Buenos Aires Backs Away From The Abyss

Domingo Cavallo, Argentina's Economy Minister, spent the past two months trying to convince investors that Argentina could avoid the financial shock waves from Mexico's peso collapse. But even his optimism has been sorely tested by $4 billion fleeing the country and the specter of bank failures. "We are going through very difficult times," he concedes, "that could push us into the bottom of a hole that would take a long time to climb out of."

Now, Cavallo and President Carlos Menem think they have a way to avoid the abyss. To shore up Argentina's dollar-backed peso, they're putting the country through a fiscal wringer with $1 billion in government spending cuts and $5.5 billion in tax hikes. The aim is to shrink the deficits in Argentina's budget and international payments and halt the capital flight. If Argentina shows it can weather the sell-off in emerging markets, it could help restore confidence in other Latin American markets as well.

The draconian measures could do the trick. They're backed by $4.7 billion in loans from the International Monetary Fund and other multilateral agencies. As part of the package, unveiled on Mar. 13, leading Argentine companies pledged to buy $1 billion worth of two-year government bonds. "The agreement is sufficient" to bolster the markets and save the peso, says Carlos Rivas, an economist at Buenos Aires' Center for Latin American Studies. The depressed Buenos Aires stock market reacted enthusiastically with a three-day, 31% price rally.

SACRIFICES. Such optimism is tempered, though, by continuing caution on the part of international investors. "We still think that Argentina looks quite vulnerable," says Lars Schunander, a Latin America economist at Barings Securities Inc. in New York. The austerity measures, from pay cuts for civil servants to hikes in value-added taxes, are intended to dampen Argentina's import boom and spur exports. That should shrink the deficit in the current account, which includes interest payments, from $10.6 billion in 1994 to around $10 billion this year. But Argentina also must pay $5.2 billion of principal on its foreign debt.

To push through the austerity plan, Cavallo and Menem, who is heavily favored to win reelection for a four-year term on May 14, have enough backing in Congress from Menem's Peronist Party. And Argentines, remembering the hyperinflation of just a few years ago, seem willing to accept the sacrifices.

Critical to the plan's success, though, will be the reaction of companies and individuals who have been pulling money out of banks at an accelerating rate. The 1991 Convertibility Plan built up confidence in the peso by making it freely exchangeable for the dollar at a 1-to-1 rate, but the withdrawals have shown an erosion of confidence in both the peso and the banks. The outflow, if it continues, could threaten to wipe out a sizable part of Argentina's banking system.

BIG SQUEEZE. Also crucial is the private Argentine and foreign financing that Cavallo hopes to raise to bolster the peso and the banks. "What the market would like to see is that the nonofficial [financial] flows are actually going to happen," Schunander says. Besides the $1 billion from Argentine private companies, Cavallo is seeking $1 billion from foreign commercial banks. In one version of the still-nebulous proposal, banks would be offered three-year "tax anticipation notes." They could be resold to Argentine or foreign companies, which would use them to pay their Argentine taxes.

For such a scheme to succeed, banks with big stakes in Argentina such as Citibank and Deutsche Bank will probably have to take the lead. "If you're a bank that doesn't have an exposure in Argentina," says a U.S. banking source, "you're going to ask yourself long and hard whether you want to lend them money."

What's certain is that Cavallo's squeeze will push Argentina into a sharp economic downturn. After a four-year run of increases in gross domestic product averaging 7.5% annually, Cavallo is projecting 3% GDP growth this year. Private economists expect zero to 2%, and a recession is possible.

The most telling sign of the downturn is the auto industry, which led Argentina's boom. In February, sales were down 25% from last year. Unemployment, already at a record 12%, will rise as companies cut back. "Those that compete with foreigners, especially, must cut costs and modernize" to stay in business, says Carlos Cortizas, commercial manager of oil and telecommunications conglomerate Perez Companc.

If Cavallo manages to avoid a Mexico-style peso plunge, his reputation as an economic strategist will gain new luster. But for all Argentines, a tough testing time lies ahead.

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