Greece – the European Argentina?
There are striking parallels between the current economic situation in Greece and the ‘Great Depression’ of Argentina around the turn of this new century. There are however enough variances to say the situation can be described as ‘same, same but different’, and therefore the solution is unlikely to be an exact replica of Argentina’s recovery.
To refresh our memory, Argentina enjoyed a period of economic prosperity during the 1990s following nearly two decades of turmoil. During this period the Argentine economy grew by more than 50 percent due to a broad based reform agenda associated with government privatisation, trade reforms, expansionary fiscal policies, currency stabilisation, and resultant growth in direct foreign investment.
Enter the ‘perfect storm’
However, by 1998 Argentina was again in an economic crisis, caused by the ‘perfect storm’ of declining world agricultural commodity prices, appreciating domestic currency, and the onset of the Russian financial crisis. Matters were then made worse by the ‘Samba effect’; the floating of the Brazilian real in January 1999, which resulted in a 35 percent currency devaluation further exacerbating trade imbalances for Argentina.
The IMF stepped in to assist the beleaguered Argentine economy with a $7.2 billion agreement to access credit, with the requirement that a range of austerity measures be put in place. The Argentine Government implemented spending cuts and tax increases, including reducing public sector wages and cutting pension payments. At the same time investors pushed up bond rates to 16 percent, and the government swapped short term bonds to longer dated ones, delaying about $30 billion in interest payments as a consequence.
In 2001 the government started paying some wages in the form of IOUs, unemployment rose to more than 16 percent, and finally the IMF refused to release a US$1.3 billion tranche of its loan package due to a failure of the Argentine Government to reach budget deficit targets. By the end of that year Argentinian’s started withdrawing cash from the domestic banking system and converting peso’s into US dollars. The government implemented withdrawal limits to minimise the risk of ‘bank runs’, and in response the people started violently protesting and rioting.
Argentina then defaulted on $132 billion of public debt in the last week of 2001.
The next response was to devalue the peso, initially setting it at 1.4 pesos per US dollar, and then within a few months it was more or less floating, devaluing to about 4 pesos per US dollar later that year. Inflation and unemployment rose dramatically, and GDP fell more than 10 percent.
Then in 2002 the Argentine economy stabilised and started to recover.
The devalued peso made exports cheaper in world markets, and correspondingly imports more expensive, encouraging substitution. The government targeted improving tax compliance and collection, but also started spending substantially more on social welfare.
Between 2003 and 2011 the Argentine economy grew at compound growth of more than 6 percent per annum, fuelled predominately by exports of commodities and industrial production.
Greece; same, same but different to Argentina.
The genesis of the Greek debt crisis really dates back to the early 1970s when structural budget deficits became entrenched, initially at low levels but gradually rising to more than 3 percent of GDP for nearly 30 years. The joining of the European Union in early 2001 allowed the Greek Government to access cheap funding due to the convergence of interest rates to those of Germany, resulting in even more inefficient public sector borrowing, culminating in debt-to-GDP ratio of about 130 percent at the end of 2009.
The onset of the GFC exposed fault-lines of the Greek economic situation. Debt and Deficit rules agreed to on joining the European Monetary Union were breached by major European economies, and investors quickly realised Greece was no Germany, and Greek interest rates blew out. Resultant contractions in economic activity driven by the financial crisis, as well as re-ratings of risk, meant the settings for a debt spiral was now in place.
In early 2010, the European Commission, European Central Bank and the IMF launched a €110 billion bailout loan package, which was anticipated to cover Greece’s financial requirements through to June 2013. The implementation of austerity measures, combined with structural reforms and government privatisations was the quid-pro-quo asked of the Greeks in return for this support.
However, continued declining economic activity and delayed implementation of reform measures resulted in the need for additional funding of €130 billion, plus the requirement of private sector holders of Greek Government bonds to accept a renegotiation of their contracts, which included a reduction of more than 50 percent of the face value of the debt.
The current situation, effectively brought on by the suspension of remaining aid until the new Greek Government either accepted the previously negotiated conditional payment terms or offered a new set of mutually agreeable terms, has resulted in a major liquidity crisis for the government and financial sectors.
Can Greece learn from Argentina’s recovery?
So, are there any lessons the Greeks can learn from Argentina’s recent economic calamity?
The ‘same, same’ of the Argentine depression to the Greek debt crisis relates to the size and complexity of the economic problem. Both countries have recorded massive debts to foreign creditors, need for IMF intervention, liquidity crises, shrinking of GDP, reduction in living standards and consequential social dislocation.
The ‘but different’ relates to the immediate levers available to begin to resolve the problem. Argentina devalued its currency, initially pegging it at a fixed value, and then floating it. Greece does not have the capacity to do that, and won’t be able to do it until it leaves the European Monetary Union. Greece needs to be able to take responsibility for its own actions, and it simply cannot do that when it’s part of a currency union.
The composition of the Greek economy is also notably ‘but different’ to that of Argentina. Greece sells tourism and shipping, both of which are heavily dependent on global economic activity, whereas Argentina is a commodity exporter, and from a timing perspective they were able to access the early 2000’s expansion of the Chinese economy.
Another ‘but different’ element is that nearly 40 percent of Argentina’s Government debt was locally held, with a significant amount of international debt held by individual foreign investors. Greek debt was initially held by European banks, but nearly half of this debt has been purchased by the Governments of France and Germany, the IMF and European Central Banks. This further complicates matters as the Greek debt is now held in the official sector, which is generally not used to making losses on investments, whereas the private sector is. Simply, Greece’s recent debt revaluation wasn’t big enough and should be reduced more. And those countries and investors that have invested since the GFC and will lose out through this revaluation simply should have known better.
Timing is also a ‘but different’. In the case of Argentina, recession came after the devaluation, whereas in the case of Greece, GDP has contracted already by 25 percent since 2009. This depression in economic activity has come before any currency adjustment, and the turmoil that would be expected to follow it.
The current political and economic turmoil is only expected to further contract the Greek economy, which is unfortunate given that before the fall of the previous government, its economy grew in the last quarter of 2014 for the first time since 2009.
Whatever the final outcome of the ongoing political negotiations between Greece and its creditors, the Greek population is likely to experience a continuation of economic uncertainty and social hardship in the short to medium term.