CASE STUDY CASE 1.1 WILL ARGENTINA DEVALUE ITS PESO?BACKGROUNDArgentina is the second largest country in South America. Its nationallanguage is Spanish nad currency called Peso. Governmental systemis federal presidential system. Argentina is the founding member ofUnited Nation, World Bank, World trade organization and is among G-20 countries. According to World Bank major exporters and importersare following.According to World Bank Argentina is in upper middle income and developing country.This case study is about Argentina currency devaluation decision making. Its include thepros and cons of Peso devaluation and dollarization. It also includes the solution andother option to stop Peso devaluation.
STATISTICS ECONOMIC 1998 1999 INDICATORS GDP GROWTH % 3.9 -3.1 CPI % 0.9 -1.2 EXCHANGE RATE 1 1 FOREIGN EXCHANGE 24752 26252 RESERVES EXCLUDE GOLD(BILLION $) EXTERNAL DEBT 144.1 148.6 ($BILLION) Devalue of Peso from 1 to 1.7 causes fiscal deficit increase to 50% which is 2.9% of GDP increased from 1.9%. If the peso devalue from 1 to 3.47 is causes the equity to zero of non financial institutions.CRITICAL ASPECTS The economic activity is slow down causing the unemployment rate to increase and devaluation of Peso. Argentina has currency board and its Peso is backed by international reserves so when global crisis occur it leads to capital outflow resulting in interest rate to move up and restrict the government access to international debt markets. Devalue of Peso give advantage to Brazilian producer and cause the Argentina exports less competitive. Devaluation of Peso effects the Argentina inflation to move up, equity of organization and banks to fall, increase the liabilities of banks and corporations, increase the budget deficit, increase the loan payment amount and cost of debt.ConclusionArgentina considers its currency for devaluation or dollarization. The pros and cons ofboth helpful for economy as well as cause problem in long and short run. But Argentinatry to adjust its monetary tools to protect its currency from devaluation, for this purposeit control the trade off loss, unemployment, interest rate and reserves.
The government of Argentina considers the dollarization as the lender of the last resort.So deep analysis is mandatory to implement one of the policies mentioned abovekeeping in mind its effects on economy, mega projects and foreign investment. QUESTIONS AND ANSWERSANSWER NO1:ADVANTAGES OF DEVALUATION OF PESO: It improve competiveness of Argentina exports-imports competing products. Reduce real interest rate The decrease in the real interstate improve trade prospect and help to reduce the unemployment and to stimulate the economic activity. It helps the government to increase the tax revenues and to reduce the unemployment compensation and other social spending.DISADVANTAGES OF DEVALUATION OF PESO: Most of the liabilities of Argentina are denominated in Dollar so it causes the liabilities to increase. It causes the redistribution of wealth from foreign creditors and local debtors. Inflation increase. Reduces the equity of bank and non financial institutions. If the public and private debt improves it causes the capital to reduce and even to zero. It appreciates the government cost of servicing the debt and as a result the budget deficit increases.
ANSWER NO 2:There is chance that Argentina devalues its Peso or adopt the dollarization to move outof the crisis. On the other hand the government of Argentina adopts other option suchas controlling the monetary policy tools to control its currency value. Devaluation affectsa lot to the Argentina economy and foreign investment. So Argentina first adopt otheroption of controlling currency value and economy stimulation tools than of devalue itsPeso.ANSWERS NO 3:ADVANTAGES OF DOLLARIZATION: Increase the credibility of Argentina to monetary Help in maintain the stability in exchange rate. Cause faster the economic growth. Increase the trade opportunities. Help in maintain the inflation rate. Unemployment rate reduces. Bring new employment opportunities. Help to diversify the risk.DISADVANTAGES Dollarization result in high credit cost. Reduces the investment opportunities. Cause the government deficit to increase and decreases the governmental revenues.If global crisis occur it effects the dollar and ultimately effects the Argentina economy.ANSWERS NO 4: Effects of peso devaluation on mega project: Devaluation cause high inflation rate and cause the estimated cost of project to rise.
Devaluation effects the liabilities of the project. Devaluation increases the liabilities of the mega project. It causes the equity of the project to decrease. Devaluation of Peso effects the importing of raw material also. we have to spend more than estimation and have to face the budget deficit.ANSWER NO 5:Effect of dollarization on mega projects Dollarization help to stabilize the economy as it absorb risk and help in estimation of cost of project and its completion. if global crisis occur the dollar denominated securities and assets value decline and have to face loss. So it ultimately also effects the project because if all estimation and loan are consider in dollar value than the effect is same as mentioned. It helps to import raw material from other countries and save the transaction cost for the mega project.ANSWER NO 6:Following are the measure to stimulate Argentina economy growth independent ofexchange policy:
Argentina utilizes itsresource to increase its Government should Trade off loss must be exports and increase decrease its budget decrease. foreign reserves. deficit. Government utilize loanfor development purposewhich ultimately increase Government should the GDP. Interest rate decreases. Government should encourage FDI.reduce the external debt ratio. Inflation must me Stabilize its political Government utilize the controlles. condition to reduce debt for developmental pootical risk. purpose