Developed-country critics were quick to complain that the International Monetary Fund’s agreement with Argentina last month amounted to a blatant cave-in. For instance, they gripe, rather than requiring Buenos Aires to run a primary budget surplus (i.e., before interest payments) of 4 percent of GDP -- enough to begin paying down the country’s massive foreign debt arrears -- the Fund consented to a far less onerous 3 percent surplus. Yet well before that September 10 deal to roll over Argentina’s IMF debt -- and Buenos Aires’s provocatively withheld $2.9 billion payment to the Fund the day before -- there were signs that the IMF was softening its attitude toward one of its chronic problem children. One key reason that hasn’t generated the same size headlines as its debt payments derring-do: Argentina has been quietly and steadily enjoying a strong economic rebound over the past 12 months.
Early this year Argentina’s dynamic young central bank governor, Alfonso Prat-Gay, spent many hours in arduous debate with IMF technicians to persuade them that a looser monetary policy was vital to reviving Argentina’s devastated economy. The country was coming off four straight years of recession, which started even before Buenos Aires defaulted on approximately $132 billion of loans in December 2001 and promptly devalued the peso by 70 percent, plunging the economy into chaos and many Argentineans into poverty. GDP contracted a brutal 11 percent last year, while interest rates reached a growth-choking near-30 percent.
Still, Prat-Gay and his deputy, Pedro Lacoste, insisted to skeptical IMF officials that the economy had actually begun to recover in mid-2002 and that an easy-money policy coming amid relatively modest inflation, a stable exchange rate and healthy export earnings could stimulate demand without sending prices sky-high. Perhaps because Prat-Gay is a highly articulate economist and former Argentina analyst for J.P. Morgan & Co. and Lacoste is an expert on currencies and markets with a Wall Street pedigree of his own, the IMF officials grudgingly relented to a regimen of monetary stimulus.
The central bank moved swiftly. In this year’s first quarter, the number of extra pesos absorbed by the market (“emissions,” in central bankerspeak) rose 1.2 percent, and that was followed by a 5.6 percent burst in the second quarter. In all, the money supply has risen 19 percent this year. The economy reacted even better than expected: Buenos Aires now projects GDP growth of more than 5 percent this year, and some private economists see an even stronger rebound. The economy surged at a 7.6 percent annual rate in the second quarter. What’s more, tax revenues are growing; the primary budget surplus -- currently at 2.7 percent of GDP -- is running above the target for this year; bank deposits are higher than they were during the ten-year era of 1-to-1 peso-to-dollar convertibility; average interest rates dropped from 20 percent to 5 percent in the first half; inflation is projected to ease further, to between 10 and 15 percent, by year-end; and the Argentinean stock market was up 67 percent in dollar terms through mid-September. IMF deputy director Anne Krueger, the onetime top cop on the Argentina beat, exclaimed in May, “To the surprise of the whole world, me included, Argentina has begun to grow without falling into hyperinflation.”
The country’s renewed growth contrasts with Brazil’s continuing stagnation. Thus it is likely to advance developing-country (and academic) arguments for more liberal monetary and other stimulative policies to promote faster growth, rather than the usual fiscal and monetary strictures associated with the old Washington consensus on development (Institutional Investor, September 2003). Joseph Stiglitz, the Nobel Prize winning economist and former World Bank chief economist who is one of the Fund’s severest critics, told Institutional Investor that “this is a recognition of the limits of the IMF.”
But as is so often the case with any story of Argentinean economic gains, this one needs to be qualified. The country, in truth, remains a mess. Buenos Aires reckons that half of Argentineans now live in poverty -- this in a nation that boasted the world’s sixth-biggest economy at the start of the 20th century. The official unemployment rate is 16 percent but is probably much higher. Political corruption and crony capitalism are all too common. Ordinary Argentineans are clamoring for better public services. Foreign direct investment has dropped, and exports are stalled. Moreover, Buenos Aires still owes $12.5 billion to the IMF and roughly $87 billion to foreign private creditors, many of them retail bondholders in Europe and Asia.
Compound this dire situation with a new president (the sixth in four years) who casts himself as a populist in the old Perónist mold and has given tongue-lashings to the IMF and even hinted at repudiating a share of Argentina’s debt, and it’s no wonder that foreign investors -- who are crucial to the country’s long-term recovery -- remain wary. Enter, reassuringly, Prat-Gay at the Banco Central de la República Argentina and the respected Roberto Lavagna at the Economy Ministry.
President Néstor Kirchner, elected barely five months ago with just 22 percent of the popular vote, may be “Hurricane K” in the media, the crowd-pleasing scourge of the establishment. But he had the eminent good sense to reappoint Lavagna, who was installed as economy czar by former president Eduardo Duhalde in April 2002, and to go along with the Senate’s approval of Prat-Gay, whom Duhalde named BCRA chief in December 2002. This gives Kirchner’s untested administration a measure of continuity in economic management and a team that has gained kudos at home and abroad for stabilizing the economy from out of the postdefault chaos.
Rumors of Lavagna’s imminent resignation rattle business and investor circles practically every week. A former colleague of the Economy minister was betting in September that Lavagna would step down shortly after the IMF deal was concluded or certainly by the end of the year, before political uncertainties could tarnish his widely praised management of the economy. Lavagna, however, has given no indication of leaving and, indeed, has strengthened his political position at home by taking a hard line against Argentina’s foreign creditors at the annual IMFWorld Bank meetings in Dubai last month.
The September agreement, which runs three years and rolls over the entire $12.5 billion that Buenos Aires owes the Fund, was no doubt made easier by the presence of Lavagna and Prat-Gay in the government. Nonetheless, the Fund was also operating from a weaker-than-usual stance. In an extraordinary gesture, IMF president Horst Köhler had publicly owned up to mistakes made by the Fund in its prior policy prescriptions for Argentina, such as going along with Buenos Aires’s pegging of the peso to the dollar. President Kirchner set the tone for the negotiations by flatly ruling out any IMF austerity measures that might undermine Argentina’s fragile recovery.
Still, the talks were less marred by conflict than negotiations in the recent past. “Both sides learned a great deal in the past year and a half, and a high degree of trust among key members of the teams was built up,” says Argentinean Finance Secretary Guillermo Nielsen, Lavagna’s No. 2 at the Economy Ministry. Sources close to the negotiations report that ministry officials argued that the Fund’s initial proposal that Buenos Aires set a primary surplus target of 4.5 percent of GDP was not only unsustainable but also unnecessary. Argentina privatized its social security system in 1991 and recognized the $5 billion cost in its debt accounts, they pointed out, so it does not face a huge future budget charge, as do other countries. Therefore, they contended, Argentina’s surplus target should be no more than 3 percent initially but could rise gradually over the length of the agreement as growth resumes, reaching 4.5 percent in 2006. Minister Lavagna was especially convincing, and the IMF capitulated. Implicit in the terms, though, was a pledge by Buenos Aires to raise tax revenues, which are among the lowest in proportion to GDP of any country in Latin America. (Rumors quickly sprouted that Brazil would likewise pursue a lower surplus target if it decides to seek a new Fund agreement.)
As central bank chief, Prat-Gay has not been involved directly in the contentious negotiations over Argentina’s private foreign debt. (Minister Lavagna’s opening gambit in late September of a 75 percent reduction in the value of the country’s defaulted bonds was met with dismay by creditors.) But the central bank chief has plenty of other crises to fill his calendar.
For a start, he must coach the BCRA back into playing shape, after a decade in which most of its central-bankerly functions were allowed to atrophy because of the country’s currency convertibility doctrine. The government, which was not discouraged by the IMF, decreed that one peso equaled one dollar, in effect ceding control over all aspects of domestic monetary policy to the U.S. Federal Reserve Board. The Argentinean central bank’s brief was confined to money-changing and banking regulation and supervision.
“The BCRA was little more than a teller machine for more than a decade,” says Prat-Gay. “That leaves us with a lot to do internally. And at the end of the day, I would like to be judged on a few but very critical things, and at the top of the list is to turn the central bank into a central bank.”
The moment is ripe. In August, Argentina’s Congress passed a bill that grants the BCRA effective independence from the Economy Ministry. The need for such legislation was noisily underscored during Lavagna’s first year in office. The Economy minister and the BCRA fought loudly and publicly over turf until the exasperated minister finally pushed two BCRA presidents in a row -- Mario Blejer and Aldo Pignanelli -- out the door. Insiders say the pair believed that the ministry was usurping the bank’s power by pushing it to the sidelines in discussions with the IMF. Given that backdrop, Lavagna and Prat-Gay sought early on to hammer out their institutions’ respective roles. The bank is concentrating on classic central bank functions. Says Finance Secretary Nielsen, “Prat-Gay and Lacoste are predictable, and the division of labor is clear and productive.”
Resurrecting the central bank is challenge enough. Experts on the BCRA say that the bank retains some of the country’s most qualified professional technicians, in spite of several years of attrition. Nevertheless, as Prat-Gay points out, ten years of a pegged currency can lead to “a loss of reflexes.” A foreign economist, declining attribution, observes: “Alfonso is going to need an army of new nerds. And given the politicized character of the board of directors and of many of the people brought in during [former Economy minister] Domingo Cavallo’s reign, he’s got a major capacity-building job on his hands.” Several bank staffers purportedly came by way of ultraliberal think tank Centro de Estudios Macroeconómicos de Argentina, in Buenos Aires, whose founders include Pedro Pou and Roque Fernández, both BCRA presidents during the 1990s.
“There is no need for a witch-hunt here,” emphasizes Lacoste, whose official title at the bank is vice president. “We have to find the right blend between the old and the new.” The bank’s hiring in the 1990s was primarily geared toward oversight, he notes, but “now we have to trade inspectors for strategists, find the best elements of the old central bank and bring in new blood from elsewhere.” Expect several top appointments from the outside to be announced before the end of the year.
IF TELEVISION EVER MAKES A REALITY SHOW about a central banker, it ought to star Alfonso Prat-Gay. At 38 he is certainly one of the youngest central bank heads ever and undoubtedly one of the best looking. A woman who knew him in high school recalls that when a girl dated Prat-Gay, “her ratings automatically went up.” Told of this comment, the banker, now married with three children, laughs that the only ratings he cares about these days are credit ratings.
Prat-Gay’s grandfather, Fernando Prat-Gay, an emigrant from Catalonia in Spain, founded a sugar mill in Argentina’s northwestern province of Tucumán. The central banker’s father, Jorge, ran the mill before going on to found and head the Banco Latinoamericano de Exportaciones as well as serve as deputy chairman of Banco de la Nación Argentina. Raised in Buenos Aires, Prat-Gay attended the tony Colegio Cardenal Newman, where he was a superb student and played first-class soccer and tennis, and also was reputed to be a ladies’ man.
At the Pontificia Universidad Católica Argentina in Buenos Aires, he studied economics under former central bank president Javier González Fraga. Another of Prat-Gay’s professors: his BCRA vice president, Lacoste, who has been a consultant on Argentina to firms such as Fidelity Alliance Financial Services, Merrill Lynch & Co. and Morgan Stanley. Prat-Gay next earned a master’s degree in economics at the University of Pennsylvania and began work on, but never completed, his Ph.D.
He gravitated to Wall Street, eventually joining J.P. Morgan. In 1996 the bank sent the then-31-year-old Prat-Gay to London to head up its global foreign exchange strategy group. There he earned the office sobriquet “Mr. Yen” for a daring call on the Japanese currency. Prat-Gay predicted, correctly, that the yen would appreciate strongly over the next several months -- rising to as few as 100 to the dollar -- at a time when market sentiment called for it to slide to 170. “Morgan gave me the opportunity to focus on the dollar, the yen and the euro during what was a difficult period in those markets,” Prat-Gay recalls.
As a country analyst for Morgan covering Chile and Argentina, Prat-Gay’s prescience about his homeland helped win him a place on Institutional Investor’s 1997 Latin America Research Team. In August 1996 investors were worried that Buenos Aires was running too big a budget deficit. But Prat-Gay, defying other forecasters, predicted that recovery would enable Argentina to trim the deficit to manageable proportions and obtain sufficient financing to meet its needs. He was right. “A great call,” said one institutional investor at the time. “Alfonso clearly established that Argentina’s economy problems were cyclical, not secular.”
After nearly eight years at Morgan, Prat-Gay left in November 2001 to return to Buenos Aires to launch a consulting firm, APL Economía, with his old professor Lacoste. “I always thought of investment banking as a stage in my life that would make it possible for me to do other things,” Prat-Gay says. “And it was so hard watching my country fall apart from afar.”
Wall Street taught Prat-Gay valuable lessons. He says he’s now convinced that many economic policy leaders -- like his predecessor, Cavallo, the great champion of convertibility -- failed because they lacked an understanding of markets.
If Wall Street was good for Prat-Gay, it was also good to him. In a nod toward transparency unheard of in Argentina, he declared his net worth before taking office. His $6 million fortune should come in handy: Prat-Gay’s salary as BCRA president is just $13,000 a year.
On the other hand, he does get a grand office. High-ceilinged and imposing, with reddish-brown walls of indigenous quebracho wood framing scenic panels painted by illustrious native artists such as Quinquela Martin, it is housed in the bank’s 1876 Greek Revival headquarters on San Martin Street in Buenos Aires. The impression is one of solidity, prosperity and prudence.
Aware of a certain irony in this, Prat-Gay calls a visitor’s attention to a small desk tucked into the corner of the waiting room outside his office. A brass plaque indicates that it once belonged to Eva Perón -- Evita -- who kept an office at the central bank in the late 1940s from which she ran her Robin Hoodesque Fundación Eva Perón.
ADDING IMPETUS TO PRAT-GAY’S CAMPAIGN TO rebuild the BCRA’s technical expertise is the bank’s commitment to implementing inflation-targeting by early next year. The bank formally announced this ambition at a seminar it held in June, attended by such well-known proponents of inflation-targeting as former Brazilian central bank president Armínio Fraga, Bank of England deputy chief economist Nigel Jenkinson and John Murray, adviser to the governor of the Bank of Canada.
Inflation-targeting, as Prat-Gay sees it, is not just a trendy economic notion but a tool for fundamentally reshaping the economic behavior of Argentineans. “Pedro [Lacoste] and I have been convinced for some time that inflation-targeting is needed,” he explains. “It moves you to the point where people’s expectations are aligned with your [inflation] target, which means we would have the utmost definition of price stability.”
Prat-Gay says Article III of the BCRA’s charter, which enjoins the bank to preserve the value of the nation’s currency, deserves to be taken seriously (as has not always been the case in Argentina). “It’s going to take lots of explaining for Argentines to understand that [stability] means the peso and not the dollar,” he acknowledges. “We have to help people to understand why a central bank is needed in the first place.”
The central bank boss says that he doesn’t want to rush inflation-targeting, especially since the ructions from the peso devaluation are still being felt. Nevertheless, the bank has already begun to put in place the necessary internal structures. “We’re not quite there yet in terms of prerequisites, but that is a matter of timing,” Prat-Gay says.
The bank has been systematically surveying the economic forecasts of some 30 research entities, from investment banks to consultants to government agencies, to determine which are consistently closest to the mark. The aim is to reduce the BCRA’s margin of error when setting inflation targets; an inherent hazard of this kind of approach is poor targeting. “Every central bank in the world has to work with a degree of inflation-targeting,” contends Lacoste. “It’s not all science and it’s not magic, but it is closest to constructive collusion between the two.”
The bank’s plan is to publish its targets three years out, starting, however, with a wide band to take into account impending relative price adjustments whose timing, magnitude and impact on consumer prices are difficult to forecast.
“Our challenge is not to bring down inflation so much as it is to preserve price stability,” emphasizes Lacoste. Once the bank establishes credibility, the theory goes, Argentineans will in time resume saving in pesos, making longer-term investments and laying the groundwork for growth.
The ostensible model for Argentina’s experiment in inflation-targeting is the Bank of England (Institutional Investor, February 2003). But the British economy is comparatively stable, and Prat-Gay is well aware that conditions in Argentina more closely resemble those of Brazil when that country launched its so-far-successful inflation-targeting regime. Accordingly, Prat-Gay’s strategy is to set up an institutional framework that promotes stable price mechanisms while still allowing for an agile and flexible response to rapidly changing economic circumstances. “We would like to think that we can eventually earn enough credibility through inflation-targeting that we can match the flexibility of the U.S. Fed,” he says.
Yet the central banker has no illusions about the difficulty of the mission he’s about to embark on. “At the end of the day, what’s the alternative?” Prat-Gay asks. “We’ve lost the nominal anchor [in the dollar], and we have to get ahold of some kind of quantitative targets. Inflation-targeting is a lot harder, a lot more ambitious, but it makes more sense.”
In this effort Prat-Gay and Lacoste will be spared at least a few distractions. Every economist in Argentina has a wish list of what needs to be done right away, and close to the top of every list are: restructure the foreign debt, recapitalize the private sector banks and reform the public sector banks. Many would like the BCRA to become more involved with, if not take charge of, these activities. But Prat-Gay demurs, “Those are not areas where we have jurisdiction.”
Recapitalizing the banks, for example, would require resource transfers straight from the federal Treasury and falls within the province of the Economy Ministry. “The central bank can’t sign the checks,” points out Prat-Gay. “What we can do is design policies that facilitate or encourage the process.”
So, in effect, the BCRA is backing into bank rehabilitation in the land of the perpetual bank crisis and permanent reform. “This is a crisis, and in times of crisis the gray areas, like financial sector reform, are larger and moving targets,” says Prat-Gay. “The Ministry of Economy and the central bank must cooperate.”
The case for doing so is compelling. Back in the 1980s Argentina found itself ludicrously overbanked following the halcyon plata dulce (sweet silver) overvalued peso days. The IMF demanded reforms. Today, says former Economy Ministry undersecretary Guillermo Rozenwurcel, an economics professor at Universidad Nacional de General San Martín, “practically all of the banks -- private, public, national, international -- are not only bankrupt but continue to lose money, as almost half their portfolio has a yield below the rate for deposits.”
Still, things could be worse. In the aftermath of the horrific events of late 2001 and early 2002 -- the record default, the maxidevaluation of the peso, a run on deposits, a full-scale banking freeze, the “pesification” (conversion to pesos) of dollar holdings -- commentators warned of an imminent collapse of Argentina’s entire banking system. Yet in sharp contrast to Mexico’s tequila crisis in 1994, when almost half of its banks went under, not one significant Argentinean bank has bitten the dust. Indeed, most of the country’s banks are, for the time being, bulging with cash from a reverse flow of flight capital that started in mid-2002. At $30 billion, total deposits are at an all-time high.
Yet the bloated financial system has seemed incapable of providing the reliable credit that the economy will need to keep expanding in the long run. According to Prat-Gay’s diagnosis, the latest banking crisis has gone through three phases: a liquidity crisis, followed by a solvency crisis and now a profitability crisis. “The central bank can do a lot about the first two and not much about the third,” Prat-Gay says. Even so, he notes that banks are likely to move into break-even territory in this year’s second half and could even turn a profit if they are willing to be looser with credit and lend from their excess cash. Bankers counter that there isn’t sufficient demand from creditworthy borrowers.
Recognizing that the financial system suffers from profound structural problems, Prat-Gay has sought to redefine the rules for banks while struggling behind the scenes to keep them afloat. As he puts it, the BCRA has “removed a lot of stones from the road by setting new rules of the game.” A package of seven BCRA measures created new mechanisms for canceling bank rediscounts and for granting additional funds through those credit lines. The central bank also revised reserve requirements to facilitate the repayment of certain deposits, and it established precise limits on how much foreign currency banks can buy and sell. In addition, the BCRA imposed severe limits on banks’ fresh loans to the public sector. It also made it much easier for debtors to refinance credits. And the central bank made it illegal for banks to discriminate against small and medium-size enterprises and individuals when imposing capital requirements.
Perhaps most important for banks’ long-term survival, though, was a BCRA edict that over the next five years they rid their balance sheets of above-market valuations for the defaulted government bonds that most banks carry at face value. The impact will be enormous: Some 50 percent of the financial system’s total assets consist of such overvalued public paper.
This proviso will end “accounting cosmetics” and result in much greater transparency in banking sector valuations, says former Finance secretary and exBanco de la Provincia de Buenos Aires vice president Lisandro Barry. “Keeping the overvaluations of defaulted debt helped keep banks alive, but this will effectively provide breathing room for recapitalization.”
The ultimate aim is to make banks’ books more transparent across the board. “Banks have truckloads of bonds and other government paper, and we must tell them how we will value bonds that were converted to pesos,” says Prat-Gay. “But we must also be clear about which stocks they must mark to market and by when.”
The BCRA has had other notable successes under Prat-Gay. It has vastly increased the liquidity of its own bonds, called Lebac; their rates have declined even faster than interest rates. Asserting its monetary domain, the bank has mopped up virtually all the “funny money” that sprang up in Argentina’s provinces during the peso crisis. At one point these local quasicurrencies exploded to almost 20 percent of the money supply.
As Prat-Gay well appreciates, however, he will be best remembered for restoring the Banco Central de la República’s status as a true central bank. Buenos Aires, not Washington, will dictate Argentina’s interest rates. Says Prat-Gay, “When it comes to monetary policy, we now call the shots.”
