Factors the Led to Argentinas 2018 Economic Crisis & Implications for MNCs
Global Financial Management
Awham Ali Alshehhi
Dr. Philip Molyneux
TOC o “1-3” h z u Introduction PAGEREF _Toc22312999 h 2Key Factors that Lead to Argentinas 2018 Monetary Crisis PAGEREF _Toc22313000 h 2The Implication of This Crisis on the US and Other Multinationals as a whole PAGEREF _Toc22313001 h 2Conclusion PAGEREF _Toc22313002 h 2References PAGEREF _Toc22313003 h 2
IntroductionArgentina is currently struggling with a serious economic crisis with its local currency, peso, having lost at least two-thirds of its overall value since 2018; the rate of inflation increased to around 30% while in 2015, the countrys economy had contracted by at least 4% (Congressional Research Service, 2019).
Notably so, it overall external debt increased by 60%. By the end of June 2018, the government then sought out financial assistance from the International Monetary Fund (IMF). As such, the country now possesses $57B IMF program, which is the largest by far in IMF history (Congressional Research Service, 2019). Despite of these measures, the government still engaged in postponing payments for a good deal of its external debt while at the same time focused on imposing currency control measures. It is important to note that this economy has faced a great deal of economic crises and in most cases; defaulted on its external debt repayments since it gained independence (Wiarda & Kline, 2018). It has so far been included in 21 IMF programs. The present economic crisis that faces the country emanates from extended issues as well as recent developments, which would form the main discussion of this paper.
Key Factors that Lead to Argentinas 2018 Monetary CrisisImmediately after Argentinas economy experienced a boom in 2017 fiscal year with the internationally- acclaimed President Macris coalition coming on top of legislative elections, market economists had so much expectations for continued growth of Argentina as at the very beginning of 2018 moving forward (Burin, 2018). However, the volatile peso currency postulated to the Argentines and especially so, the local investors that economy instability was only but taking shape. In lieu of this, the next section discusses factors that contributed to this crisis;
First, there was uncertainties in Peso/USD Spot rate for the period extending to 2018. It is important to note that economists had for a long period now argued that Argentinas peso currency was somehow overvalued and the sitting government had, in fact, affirmed this fact indicating that it would certainly depreciate over the coming years or so (Cohen, 2018). However, it was no one anticipation for the speed in which the peso successfully plunged against the US dollar in April of 2018 (Cohen, 2018). This plunge was as a result of investors showing high level of concerns on the government capacity to successfully manage its inflation rates. It was also as a result of its inability to control interest rate increases especially as dictated by the US Federal Reserve move that saw a strengthened US dollar across the globe. As such, the depreciation resulted to Argentinas dollar debts ballooning even more for its government to pay, which compelled it to seek assistance from the International Monetary Fund (IMF) for the $50B loan (Cohen, 2018). In essence, the decision to hike interest rates by the US Federal Reserve led to a significant reduction of investor interest in Argentine bonds. It is also noted that the countrys central bank focused on resetting its inflation targets, which resulted to queries on the underlying independence and commitment of the government to reduce its inflation. It should be comprehended that as a result of this spot rate, most of the investors initiated efforts to sale-off Argentine-based assets; a process that only went ahead to put a downward pressure on the peso (Cohen, 2018).
Source: IMF, Argentina: Fourth Review Under the Stand-By Arrangement, July 2019.
Secondly, the economy faced extensive national inflation rates. In consequence, Argentinas higher inflation rate remained to be one of the key drivers of the economic crisis. It exposed the country to a more vulnerable position in comparison to other emerging markets, which then resulted to a good number of investors shying away from putting their money into risky-Argentine assets (Cohen, 2018). For a good number of years prior to the crisis, most of the populist governments engaged in printing a good deal of money in order to successfully finance enormous wide budget deficits that resulted to a tremendous increase in underlying consumer prices. The current regime has been focused on reducing the entire practice however; the hikes especially in
relation to utility prices as an effort to significantly minimize subsidies and thereafter, close the fiscal deficit altogether have continued to position the inflation way above the recommended rates (Hornbeck, 2013). The robust reduction in the exchange rate has further resulted to inflation accelerating in the recent months. The most recent inflation figure for Argentina stands at 30%, which remains to be one of the highest across the globe (Cohen, 2018). The country had in the 2000s been able to sustain a favorable rate however, this did not last long enough as shown in Fig-1 below:
Thirdly, the underlying foreign currency reserves uncertainty further played a fundamental role in progressing the economic crisis. It resulted whenever the central bank focused its response mechanism on trying to handle the robust depreciation and thereby increase the existing inflation levels by overall hikes in interest rates to at least 45 per cent while at the same time releasing an enormous amount of the US dollars to the money market as a way of shielding the local currency-
peso (Cohen, 2018). Distinctively, this move led to a definite decrease in the level of foreign reserve currencies, which had grown substantially since the new regime assumed duties in 2015. As much as the International Monetary Fund offered loan, which resulted to a significant boost in the overall foreign reserve of the country, the never-ending pressures exerted on the peso prompted a renewal of the central bank interventions in an effort to curtail its overall effects (Cohen, 2018).
Consequently, the economic activity, which relates to export of agricultural revenues, played a part in enhancing overall economic crisis. The country experienced the worst ever drought that significantly reduced soybeans and corn yields, which is the backbone of the countrys economic activity. As a result of this unfortunate occurrence under Macris leadership, the Argentine economy certainly shrunk massively for a good number of months in 2018, with agricultural sector being perceived as an area that would result to imminent economic recession (Cohen, 2018). As at the end of June 2018, the entire economy had dropped by 6.7 per cent, which is considered the worst fall since the start of the global financial crisis in 2009. It is noted that the countrys 2017/18 soy yields was the poorest in a span of nine years (Walker & Palumbo, 2018). As a result of this drought, there was intense increase in overall agricultural markets, which left China, the major importer, without one of its main commodity suppliers especially with the tensions soaring with the United States of America (Walker & Palumbo, 2018).
President Macri, whose approval ratings continue to dwindle with time, has only recently affirmed that the regime committed some notable mistakes especially in setting unrealistic and unattainable economic goals (Walker & Palumbo, 2018). He also noted that he had not successfully engaged in sufficient coordination of policies. Notwithstanding, the level of economic confidence continued to be downplayed by massive government corruption cases. The recession
threatened the Presidents major campaign promises of attaining a zero poverty rate and creation of quality jobs for the mass (Walker & Palumbo, 2018). However, as a result of this crisis, the regime confirmed that poverty had, in fact, hit an all-time high especially as a result of imminent inflation and economic downturns with the overall number of registered workers declining over the period from a peak in 2017 (Walker & Palumbo, 2018). It should be clearly understood that despite of IMF interventions, and thus infusion of a great deal of funds into the economy coupled with the fact that there were major promises made on fiscal reforms, the countrys local currency continued to depreciate in the major months of 2018.
Going into 2019, the Macri regime focused on pursuing imminent fiscal reforms that greatly involved a reduction of the overall budget deficit from a high of 5.3% to 2.5% in the periods 2018/19 respectively (Walker & Palumbo, 2018). The government also engaged in significant reduction of current account deficits to 2% in early 2019 (Walker & Palumbo, 2018). Despite of this, the economy certainly contracted majorly by at least 1.2% in 2019 (Walker & Palumbo, 2018). The underlying austerity measures as well as the higher interest rates have notably contributed majorly to the countrys economic contraction. In fact, the never-ending depreciation trend for peso provided a hard time controlling the level of inflation that was positioned at 30% by 2019 and tremendously resulted to an increase in the countrys overall debt that were mostly denominated in dollars; predicted at 76% of GDP (Walker & Palumbo, 2018).
The Implication of This Crisis on the US and Other Multinationals as a wholeIt is important to note that as a result of the crisis; the US economic exposure to Argentina, which is mainly conducted through forms of direct trade and investment had been curtailed in
relation to financial exposures. In fact, it is important to check that some of the foreign investors were likely even going to be affected more in the event that existing regime engaged in seeking ways of restructuring its overall debt position (Congressional Research Service, 2019). Notably so, the underlying role of IMF presented a wide array of implications for the United States of America, which is the economys largest shareholder. For a good number of years, it has been noted that Argentina is a frequent borrower with past IMF programs facing imminent challenges especially in relation to repayment (Congressional Research Service, 2019). To be specific, the nations default of its IMF loan led to this institution extensively engaging in the revision of most of lending policies. As at the end of 2018, the US government had enormously fronted the idea of IMF loans for this country especially since Macri regime had in fact portrayed a higher level of commitment towards improving US-Argentine ties and in reforming its overall economy as a whole (Congressional Research Service, 2019).
As recently highlighted by the different financial crisis and especially the Asian crisis, multinationals companies play a fundamental part in the overall stabilization of the economic circumstance of nations facing it altogether (Gao & Eshaghoff, 2004). To say the least, an overall understanding of multinationals reaction can successfully prove essential in the creation of the host countries policies, which are focused on restoring and fostering their immediate confidence level. For multinationals, such an economic crisis as the Argentine would have serious ramifications considering that they would now focus on formulating pertinent responses that can either be strategic or even operational in nature; entrepreneurial or adaptive or even long or short term response mechanisms (Gao & Eshaghoff, 2004). First, these multinationals could adopt a strategic expansion strategy, which greatly involves the decision to improve on the overall resource
commitments in order to gain massively of the opportunities that can emanate from the Argentina crisis. For instance, there is a higher likelihood that these multinationals would have increased their resource commitments towards immediate exploitation of the exporting opportunities or even utilize low cost production factors. True to this, it is noted that the countrys major soy exports to China decreased sufficiently while also the total number of registered workers fell within the period extending to the crisis (Gao & Eshaghoff, 2004). This is a situation that presents multinationals with an opportunity to use cheaper factors of labor for their production processes and engage massively into exporting soy into the different destinations in China. The decision to increase resource commitments by multinationals especially within the downtrodden economy only facilitates multinationals to attain long-term benefits. Through investment into provision of job opportunities however low-paying they can be; commitment towards provisions of new skills and technology as well as an opportunity to access capital by the existing domestic industry in the course of the crisis; the investor portrays a good faith to the underlying local consumers as well as the government of the day (Gao & Eshaghoff, 2004). As the Argentine economy then grows into recovery, multinationals will already be positioned fairly to meet the ever-growing needs of the existing domestic market. On the contrary though, these multinationals can also possibly adopt a strategic retrenchment approach, which is majorly a decision towards the reduction of resource commitments within the market that are typically postulated by entities that perceive the crisis as a key threat to attaining their long-term performance targets (Gao & Eshaghoff, 2004). In some cases, there is a higher chance that multinationals might also grasp this situation and use it as an opportunity to reconfigure their wider regional or even global competitive strategies so that the resources that are presently situated in Argentina are shifted and redeployed either within the
region or global markets as a whole. Resource restrictions provides a fundamental rationale for the withdrawal of resources completely (Gao & Eshaghoff, 2004). In addition to this, these multinationals might choose not respond in any manner possible to the crisis through adoption of a status maintenance approach. This is especially since they are certainly focused on maintaining their respective status quo within the region as relates to its operational and strategic business aspects. Multinationals can adopt this approach as a way of riding out the Argentine crisis altogether(Gao & Eshaghoff, 2004). However, these multinationals understands that there are a wider array of risks involved especially when the condition deteriorates even further also that they can then understand that they had failed to act or acted too later hence missed on perfect opportunities to salvage their investments and exposed to unexplainable level of damages altogether (Gao & Eshaghoff, 2004).
Multinationals should come to the understanding that as long as the IMF is strongly committed towards backing Macri-administration in its endeavors to reform the economy then the economy will enjoy sufficient financial support that would finance its operations till 2020. However, the multinationals should anticipate for a significant reduction of economic activities due to the proposed austerity measures. It is certainly clear that the regime has focused on sacrificing economic growth in 2018 and 2019 in order to attain a financial sustainability within the medium to long term period. The possibility of additional taxes being introduced would negatively affect multinationals businesses engaged in exporting businesses. All in all, the MNCs should continue to expect for a continued peso depreciation and currency volatilities till the 2019 presidential elections are finalized.
ConclusionIn sum, it can be noted that the Argentine 2018 crisis is not a unique happening considering that the country has received IMF loan programs nine times now. In all these periods, there were experienced defaults of these loans, which had negatively impacted Argentina reputation with the international money lending body. However, the appointment of Macri as the countrys president who hinted at reforming the entire economy and improving the countrys relations with USA means that they can continue being supported into the future. The 2018 economic crisis was a creation of both internal and external factors that include; a prolonged drought that negatively soybeans yield-a main cash crop for export to China; the economy faced intense inflation as well as interest rates hikes, which plummeted even more Argentines into poverty as well as foreign currency reserves being depleted by the day. The implications of this on MNCs is that they can choose to either stay or engage a strategic retrenchment to successfully salvage their investments.
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