Breaking Bad (The Rules): Argentina Defaults, Inflates (And Grows), 1997–2015

Written Analysis of Case

Submitted to Dr Tanveer Shehzad

20010063

November 3rd, 2019

 Breaking Bad (the Rules): Argentina Defaults, Inflates (and Grows), 1997–2015
Roll No: 20010063

Unusual Case of Argentina Defaults, Inflation and Growth

1. Factors Behind Argentina’s Economic and Societal Breakdown in
2001

The case gives a brief account of Argentina’s history of economic policies and
political instability leading to recession, deflation, inflation among other things.
While economic policies and their implications are highly complicated, it seems like
Argentina’s once Minister of Economics, Domingo Cavallo, and IMF seems to be the
key players behind the crisis of 2001.

In the year 2001, Argentina was facing multiple crises at the same time which
exacerbate the situation.

1.1. Crisis 1: As A Result Of Pegging Of Peso With Us Dollars

Argentina pegged Pesos to US dollars and the intentions behind this measure was it
will end hyperinflation. However, this made them more vulnerable. When the dollar
appreciated against other countries, Argentinian exports and investment became
less competitive internationally. Specially in case of devaluation of Brazil’s currency,
most of Argentina’s industries couldn’t compete abroad and exports dried up. The
only way out of the crisis was the devaluation of Argentinian currency and the
presence of currency board, didn’t allow that to happen.

1.2. Crisis 2: Extensive Borrowing

Governments of Menem and De La Rua, both took excessive debts to either cater to
fiscal deficit and buttress GDP growth from international as well as a local banks.
Due to a limited amount of funds being available, private lending by the
government not only created a situation of crowding out, but it also hiked up the
interest rates.

1.2.1.Interest Rate Hike:

De La Rua took a massive loan of $40 billion to stimulate the economy, however, it
did not yield results. Neither did the tax revenue picked nor did the consumer
confidence index increased. It became expensive for private firms and business to
take up a loan. As investments went down, businesses closed, leading to
unemployment increase, and demand saw a downward spiral. I believe it also
exacerbated the Argentinian Governments’ fiscal deficit situation.

1.2.2. Debt Swapping:

At the beginning of the year 2001, Argentina swapped US$4 billion in bonds
maturing soon with longer-term bonds. They again extended maturities of their
US$30 billion debt in exchange of higher rate of interest equivalent to 15% per
year. Then again towards the end of the year, Argentina attempted for another debt
swap which led to increased capital flight from the country and country risk
increased by 1700 basis points.

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 Breaking Bad (the Rules): Argentina Defaults, Inflates (and Grows), 1997–2015
Roll No: 20010063

What Argentina was attempting here is called Debt Swap. Argentina is swapping its
shorter-term debt for the longer-term. One reason for doing that is to delay the
principal repayment of the bond to the bondholders. This sends out a signal that
Argentina cannot deliver on its principal payments. Debt as a percentage of GDP
rose to almost 55% in 2001. This increases the riskiness of the country and is why
Argentina is offering a higher yield on bonds. Argentina is now leveraged for a
longer period. This adds term-risk. The longer the tenor of the loan, the higher the
risk. Hence the capital flight.

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