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Thursday, 26 April, 2001, 08:13 GMT 09:13 UK
Argentina's struggle to contain crisis
Another financial crisis with great risks for the global economy is looming, this time in Argentina. As BBC News Online's Emma Clark explains, the repercussions could be serious.
The consensus view on Argentina is that it's a bad time to be having a crisis.
Not that there is ever a good time, but the US economic slowdown rumbling in the background has intensified the pressure.
Argentina owes billions of dollars to international investors and unless it can win more time to pay it back, the country could plunge into crisis, bringing other emerging economies down with it.
Not only could this cause a global crisis, it also raises questions about the success of the International Monetary Fund's approach to financial turmoil.
"People are watching (Argentina) really closely on a daily basis," says Justine Thody, a senior economist at the Economist Intelligence Unit.
"If there are no signs of a recovery by mid-year, there will be an intensification of concerns over (the country's) medium-term prospects and its ability to service debt."
Argentina's ability to continue borrowing money to pay off maturing debt is key.
An IMF package of $39.7bn should cover the country's needs this year, but there are fears Argentina could burn its way through this money if it is unable to borrow from foreign investors.
Argentina's bond debt alone accounts for almost one quarter of total emerging market bonds.
This means that any investor with a neutral portfolio of emerging market bonds would have a 25% exposure to Argentina.
A default or massive crisis of confidence in Argentina could prompt such investors to sell off investments in other countries to cover their positions.
Within days, the world could be facing a major financial crisis, on the scale of the Asian crisis of 1998, which was sparked by Russia's default on domestic debt.
Too 'awful' to contemplate
"If the worst-case scenario came true in Argentina, the consequences would be very serious," says Fitch's Mr Fox.
However, because "the consequences would be so awful to contemplate", Mr Fox suspects the meltdown would never be allowed to happen.
They have even expressed hope that the US Treasury would intervene with direct assistance, despite the Bush administration's ideological opposition to such a move.
"It would be a bit odd if he washed his hands of them," says Mr Fox, noting President Bush's commitment to negotiating a free-trade zone in Latin America.
A 'vicious cycle'
Nevertheless, John Williamson, a senior fellow at the Institute for International Economics, says lending more money would not be the answer in a default situation.
The EIU's Ms Thody describes the crisis of investor confidence as a "vicious cycle".
Investors are demanding higher interest on money they lend, she says, which in turn exacerbates Argentina's attempts to service its debt.
Argentina's debt represented 44% of its gross domestic product in 1997. At the end of 2000, it was 54%.
The root of Argentina's problems
The country, which is the world's 29th largest economy and Latin America's third largest after Mexico and Brazil, slipped into recession after the devaluation of the Brazilian currency in 1999.
The weakening of the Brazilian currency put the squeeze on Argentina's trade with its neighbour.
The fact that Argentina's own currency is tied to the US dollar, which remains strong, has also hurt its competitiveness.
Last December, the agreement of the $39.7bn bail-out package with the International Monetary Fund provided a brief boost of confidence.
But political uncertainty, which resulted in the appointment of Domingo Cavallo as the third economic minister in as many months, and the US slowdown meant the confidence was short-lived.
According to a recent survey by the accounting and consulting firm PricewaterhouseCoopers, Argentina has missed out on about $19bn of annual foreign direct investment - partly as a result of problems with its economic policy.
"I think the Argentine crisis is very serious for Argentina," says Mr Williamson.
No case for contagion?
However, unlike some economists, Mr Williamson believes that Argentina's problems will be contained.
"I don't see the potential for contagion," he says, though he admits it is difficult to be certain.
He notes that Brazil and Chile - the two main candidates for contagion - are well-placed to withstand the impact.
Both Brazil and Chile are less indebted relative to the size of their GDP and they have floating exchange rates, which act as "shock absorbers", he says.
Fitch's Mr Fox is also hesitant to draw comparisons with the contagious impact of the Russian default in 1998.
He says Russia was "a bit of a bolt out of the blue" in contrast to the situation in Argentina where there has been a lot of advance warning.
While the financial world watches and hold its breath, Argentina is stepping up its efforts to win back investor confidence.
Mr Cavallo's latest package of reforms are aimed at reassuring the markets that retrenchment is underway.
But only time will tell whether Argentina can turn its vicious cycle into a virtuous circle.
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