An historic agreement has been reached between Argentina over outstanding debt owed to creditor nations. Creditor nations come together as the ‘Paris Club’ and at a Paris Club meeting on May 28, details of a repayment plan were agreed. Argentina hopes that the agreement will enable it to start borrowing again on international markets: something that had been largely blocked by outstanding debt, which, up to now, Argentina had been unwilling to repay.
The problem goes back to 2001. Argentina was faced with international debt payments of $132bn, equalling some 27% of GDP and over 300% of export earnings. But at the time the country was in recession and debts were virtually impossible to service. It had received some help from the International Monetary Fund, but in December 2001, the IMF refused a request for a fresh loan of $1.3 billion
As Case Study 27.5 in MyEconLab for Economics, 8th edition explains:
This triggered a crisis in the country with mass rioting and looting. As the crisis deepened, Argentina announced that it was defaulting on its $166 billion of foreign debt. This hardly came as a surprise, however. For many commentators, it was simply a question of when.
Argentina’s default on its debts was the biggest of its kind in history. In a series of dramatic measures, the Argentine peso was initially devalued by 29%. Over the next three months, the peso depreciated a further 40%.
The economy seemed in free-fall. GDP fell by 11% in 2002 and, by the end of the year, income per head was 22% below that of 1998. Unemployment was 21%.
Then, however, the economy began to recover, helped by higher (peso) prices for exports resulting from the currency depreciation. In 2003 economic growth was 9.0% and averaged 8.4% per annum from 2004 to 2008.
But what of the debt? In 2005, Argentina successfully made a huge debt swap with banks and other private creditors (see Box 27.1 in Economics, 8th edition). A large proportion of its defaulted debt was in the form of bonds. It offered to swap the old bonds for new peso bonds, but worth only 35% as much (known as a ‘haircut’). By the deadline of 25 February, there was a 76% take-up of the offer: clearly people thought that 35% was better than nothing! At a stroke, bonds originally worth $104 billion now became worth just $36.2 billion. Later the take-up of the offer increased to 93%. But still 7% held out.
Then in 2006 its debt of nearly $10 billion was repaid to the IMF. General government debt stock as a percentage of GDP fell from 172% in 2002 to 106% in 2006 and to 48% in 2010.
In September 2008, the government of President Cristina Kirchner pledged to use some of its foreign currency reserves of $47 billion to pay back the remainder of the defaulted debt still owed to Paris Club creditors. But negotiations stalled.
However, at the Paris Club meeting of 28 May this year, agreement was finally reached. Argentina will repay the outstanding $9.7bn owed to individual creditor countries. This will take place over 5 years, with a first instalment of $1.15bn being paid before May 2015.
Argentina hopes that the agreement will open up access to overseas credit, which, up to now, has been limited because of this unresolved debt. However, Argentina still owes money to the holders of the 7% of bonds who did not accept the haircut offered in 2005. Their claims are being heard in the US Supreme Court on 12 June this year. The outcome will be critical in determining whether Argentina will be able to raise new funds on the bond market.
What is the Paris Club? Why did the recent meeting of the Paris Club concerning Argentina’s debt not include the IMF?
What moral hazards are involved in (a) defaulting on debt; (b) offering debt relief to debtor countries; (c) agreeing to pay bond holders who did not accept the haircut?
In hindsight, was it in Argentina’s interests to default on its international debts in 2001?
Assume a country has a severe debt problem. What are the benefits and costs of using devaluation (or depreciation) to tackle the problem?
The latest balance of payments data for the UK show that in the final two quarters of 2013 the current account deficit as a percentage of GDP was the highest ever recorded. In quarter 3 it was 5.6% of GDP and in quarter 4 it was 5.4% of GDP. The previous highest quarterly figures were 5.3% in 1988 Q4 and 5.2% in 1989 Q3. The average current account deficit from 1960 to 2013 has been 1.1% of GDP and from 1980 to 2013 has been 1.6% of GDP.
The current account has four major components: the balance on goods, the balance on services, the balance on current transfers and the balance on income flows (e.g. investment income). The chart below shows the annual balances of each of these components, plus the overall current account balance, from 1960 to 2013.
There are large differences in the balances of these four and the differences seem to be widening. (Click here for a PowerPoint of the chart.)
Traditionally the balance on goods has been negative. In 2013 Q3 the deficit on goods reached a record 7.3% of GDP. It fell back somewhat in Q4 to 6.5%, still significantly above the average since 2000 of 5.5%. With the economy still recovering slowly, it would normally be expected that the trade deficit would be low. However, the high exchange rate has made it difficult for UK exporters to compete. Also with consumer confidence returning, imports are rising, again boosted by the high exchange rate, which makes imports cheaper.
The services balance, by contrast, is typically in surplus. In the final two quarters of 2013, the surpluses were 4.9% and 5.1% of GDP respectively. These compare with an average of 3.3% since 2000. It seems that the service sector, which includes banking, insurance, consultancy, advertising, accountancy, law, etc., is much more able to compete in a global environment.
The balance of current transfers to and from such bodies as the EU and UN have traditionally been negative, although as a proportion of GDP this has gradually widened in recent years. In 2013 the deficit was 1.7% compared with an average of 1.0% since 2000.
The most dramatic change has been in income flows and particularly those from investment. Before the crash in late 2008, the returns to many of the risky investments abroad made by UK financial institutions were very high. Income flows in the 12 months 2007 Q4 to 2008 Q3 averaged a surplus of 2.8% of GDP. They stayed positive, albeit at lower levels, until 2012 Q1, but then became negative as UK institutions reduced their exposure to overseas investments and as earnings in the UK by overseas investors increased. In the last two quarters of 2013, the deficits on income flows were 1.4% and 2.5% of GDP respectively.
How do these figures accord with the Chancellor’s desire to rebalance the economy towards exports? In terms of services, the export performance is good. In terms of goods, however, exports actually fell in the last two quarters from £78.4bn to £74.8bn. Although imports fell too in the final quarter, there is a danger that, with recovery and a high pound, these could begin to rise rapidly
So should the Bank of England attempt to bring the sterling exchange rate down? After all, the exchange rate index has risen from 79.1 in March 2013 to 85.9 in February 2014 (an appreciation of 8.6%). But if it did want to do so, what could it do? The traditional methods of reducing Bank rate and increasing the money supply are not open to it at the present time: Bank rate, at 0.5%, is already about as low as it could go and the Bank has ruled out any further quantitative easing.
The articles consider the latest balance of payments figures and their implications for the economy and for economic policy
If the current account is in deficit, how is the overall balance of payments in balance (i.e. is in neither deficit nor surplus)?
If the current account is in record deficit, why has sterling appreciated over recent months? What effect is this appreciation likely to have on the balance on trade in goods and services?
Why has the balance on investment income deteriorated? In what ways could this be seen as a ‘good thing’?
To what extent do the balance of payments figures show a rebalancing of the economy in the way the Chancellor would like?
What could the Bank of England do to bring about a depreciation of sterling?
What would be the benefits and costs of a depreciation of sterling?
Why do investors overseas seem so willing to lend to the UK, thereby producing a large surplus on the financial account?
It is rising inflation that typically causes problems for countries, whether it is demand-pull or cost-push. However, one country that has not been subject to problems of rising prices is Japan. Instead, this economy has been suffering from the gloom of deflation for many years and many argue that this is worse than high inflation.
Falling prices are popular among consumers. If you see a product whose price has fallen from one day to the next, you can use your income to buy more goods. What’s the problem with this? The Japanese economy has experienced largely stagnant growth for two decades and a key cause has been falling prices. When the prices of goods begin to fall over and over again, people start to form expectations about the future direction of prices. If I expect the price of a good to fall next week, then why would I buy now, if I can buy the same good next week at a lower price? But, when next week arrives and the price has fallen as expected, why would I purchase the product, if I think that the price fall is set to continue? The problem of deflation is that with continuously falling prices, consumers stop spending. Aggregate demand therefore declines and economic growth all but disappears. This is the problem that the Japanese economy has been faced with for more than 20 years.
However, the latest data from Japan shows core consumer prices growing faster than expected in December 2013, compared to the previous year. This figure was above market forecasts and was the fastest rate of growth in the past 5 years. These data, together with those on unemployment have given the economy a much needed boost.
Recent government policy has been focused on boosts in government spending, with an aim of reducing the value of the currency (click here for a PowerPoint of the chart). Such policies will directly target aggregate demand and this in turn should help to generate an increase in national output and push up prices. If the price trend does begin to reverse, consumers will start to spend and again aggregate demand will be stimulated.
The future of the economy remains uncertain, though the same can be said of many Western economies. However, the signs are good for Japan and if the recovery of other economies continues and gathers pace, Japan’s export market will be a big contributor to recovery. The following articles consider the Japanese economy.
World markets were taken by surprise by a large rise in Turkish interest rates on 28/1/14. In an attempt to combat a falling lira and rising inflation, the Turkish central bank raised its overnight lending rate from 7.75% to 12%. Following the decision, the lira appreciated by over 3%.
Since the start of this year, the Turkish lira had depreciated by 7.1% and since the start of 2013 by 22.8%. Along with the currencies of several other emerging economies, such as India and Brazil, speculators had been selling the Turkish currency. This has been triggered by worries that the Fed’s tapering off its quantitative easing programme would lead to a fall, and perhaps reversal, of the inflow of finance into these countries; in the worst-case scenario it could lead to substantial capital flight.
Consumer price inflation in Turkey is currently 7.4%, up from 6.2% a year ago. The central bank, in a statement issued alongside the interest rate rise, said that it would continue with a tight monetary policy until the inflation outlook showed a clear improvement.
The Turkish Prime Minister, Tayyip Erdogan, has been opposed to rises in interest rates, fearing that the dampening effect on aggregate demand would reduce economic growth, which, as the chart shows, has been recovering recently (click here for a PowerPoint of the chart). A slowing of growth could damage his prospects in forthcoming elections.
World stock markets, however, rallied on the news, seeing the rise in interest rates as a symbolic step in emerging countries stemming outflows of capital.
Why did the Turkish central bank decide to raise interest rates by such a large amount?
Why has the Turkish lira been depreciating so much over the past few months? How has this been linked to changes in Turkey’s balance of payments and what parts of the balance of payments account have been affected?
Why did global stock markets rally on the news from Turkey?
What will be the impact of the central bank’s actions on (a) inflation; (b) economic growth?
How has the USA’s quantitative easing programme affected developing countries?
When the rest of the developed world went into recession after the financial crisis of 2007/8, the Australian economy kept growing, albeit at a slightly lower rate (see chart 1: click here for a PowerPoint). Then as the world economy began to grow again after 2009, Australian grow accelerated. Partly this was the result of a strong growth in demand for Australian mineral exports, such as coal, iron ore and bauxite, especially from China and other east Asian countries.
But in 2013, Australian growth slowed and jobs grew by their lowest rate for 17 years. Employment actually fell by 22,600 in December and unemployment was only prevented from rising by a fall in the participation rate. The Australian dollar, which has been depreciating in recent months, fell further on the news about jobs, reaching its lowest level for over two years (see chart 2: click here for a PowerPoint).
Chart 1 Chart 2
The following articles look at the reasons behind Australia’s slowing growth and at possible reactions of the Australian government and the Reserve Bank of Australia (Australia’s central bank). They also look at the link between economic performance and policy on the one hand and the exchange rate on the other.
Why has the Australian dollar been depreciating in recent months?
Why did the Australian dollar fall further on the news that economic growth had slowed and employment had fallen?
Find out what has been happening to commodity prices in the past three years (see Economic Data freely available online and especially site 26) How has this affected (a) the current account of Australia’s balance of payments; (b) the exchange rate of the Australian dollar?
If commodity prices are in US dollars, how is a depreciation of the Australian dollar likely to affect Australia’s balance of payments?
How are possible fiscal and monetary responses in Australia likely to affect the exchange rate of the Australian dollar?
What determines the magnitude of the rise or fall in demand for Australian exports as the world economy grows or declines? How are the determinants of the price and income elasticities of demand for Australian exports relevant to your answer?
An historic agreement has been reached between Argentina over outstanding debt owed to creditor nations. Creditor nations come together as the ‘Paris Club’ and at a Paris Club meeting on May 28, details of a repayment plan were agreed. Argentina hopes that the agreement will enable it to start borrowing again on international markets: something that had been largely blocked by outstanding debt, which, up to now, Argentina had been unwilling to repay.This hardly came as a surprise, however. For many commentators, it was simply a question of when.
