Emerging Markets: 30 Years of Crisis. Part 3: The 2000s and beyond

The 2000s

Dollarization

After several failed attempts of convertibility and currency pegging in Latin America and Asia, a new attempt at FX stability was taking place in Ecuador, out of all places.

The main reason that convertibility had failed in Mexico, Brazil, and several times over in Argentina was that while the currency was pegged to the US dollar, the central banks had not lost their ability to print money, and the international reserves could get depleted faster than the authorities could suck dollars out of the economy.  Central banks often gave into the temptation to print out more money creating implicit devaluations to a point where they could not cope and were forced to devaluate.

The 1996 crisis took its toll in the wider economy, as the real sector started shrinking and the slowing economy began affecting the financial sector. There was an explosion in the banking sector (there were 46 banks catering for less than 12 million people by 1999), and record levels of corporate and consumer loans.  Once again there was a mismatch between the assets and the liabilities that funded them.  Long term investments were funded with short term paper, as short term rates shot up; the Sucre, which by then was free floating (or free falling), dropped 80% of its value in 9 months.  The government gave explicit guarantees for all deposits regardless of the size or rate, this drove banks with problems to start offering aggressive rates in order to attract the most deposits.  This was an unsustainable position that drove the government of Jamil Mahuad to declare a “banking holiday” – a precursor of what 2 years later would be known as “el corralito” in Argentina.

It is important to note that by 1999 Ecuador had a de-facto dollarization, where contracts were drawn in dollars, prices of cars and homes were set in dollars, even everyday goods were quoted in dollars and then multiplied by the day’s exchange rate just before the sell.

The banking holiday would be a week where all banks were to be shut to the public, and most employees would be sent home. The goal was three-fold: first to protect the banks from a run; second allow the banking authorities to run stress tests on the banks in order to determine which ones would continue and which ones would be closed.  Banks were divided into 3 categories: viable, to be restructured, or to be liquidated.  Viable banks would continue business as usual, banks to be restructured needed to be capitalized, merged amongst them or acquired by more stable banks.  Banks to be liquidated were simply dissolved, assets were sold to pay for liabilities, and the government acquired all the toxic assets into one purposely built corporation called AGD (Deposits Guaranty Agency) – something similar to TARP 15 years later.  Third, the week would allow the surviving banks to adjust their banking systems to the new currency: The US dollar.

All assets and all liabilities for individuals and corporations would be converted into US dollars at an exchange rate of 25,000.  After that week all the bank accounts would have a dollar balance.  It took a further year to remove all the cash sucres from the economy.

Argentina 2001

Argentina’s 2001 crisis was another example of convertibility gone badly.  After a decent period of growth, and stability, even surviving the 1995 crisis unblemished, Argentina’s peso pegged to the US dollar became a burden to the export sector.  By 2000 interest rates in pesos were twice as high as those in dollars, which led investors to borrow in dollars and invest in pesos.  By 2001 the country couldn’t take it anymore and the government defaulted on its debt, it would cut billions in government spending which meant that public sector employees would see their wages decline by up to 13% while overall employment dropped by 20%.
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The government created “el corralito” which involved among other economic measures the freezing of all US dollar denominated accounts, and as time passed those deposits would be exchanged for peso-denominated government paper.  There was civil unrest, riots, and many instances of “cacerolazos” (demonstrations by people with empty pots arguing that frozen deposits were preventing them from buying food).

The final toll was a peso devalued from 1 to 4 per dollar, 40% inflation and an 11% drop in GDP

Argentina once again

After the 2001 crisis, Argentina was left with a massive debt that couldn’t be serviced.  In 2005 they managed bring 76% of the debt out of default through restructuring, and this number was brought up to 93% by 2010.  There were a small number of creditors who refused to participate in the voluntary restructuring of the debt, they are known as the hold-out creditors known also as “holdouts”.

The holdouts demanded to be paid at 100 cents on the dollar, unlike other bond holders that accepted a haircut during the restructuring process.  The case has was taken to the courts and finally settled towards the end of 2015.

The new reformist government led by Mauricio Macri has proven to be a breath of fresh air to Argentines, after 12 years of Kirchners in power.  His mere presence in la Casa Rosada has encouraged investors to open their wallets managing to successfully place a $16.5 billion issue, the largest ever by any emerging market.  Argentina under Macri, is on course to abandon economic interventionism, liberalize trade, eliminate currency controls, and open Argentina to the world in a way that hasn’t happened in over a decade.

Venezuela’s Chavismo

If you thought that Chavez’s early departure from this world would change the course of Venezuela’s limping economy, you were right: It worsened.

Under Maduro, Venezuela is at the brink of total collapse or civil war.  The artificially high priced Bolivar is – in reality – trading at a fraction of the official rate, there are 80s-style currency controls in place, government interventionism, a bloated public sector, and sovereign debt yielding an eye-watering 28%.  Add to this a power crisis, a food crisis, companies shutting down for lack of demand for their products, or lack of raw materials, high crime rates, hunger, no tourism, and crude oil  prices averaging one third of the price used in their 2016 budget makes a recipe for disaster.

Recently, the opposition won the majority in congress, but that doesn’t seem to have helped in any way.  There are no indications of elections being brought forward, and Maduro doesn’t seem to be in any hurry to leave.

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