BRANDEIS UNIVERSITY International Business School
Case Write-Up
The Fiscal Mismanagement and Fixed Exchange rate were the cause of Argentina 2001 Crisis

Summary: Argentina’s economy verge to a state of collapse in the year of 2001, but the economy started to struggle with an economic recession in 1997. The fiscal mismanagement paired with the fixed exchange rate policy conducted the country to a financial crisis. IMF policies in lending to a country with struggling economy made people think if IMF was the responsible for the default crisis that affected Argentina in 2001.

Public Deficit – The Major “devil”
As economic reforms were happening in Argentina, the country started to face large capital inflows, as it was able to borrow large capital amounts at lower interest rates because of the currency pegging, in the global market. However the government fiscal policies failed to maintain surpluses during economic growth period and actually even during this period the government budget deficits were large.
Fiscal mismanagement can be considered as the main reason for the economic crisis, which includes: * Weak fiscal policy – the fiscal policy should have been adjusted during times of economic rapid growth in order to achieve fiscal surpluses and give a cushion in government accounts against future downturns. Lax in tax collection and high budget expenditures led the government budget to deficits which combined with the economic recessions led to long-run budget constrains because the deficit was unsustainable. * Structural Reforms – failed to place the key structural reforms during the economic growth period in some critical areas hindered the ability of domestic wages and prices to adjust quickly, making the expenditures in social issues higher than normal. * Political Factors – political factors limited the federal government to take decisive actions, and the provinces had been entrusted with major public expenditures responsabilities which reduced the flexibility of fiscal policy.
The Convertibility regime – The second “devil”
Argentina Peso was fixed at 1-to-1 to US dollar, and it helped to improve macroeconomic stability before 1998. However, when Brazil currency faced depreciation and US dollar faced an appreciation among other major currencies, the Argentina currency was overvalued and the country lost competitiveness.

The IMF Role and Banking runs
Argentina currency board gained credibility when passed the Tequila Effect in 1995 and for this reason IMF considered supporting Argentina and the convertibility plan. For this reason IMF was a target of many critics. It also supported a contractionary fiscal policy during the recession period which ended up slowing the economy. So, the basic mistake of IMF was to keep supporting the Argentina economy despite its weakness. What happened when the investors lost confidence in the country is that the banking runs started. People were running to withdrawal their capitals causing a liquidity issue in the banking system.

Conclusion
Argentina fiscal policy could have been more sustainable if the convertibility regime had not been placed.
Argentina should have avoided the economic policies that combine a fixed exchange rate, external over-borrowing and fiscal laws at same time. During the economic boom, the government should be focused in structural reforms and tightened fiscal policy in order to promote or improve the macroeconomic stability. Other point is that the country was depending too much on foreign direct investment which increased the likelihood of a financial crisis when investors started to face credibility issues.
IMF wasn’t the best support for Argentina economy, because even though they were supporting the free float of the currencies, they kept supporting Argentina exchange rate policy. I believe that IMF should have been more austere while monitoring the economy. Also, I believe that capital inflows given by IMF were too large and helped to raise the moral hazard in the economy.
Better fiscal policies and more transparency could have saved Argentina from this economic crisis.

Chart 1 – GDP and Unemployement rates

Chart 2 – Bank Deposit Flow in Argentina

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[ 1 ]. Source: The 2001 Crisis in Argentina: An IMF-Sponsored Default? (A); Harvard Business School Publications