Can Argentina’s Experience Help Predict the Effects of a Potential Grexit?

In the debate about a possible exit of Greece from the euro area, Argentina is often referred to as an example–both by those in favour of and those warning of the adverse effects of a Grexit. Yet, while Argentina pulled off an impressive economic recovery after its 2001-02 crisis–one that goes beyond a mere commodity boom–there are important structural differences between the two countries, which still render a potential Grexit a very risky endeavour.

fi nancial markets since its default, it has actually performed quite well economically (see Figure 1). The dispute is between those who claim that Argentina's recovery was due to the depreciation of the peso and the newly gained fi scal space thanks to the reduced interest burden 4 and those who assert that Argentina just got lucky and surfed on the wave of rising commodity prices. 5 While the debate on a Greek exit from the euro area has somewhat abated, it could resurface at any time. As of the spring of 2016, the Syriza-led government was again in negotiations over the terms of continuation of the bail-out programme. Moreover, while part of the austerity package promised in 2015 was swiftly enacted, other elements have been delayed. In addition, debt sustainability analyses of Greece began questioning once more whether the country could service its liabilities in the long term. This paper attempts to assess what parallels really exist between Greece today and Argentina in the 2001-02 crisis. In particular, it will ask what role default and depreciation played for Argentina's recovery and what structural similarities or differences there are between the two countries that might make a replay of the Argentine experience more or less likely in Greece. As a reference scenario for Greece, the reintroduction of a national currency and a sovereign debt default is assumed. Our contribution will fi rst outline briefl y the Argentinian crisis of 2001-02, the country's crisis management and its recovery thereafter. In a second step, it will evaluate the degree to which the conditions in Argentina during this time are comparable to those in Greece today.

The origins of Argentina's 2001-02 crisis
The most widespread narrative of Argentina's 2001-02 crisis emphasises fi scal mismanagement as the main driver of the crisis. 6 It is hard, however, to reconcile this view with actual data. In 1998, when the confi dence crisis started, Argentina's public debt was 38% of GDP, which is a relatively low value according to international standards, even for emerging markets. Until this moment, there was no sign of fi scal policy mismanagement. Since the adoption of the currency board in 1991, the government had been running an average primary surplus of 0.9% of GDP and an average total defi cit of only 0.7% of GDP. Fiscal fi gures began to worsen in 1999. The government accumulated a defi cit equivalent to 7.3% of GDP between 1999 and 2001; public debt rose to a peak of 54% of GDP in 2001. This deterioration occurred despite several attempts at fi scal consolidation and was largely due to two factors that were endogenous to the economic and con- fi dence crises. First, tax collection shrank due to the contraction of the economic activity. Second and most significant, the confi dence crisis caused a rise in interest rates and thus raised the interest payments on public debt. Thus, fi scal underperformance was more a consequence than a cause of the economic crisis.
The widespread "fi scalist view" of Argentina's crisis may relate to the fact that the crisis was indeed triggered by the private sector's concerns about the sustainability of public debt. However, these concerns were based on the fact that 97% of the country's public debt was denominated in foreign currency. Consequently, fi scal solvency was highly dependent on the maintenance of the fi xed exchange rate: if the peso were to be devalued, Argentina's public debt would become unsustainable. As a series of emerging market countries had started devaluing their currencies beginning in 1997, the fear that Argentina would follow their lead arose and spread in international fi nancial markets. These concerns were not unfounded. There were clear signs that Argentina's peso was highly overvalued. The degree of real exchange rate overvaluation was in the 30-50% range, and the effects of such an overvaluation were refl ected in the dynamics of the balance of payments. 7 Since the adoption of the currency board, both the trade balance and the current account had always been negative, except for during the years of economic recession. As a result, external debt increased between 1991 and 2001 from 4.2 to 5.3 times the value of exports.
Thus, Argentina's crisis was not a fi scal crisis but a balance of payments crisis or, using the jargon adopted for the eurozone, a "sudden-stop" crisis. 8 In other words, given the overvaluation of the peso, Argentina could not grow without running increasingly larger current account defi cits. The real exchange rate misalignment had to be corrected, and this would make public debt unaffordable.

Sovereign Default
to a depreciation-infl ation spiral and put the economy on a path to high or even hyper-infl ation. Infl ation, in turn, would reduce real incomes, output and employment in the short run, negatively affecting the unemployment and poverty rates. Finally, because the US dollar was widely used for private contracts, devaluation would involve massive wealth and income redistributions. The dollarisation of contracts was prevalent in rentals, public utility rates and, most importantly, the balance sheets of banks. Indeed, in December 2001, around 72% of bank credit to the private sector was denominated in US dollars.
In order to address all these challenges, the Argentinian approach to crisis management was based on four main pillars: 1) the default and restructuring of public debt; 2) a strategy to stabilise the exchange rate and prices; 3) a comprehensive cash-transfer programme to contain the negative effects of the crisis on the most vulnerable social groups; and 4) the transformation of dollar-denominated contracts into pesos, the so-called "pesifi cation" of contracts.
The default was announced in late December 2001, a few weeks before the devaluation. Then, devaluation made clear that servicing the public debt was unaffordable. Mostly due to the adverse effect of the devaluation on nominal GDP, the public debt-to-GDP ratio jumped from rate. The idea was to use this scheme only temporarily, in order to stabilise the exchange rate while domestic prices absorbed the impact of devaluation, and then to adopt a free-fl oating arrangement. However, this strategy was quickly abandoned. Pushed by the IMF, the government unifi ed the FX markets and let the peso fl oat. The peso collapsed abruptly; after a few months, the exchange rate reached levels close to four pesos per dollar. The central bank managed to stabilise the exchange rate by mid-2002 through a series of measures aiming to curb the demand and to induce the supply of FX. The most important measures were the obligation to surrender export proceeds above $1 million, the introduction of controls on FX transactions and the rise of domestic interest rates to a peak of 115%. These initiatives were successful and helped the central bank to consistently accumulate FX reserves. 10 Although the pass-through on prices was small due to high unemployment, infl ation did accelerate. In 2002, consumer price index (CPI) infl ation reached a peak of 41%, and the average real wage fell by 24%. The contractionary effect of devaluation was powerful during the fi rst quarter of 2002, when GDP fell about fi ve per cent. As a result, unemployment reached a peak of 22%, and half of the population fell below the poverty rate. A cash transfer programme launched in early 2002 was key to stabilising this delicate social situation. The programme targeted unemployed heads of households and reached almost 2 million poor families. It amounted to about one per cent of GDP. The introduction of tariffs on primary exports (e.g. soybeans, wheat, meat and oil) was important to curb the pass-through of the devaluation to domestic prices and the contraction of real incomes. Besides, the revenues captured with these tariffs -together with lower debt services due to the default -helped fi nance public spending, including the cash transfer programme. 11 The fourth main element of the crisis management strategy was the "pesifi cation" of previously dollarised contracts, which neutralised the effects of devaluation on debtors' balance sheets and on households' and tenants' real income. Rentals, public utility rates, bank credits and other debts were converted to pesos at an exchange rate of one peso per dollar. Jointly with pesifi cation, rentals and other contracts were indexed to CPI infl ation, bank

Sovereign Default
credits to wage infl ation, and public utility rates were not indexed at all. Banks' deposits were converted to pesos at a rate of 1.4 pesos per dollar and indexed to CPI infl ation. The government issued debt to compensate commercial banks for this "asymmetric pesifi cation" of their balance sheets (a higher exchange rate for deposits than for credits) and the "asymmetric indexation" schemes (wage indexation for credits vis-à-vis CPI indexation for loans). Because the FX market had not yet been stabilised at the time of the pesifi cation, the authorities also decided to extend the maturity of all banks' time deposits, including those newly converted to pesos. This measure -colloquially known as corralón, i.e. the big fence -was meant to prevent depositors from converting their pesos to dollars and thereby putting more pressure on the foreign exchange market.

Argentina's post-crisis recovery
In a development that was rather unexpected by most observers, Argentina's economy began a rapid and strong recovery in mid-2002 that it succeeded in transforming into enduring economic growth. Between the fi rst quarter 2002 and third quarter 2008 -when the effects of the US fi nancial crisis began to spread to the rest of the world -Argentina's GDP grew at a stable annual rate of eight per cent. To be sure, part of this process was not accelerating underlying economic growth but just a post-crisis recovery. However, from the fi rst quarter 2005 -when GDP surpassed the pre-crisis peak -the average annual growth rate was 7.7%. This suggests that the shift from recovery to growth was not accompanied by a sizable deceleration. Economic growth was accompanied by a rapid rise in employment as well as by a signifi cant reduction of poverty. Beyond the short run, a SCRER fostered GDP growth by stimulating investment and growth in tradable sectors such as agricultural activities, manufacturing and some special tradable services (e.g. professional consulting), and also by promoting macroeconomic stability. Regarding the latter, a SCRER helped Argentina run both current account and fi scal surpluses while accumulating international reserves. This macroeconomic environment reduced the risk associated with sudden stops -which have been the traditional source of growth interruptions in Argentina -and stimulated spending and investment. The investment rate between 2003 and 2008 averaged 21.4%; this compares with a rate of 17.6% during 1991-1994, the fastest growth period under the currency board. The manufacturing sector experienced a virtuous process of recovery and growth of employment, real wages and productivity (see Figure 2). The performance of non-commodity exports was also strong between 2001 and 2008.
Manufacturing exports grew at a 15% annual rate and diversifi ed their markets. More notably, exports of services based on high-skilled labour -including IT, audiovisual and professional consulting -increased by a factor of ten, rising from $490 million in 2001 to $5.07 billion in 2008.
Argentina's successful performance with a SCRER was fi rst interrupted by the effects of the global fi nancial crisis and later by a shift in the country's macroeconomic policy

Figure 2
Manufacturing sector performance: real wages, labour productivity and employment Index: 4Q 2001=100 orientation towards a more inward/populist strategy. This new macroeconomic strategy led to a signifi cant and sustained real exchange rate overvaluation, stagnation and ultimately to a balance of payments crisis during the 2012-15 period. For the purpose of this article, it is important to stress that the decisions and outcomes during this period were unrelated to the country's path out of the 2001-02 crisis. 13

Greece's path into the crisis: parallels to Argentina
While at fi rst sight the Greek crisis looks more like a typical fi scal crisis caused by overspending -the country recorded debt-to-GDP ratios of more than 100% since its accession to the eurozone in 2002 -the story is more complicated. Similarly to Argentina after the introduction of the currency board, capital infl ows surged when Greece joined the euro. In both countries, risk premia on both government bonds and in the interbank market fell sharply relative to the US and German markets. This made foreign borrowing cheaper and easier for both the government and the private sector. Capital infl ows fuelled domestic credit, yielding increases in investment and private consumption and accelerating economic growth.
Capital infl ows went hand in hand with a real appreciation in both countries. The forces which led to this real appreciation, however, were somewhat different. As growth accelerated in Greece, unemployment fell and wages rose.
In Argentina, real appreciation largely occurred as a result of the abrupt disinfl ation following the pegging of the peso to the US dollar in 1991. As in all successful disinfl ation experiences that used the exchange rate as the main nominal anchor, real appreciation resulted from the faster disinfl ation of tradable prices than non-tradable prices and wages. With a fi xed exchange rate and open trade, tradable prices decelerated more rapidly than non-tradable prices and wages because they faced competition from foreign goods, whereas the latter maintained some inertia from the infl ationary past. As productivity did not increase quickly enough to counteract non-tradable rising costs (including wages), both countries experienced a pronounced appreciation of their real effective exchange rates. Both the income effect and the deterioration of domestic companies' competitiveness led to a surge in imports and rising trade defi cits. Capital infl ows and current account defi cits led to sharp increases of foreign debt in both countries, making them highly vulnerable to negative external shocks.
As in Argentina, the problems in Greece turned serious when the external environment deteriorated. In the case of Argentina, the deterioration began with the reversal of capital infl ows to emerging markets after the 1997 Asian fi nancial crisis, but it turned especially hard in 1999 after the currency devaluation in Brazil, Argentina's main export market. In Greece, the deterioration was triggered by the Great Recession that followed the default of the US investment bank Lehman Brothers in 2008-09, which led to a collapse of exports and output and eventually triggered the European sovereign debt crisis of 2010.
A second parallel is the lack of debt sustainability at the onset of the crisis. Similarly to Argentina, the combination of economic depression, higher interest rates and real exchange rate overvaluation made the Greek debt level unsustainable. While the fi rst debt sustainability analysis (DSA) by the IMF and the EU in 2010 came to the conclusion that Greek debt could be made sustainable by harsh austerity programmes, it later turned out that this conclusion was based on completely unrealistic assumptions of low fi scal multipliers. Given that a competitive real exchange rate level within the euro area could only be reached by internal devaluation, which would bring down prices and hence nominal GDP (and consequently would push up the debt-to-GDP ratio), Greek debt was not sustainable. Despite the debt restructuring in 2012, the situation has not fundamentally changed.

What Greece can learn from Argentina's experience
Given these similarities, it is worth pondering whether a Greek exit from the euro area would share some similarities to Argentina's default and exit from the currency board.
First, the reaction of the exchange rate to the introduction of a new currency in Greece could be expected to be similar. Real exchange rate overvaluation in Argentina before devaluation was in the 30-50% range. The correction of the misalignment was not smooth, and the exchange rate strongly overshot. Uncertainty about the future course of economic policy and the default led to capital fl ight, triggering a 75% depreciation of the peso in just six months. Even though Greek overvaluation is probably much less, there is no reason to expect that a new currency would behave much differently in Greece; an exchange rate overshooting could also be expected. It is reasonable to think that an exchange rate overshooting might have severe impacts on domestic prices and infl ation, which we discuss in the next section.
Second, Greece could be expected to default on its government debt after a depreciation, just as Argentina did.
Greek debt is currently 180% of GDP, and it is basically all denominated in euros. As mentioned above, this level is already deemed unsustainable by standard debt sustainability analyses. If Greece leaves the euro area and its new currency depreciates, the value of its debt in domestic terms would skyrocket. In such a case, Greece would clearly stop servicing its debt. It would thus need to fi nd some solution for its debt -either an outright default or some kind of restructuring. Moreover, given that Greek banks hold a signifi cant share of the outstanding public debt, it is likely that in such a scenario Greece would need to fi nd some solution for its banking sector as well.
Third, Greece could learn from Argentina about de-dollarising (or de-euroising) the balance sheets of households, banks and companies. As discussed above, the de-dollarisation (or pesifi cation) of bank balance sheets was asymmetric and involved signifi cant fi scal costs (i.e. the government had to issue new bonds to compensate both banks and savers, totalling about 5.4% of GDP). Asymmetric pesifi cation was meant to mitigate the discontent of depositors who saw their deposits in dollars evaporate.
While it is certainly very diffi cult to administer situations that involve signifi cant redistributions of wealth, it seems clear that a lack of planning in Argentina made the pesifi cation and asymmetric indexation processes even costlier than they had to be. If Greece is forced to exit the euro area, it would be well advised to choose a more straight-forward way of de-euroising its banking sector by converting all assets and liabilities at the same parity to the new currency and with a symmetric indexation mechanism that would protect both banks and depositors from infl ation without carrying a fi scal cost.

Where Greece is different
Despite all these similarities, however, there are also a number of crucial differences between Argentina and Greece that make a direct transfer of the Argentinian experience to Greece diffi cult.
The fi rst, most obvious, difference is that Greece does not have its own currency anymore, while Argentina still had the peso. This difference has two important dimensions. First, it might be physically diffi cult to introduce a new currency. Second, the Greek population might be unwilling to hold on to the new currency and convert all of it to euros as quickly as possible.
On the physical challenges of a currency reform, a number of authors have pointed out that it took the US army several months to prepare the introduction of a new currency in Iraq and that it was a major logistical challenge to distribute the currency across the country. 15 However, this comparison might overstate the problems. First, Greece is not a country in a civil war. Systems and procedures are in place to distribute bank notes to banks and ATMs. Second, if Greece were to introduce a new currency, the issue would not be to exchange old currency against new; rather, authorities could simply print new currency and provide it to banks and ATMs, as the Greek population would by and large be expected to hold on to their euro notes and coins as assets. Third, the changeover would not have to happen overnight without hiccups. Payments could still be made by bank transfer (with deposits converted into the new Greek currency) and with euro cash (at the current exchange rate vis-à-vis the new currency).
The willingness of the Greek population to hold a newly introduced currency might be more of a problem. Argentina, on the contrary, had its own currency that had relatively solid demand from the country's population. The purpose of introducing a new currency in Greece would be to obtain an immediate improvement in terms of international competitiveness. In such a scenario, it is conceivable that the expectations of depreciation against the euro would depress the demand for the new currency. A massive switch from the new currency to euros could Linked to this is the different degree of fi nancial depth in the two economies. Argentina has traditionally been an economy with a low credit-to-GDP ratio, and this ratio declined even further after the default and depreciation. Before the crisis, domestic credits by the private sector peaked at 23% of GDP in Argentina, whereas in Greece, bank loans to corporates and households have contracted, but still stand at around 100% of GDP. A new meltdown of the Greek banking system due to a mishandled changeover or a massive repudiation of a new currency might thus have much more severe consequences for the Greek economy than it did in Argentina.
Another important difference is that Greek debt is mainly obligations to multilateral institutions and the rest of the euro area. According to the Wall Street Journal, in the spring of 2016, the Greek government owed 71% of its roughly €320 billion in upcoming debt service and repayment to other euro area governments and institutions such as the European Financial Stability Facility, seven per cent to the European Central Bank, about fi ve per cent to the IMF, and only about 17% to private creditors. 16 Widening the scope beyond the government to include the broader public sector, including the central bank, these amounts are even larger. In addition to the government's debt, at the end of 2015, the Greek central bank had liabilities against the European System of Central Banks (ESCB) from TARGET2 balances of roughly €100 billion. Taking these liabilities into account, overall, only about 13% of total debt is held by the private sector.
The reverse was true for Argentinian debt in 2001, of which only 22% of total debt was held by multilateral institutions, with the remaining 78% held by private creditors.
The difference in the debt structure makes a default easier in some ways, but more diffi cult in others. The fact that Greece only faces a handful of creditors means that, in principle, a compromise should be easier to strike than was the case for Argentina, where a handful of creditors

Sovereign Default
still present that could be put to work once the conditions changed. The open question is whether Greece also has such capacities or, on the contrary, it has been deindustrialised for too long to build upon an existing base. Additionally, the fact that South American countries -the main destination for Argentina's manufactured exports -experienced a boom beginning in 2004 differs from Greece's current situation, in which the European Union has been facing a prolonged stagnation for several years. A positive reaction of tradable services in Greece may be a more likely possibility.

Uncertainty remains
We have stressed the existence of important parallels between Argentina in 2001-02 and Greece currently. However, the differences between the two countries are signifi cant enough to remain cautious in forecasting that the Argentine experience of a relatively positive economic performance after default and devaluation can be transferred to Greece.
We have made the case that some of the common arguments about Argentina's recovery -such as the claim that it was primarily driven by commodity prices -do not really hold up to scrutiny. We have shown that it was not only the boom of commodity prices that explained Argentina's successful economic performance during the 2002-08 period but also the country's economic policy based on maintaining a stable and competitive real exchange rate and sound fi scal fi gures. This more accurate description of facts, however, does not imply that Argentina should be taken as a model to pursue a Grexit. We have emphasised several concerns that might make such an option quite diffi cult. The introduction of a new currency, for instance, entails a not insignifi cant risk of high infl ation (or even hyperinfl ation). Moreover, there remain important question marks about the current state of Greece's productive capacities and hence the price elasticities of supply. Finally, the Greek banking system still has much more room for a contraction after the introduction of a new national currency.
Given these risks, the better outcome would appear to be to fi nd a solution to the unsustainable Greek debt level inside the euro area and some sort of fi nancial help to support the structural transformation necessary to make Greece's economy competitive. However, striking a deal with its EU partners that will sustainably resolve the country's debt problems has proven diffi cult. If a solution to Greece's current over-indebtedness remains elusive while it remains part of the euro area, the uncertain costs of a Grexit might become more attractive than the known costs of permanent stagnation.