Measures Seek to Keep Argentina From the Abyss Latin America: Taxes and tariffs will be imposed to keep the country from economic collapse that could jeopardize billions in foreign investment.

By CHRIS KRAUL, Times Staff Writer

Argentina's economic malaise has reached crisis proportions, which forced it to take radical steps last week in an effort to avoid a financial implosion that could spread to other Latin American nations and discredit the free-market doctrines they have embraced over the last 10 years. Argentina's woes are considered among the world's most worrisome, with symbolic, political and financial ramifications. Latin America's third-largest economy after Brazil and Mexico, Argentina has led the way for economic reforms that have opened emerging markets to outside investment, in expectation of reaping greater growth, jobs and prosperity. But continuing political chaos, plunging bond markets and surging capital outflows have brought the country closer to an economic collapse that could jeopardize billions of dollars in investments by foreign corporations, bondholders and mutual fund investors and cause a reevaluation of a decade's worth of reforms. The urgency of the situation forced Argentina's Congress on Friday to grant emergency powers allowing new Economic Minister Domingo Cavallo to dictate economic policy over the next year. Giving those powers to Cavallo, who enjoys enormous prestige on Wall Street and at home, has generated optimism that the crisis can be overcome. That belief has been scarce lately among Argentines. Instead of the prosperity they have a right to expect after 10 years of painful reforms, they are in the 33rd month of recession and suffering unemployment of 14%. After an unending series of tax hikes and layoffs, a political backlash is gathering steam among citizens who routinely take to the streets to protest the latest austerity measure. The heat is on now because of growing fears that Argentina could default on $88 billion in foreign debt early next year. The reason is simple: The government continues to spend billions more than it takes in from taxes, in part because of irresponsible spending, but also because tax revenues have shrunk along with the economy. Stocks and bonds are falling and capital is fleeing. A debt default looms despite a $40-billion bailout in December led by the International Monetary Fund that was to have provided the Argentine economy with blindaje, or armor coating. That armor now is looking porous and flimsy amid a rising crisis that saw Argentine President Fernando de la Rua fire two economic ministers last month. The default looms next year because that's when the IMF money could run out. "A 33-month slump has turned into a crisis," said Steve Hanke, professor of applied economics at Johns Hopkins University and a former advisor to previous Argentine President Carlos Menem. The increasing odds of a default caused major bond rating firms Standard & Poor's and Moody's Investors Service to downgrade the country's sovereign and corporate debt last month. An Argentine default on its sovereign debt would reverberate throughout the hemisphere as its bonds amount to about 25% of all those issued by emerging-market countries. Just how much contagion would spread to other parts of the world is open to question. Sure to be hurt are U.S. investors, including banks, auto parts makers and consumer goods manufacturers that have invested an estimated $15 billion in Argentina in the last decade. "I think we have seen in the recent past that problems in one country can quickly infect its neighbors," said Jeff Schott, senior fellow at the Institute for International Economics in Washington. "So the immediate concern is not only to forestall a reversal after a decade of tremendous progress but to prevent a new round of instability." Most vulnerable is Brazil, which has a strong trade relationship with its southern neighbor, said Sebastian Edwards, a UCLA professor and former top World Bank economist. He noted that Brazil's currency lost 4% of its value last week amid default fears. Jagdish Bhagwati, an economics professor at Columbia University and authority on developing economies, said an Argentine collapse could scuttle or delay the forging of the Free Trade Area of the Americas, a proposed hemispheric free-trade zone favored by both the United States and Argentina. "We don't want Argentina to go down the tubes because of the role it plays for us as a trade ally and a counterbalance to Brazil, which is more protectionist in its trade," Bhagwati said. "So helping them is a foreign policy argument, not a contagion argument." At risk in Argentina are billions of dollars of foreign investments made over the last decade in telecommunications, banking and energy. International banks, including Spanish and U.S. lenders that have bet on Argentina's prosperity, also could be hurt badly. Cavallo hopes the nation won't come close to needing additional outside aid. To raise cash, Cavallo will impose a financial transactions tax and new tariffs of as much as 35% on imported consumer goods that together will raise $3 billion in revenue and keep the country's budget deficit within the prescribed IMF guideline. Knowing Argentina's only long- term hope is growth in an economy that has shrunk 4% over the last two years, Cavallo also is eliminating duties on imported capital equipment and giving tax breaks to companies that reinvest profits. What isn't apparent yet is whether and by how much Cavallo will try to cut government spending. So far, Cavallo has highlighted revenue-generation measures, mindful that attempts by his predecessor, Ricardo Lopez Murphy, to cut $4 billion in government expenditures resulted in only political outrage and his dismissal. "The crux of this issue is that Argentina refuses to live within its means. But special interests like the tobacco industry don't want to give up their subsidies, the public sector won't take any more downsizing, and taxpayers don't want to pay any more money," said Walter Molano, head of research at BCP Securities in Greenwich, Conn. Cavallo is the much-respected architect of the country's "dollar convertibility" scheme, in which one U.S. dollar is kept in reserve for each Argentine peso in circulation. The plan killed the hyper-inflation of the 1980s and introduced economic stability that, along with other reforms, attracted billions in foreign investment in the 1990s. The economy enjoyed a growth spurt averaging 7% a year during the 1990s, although most of that came in the first half of the decade. "Argentina was a poster child in dealing with fundamental economic problems, notably hyper-inflation and an economy that wasn't performing," said Geoffrey Dennis, Latin America equity strategist at Salomon Smith Barney in New York. But there is a catch to the dollar peg. It is killing trade and economic growth because the strong currency makes Argentine goods unaffordable at home and abroad. "Tying their currency to the dollar solved their basic problem. The question now: Is it the right system for current problems? The answer may be tying the peso to a basket of foreign currencies, including the euro, which I'm afraid would be viewed in the investment community as a backdoor devaluation," Dennis said. Argentina's collapse also would deliver another blow to the IMF, which has been harshly criticized for its handling of bailouts in Asia, Russia and Turkey. Failure in Argentina, with which it has worked closely in the 10-year economic transformation, could be crippling. Will Cavallo's measures--still not fully revealed--be enough to save Argentina from the abyss? The outcome is very much in doubt and could be a cliffhanger that keeps Wall Street on edge over the next year. Mauro Guillen, professor of management at the Wharton School in Philadelphia and author of a book on emerging economies, likes Cavallo's chances. "I don't think Cavallo is going to fail. He's done one thing correctly in recognizing that it's not enough to cut the deficit, that the only long-term hope is in reactivating the economy. He has the right priorities," Guillen said. Among the pessimists is Vincent J. Truglia, managing director of sovereign risk at Moody's. "Argentina has been trying the same thing for three years, driving down costs, imposing austerity, raising taxes," he said. "Now they say they want to drive up productivity, but that's a long, slow process, especially when the government with all its debt is using up all the available credit."

Personal Note: There isn't a snowballs chance in hell that they won't default unless the IMF keeps giving them more money, which of course they will thereby exacerbating the problem.

-- Guy Daley (guydaley@altavista.com), April 06, 2001