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Banks not be able to shoulder the debt burden

April 2001

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IDB meetings go banana-shaped



Chile is reckoned to be the best organized country in Latin America, so no-one was expecting any surprises when Santiago was chosen to host the Inter-American Development Bank (IDB) annual meetings in March.

It was expected that there would be lots of optimism about Mexico and its investment-grade credit rating, optimism too about the surprisingly smooth way in which the Peruvian elections seem to be panning out, and positive noises about a US soft landing and the way in which Argentina, with the help of the IMF, was attempting to extricate itself from economic stagnation.

It didn't quite work out like that. Chile did its bit, to be sure: riot police vastly outnumbered the small groups of foolhardy protesters, who were dealt with in typically forthright fashion. But the US didn't manage to step up to the plate: plunging stock markets and talk of forthcoming recession got everybody worried about the rest of the hemisphere, especially Mexico. One of the biggest worries was that far from rebounding quickly, the US would have a "banana-shaped" recovery. And Argentina had obviously thrown away the script completely.

First the finance minister, Jose Luis Machinea, resigned a couple of weeks before the conference was due to start, to be replaced by economic hawk Ricardo Lopez-Murphy. Political support for the new minister was never strong, and seemed to evaporate completely on the Friday before the meetings, when he announced $4.5 billion in budget cuts in an attempt to bring some semblance of balance to Argentina's fiscal accounts.

The verdict came within a couple of hours. Every minister belonging to the junior partner in the ruling Alliance coalition resigned, plunging Argentina into a full-scale political crisis. Suddenly, what had been unthinkable only a few hours previously was now necessary: the ambitious Domingo Cavallo would have to be brought back into government.

In 1991, as economy minister under former president Carlos Menem, Cavallo devised the convertibility plan which fixed Argentina's exchange rate. Cavallo came nowhere in the 1999 presidential elections and also failed to get elected mayor of Buenos Aires. He may see the present crisis as an opportunity to revive his presidential ambitions. Cavallo was in Santiago on Saturday morning, but quickly flew back to Buenos Aires for negotiations with president Fernando De la Rua about joining the Cabinet.

Meanwhile, Guillermo Perry, the chief economist for Latin America at the World Bank, was giving a presentation about the effect of the US slowdown on Latin America. His conclusion? "The farther away from the US, the closer to God". Mexico was going to be hit hard, but South America was much less reliant on the US economy continuing to boom. Perry, however, hadn't built political turmoil into his economic models. Deutsche Bank's head of emerging markets strategy, Jose Luis Daza, had an unarguable rejoinder: "The further you are from the US," he said, "the closer you are to Argentina".

For the rest of the conference, Argentina was the only topic of discussion. Bankers clustered around the Bloomberg terminals in the Hyatt, watching Argentine Brady bonds crash to new lows, with the spread on the benchmark FRB bond widening out to 1,150 basis points over treasuries. The Brazilian real was dragged down, forcing intervention from the Brazilian central bank and casting doubt on Brazil's ability to make its 4% inflation target for 2001.

Superlatives started flying. This was the most difficult crisis Argentina had faced since convertibility, said Miguel Kiguel, former Argentine finance under-secretary and now president of Banco Hipotecario.

One day previously, Carlos Massad, the governor of the Bank of Chile, had been shrugging off worries that the Argentine crisis might spill over into Chile. Now, contagion was seen everywhere: even possibly from China.

Development bank meetings often coincide with crises. The difference at this meeting was that no-one could see a way out. The Brazil crisis dominated the 1999 IDB meetings, for instance, but the mood was overwhelmingly upbeat, with the market trusting new central bank president Arminio Fraga to work some magic.

In 2001, there is no obvious way past the Argentine political impasse, and even if there were the country would still have enormous difficulty financing its huge debt burden. It's already been bailed out once: the market can't hope for a second IMF package so close to the first. The rating agencies started to draft their downgrade notices.

And even if Argentina's fiscal woes were magically to disappear, there's still the fact that the country seems congenitally unable to grow. Thirty months of deflationary recession have depressed consumer and business confidence to the point at which total credit continues to decline even in an environment of falling interest rates.

Something of a morbid mood was the order of the day: bankers started placing bets on how long Lopez-Murphy would keep his job, and the booze at the lavishly funded bank receptions tended to get polished off long before the events were due to finish. Even Argentine officials gave up any pretence that there was anything normal about the situation, openly admitting that they had no idea what was going on and that even if they did, everything was bound to change in a matter of hours.

The temperature peaked, in more ways than one, at 3pm Santiago time on Monday. Lopez-Murphy and De la Rua were scheduled to give a presentation at Mapocho Station, the convention centre housing the conference, and everybody in town was determined to go.

Bankers who had flown down just for their own meetings in hotels outside the city centre suddenly started casting around for ways to gain admission to the conference proper. Television feeds were set up, security was tightened.

By 2.30pm the seminar room where the presentation was due to take place was already full to bursting; by 2.45pm the overflow room, with its audio-visual link-up, was full as well.

That was bad news for the Argentines. Mapocho Station, a former railway terminus, gets its grandeur from its lofty steel roof, and is therefore almost impossible to keep cool during the heat of the day. As bankers crowded into the seminar room, shoving their way towards the video screens, the temperature and humidity rapidly became unbearable.

Eventually, it dawned on the assorted crowd that Lopez-Murphy was sitting at the table, alone and was about to start speaking. As the cameras zoomed in, he launched into a familiar litany: how he was committed to fiscal adjustment, how convertibility was not at risk, how Argentina would never default, and so forth. If the strength of any currency peg is inversely proportional to the vehemence and frequency with which its inviolability is asserted by government officials, then Argentina's foreign exchange regime will not last long.

The bankers were getting restless. There was nothing new here. Lopez-Murphy was simply going over the details of his economic plan, and refusing to talk about the biggest worries, which were political in nature: he didn't even mention Cavallo. Lopez-Murphy was at a disadvantage in that he couldn't see most of his audience, but that's hardly unusual for a politician. In any case, he was losing whatever goodwill the delegates might have borne him as they mopped their brows and further loosened their ties.

Things only got worse with the arrival of the president. By this point, bankers were crowding into anywhere with a television, giving a whole new meaning to the phrase press room. De la Rua was exhausted, on the verge of having to be physically propped up by his aides. Looking at him, there was no doubt that the arrival of Cavallo would turn the presidency into little more than a figurehead's office. De la Rua, like his finance minister, stuck to economics, receiving only the barest minimum of applause.

Hours later, the bankers - by now partying to the Gipsy Kings at a concert organized by Credit Suisse First Boston - learnt that the trek to Mapocho Station had been a complete waste of time. Lopez-Murphy had resigned, and Cavallo had consigned the new economic plan to the wastebin. Consumption of pisco sours - the Chilean national drink - increased above its already-high level.

By the following morning, the meetings still officially had two days to run, but to all intents and purposes they were already over. The Argentines and the bankers had flown to Buenos Aires, and the markets were much more interested in how much Alan Greenspan would cut rates than they were in whether Argentina's Peronists would grant Cavallo the power to rule by decree. Argentina had failed to resolve its latest, and largest, crisis just as every banker and investor in the region was gathered in the same place. The bankers will continue to look for mandates, but the investors look as though they've thrown in the towel already.

The only question now is how bad Argentina can get. Investors aren't crunching fiscal numbers any more. They've already moved on to trying to place a dollar value on Argentine moral hazard: the fact that the international financial community is desperate that its first poster-child not go the way of Russia.

Cavallo will probably ask the IMF for more money, and no-one knows what the answer will be.

Back in Chile, the authorities will remember the IDB meetings of 2001 as the time when their best-laid plans were comprehensively scuppered. Chile itself was all but ignored as the financial community glommed onto Argentina, and the financial community only saw bad news despite the attempted emphasis on the good.

Next year, the IDB meetings will be held in Brazil. The hope must be that in 2002 there will perhaps be more talk of fruitfulness and less talk of bananas.