash further undermines the economy, while there is a serious risk that international banks -- opposed to the ‘pesoisation' of debts and banking controls -- will pull out of the country. A crisis of this magnitude would increase the problem of governability.

BUDGET WOES. The devaluation will be insufficient to reduce the budget deficit to a manageable level. Despite efforts to impose a `zero deficit' in the past six months, the 2001 budget deficit is now estimated at some $11 billion. This implies that the 2002 budget will probably have to maintain existing wage and pension cuts and make further substantial cuts if it is to achieve the zero deficit sought by the government. A new 2002 budget bill has not yet been presented; until that budget is approved, there will be no further negotiations with creditors.

Once a budget is accepted, Remes Lenicov is set to begin talks with the IMF and with the U.S. Treasury in early February to seek some $20 billion in new aid -- some of it from existing undisbursed credits -- while Ruckauf will initiate efforts to renegotiate the country's foreign debt. However, in the light of the present suspension of payments and the continuing crisis, it is unlikely that the government will be able to count on new funds to cover even an austere budget, while further deep cuts will increase popular dissent. Remes Lenicov has admitted that the IMF has called for an immediate floating exchange rate, and has stressed that the official exchange rate will be freed within a few months, once rates stabilize.

CONCLUSION: Lack of liquidity, high costs and falling dollar reserves had made the convertibility plan unviable, and its elimination was inevitable. However, the end of the currency board will cause further economic distress at all levels and will not in itself halt the crisis. If there is no economic recovery in the short to medium term, popular opposition may make the task of governing virtually impossible.

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ARGENTINA: Economic Emergency

EVENT: The government of President Eduardo Duhalde on January 6 announced a package of emergency economic measures, including devaluation of the peso.

(Part 2 of 2: political consequences).

SIGNIFICANCE: The economic measures proposed will have painful consequences and may cause new protests. However, the lack of viable alternatives and the relatively wide institutional support for Duhalde make a further change in government less likely.

ANALYSIS: Peronist Senator Eduardo Duhalde was chosen by the Legislative Assembly as Argentina's interim president on January 1, two days after the previous transitional leader, Adolfo Rodriguez Saa, was forced to resign only one week after taking office. Rodriguez Saa, generally perceived as corrupt and a political lightweight, provoked strong public protests by incorporating into his cabinet members of the administration of Carlos Menem (1989-99), who is accused of corruption. At the same time, his ambition to retain the presidency beyond the three-month limit initially set, and the announcement of a series of populist measures -- including the creation of a new currency (the argentino), job-creation schemes and scrapping cuts in public sector wages and pensions -- lost him the support of leading Peronist figures and provoked his rapid resignation.

Unlike Rodriguez Saa, a figure from the second division of the party who received only a narrow mandate from the Legislative Assembly, Duhalde was chosen by 262 votes in favor (there were only 21 against and 18 abstentions), having negotiated the support of both the Radical and Frepaso parties which had formed the Alianza coalition of former President Fernando de la Rua, as well as the Peronists. Also unlike Rodriguez Saa, Duhalde was named to serve out the remainder of De la Rua's term, ending on December 10, 2003. He confirmed that he would not be a candidate in the October 2003 elections.

Cross-party support for the government was demonstrated by the vote on the emergency economic package: the bill was supported in the Lower House on January 5 by the Peronists, Radicals and Frepaso, as well as the Polo Social and Socialist parties. It received similar support one day later in the Senate, albeit with some defections by individual Peronist and Radical senators.

DUHALDE DOUBTS. The designation of Duhalde has both positive and negative implications:

--On the positive side, Duhalde is a powerful figure within the Peronist party and has vast political experience, having served as mayor of the Buenos Aires suburb of Lomas de Zamora, vice-president under Menem (1989-91), and governor of Buenos Aires province (1991-99). As the Peronist presidential candidate in 1999 he received around 39% of the vote, despite strong opposition from then president Menem, Duhalde's chief enemy within the party. Following that defeat, Duhalde's position was strengthened by his convincing victory in the October 2001 senatorial elections in Buenos Aires.

-- He has voiced opposition to existing economic policies over many years, and the decision to abandon the currency board does not therefore represent a change of heart on his part.

-- However, Duhalde has been the subject of persistent corruption allegations throughout his career. This, and his image as a populist who increased social spending and left a heavy budget deficit in the province during his term as governor, makes him a controversial figure, in particular for the middle classes whose protest demonstrations were crucial in bringing down both De la Rua and Rodriguez Saa. Those sectors will be especially hard hit by the economic program announced on January 6: although there is no readily apparent alternative to the planned devaluation and the maintenance of banking controls, middle class sectors have already suffered from four years of recession and will not accept further economic hardship with resignation, in particular given widespread distrust of Duhalde.

UNCERTAIN FUTURE. Despite these doubts, Duhalde's designation as president is the most realistic alternative to try to stabilize the highly volatile situation. Unlike Rodriguez Saa, Duhalde is a political heavyweight and a pragmatist who enjoys the support -- at least at present -- of both leading Peronist figures and of the other major parties. In effect, given the discrediting of the Radicals in particular and the unwillingness of other Peronist figures to sacrifice their future ambitions by taking on a difficult and unpopular task, Duhalde is the strongest option within the political establishment.

It cannot automatically be assumed that Duhalde will retain the support of other political parties if public opposition becomes stronger. The support of the Radicals in particular reflects primarily their wish to avoid the calling of new elections this year, as their own party is heavily discredited in the eyes of the voters. However, the lack of a viable alternative within the political establishment will help to sustain the support of institutional parties and will make it more difficult for Duhalde to be forced out of office by popular protests; De la Rua and Rodriguez Saa lacked the support of even their own parties, facilitating their removal.

PERONIST AMBITIONS. The Peronist party damaged its credibility by its initial choice of Rodriguez Saa as an interim president whom it considered too inadequate to represent a threat to the presidential aspirations of its major figures. The party will not wish to undermine its position further by abandoning Duhalde. Moreover, other leading Peronists have a vested interest in Duhalde's success:

-- A reasonably successful Peronist transition government would strengthen the chances of the party's presidential candidate next year, implying that probable contenders such as Foreign Minister Carlos Ruckauf and provincial governors Jose Manuel de la Sota, Carlos Reutemann and Nestor Kirchner will make every effort to support Duhalde.

-- Ruckauf will use the post of foreign minister to further his presidential ambitions. These may be advanced by the fact that he will relinquish his post as Buenos Aires governor and therefore evade the blame for any future worsening of the economic and social situation. On the face of it, Ruckauf is not the most plausible choice of foreign minister -- he has a poor image abroad as a result of corruption allegations, his deficit spending during his term as governor, and his espousal of a `hard line' on crime which translated into a virtual carte blanche for police abuses. However, his desire to improve that image will make him seek to perform well in his post, in particular with respect to the renegotiation of foreign debt.

-- Self-interest will further unite other party leaders against Menem, still president of the party and its only major figure who could benefit from Duhalde's failure. Menem, already facing low public opinion ratings, has seen his position further weakened in recent weeks by his decision to support both De la Rua and Rodriguez Saa, against the current of popular opposition. His already slim chances of competing for the presidency in 2003 would be virtually eliminated by a moderately successful performance by Duhalde.

POPULAR PRESSURES. Popular protests to date have expressed opposition to the government and to political figures across the spectrum, but not support for any specific alternative candidate or policy. Given economic constraints, even another change of government would imply little possibility of a significant policy change. Although fears have been expressed of a populist backlash, as yet no such alternative figure has emerged from outside the establishment -- Rodriguez Saa, who attempted to fill this role, was quickly ousted. Even the armed forces no longer represent a likely contender to occupy a future power vacuum. If major protests continue, rather than generating yet another change of leader, the government is likely to resort to emergency measures and increased repression.

CONCLUSION: Duhalde's controversial image and the inevitable imposition of unpopular economic measures will make governability difficult to maintain. However, reasonably strong cross-party consensus and the lack of other alternatives within the political mainstream improve his prospects for survival. If Duhalde were to be forced to resign, the resulting power vacuum would make the future even more uncertain and a complete collapse of the political system a real possibility.