Economic Crises

Markets welcomed the International Monetary Fund’s (IMF) $50 billion rescue stabilization package last week, which seems to be stabilizing the peso. But the financial umbrella will be costly. Rightly or wrongly, Argentines blame the IMF for precipitating their country's worst economic crisis. In the eyes of many voters, the mere association will damage President Mauricio Macri’s standing. As detrimental, the IMF entrance means an end to the economic gradualism of the last two-and-a-half years: Macri's strategy of trying to right the policy wrongs of more than a decade of mercurial rule by his predecessors while avoiding the political pain of austerity. Despite the public messaging that Argentina will make the decisions, and that social policies will remain in place, the new economic constraints accompanying the package threaten the political future of one of Latin America’s most market-friendly leaders. Macri’s fate shows how hard it is to recover from economic populism. Despite a deep bench of technocrats and broad societal support for change, Argentina’s structural flaws remain, hampering growth, productivity, and competitiveness. Gradualism achieved some real results. Macri freed the exchange rate, eliminated capital controls, and reduced agricultural export taxes. He rebuilt the statistics agency, gave the Central Bank back its autonomy and opened up infrastructure projects to private investment. He began to tackle the gaping budget deficit by hiking utility prices, re-calculating pension benefits, and resolving a protracted dispute over financial transfers to the provinces. All of these market-affirming steps were incremental—slowly reducing distortions of quotas, subsidies and other taxes, and trimming or re-orienting government spending. And they were complemented by millions more in social assistance and by billions more in public investments. The economy bounced back. By the second half of 2017 construction was flourishing and manufacturing recovering. Inflation finally started to decline. What didn’t change was the government’s need for cash, as economic gradualism required lenders to keep it afloat. After resolving claims from Argentina’s debt default saga, Macri’s administration swiftly became one of the most active international emitters—placing more than $100 billion in debt. Yet now, hit by a global investor pullback from emerging markets, the worst drought in three decades and a few homegrown political stumbles, Argentina is again being forced onto a more orthodox economic and financial path. With the IMF back in the picture, inflation will have to come down faster. This means the Central Bank will keep interest rates higher for longer, choking the incipient economic recovery. The deficit, too, has to be cut more drastically. Infrastructure spending that might otherwise spur growth will take a hit. But the real budget-buster is public sector employment, which grew under the Kirchners to represent nearly one in three jobs. To balance accounts, Macri will have to take on government workers. And voter patience is finally wearing thin. Since his victory in the October 2017 midterm elections, polls show Macri losing ground; fewer than half of Argentines approve of him or his government. Economic austerity will further erode this base. The crisis has become a rallying point for a deeply divided opposition. For the first time since Macri came to office, Peronist and Kirchner congressional delegates have teamed up, passing a bill that lowered utility tariffs back to November 2017 levels and forcing the president into an uncomfortable veto. Macri and his team still have 16 months before the next presidential election. The economic pain could fade before voters truly contemplate their vote. A push for concessions and other infrastructure partnerships could let private investors pick up some of the public-sector slack, lessening the cost to jobs and growth. And while the opposition shows signs of coalescing, it is far from uniting around a candidate to challenge Macri in the 2019 election. Macri’s stumbles also highlight the systemic destruction economic populism reaps. Debt can be renegotiated, currencies devalued, and other one-time shocks absorbed and overcome. But the entrenched political clienteles created by subsidies, quotas, bloated public payrolls, and other forms of political patronage are much harder to break up. Public largesse in the form of expanding benefits and entitlements become both unassailable and unsustainable. Even the ways of doing business change the calculus of the profit-minded, at least in some sectors, to favor rent-seeking over market-based competition. To reverse these pernicious shifts requires more than one presidential term. Sadly, Argentines may not grant Macri’s Cambiemos coalition the benefit of the doubt. View article originally published on Bloomberg.

John Hosinski is the former senior program officer of the Africa department at the Solidarity Center. He is currently a freelance writer based in Paris, France. The rapid fall of Robert Mugabe and ascent of former ally Emmerson Mnangagwa stunned even those closely following the country’s long-running succession drama. The decisive end of the succession question caught many by surprise, including most Zimbabweans, who poured into the streets to celebrate the end of Mugabe’s thirty-seven year rule. The crowds on the streets testify to both the pent-up energy of people suffering through extended economic malaise as well as the much understood (if unstated) illegitimacy of Mugabe’s personal leadership. Decades of rigged and stolen elections, rampant corruption and nepotism, and outlandish propaganda clearly atrophied support for the nonagenarian president.  Though this is not a democratic transition, it’s clear there is rising public expectation that things will get better—particularly in terms of jobs. Managing the elevated expectations of the people will be a key test for Mnangagwa. He inherits the leadership of an economy that has barely managed to stay afloat. Zimbabwe likely lost over seventy-five thousand formal jobs annually between 2011 and 2014. Another thirty thousand were lost in 2015 and an estimated eighteen thousand in 2016. This decline highlights the country’s two decades of deindustrialization, when formal employment was curtailed in rail, industry, agricultural processing, and transport. This process has resulted in over 95 percent of the country’s citizens making their living through informal employment. These job losses, more than anything, withered what was once the country’s most viable democratic opposition, organized labor. With formal jobs and union membership in decline, it has been workers in the informal economy who not only help Zimbabweans survive economically, but have steadily become more organized and aggressive in their demands for economic access and rights. Street vendors and other informal workers, organized into membership-based organizations, embody both the entrepreneurial as well as associational traditions of Zimbabweans in the face of decades of downward mobility as well as the desire of people for more say.  Informal workers long garnered the negative attention of both Mugabe and the ZANU-PF. Seen as a base of democratic opposition, the government attacked informal workers in 2005’s Operation Murambatsvina (“drive out the trash” in Shona), razing informal markets and settlements and putting almost six hundred thousand people into immediate homelessness. In recent years, well-organized groups of street vendors have faced ZANU-PF authorities in Bulawayo and Harare in arguments over economic access and vendors’ rights, which were somewhat overshadowed by the public and media focus on succession infighting. These arguments often escalated to violent attacks on vendors and took on a more political tone, with Mugabe himself weighing in and threatening action. Zimbabwe’s informal economy is not only where most people earn their living but also where they spend their money and it is a critical link between urban and rural markets. Though President Mnangagwa faces a withered and splintered democratic opposition, a key test for him and his government will be how restive informal workers like street vendors and their associations fare in the coming years. The question remains whether these workers will have more access to formal jobs, rights, and economic opportunities, or whether Zimbabwe maintains an ossified, corrupt economy which only benefits the well-connected at the top.   

President Nicolas Maduro has neither the desire nor the capacity to institute the market reforms and debt restructuring needed to revive Venezuela’s sinking economy, says economist Ricardo Hausmann.

One key question around China is pretty straight forward: will losses in China’s banks and shadow banks—whether on their lending to Chinese firms or their lending to investment vehicles of local governments* necessarily give rise to a currency crisis? Or can China, in some sense, experience a banking crisis—or at least foot the bill for legacy bad loans—without a further slide in the yuan (whether against the dollar or against a basket)? To answer this question I think it helps to review the reasons why banking crises and currency crises can be correlated, and to see what vulnerabilities are and are not present in China. The first reason why a banking crisis can lead to a currency crisis is simple: the banks have financed their lending boom by borrowing from the rest of the world, and the rest of the world decides the banks are too risky and wants its money back. The need to repay external creditors leads the country to exhaust its foreign exchange reserves, and ultimately, without reserves, the country is forced to devalue. Thailand in 1997 is probably the best example. This risk simply is not present in China. China has more external reserves than it has external debt, let alone short-term external debt. China's lending boom hasn’t been financed by the world—it has been financed out of China’s own savings, intermediated through Chinese financial institutions. The second reason is also straightforward: losses in the banks and shadow banks could lead Chinese residents to pull their funds out of China’s financial system, and seek safety offshore.  This no doubt could happen—though China’s financial controls are meant to limit this risk. China—like other big countries—doesn’t have enough reserves on hand to cover all its domestic bank deposits, let alone the shadow banking system’s analogue to “deposits.” And while some deposit flight can be financed out of China’s existing trade surplus, it is certainly possible to imagine more flight than could be financed out of China's exports.   On the other hand, losses in China’s domestic banking system will not necessarily result in a run into offshore deposits. The system may be recapitalized before there is a run. Or those who flee the shadow banking system might move their funds into China’s banks, not into foreign deposits. Or those who flee China’s risker mid-tier banks might run to the safety of the big state commercial banks (effectively running out of institutions backed by weak provincial government balance sheets to institutions backed by the much stronger balance sheet of the central government).   But a run out of all Chinese bank deposits is a risk, both to China and the world. It is in some sense is the flip side of China’s lack of external vulnerability: very high domestic savings intermediated through domestic financial institutions means a ton of domestic deposits and shadow deposits. And limiting this risk is a big reason why I believe China needs to be cautious in liberalizing its financial account. The third reason is that China’s government might not be able to cover the cost of recapitalizing its banks, and the government—not the banks per se—might need to turn to the central bank for financing. This is one of the risks that Christopher Balding highlights for example (more here). And while it is a risk, I don’t think it is a big risk.    A bank doesn’t actually have to be recapitalized with cash. It can be recapitalized with government bonds (see Jan Musschoot for the mechanics, or look at this IMF paper). Say a bank writes down the value of its existing loans, and that loss wipes out its equity capital. The government can exchange government bonds for “new” equity in the bank.    It doesn’t have to go out into the market and sell bonds and hand the cash over to the bank.   An asset management company can also be funded in the same way: the government can swap newly issued government bonds directly for a portfolio of bad loans (and hand the bad loans over to an asset management company to try to recover something). This raises the government’s stock of debt, but it doesn’t require raising cash and handing the cash over to the bank in exchange for a portfolio of bad loans. It also doesn't require making use of the central bank's balance sheet.**   And even if the government wants to recapitalize its banks by handing the banks cash in exchange for either new equity or for bad debts, it can raise the cash by issuing bonds in the market—that doesn’t require a monetary expansion either, though it can put upward pressure on interest rates. The IMF's 2016 estimate of bank losses on corporate credit (7 percent of China's GDP) may be too low, but if it is close to right, it is not a sum that China would have trouble funding.*** To be clear, if a recapitalized bank experiences a run, the bank will need to take the government bonds it has received from the government to the central bank and borrow cash against its “good” collateral (or not-so-good collateral; I agree with Balding's World that a no-recourse loan against bad collateral is a backdoor bank recapitalization through the central bank). But it is the run that gives rise to the need “to print” money, not the recapitalization. And the money provided to depositors fleeing a troubled institution often ends up in other institutions—it doesn’t necessarily leave the system. The central bank can mop up liquidity provided to a troubled institution by withdrawing liquidity elsewhere, with no change in its monetary policy stance. One additional point here: a preemptive recapitalization which adds to the system’s capital and allows some shadow banking liabilities to migrate on-balance sheet would in my view reduce the risk of a run—as it would be clear that the recapitalized institutions would be able to absorb losses without passing the losses on to depositors. It thus in my view reduces the risk that the banking system's legacy bad loans would lead to a monetary expansion that jeopardizes currency stability.  The fourth reason why a banking crisis can lead to a currency depreciation is that the banking crisis leads to a slowdown in growth—and in response to the slowdown in growth, the central bank may need to ease monetary policy. Capital controls can give a country with a currency peg a bit more space to keep its currency stable without following the monetary policy of its anchor currency (or for a basket its anchor currencies). For example, for much of the last 15 years, China has been able to have a tighter monetary policy—or at least higher lending rates—than the United States without being overwhelmed by inflows (from 2003 to 2013, China’s challenge was limiting inflows, not outflows). But there is a limit to how much any country, even China, can ease monetary policy while maintaining a stable exchange rate, especially if China is managing its currency against the dollar, and the U.S. is tightening monetary policy. China’s controls can make it significantly harder to swap yuan for dollars or euros, but they are likely to work best if the controls are reinforced by a positive interest rate differential. Here too China has options. It could respond to a slowdown in growth by easing fiscal policy without easing monetary policy, maintaining an interest rate differential that would encourage Chinese residents to keep their funds in China.***  And that could maintain demand—taking pressure off the central bank. In any case, the PBOC is now tightening monetary policy to slow the economy, so this is a theoretic rather than a current risk.**** While there is a path out of China’s current banking troubles that doesn’t involve a further depreciation, there isn’t a path out of China’s current difficulties that doesn’t involve the use of the central government’s balance sheet. *****    Let me offer up an imperfect analogy—imperfect both because it involves a currency union that isn’t a full political union, and even more imperfect because it involves a currency that floats, not a peg. Ignore it if you want, my argument doesn’t depend on it. Before its crisis the eurozone ran a balanced current account. The current account deficits of countries like Greece, Ireland, and Spain were essentially financed (in euros) by German and Dutch current account surpluses, not by borrowing from the rest of the world. And the run out of Greek, Irish, and Spanish banks in 2010 and 2011 was largely a run into safe assets in the eurozone’s core, not a run out of the euro. That all was a big reason why the euro didn’t depreciate significantly in the early phases of the eurozone’s crisis, despite violent swings in financial flows inside the eurozone. Keeping the eurozone together required the ECB act as a lender of last resort (essentially borrowing from German banks to lend to Spanish and Italian banks through the target 2 system to offset the withdrawal of private financing from the periphery) and that the eurozone create common institutions (EFSF, ESM) to help weaker countries finance the cost of bank recapitalization. But the ECB’s provision of lender of last resort financing to banks in troubled countries on its own did not drive the euro down.   The euro ultimately did fall in 2014 because the ECB needed a looser monetary policy to support overall eurozone demand (negative rates, QE, etc). If the eurozone as a whole had relied more on fiscal rather than monetary easing to rebuild demand, the ECB wouldn’t have needed to ease quite as much—and the eurozone today would have a smaller current account surplus.  I think there is a parallel: China’s shadow banks and some mid-tier banks are the periphery, relying on funding from China’s core (so to speak). A run back to the core is no doubt a significant problem. But it also is something that conceptually China has the resources to manage without necessarily needing a weaker currency and more support for its growth from net exports.   * China’s central government's credit risk is low; central government debt is low—and lending to Chinese households also isn’t generally believed to pose a problem. ** The asset management companies (AMCs) that were set up to clean up the balance sheets of the major state commercial banks initially had this structure: the banks handed over their bad loans to the AMCs, and got a bond that the AMCs issued in exchange. The AMC bond was never explicitly guaranteed, so technically it wasn’t the government’s debt. But the government pretty clearly was going to stand behind the AMC loans. There was no direct need to use the PBOC’s balance sheet in this transaction. Christopher Balding notes that the central bank can also provide liquidity directly to the banks against dodgy collateral, and thus lift bad loans directly off a troubled bank's balance sheet (either by buying the bad loan, or by providing a no-recourse loan against the loan). That is no doubt true: China has been known to hide the cost of a bailout by in effect netting it against the central bank's ongoing profits in a less than transparent way. But the orthodox way of structuring an AMC would use the Ministry of Finance's balance sheet, and the central bank would lend against recapitalization bonds or AMC bonds with a guarantee not directly against bad collateral. And any injection of liquidity to a troubled bank would be offset by withdrawing liquidity elsewhere. For those interested in the details of China's recapitalization of the big state banks, there is no better source than Red Capitalism.    *** China is now big enough that a slowdown in its growth affects growth elsewhere, and thus monetary easing by China's partners also might play a role in maintaining the interest rate differential. In 2016 for example, risks around China seem to have contributed to the Fed's decision to slow its pace of tightening. **** A couple of additional technical points here. In 2015 and in early 2016, the PBOC was loosening policy not tightening policy (cutting rates, reducing the reserve requirement and so on). That added to the pressure on China's currency. And with reserves falling, the PBOC needed to buy domestic assets (or increase its domestic lending) to keep its balance sheet from shrinking. Its overall monetary policy stance consequently cannot be inferred by looking only at its domestic balance sheet. ***** A restructuring of local government debt also does not require the use of the central bank's balance sheet. For example the central government could swap a Ministry of Finance bond for provincial debt, leaving the market (read banks and shadow banks) with a claim on the central government and leaving it to the central government to collect on provincial debt.  

Tough economic times are likely to be Egypt’s reality for a while, despite the announcement that Egypt and the International Monetary Fund have agreed to a much-needed $12 billion loan.

[This post was co-authored with John Polga-Hecimovich*] By the end of 2017, the Venezuelan economy will likely be less than three-quarters of its 2013 size. Inflation is set to increase from 700 percent in 2016 to a hyperinflationary 1,500 percent next year. Despite the government’s best efforts to continue payments, a crippling debt default seems increasingly inevitable. The human costs of the crisis are readily apparent, with food and medicine shortages, rising infant mortality, and increasing violence. Fully three-quarters of Venezuelans polled claim to want President Nicolás Maduro out. But last week, a series of judicial decisions appear to have quashed one of the most promising routes out of the political crisis, the presidential recall referendum. This string of suspect decisions confirms the Maduro administration’s descent into blatant authoritarianism and cuts off one of the last avenues for the peaceful restoration of a democratic system. Incongruously, all of this is in a country with the richest reserves of oil in the world, where the government has long proclaimed a commitment to social progress, inequality reductions, and popular legitimation. How did Venezuela reach this crisis point, and what could turn it around? The short answer to the first question is a combination of the resource curse, populist spending, and bad policymaking. We briefly unpack these elements in this post. As for the second question of what might be done to overcome the crisis, we discuss what domestic and foreign actors could do to help the country to find a way out from the current debacle in subsequent posts here and here. An Anatomy of Chavista Power The ascendance, popularity, and consolidation of power of the late President Hugo Chávez (1999-2013) was premised on twenty-first century socialism, anti-elite mobilization, and the gradual accumulation of the levers of state power by electoral means. Helped by oil prices, which surged from $10 a barrel in the late 1990s to a peak of $140 in 2008, Chávez was able to build a series of social programs, the so-called misiones sociales, to provide unprecedented services to the popular sectors. Simultaneously, Chávez moved to slowly accumulate power and eliminate checks on his socialist project: he packed the courts, gradually filled the ranks of the military with loyalists (and the ranks of political underlings with these military officials), staffed the state oil company PDVSA with supporters, and systematically dismantled independent media. By the time of his death in 2013, the Chavista state was a hybrid regime—neither a liberal democracy nor an outright dictatorship. As one of its leading critics noted, “if the ’physiology’ of the regime is doubtfully democratic, its ’anatomy’ is formally democratic.” This formal adherence to democracy provided symbolic cover that permitted other Latin American nations sympathetic to the Chavista project to work with Venezuela, despite creeping authoritarian practices such as the imprisonment of opposition leaders, and troubling economic policies such as expropriation. The “Bolivarian” project—founded on Chávez’s devotion to South American liberator Simón Bolívar—gained adherents among other left-of-center governments in the region, and institutional presence through the Bolivarian Alliance for the Americas (ALBA), the Union of South American Nations (UNASUR), and even the transnational media company TeleSur. Left-leaning governments in Argentina, Uruguay, and Brazil worked closely with Chávez, bringing Venezuela into the Mercosur trade bloc out of a mix of ideological affinity and realist calculation that this might enable them to temper his grander plans for the region. And Chávez was masterful in using Venezuelan oil to buy enduring influence with Cuba and the seventeen Caribbean members of PetroCaribe, which enjoy preferential terms on oil purchases from PDVSA. Chávez also benefitted from a ham-handed and internally divided political opposition. The opposition has engaged in bold actions, but often at a net loss to its objective of curbing Chavismo. The short-lived coup of 2002, in particular, backfired spectacularly by providing Chávez an opportunity to question the democratic values of the opposition, while simultaneously allowing him to restructure the armed forces and remake it into a far more ideological and regime-loyal institution. Revelations that the Bush administration had prior knowledge of the coup plans also helped feed Chávez’s anti-Americanism. The oil strike of 2002-2003 likewise provided a justification to remove opponents from strategic sectors, while subsequent boycotts and demonstrations have frequently served to strengthen the regime and demonstrate its superior force. It is also vital to recognize that whatever his faults as a democrat, Chávez had electoral support that frequently exceeded half of the electorate and allowed him to repeatedly outpoll the opposition, which was tarred as excessively elitist. Beginning in 2011, Chávez’s health deteriorated, leading him to tap long-time foreign minister and (later) vice president Nicolás Maduro as his successor. After Chávez’s death from cancer, Maduro narrowly defeated Henrique Capriles of the opposition Democratic Unity Roundtable (MUD) coalition in the April 2013 presidential election. From Bad to Worse Maduro’s time in office has been marked by declining economic and political fortunes. The economy has been devastated by a combination of bad policies, especially currency and price controls; a monoproduct export economy dependent on an especially volatile product whose price has plummeted; and populist spending. Chávez and Maduro share the blame for the country’s bad macroeconomic policy. To deal with loss of revenue from the PDVSA strike in 2003, Chávez fixed the exchange rate between the local bolívar and the U.S. dollar, and gave the government the authority to approve or reject any purchase or sale of dollars. While this was a short-term fix, the measure also became a ticking time bomb. With a decline in dollars under government control after the fall in oil prices in 2009, black market demand skyrocketed (causing some Venezuelans to engage in the so-called raspao and other forms of arbitrage). Instead of lifting currency controls and normalizing the exchange rate, the Maduro government continues to print more money, further raising inflation. Price controls on basic goods, a constant in Venezuela since World War II, have also disincentivized domestic production. What is more, far from heeding Arturo Uslar Pietri’s famous advice that Venezuela should “sow the oil” (sembrar el petróleo), Fifth Republic governments have depended on oil proceeds more than ever to fuel their spending. This has had disastrous consequences as crude prices and production have simultaneously dropped. Oil, which expanded from 80 percent of all exports in 1999 to 95 percent today, is at just over $50 a barrel today. As a consequence of low oil prices and declining PDVSA production, the country is facing a critical shortage of foreign currency, even after a devaluation in February. A ballooning set of payments on the country’s $138 billion debt is approaching, and the government’s efforts at a bond swap have been only partially successful. The government quietly loosened price controls last week in six states, which is allowing stores in those places to import food and sell it at whatever price they please. This is a major development, insofar as queuing for food may decrease in those states, removing a key source of public discontent. However, inflation will still make most products unobtainable to the average citizen, so long-term, the political impact may not be very significant. Meanwhile, despite having borrowed some $65 billion from China since 2005, the country is reportedly running out of the ability to import goods. On the political front, the picture is no better. Clashes with protesters in 2014 left at least 40 dead, and more than 870 wounded. These tumultuous events resurrected fears that the military might once again be dragged into the type of repression against the public that scarred it deeply in the Caracazo protests of 1989. But the government also used the protests as an excuse to arrest opposition leader Leopoldo López, who was sentenced to fourteen years in prison for allegedly inciting the protests. In December 2015, the MUD won a supermajority in the National Assembly for the first time under Chavismo, and by April 2016 it had approved a recall referendum against Maduro (the Venezuelan Constitution of 1999 does not provide for presidential impeachment). Over the past two weeks, a number of developments have deepened the political crisis. The National Electoral Council (CNE) postponed December’s elections for governors and mayors, in which the PSUV seemed certain to suffer. Maduro stripped powers away from National Assembly, most notably by giving the Supreme Court (TSJ) power to approve the budget law. Most recently, as noted above, several criminal courts ruled on 20 October 2016 that signers committed fraud during the first signature collection in June, in what is clearly an unusual act. This last news is particularly disheartening for the MUD and for anyone else holding out hope for a recall referendum in 2016. It all but ensures that any referendum will only take place after 10 January 2017, which would ensure the continuity of Chavismo in office until the 2018 presidential elections, even if it removes Maduro. Pending a final decision from the TSJ, furthermore, it is likely that the referendum will be cancelled altogether, blocking a constitutional path out of crisis. In sum, Venezuela’s descent into an unprecedented political and economic crisis has accelerated. The potential impact could be significant: the continued worsening of humanitarian conditions, increasing political violence, and the likelihood of rising emigration (more than 1.8 million have fled Venezuela since 1999) are all potential consequences. In our next post, we look at the political economy of support for Maduro, and what it means for the possibility of change from within the regime. The third and final post will look at how external actors might alter the conditions that sustain the Chavista regime. *John Polga-Hecimovich is an Assistant Professor of Political Science at the U.S. Naval Academy. His research interests include comparative institutions of Latin America, especially the executive and the bureaucracy, as well as presidential instability. He has published peer-reviewed articles in The Journal of Politics, Political Research Quarterly, Electoral Studies, Party Politics, Latin American Politics and Society, and others, and conducted fieldwork in Venezuela, Ecuador, and Brazil. His Twitter handle is @jpolga. Disclaimer: The views expressed in this blog post are solely those of the authors and do not represent the views of or endorsement by the United States Naval Academy, the Department of the Navy, the Department of Defense, or the United States government.