CASE STUDYCASE 1.1

WILL ARGENTINA DEVALUE ITS PESO?

BACKGROUND

Argentina is the second largest country in South America. Its national language is Spanish nad currency called Peso. Governmental system is federal presidential system. Argentina is the founding member of United Nation, World Bank, World trade organization and is among G-20 countries. According to World Bank major exporters and importers are following. According to World Bank Argentina is in upper middle income and developing country. This case study is about Argentina currency devaluation decision making. Its include the pros and cons of Peso devaluation and dollarization. It also includes the solution and other option to stop Peso devaluation.

STATISTICS

ECONOMIC INDICATORS

1998 1999

GDP GROWTH % 3.9 -3.1CPI % 0.9 -1.2EXCHANGE RATE 1 1FOREIGN EXCHANGE RESERVES EXCLUDE GOLD(BILLION $)

24752 26252

EXTERNAL DEBT ($BILLION)

144.1 148.6

Devalue of Peso from 1 to 1.7 causes fiscal deficit increase to 50% which is 2.9% of GDP increased from 1.9%.

If the peso devalue from 1 to 3.47 is causes the equity to zero of non financial institutions.

CRITICAL ASPECTS

The economic activity is slow down causing the unemployment rate to increase and devaluation of Peso.

Argentina has currency board and its Peso is backed by international reserves so when global crisis occur it leads to capital outflow resulting in interest rate to move up and restrict the government access to international debt markets.

Devalue of Peso give advantage to Brazilian producer and cause the Argentina exports less competitive.

Devaluation of Peso effects the Argentina inflation to move up, equity of organization and banks to fall, increase the liabilities of banks and corporations, increase the budget deficit, increase the loan payment amount and cost of debt.

Conclusion

Argentina considers its currency for devaluation or dollarization. The pros and cons of both helpful for economy as well as cause problem in long and short run. But Argentina try to adjust its monetary tools to protect its currency from devaluation, for this purpose it control the trade off loss, unemployment, interest rate and reserves.

The government of Argentina considers the dollarization as the lender of the last resort.

So deep analysis is mandatory to implement one of the policies mentioned above keeping in mind its effects on economy, mega projects and foreign investment.

QUESTIONS AND ANSWERS

ANSWER NO1:

ADVANTAGES OF DEVALUATION OF PESO:

It improve competiveness of Argentina exports-imports competing products. Reduce real interest rate The decrease in the real interstate improve trade prospect and help to reduce the

unemployment and to stimulate the economic activity. It helps the government to increase the tax revenues and to reduce the

unemployment compensation and other social spending.

DISADVANTAGES OF DEVALUATION OF PESO: Most of the liabilities of Argentina are denominated in Dollar so it causes the

liabilities to increase. It causes the redistribution of wealth from foreign creditors and local debtors. Inflation increase. Reduces the equity of bank and non financial institutions. If the public and private debt improves it causes the capital to reduce and even to

zero. It appreciates the government cost of servicing the debt and as a result the

budget deficit increases.

ANSWER NO 2:

There is chance that Argentina devalues its Peso or adopt the dollarization to move out of the crisis. On the other hand the government of Argentina adopts other option such as controlling the monetary policy tools to control its currency value. Devaluation affects a lot to the Argentina economy and foreign investment. So Argentina first adopt other option of controlling currency value and economy stimulation tools than of devalue its Peso.

ANSWERS NO 3:

ADVANTAGES OF DOLLARIZATION:

Increase the credibility of Argentina to monetary Help in maintain the stability in exchange rate. Cause faster the economic growth. Increase the trade opportunities. Help in maintain the inflation rate. Unemployment rate reduces. Bring new employment opportunities. Help to diversify the risk.

DISADVANTAGES

Dollarization result in high credit cost. Reduces the investment opportunities. Cause the government deficit to increase and decreases the governmental

revenues.

If global crisis occur it effects the dollar and ultimately effects the Argentina economy.

ANSWERS NO 4:

Effects of peso devaluation on mega project:

Devaluation cause high inflation rate and cause the estimated cost of project to rise.

Devaluation effects the liabilities of the project. Devaluation increases the liabilities of the mega project.

It causes the equity of the project to decrease. Devaluation of Peso effects the importing of raw material also. we have to spend

more than estimation and have to face the budget deficit.

ANSWER NO 5:Effect of dollarization on mega projects

Dollarization help to stabilize the economy as it absorb risk and help in estimation of cost of project and its completion.

if global crisis occur the dollar denominated securities and assets value decline and have to face loss. So it ultimately also effects the project because if all estimation and loan are consider in dollar value than the effect is same as mentioned.

It helps to import raw material from other countries and save the transaction cost for the mega project.

ANSWER NO 6:

Following are the measure to stimulate Argentina economy growth independent of exchange policy:

Argentina utilizes its resource to increase its exports and increase

foreign reserves.

Trade off loss must be decrease.

Government should decrease its budget

deficit.

Government utilize loan for development purpose which ultimately increase

the GDP.Government should

reduce the external debt ratio.

Interest rate decreases. Government should encourage FDI.

Stabilize its political condition to reduce

pootical risk.

Government utilize the debt for developmental

purpose

Inflation must me controlles.