POLICY RESPONSES TO SUDDEN STOPSSome comments from Argentina

Hernán LacunzaHead of ResearchCentral Bank of Argentina

Inter-American Development BankOctober 18, 2007

Plan

• Transmission mechanisms of sudden stops

• Responses vs. prudential policies

• Argentina sudden stops (1995 & 1998-

2001)

• Argentina current policy

• Concluding remarks

Sudden stops’ transmission mechanisms

Transmission mechanisms (Calvo, Izquierdo and Mejía,

2004)

Trade Openness

Financial dollarization

An example: Argentina and Chile (Calvo and Talvi, 2005)

CountryOpenness

(share of tradables in GDP, avg 91-97)

Current account deficit (% of GDP)

Required change in the

equilibrium RER

Chile 35% 6.5% 48%

Argentina 24% 4.7% 75%

Sudden stop, openness and real exchange rate adjustment in Argentina and Chile

0%

20%

40%

60%

80%

100%

120%

Argentina Chile

private public

Dollarization of debt (share of dollar denominated debt in total debt)

Trade openness: “timing and CA composition matters”

Trade openness ( % of GDP)

0%

5%

10%

15%

20%

25%

30%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Exports Imports Total trade

CURRENT ACCOUNT COMPOSITION

0

1

2

3

4

5

6

1992 1993 1994 1995 1996 1997 1998 1999 2000

% G

DP

Trade Balance

Investment returns

Fear of floating exceeds dollarization

Dollarization and exchange rate flexibility

0

1

2

3

4

5

6

0 5 10 15 20 25

Composite dollarization index, 1980-2001

Exch

ange

rate

regi

me

clas

sific

atio

n (1

=flo

at;

5=pe

g), 2

004

China

Argentina

India

Malaysia

TurkeyS. Africa

Chile Thailand

Peru

Jordan

Fix

Flex

Source: Eichengreen & Razo Garcia (2006); Reinhart et al (2003)

Asia?

Policy responses to sudden stops?

Montiel (2003): “ a lesson we have not learnt”

Reasons for contractionary fiscal policies

Resources for financial sector insolvency

Current account adjustment

But

Procyclical effects (Ortiz, Ottonello, Sturzenegger,

Talvi, 2007): sudden stop only gets worse

Argentina: the role of fiscal adjustment

A much tighter adjustment after the Russia-Brazil

sudden stop

Fiscal stance (observed vs. structural fiscal balance)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Sep

-94

Dic

-94

Mar

-95

Jun-

95

Sep

-95

Dic

-95

Mar

-96

Jun-

96

Sep

-96

Dic

-96

Mar

-97

Jun-

97

Sep

-97

Dic

-97

Mar

-98

Jun-

98

Sep

-98

Dic

-98

Mar

-99

Jun-

99

Sep

-99

Dic

-99

Mar

-00

Jun-

00

Sep

-00

Dic

-00

Mar

-01

Jun-

01

Sep

-01

Dic

-01%

GD

P (

hig

her

lev

els

ind

icat

e ti

gh

ter

fisc

al s

tan

ce)

Fiscal impulse= -0.7 p.p. (IV-94 vs IV-95)

Fiscal impulse= -1.5 p.p. (I-98 vs IV-00)

Argentina: costly adjustment to sudden stops

Episode I: Tequila

1994 1995

Current account / GDP -4.3% -2.0%

Change in imports (real, %) -9.8%

Change in exports (real, %) 22.5%

Change in GDP (real, %) -2.8%

Episode II: Russia & Brazil

1998 2002

Current account / GDP -4.8% 8.6%

Change in imports (real, %) -61.9%

Change in exports (real, %) 7.4%

Change in GDP (real, %) -18.4%

“Transitory” vs “permanent” shock:

• Higher c/a reversal

• Higher drop in absorption

• Lower export response

• Higher output drop

Argentina 2001: conditions for a “perfect storm”Real exchange rate misalignment

(Escudé and Garegnani, 2005)

-100%

-50%

0%

50%

100%

Mar

-90

Jul-9

0N

ov-9

0M

ar-9

1Ju

l-91

Nov

-91

Mar

-92

Jul-9

2N

ov-9

2M

ar-9

3Ju

l-93

Nov

-93

Mar

-94

Jul-9

4N

ov-9

4M

ar-9

5Ju

l-95

Nov

-95

Mar

-96

Jul-9

6N

ov-9

6M

ar-9

7Ju

l-97

Nov

-97

Mar

-98

Jul-9

8N

ov-9

8M

ar-9

9Ju

l-99

Nov

-99

Mar

-00

Jul-0

0N

ov-0

0M

ar-0

1Ju

l-01

Nov

-01

Mar

-02

Jul-0

2N

ov-0

2

1990-2001: -36%

Jun-98: -51%

Jun-99: -88%

PUBLIC DEBT / GDP

0

20

40

60

80

100

120

140

160

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

%

Argentina 2001: conditions for a “perfect storm”

0.0

0.3

0.5

0.8

1.0

1.3

1.5

1.8

2.0

2.3

2.5

2.8

3.0

Match

Financial system's exposure to the public sector

0%

10%

20%

30%

40%

50%

60%

Ene-

94

Jul-9

4

Ene-

95

Jul-9

5

Ene-

96

Jul-9

6

Ene-

97

Jul-9

7

Ene-

98

Jul-9

8

Ene-

99

Jul-9

9

Ene-

00

Jul-0

0

Ene-

01

Jul-0

1

Ene-

02

Jul-0

2

Ene-

03

Jul-0

3

Ene-

04

Jul-0

4

Ene-

05

Jul-0

5

Ene-

06

Jul-0

6

Ene-

07

Jul-0

7

Credit to government as % of total financial system's assets

Healing wounds or preventing accidents?

Response? Few to do once the sudden

stop happens

Countercyclical policies are not available

during sudden stops: fiscal tightening may

be worse

Prudential policies: higher ability to face

sudden stops

Corridor: Argentina – Australia - Brazil

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1914 1918 1922 1926 1930 1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006

Argentina: % Consumo per cápita

Argentina: Corredor

Australia: % Consumo per cápita

Australia: Corredor

1914-1930Primera Globalización

1931-1945Autarquía

1946-1978Bretton Woods

1979-2005Segunda Globalización

Inferior Superior Total Inferior Superior Total1914-1930 5.9% 11.8% 17.6% 11.8% 11.8% 23.5%

1931-1945 13.3% 20.0% 33.3% 20.0% 20.0% 40.0%

1946-1978 21.2% 24.2% 45.5% 15.2% 15.2% 30.3%

1979-2006 21.4% 14.3% 35.7% 10.7% 7.1% 17.9%

en % sobre el total de obs. del período:Argentina Australia

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1914 1918 1922 1926 1930 1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006

Argentina: % PIB per cápita

Argentina: Corredor

Brasil: % PIB per cápita

Brasil: Corredor

1914-1930Primera Globalización

1931-1945Autarquía

1946-1978Bretton Woods 1979-2005

Segunda Globalización

inferior superior Total inferior superior Total

1914-1930 17.6% 5.9% 23.5% 0.0% 5.9% 5.9%

1931-1945 20.0% 20.0% 40.0% 20.0% 13.3% 33.3%

1946-1978 15.2% 15.2% 30.3% 15.2% 15.2% 30.3%

1979-2006 17.9% 25.0% 42.9% 10.7% 14.3% 25.0%

Argentina BrasilEn % sobre el total de obs. del período:

Argentina: no absortion mechanisms

Consumption volatility

0,0000,5001,0001,5002,0002,5003,0003,5004,0004,500

Arge

ntin

a

Bras

il

Mex

ico

Cor

ea

Chi

le

Espa

ña

Can

adá

Aust

ralia

Esta

dos U

nido

s

Coe

ficie

nte

de v

aria

ción

1970- 2004 1988- 2004

Brasil

Nueva Zelanda

Argentina

Australia

EE.UU. LuxemburgoSuiza

Irán

Jordan

Nicaragua

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Standard deviation of GDP grow th rate

Sta

ndar

d de

viat

ion

of H

ouse

hold

exp

endi

ture

gr

owth

rat

e45º

Negative correlation between volatility and growth

ChileBrasil

Argentina

EE.UU.

Australia

Rep. Corea

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14Standard deviation of per capita GDP

Pe

r ca

pit

a G

DP

(a

vg

., l

og

s)

* en dólares de 2000

Prudential policies

Contingent credit lines: not available in sudden

stops

De-dollarization: not so easy

Argentina 2007:

Capital controls: effective to alter inflow

composition

Reserves accumulation: self-insurance

Financial & fiscal strengthening

Exchange rate regime: flexibility to cope with

shocks

Strenghtening of financial system

Exposure to Foreign Currency Mismatch RiskAssets and liabilities denominated in dollars

22

26

30

34

38

42

46

50

54

58

Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07

%

Assets - Liabilities / Net worth

Assets NormalizationFinancial system

40

20

22

32

26

22

17

34

27

10

15

20

25

30

35

40

45

as % of

total assets

Credit to the

public sectorLiquid assets + Lebac

and Nobac

Credit to the

private sector

2004 2004 2004 2005 2005 2005 2007* 2007* 2007* * Up to july

Reserve accumulation

International Reserves

0

5

10

15

20

25

30

35

40

45

50

Jan-96 Feb-97 Mar-98 Apr-99 May-00 Jun-01 Jul-02 Sep-03 Oct-04 Nov-05 Dec-06

billion US$

5

7

9

11

13

15

17

19

21

23

25

%

International Reserves/GDP(right axis) International Reserves

0

200.000

400.000

600.000

800.000

1.000.000

1.200.000

1.400.000

Mill

ion

s o

f co

nst

ant

do

llars

Developed Emerging Others

Fiscal solvency

Primary Surplus(% GDP)

-1.5%

-0.5%

0.5%

1.5%

2.5%

3.5%

4.5%

5.5%

Sep-94 Sep-96 Sep-98 Sep-00 Sep-02 Sep-04 Sep-06

Surplus required to sustain debt-gdp ratio

Cycle-adjusted surplus

Observed surplus

External solvency

Goods & services balance

(% GDP)

-5%

0%

5%

10%

15%

20%

Dic-94 Dic-95 Dic-96 Dic-97 Dic-98 Dic-99 Dic-00 Dic-01 Dic-02 Dic-03 Dic-04 Dic-05 Dic-06

Goods & services balances "required" to keep debt-to-gdpratio stableGoods & services balance adjusted by cycle and prices

Observed goods & services balance (% GDP)

What role for the foreign exchange regime?

Flexibility to deal with crises (Arg vs. Chile)

Asymmetric role in triggering crises

Macroeconomic consistency

Avoiding overvaluations is associated to growth

(Rajan, 2007); undervalued real exchange rate

linked to growth (Rodrik, 2007; Levy-Yeyati,

2007; Eichengreen, 2007)

Real exchange rate policie foster domestic

savings, reduce required adjustment in face of

sudden stops

Real exchange rate misalignments

Misalignment when a sudden stops hits is

far from neutral

Real exchange rate misalignments (Carrera and Restout, 2006)

-80%

-60%

-40%

-20%

0%

20%

40%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

ARGENTINA Promedio Latinoamericano ChileArgentina Latin America (average)

Concluding remarks

Sequence of international insertion matters

Worldbank 1997, about SS: initial condition matters: real exchange rate out of line, large government debt, fiscal adjustment perceived as infeasible

IMF 2007: heavy capital inflows may pose significant challenges to macroeconomic stability (fiscal policies); countries with more volatility… faced stronger real value of the currency during the period of capital inflows

Few to do once sudden stops happen;

prudential policies and macroeconomic consistency