Economics: LatAm lesson for EU

In spite of the traditional warning accompanying investment products, that past performance is no guide to future performance, when it comes to the eurozone crisis precedents can most definitely be cited.

The most recent of these was Latin America’s financial crises, culminating in Argentina’s default in 2001. Here are some of the lessons investors can learn from the Argentine crisis 11 years ago.

2001: Crisis in Argentina

- Reductions in fiscal deficits through budget cuts or tax increases did not inspire confidence or improve stability in Argentina. Instead they caused public unrest, leading to riots, runs on banks and the eventual resignation of the government.

- Argentina relied on a currency peg to the dollar and only started to recover once it abandoned the peg and reverted to the peso. Devaluation of the currency helped exporters and also boosted import competing companies.

- The country relied heavily on foreign creditors to buy their bonds and the economy, which had a debt to GDP ratio of roughly 50 per cent before its default. It was also sensitive to external events and shocks, particularly from neighbouring countries. The Brazilian and Mexican currency crises exacerbated Argentina’s situation.

- The government initiated an exchange rate policy in the second quarter of 2002. It strengthened foreign exchange controls and intervened in the foreign exchange market by selling and later buying dollars and restricting the outflow of pesos. This helped to stabilise the country and manage the inflation that ensued after the peso was devalued. By 2003 the government set out its plans to maintain a “stable and competitive real exchange rate”.

- Argentina’s default was not as expensive as expected. A paper from the US Center for Economic and Policy Research suggested the IMF placed pressure on the government to offer better terms to the defaulted foreign creditors but eventually a debt swap was arranged in 2005 that wiped $67.3bn of foreign debt off the books, at the time a record 65.6 per cent “haircut”.

- Further measures implemented following the default included two taxes. One was applied to financial transactions and the other to exports. This allowed the government to get some of the windfall profits that exporters received as a result of the devaluation. Together these two taxes pulled in roughly 2.7 per cent of GDP in 2004.

2012: Crisis in Europe

- Peripheral European countries in particular, but also core European countries such as the UK, have imposed austerity measures as a way to tackle government deficits. However, the trend in recent months has been towards growth and away from austerity, as demonstrated by the election of left-wing French president François Hollande.