Summary of the Case Study
Profits at the global banking group HSBC have fallen after it made provisions of more than $1.1 billion to cover losses from the economic crisis in Argentina. The Argentine crisis accounted for $1.12 billion of the write-down - which was slightly higher than analysts had forecast. The figures were in line with analysts' expectations and this helped push shares in HSBC 59p higher to close at 837p. Last year Argentina descended into chaos as people protested against draconian policies introduced to try and avoid default on overseas debt and devaluation of the peso. Eventually the pressures became too strong, and Argentina defaulted on its debts and floated the peso against the dollar. HSBC took a $520m charge to cover losses stemming from the change in value of the peso, and a general provision of $600m for losses in Argentina. Concerns about HSBC's exposure to the crisis in Argentina came to the fore yesterday as it emerged that its investment banking arm was preparing to lower its profits forecast for the company. HSBC Group's 2001 results, notably the economic crisis in Argentina and the related devaluation of the peso by the government which forced HSBC to book a US$1.12 billion charge. Argentina has been a major disappointment foe HSBC and they have a very talented team and all the necessary elements for success in a stabilised economy to have a profitable business. Nevertheless, the situation in Argentina remains both fluid and disturbing. The Argentine monetary collapse in 2001 was devastating to the economy and to a large number of Argentine citizens. Their currency was pegged to the U.S. dollar, 1-to-1, but sank to 3-to-1 after the collapse. The resulting loan default, naturally, created a firestorm in the global financial community. The fine print to all this, however, is that, in Argentina, like everywhere it seems, the rich got richer and the poor got one hell of a lot poorer. Of course, the sanctimonious world press, smelling blood, rushed in. At least there was some, albeit grudging, admission of IMF culpability but, as one could predict, not for the right. Argentina's government won a respite from its mounting economic crisis last night as fears that the peso would go into freefall in its first day of trading against the dollar for a decade proved unfounded. After opening at about $2.20, the peso staged a rally in afternoon trading, breaking through $1.90, and raising hopes that the government's gamble on floating the currency would pay off. Developments in Argentina in the past few days are sad. The economic fundamentals are a basket case -- the nature of the country's problem is not so much a currency issue, but a major fiscal and debt problem. Exports account for a small proportion of Argentina's GDP, and even if the currency depreciates significantly, it is debatable how far this would help the economy. There's a big hitch, however: The government, having defaulted on $143 billion in debt, has no standing to issue new paper. And its bid for a $20 billion rescue package from the International Monetary Fund, which could be used to back a bond issue, is stalled. The IMF wants to see the government implement a bare-bones budget and get a grip on the money supply before it puts up more. From an investor’s point of view, some mistakes, such as fiddling inflation figures, which the national statistics agency has been accused of doing in recent months, are too big to forgive. Investors also hope that finally an action plan to tackle the energy shortage is being developed. Bankers and companies realize that this problem is likely to be solved by a combination of foreign investment with local management. But the foreign investment is not going to flow into large-scale, five-year to 10-year projects. This is also penalizing Argentine money that was moved offshore just before the crisis '' now these funds can’t return easily, and so aren’t returning. Despite Argentina growing at an average of 8.8% for the past three years, having a trade surplus of 6% of GDP, and holding a current account surplus of 3.5%, the market is still pricing in risk that isn’t reflected in these measures. Even if inflation is 12% or 8%, this isn’t at a level that is out of control. The government’s default in itself may force Argentina out of international capital markets for at least a decade as investor confidence will be slow to recover, particularly if the government does not negotiate the debt restructuring favorably. Consensus participants expect the recession to have persisted through the end of 2001, with economic activity contracting again by 2.6% in the whole year, down from the 0.5% drop observed in 2000. Forecast participants continue to await a more satisfactory conclusion to the current crisis and, therefore, the disparity between different forecasts remains very large with growth estimates ranging from a minimum contraction of 0.5% to a maximum decline of 11.4%. HSBC renewed its warning that it might pull out of Argentina entirely if the political situation worsened, and said it would invest no new shareholders' money there until the situation became clearer. The main dampener on profits was$1.11 billion uplift in bad debt provisions which took the charge to $2.04 billion. Some $1.12 billion of the provision related to the Argentina crisis, of which $520m reflected the anticipation that HSBC would receive no compensation for the effects of the forced devaluation of the peso.
Q. 1. What are the major factors that caused the peso to fall in value against the dollar? What has the government done to reverse the recession?

Ans: Problems:

1. Consumers and firms: huge amounts of dollar denominated debt

'''Rising debt burden'''bankruptcies

2. Government sold debt to Argentine banks

'''huge write downs'''losses'''bankruptcies'''bank runs

3. Bankruptcies + write downs + bank runs:

Fewer loans''' economic activity down''' depreciating of the''' Currency...

➢ Why no earlier devaluation of peso?

' ' Fear of returning inflation

' ' Huge amounts of foreign denominated debt

' ' Hope for a favorable change

➢ What are the consequences of the devaluation of peso?

1.) (Exports up'''GDP up)

2.) Large number of bankruptcies

3.) Bank runs

'''Recession

'''unemployment rises

'''poverty

➢ Major factors

• Fixed Exchange Rate

• High debt

A. Exports down

Imports up

'''Trade imbalance

''' Current account deficit

''' Debt

B.) Exports down ''' GDP down''' Recession''' taxes down

''' Pressure on the government

'''debt up

'''or taxes up ... further fueling the recession

The stages leading up to the caused that peso to fall in value against the dollar can be summarized as follows:

• There are at least three factors that are related to the collapse of the currency board arrangement and the ensuing economic crisis:

• Lack of fiscal discipline

• Labor market inflexibility

• Contagion from the financial crises in Brazil and Russia

❖ Government debt grew rapidly during good times with the debt financed at low interest rates.

❖ During an economic downturn, debt growth accelerated until international lenders began to question the government's ability to repay the debt. Interest rates began to climb.

❖ Interest rates accelerated to unsustainable levels as international lenders first demanded higher interest rates to accommodate higher and higher perceived risk.

❖ Lenders panicked triggering a collapse of the currency, the banks and the economy.

❖ The strong peso hurt exports from Argentina and caused a protracted economic downturn that led to the abandonment of peso'' dollar parity in January 2002.

❖ The unemployment rate rose above 20 percent

❖ The inflation rate reached a monthly rate of 20 percent

Government done to reverse the recession

Accusations:

1. Argentina not warned adequately of the danger of its policies

2. Concretionary policies

3. “Sustained the unsustainable”

➢ In 1991 the Argentine government passed a Convertibility law that linked the peso to the U.S. Dollar at parity.

➢ The initial economic effects were positive

➢ Argentina’s chronic inflation was curtailed

➢ Foreign investment poured in

➢ As the U.S. dollar appreciated on the world

➢ Market the Argentine peso became stronger as well.

Lessons for the government:

1. Fixed exchange rate is dangerous

2. Short term foreign debt is dangerous

3. Privatization, opening the economy to trade, etc did not cause the crisis

Q. 2. What has been Argentina’s experience with the IMF? Has the IMF been helpful or not?

Ans: Argentina’s experience with the IMF

The occurrence and severity of the Argentine crisis has been particularly disturbing to the Fund given its extensive engagement for many years beforehand. There is little doubt that the Fund’s experience in Argentina calls for some fresh thinking about its role, both in normal times and in the context of a crisis.

➢ The International Monetary Fund suffered no discounts in its part of the Argentine debt. Some payments were refinanced or postponed on agreement. However, the authorities of the IMF at times expressed harsh criticism of the discounts and actively lobbied for the private creditors.

➢ In 2005, as a large and consistently growing fiscal surplus made it possible, Argentina shifted to a policy of "disinvestment" towards the IMF: paying the IMF in schedule, with no negotiation whenever possible, with the intention of gaining independence from it.

➢ There are shortcomings in Fund surveillance in identifying key vulnerabilities early, and in bringing about needed changes once these vulnerabilities became apparent. The Argentine experience with IMF highlights the risk that, in a program country, where attention is focused on implementation of the program, it is easy to lose sight of the need for a fresh and critical assessment of the overall direction of policies.

➢ A second area in which the Argentine experience with IMF has had an important impact is with regard to the decision to commit IMF resources. The Argentine experience with IMF raises difficult questions about how the IMF can strike the right balance between supporting a member country experiencing difficulties without financing—and implicitly perpetuating—policies that are doomed to fail. Following the collapse of the currency board, the IMF took a more cautious approach by waiting for the authorities to assemble a viable policy package rather than rushing to provide new financing.

➢ The Argentine experience with IMF raises more general questions about the Fund’s use of its “seal of approval”. Attempts to make strategic use of the “seal of approval” ultimately devalue that signal and compromise the Fund’s credibility more generally. The limits to the Fund’s involvement should be based on the underlying quality of policies, not on the perceived cost of withdrawing support. That said, the Fund’s decisions to continue or withdraw its support to a member country in particular circumstances are always decisions made under uncertainty, and it is more likely than not that the Fund will continue to make occasional judgment errors and take decisions that will prove wrong ex post.

➢ The IMF did not provide it’s financing in a situation when the debt dynamics are clearly unsustainable in Argentina. To the extent that such financing helps stave off a needed debt restructuring, it only compounds the ultimate cost of such a restructuring. This consideration has led the IMF to search for better ways of facilitating debt restructuring in cases in which it is a necessary element in the policy package.

Has the IMF Helpful or not?

Yes IMF obviously Helpful

Role of IMF Internationally

' ' '98: “explosive cocktail in Argentina” and “Molotov Cocktail”

' ' Less pressure after Russia's default in '98

' ' Dec 2000: 14 billion $ loan

' ' Aug 2001: 8 billion $ loan

1. The IMF acknowledges that it played a large role in causing the current crisis of Argentina’s economy.

2. The IMF, World Bank, Inter-American Development Bank, and other official creditors declare a moratorium on Argentina's debt service payments until the economy has recovered from the recession and achieved solid growth for at least a year.

3. The IMF (and US Treasury) should not try to impose austerity conditions on Argentina, and they should not take advantage of the crisis to impose other conditions for opportunistic or ideological reasons.

4. The first priority of any economic program of IMF must be to revive spending and production, and pull the economy out of the depression.

5. The IMF state publicly what it is demanding from the Argentine government.