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.
Argentina clinches landmark debt repayment deal with Paris Club Reuters, Leigh Thomas and Sarah Marsh (29/5/14)
Argentina Will Repay Paris Club Debt 13 Years After Default Bloomberg, Charlie Devereux and Pablo Gonzalez (29/5/14)
Argentina and the capital markets: At least they have Paris The Economist (30/5/14)
Argentina’s Paris Club Deal to Bring Investment, Kicillof Says Bloomberg, Charlie Devereux (30/5/14)
Argentina Leaves Singer for Last in Preparing Bond Market Return Bloomberg BusinessWeek, Camila Russo and Katia Porzecanski (30/5/14)
Argentina in deal with Paris Club to pay $10bn debts BBC News (29/5/14)
Argentina debt deal could help ease re-entry to international markets The Guardian (29/5/14)
Argentina agrees deal to pay back $10bn debt The Telegraph (29/5/14)
Questions
- 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 IMF has just published its 6-monthly World Economic Outlook report. The report is moderately optimistic, arguing that ‘global activity has broadly strengthened and is expected to improve further in 2014–15’. World growth is expected to rise from 3.0% in 2013 to 3.6% in 2014 and 3.9% in 2015,
Much of the impetus for an acceleration in growth is expected to come from advanced countries. Growth in these countries is expected to average 2¼% in 2014–15, a rise of 1 percentage point compared with 2013. Part of the reason is that these countries still have large output gaps and thus have considerable scope to respond to rises in aggregate demand.
Monetary policy in advanced countries remains accommodative, although the USA has begun to taper off its quantitative easing programme. It is possible, however, that the ECB may make its monetary policy more accommodative, with signs that it might embark on quantitative easing if eurozone growth remains weak and if the risks of deflation rise. If the average price level in the eurozone does fall, this could dampen demand as consumers defer consumption until prices have fallen.
As far as emerging economies are concerned, growth is projected to ‘pick up gradually from 4.7 percent in 2013 to about 5 percent in 2014 and 5¼% in 2015’. Although predicted growth is higher in emerging countries than in advanced countries, its acceleration is less, and much of the predicted growth is dependent on rising export sales to the advanced countries.
Global growth, however, is still fragile. Emerging market economies are vulnerable to a slowing or even reversal of monetary flows from the USA as its quantitative easing programme winds down. Advanced countries are vulnerable to deflationary risks. ‘The result [of deflation] would be higher real interest rates, an increase in private and public debt burdens, and weaker demand and output.’
The UK is predicted to have the strongest growth (2.9%) of the G7 countries in 2014 (see above chart). But the IMF cautions about being too optimistic:
Growth has rebounded more strongly than anticipated in the United Kingdom on easier credit conditions and increased confidence. However, the recovery has been unbalanced, with business investment and exports still disappointing.
Articles
IMF: World economy stronger; recovery uneven USA Today, Paul Davidson (8/4/14)
Emerging markets feel the pressure The Telegraph, Szu Ping Chan (8/4/14)
IMF cuts downturn danger to near zero Financial Times, Chris Giles (8/4/14)
IMF warns eurozone and ECB on deflation threat RTE News (8/4/14)
Recovery strong but risk shifts to emerging markets: IMF CNBC, Kiran Moodley (8/4/14)
IMF: World economy is stronger but faces threats Bloomberg Businessweek, Christopher S. Rugaber (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News, Hugh Pym (8/4/14)
Five signs that the global economic recovery may be an illusion The Guardian, Larry Elliott (6/4/14)
Report and data
World Economic Outlook (WEO) International Monetary Fund (8/4/14)
World Economic Outlook Database IMF (8/4/14)
Questions
- Why does the IMF expect the world economy to grow more strongly in 2014 and 2015 than in 2013?
- What are the greatest risks to economic growth for (a) advanced countries; (b) developing countries?
- What geo-political events could negatively affect economic growth in (a) the eurozone; (b) the global economy?
- In what ways is the UK’s economic growth unbalanced?
- How much credence should be given to economic forecasts?
- Should countries’ economic performance be judged primarily by their growth in GDP?
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
Articles
UK current account deficit far bigger than forecast The Guardian, Katie Allen (28/3/14)
UK current account deficit near record high at £22.4bn BBC News (28/3/14)
UK current account gap second widest on record The Telegraph, Szu Ping Chan (28/3/14)
When will the UK pay its way? BBC News, Robert Peston (28/3/14)
Current account deficit crisis creeping up on UK can no longer be ignored The Guardian, Larry Elliott (30/3/14)
Data
Balance of Payments, Q4 and annual 2013 ONS (28/3/14)
Statistical Interactive Database – interest & exchange rates data Bank of England
Questions
- 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?
In August 2012, the ECB president, Mario Draghi, said that the ECB would ‘do whatever it takes‘ to hold the single currency together and support the weaker economies, such as Greece, Portugal and Spain. At the same time, he announced the introduction of outright monetary purchases (OMTs), which would involve purchasing eurozone countries’ bonds in the secondary markets. There were no limits specified to such purchases, but they would be sterilised by the sale of other assets. In other words, they would not increase the eurozone money supply. But despite the fanfare when OMTs were announced, they have never been used.
Today, the eurozone economy is struggling to grow. The average annual growth rate across the eurozone is a mere 0.5%, albeit up from the negative rates up to 2013 Q3. GDP is still over 2% below the peak in 2008. Inflation is currently standing at 0.8%, well below the 2% target. The ECB’s interest rate (‘main refinancing operations rate’) is 0.25%.
The recovery is hindered by a strong euro. As the chart shows, the euro has been appreciating against the dollar. The euro exchange rate index has also been rising. This has made it harder for the eurozone countries to export.
So what can the ECB do to stimulate the eurozone economy? Other central banks, such as the Bank of England, the US Federal Reserve and the Bank of Japan have all had substantial programmes of quantitative easing. The ECB has not. Perhaps OMTs could be used without sterilisation. The problem here is that there are no eurozone bonds issued by the ECB and hence none that could be purchased, only the bonds of individual member countries. Buying bonds of weaker countries in the eurozone would be seen as favouring these countries and might create a moral hazard.
Reducing interest rates is hardly an option given that they are at virtually zero already. And expansionary fiscal policy in the weaker countries has been ruled out by having to stick to the bailout conditions for these countries, which require the pursuit of austerity policies.
One possibility would be to intervene in the foreign currency market by buying US and other countries’ bonds. This would drive down the euro and provide a stimulus to exports. This option is considered in the Jeffrey Frankel article.
Articles
Why the European Central Bank should buy American The Guardian, Jeffrey Frankel (13/3/14)
Draghi holds course in face of deflation threat Reuters, Paul Carrel and Leika Kihara (13/3/14)
ECB’s Draghi: Strong Euro Pulling Down Euro Zone Inflation Wall Street Journal, Christopher Lawton and Todd Buell (13/3/14)
Draghi Bolstering Guidance Seen as Convincing on Rates Bloomberg, Jeff Black and Andre Tartar (13/3/14)
ECB president Mario Draghi counters euro upswing Financial Times, Claire Jones (13/3/14)
Turning Japanese? Euro zone exporters must hope not Reuters, Neal Kimberley (14/3/14)
Prospect of ECB QE drives eurozone bond rally Financial Times, Laurence Mutkin (12/3/14)
Data
Statistical Data Warehouse ECB
Winter forecast 2014 – EU economy: recovery gaining ground European Commission: Economic and Financial Affairs DG
AMECO online European Commission: Economic and Financial Affairs DG
Questions
- Why is the ECB generally opposed to quantitative easing of the type used by other central banks?
- What is meant by ‘sterilisation’? Why does sterilisation prevent OMTs being classed as a form of quantitative easing?
- Would it be possible for OMTs to be used without sterilisation in such as way as to avoid a moral hazard for the highly indebted eurozone countries?
- Is the eurozone in danger of experiencing deflation?
- What are the dangers of deflation?
- Why does the ECB not cut its main refinancing rate below zero?
- If the ECB buys US bonds, what effect would this have on the euro/dollar exchange rate?
- Would purchasing US bonds affect the eurozone money supply? Explain.
- What other means are there of the ECB stimulating the eurozone economy? How effective would they be likely to be?
According to latest evidence from the Bank for International Settlements, in April 2013 some £3.2 trillion ($5.3 trillion) of foreign exchange was traded daily on global foreign exchange (forex) markets. About 40% of forex dealing goes through trading rooms in London. This market is highly profitable for the UK economy. But all is not well with the way people trade. There is a scandal about rate fixing.
Exchange rates on the forex market are freely determined by demand and supply and fluctuate second by second, 24 hours a day, except for weekends. Nevertheless, once a day rates are fixed for certain trades. At 4pm GMT a set of reference rates is set for corporate customers by banks and other traders. The rates are set at the free market average over the one minute from 16:00 to 16:01. The allegation is that banks have been colluding, through text messaging and chat rooms, to manipulate the market over that one minute.
Since the early summer of 2013, the Financial Conduct Authority (FCA) in the UK, along with counterparts in the USA, Switzerland, Hong Kong and elsewhere, has been looking into these allegations. Last week (4/3/14), the Bank of England suspended a member of its staff as part of its own investigation into potential rigging of the foreign exchange market. The allegation is not that the staff member(s) were involved in the rigging but that they might have known about it.The Bank said that, “An oversight committee will lead further investigations into whether bank officials were involved in forex market manipulation or were aware of manipulation, or at least the potential for such manipulation.”
Meanwhile, the House of Commons Treasury Select Committee has been questioning Bank of England staff, including the governor, Mark Carney, about the scandal. Speaking to the Committee, Martin Wheatley, head of the FCA said that the investigation over rigging had been extended to 10 banks and that the allegations are every bit as bad as they have been with Libor.
Forex rigging ‘as serious as’ Libor scandal: Carney Yahoo News, Roland Jackson (11/2/14)
Forex manipulation: How it worked HITC (Here Is The City), Catherine Boyle (11/3/14)
Bank of England Chief Grilled Over Forex Scandal ABC News, Danica Kirka (11/3/14)
Carney Faces Grilling as Currency Scandal Snares BOE Bloomberg, Scott Hamilton and Suzi Ring (10/3/14)
UK financial body urges quick action over foreign exchange ‘fixing’ Reuters, Huw Jones (11/3/14)
Timeline -The FX “fixing” scandal Reuters, Jamie McGeever (11/3/14)
Forex in the spotlight Financial Times (16/2/14)
Forex scandal: What is that all about? BBC News (11/3/14)
Bank of England in shake-up after rate manipulation criticism BBC News (11/3/14)
Mark Carney faces Forex questions from MPs BBC News, Hugh Pym (11/3/14)
Bank of England’s Paul Fisher: ‘It’s not our job to go hunting for market wrongdoing’ Independent, Russell Lynch , Ben Chu (11/3/14)
Questions
- For what reasons would sterling appreciate against the dollar?
- Most of forex trading is for speculative purposes, rather than for financing trade or investment. Why is this and does it benefit international trade?
- If foreign exchange rates fluctuate, is it not a good thing that banks collude to agree the 4pm fixed rate? Explain.
- What was the Libor scandal? Why are some people arguing that the current forex scandal is worse?
- What can the FCA do to prevent collusion over exchange rates?
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.
