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Argentina: Deflating Washington's Free Trade Hopes Summary While in Quebec City, U.S. President George W. Bush said he will make the creation of a Free Trade Area of the Americas (FTAA) his top foreign policy priority in Latin America. But hard on the heels of the summit, Argentina's mushrooming financial crisis will bump hemispheric trade expansion off the top of the administration's agenda. Instead of expanding trade, Washington soon will face a potential debt crisis. And Argentina increasingly looks like ground zero for faltering Latin American economies. Analysis Argentina's main financial problem is not the peso's convertibility to the U.S. dollar but rather the country's inability to pay off its debt. Argentina simply is not earning enough hard currency to pay down its public and private sector foreign debt. Argentina has a consolidated public sector debt of $143 billion, which includes $128 billion in federal government debt and $24 billion in provincial government debt. Almost 70 percent of the debt is denominated in U.S. dollars. Private sector debt totals about $61 billion. Public and private sector foreign debt together total about $204 billion. The public sector alone needs to come up with about $20 billion a year to meet its debt service commitments. Economy Minister Domingo Cavallo insists he can lift Argentina out of its 33-month recession without devaluing the peso or defaulting. Argentina's man of the moment has floated a bold plan to rescue the economy by increasing competitiveness and pegging the peso to a dollar/euro basket, which will be implemented when the euro reaches parity with the dollar. Cavallo claims his proposals already are stimulating growth, but global financial markets are skeptical. His peso proposal only caused increased uncertainty in international markets, which had already assigned Argentina the staggeringly high-risk premium of 938 basis points April 20. Apparently aware of the looming abyss, on April 23 the Argentine government abruptly suspended the following day's planned auction of $350 million in Treasury bills and between $200 million and $400 million in Treasury bonds amid fears the markets would charge exorbitant interest rates. Cavallo clearly does not have all the answers. He recently admitted the peso was overvalued by about 20 percent - but insists devaluation will not occur on his watch. Critics of the convertibility system Cavallo created a decade ago as economy minister under President Carlos Menem claim the peso's rigidly fixed one-to-one exchange rate with the U.S. dollar has perpetuated high domestic prices and wages, undercutting the competitiveness of Argentine commodities and industrial exports as the dollar has strengthened against other currencies. Yet, Cavallo also has rejected adopting the U.S. dollar as Argentina's national currency. Instead, he claims the adoption of a dollar/euro currency basket sometime in the future, when the euro achieves parity with the dollar, will make the peso more stable and competitive against the dollar. However, many financial analysts see the proposal as a disguised devaluation, noting that the euro was at 89 cents to the dollar last week and may not reach parity for months or even years. Other analysts puzzle over how tying the peso to both the dollar and the euro would solve Argentina's financial dilemma: how to earn enough hard currency to pay its foreign debts. Cavallo will go to the International Monetary Fund again before defaulting or devaluing. The IMF desperately wants to prevent both a default and a devaluation of the peso, fearing the regional and global consequences of a financial meltdown. However, even another IMF bailout like the $40 billion aid package assembled only last December will not solve the country's fast-approaching debt payment crisis. At most, a bailout will only postpone the inevitable moment when Buenos Aires finally declares a default and seeks new restructuring talks with international creditors. There are regional implications, too. Brazil also is getting hammered. As Argentina's financial crisis has ballooned this year, Brazil's currency - the real - has come under increasing pressure. The real has depreciated more than 15 percent since January. On April 20 it dropped to R$2.24 per U.S. dollar, its lowest level since the currency was launched in 1994. Last week the Bovespa, Brazil's leading stock market index, fell 8.52 percent - plunging almost 5.09 percent immediately after Cavallo declared he favored loosening Argentina's ties to the South American Common Market (Mercosur) in favor of a stronger bilateral relationship with the United States. Furthermore, when Argentina finally does default, U.S. President George W. Bush will have little choice except to push trade expansion aside and focus on debt restructuring negotiations in which Argentina's creditors may have no choice but to write off between 25 percent and 30 percent of what they are owed. If Bush fails to engage the U.S. government quickly in solving Argentina's financial meltdown, the crisis will spread regionally and almost certainly will wreck plans to expand hemispheric trade in Latin America. |