Political Fallout Is the Fear in Wake of Argentina’s Crisis

Indifference may best describe the reaction of world markets to Argentina’s economic implosion and likely debt default and currency devaluation--a sharp contrast to the 1990s, when crises in Mexico, Thailand and Russia rippled around the globe.

As expected, Argentina’s new president, Adolfo Rodriguez Saa, declared a moratorium on the nation’s $132-billion debt Sunday. He said he would use the savings on principal and interest payments to create 1 million jobs and feed the hungry.

The financial debacle is a chronicle foretold, but what Latin America watchers fear most is political rather than economic consequences if a widening circle of violence from Argentine protests against the United States and the International Monetary Fund spills across borders and provides a rallying point for opponents of globalization.

“The surprise here is how quickly it’s all fallen apart. Most everyone felt it would not happen through [social] unrest, so the speed with which it happened is a source of concern to everyone, as is the possibility such violence might spread,” said one Wall Street analyst who asked not to be identified.

Stocks, bonds and currencies in emerging markets such as Brazil and Mexico have either held their own or gained in recent days, even as the world has been shaken by images of Argentine looting and of former President Fernando de la Rua fleeing office via helicopter from the roof of his presidential palace.

Mexico’s main stock index rose on Friday to its highest level in three months. The Brazilian Bovespa index, up 3.5% to 13,368 on Friday, has risen 28% since Sept. 21. Thus, the region’s two largest economies hardly seem to be trembling at the prospect of an Argentine collapse.

“All across emerging markets the crisis was digested in a very civilized way,” said Fernando Losada, an economist with ABN Amro investment bank in New York.

Rodriguez was sworn in as caretaker president of Argentina on Sunday. In his recovery plan, he pledged to maintain the value of the peso but said he would suspend debt payments immediately.

“This is not a rejection of foreign debt,” Rodriguez told cheering supporters in his inaugural address, “but rather, the first move by a rational government to deal with the foreign debt correctly.” Rodriguez, the nation’s third president in less than a week, will try to deal with an economy in its fourth year of recession, with 18% unemployment and the crushing foreign debt.

The next debt payment, about $500 million, is due this week. If Argentina fails to pay, it would technically be in default.

Yet calm is the watchword in global financial markets. That response is due to many factors, some having to do with Argentina, others with what the world has been through in recent years. Unlike the shocks of the 1990s such as the Russian default, Argentina’s economic agony has been prolonged and transparent.

Although by no means insignificant, Argentina’s economy has little impact on world trade, and thus its collapse is unlikely to hurt corporate profits on a global scale.

Debt defaults and currency devaluations in Southeast Asia and Russia were felt throughout Asia and Europe, respectively, because of corporate and banking ties and widespread capital flight by nervous investors. No such capital flight has been evident this year in Latin America overall.

In fact, repatriated capital levels and foreign direct investment are up considerably in Mexico. Although such investment in Brazil is down from last year’s record-setting $30 billion, it is still expected to top a respectable $20 billion, according to Merrill Lynch’s Robert Berges.

The world has in recent years gained experience in withstanding financial contagion and is better prepared. What’s more, having been through unprecedented terrorist attacks this year, markets now seem inoculated against shock.

Another stabilizing factor is that many global investors have more appetite for risk these days, said Michael Gavin, a Latin America economist at UBS Warburg in Stamford, Conn. Low interest rates and still-heavy losses in the U.S. stock market have sent some investors foraging abroad for higher potential returns, he said.

Gavin said he expects Argentina’s suspension of debt payments to last several months, with some sort of debt restructuring in the second half of next year. That would be the best-case scenario.

But that outlook could shift if violence spills into other parts of the hemisphere, giving opponents of globalization a chance to take out their frustrations on governments that they believe have sold them a bill of goods in encouraging increased trade and foreign investment.

Economists expect that whatever currency plan Argentina adopts will include a de facto devaluation of between 25% and 50%, slashing Argentines’ purchasing power.

Any devaluation of the peso would be devastating for an economy in which salaries are paid in pesos but liabilities from mortgages to cable TV bills are payable in U.S. dollars.

A debt restructuring program costing $5 billion to $10 billion could be necessary to keep banks open, said Gary Hufbauer, senior fellow at the Institute for International Economics in Washington.

Such a rescue plan is imperative, or Argentina’s new leader might watch helplessly as foreign banks, which now control about 80% of the country’s banking system, walk away, Hufbauer warned.

To gain international favor, Rodriguez must somehow continue to cut the federal and state governments’ spendthrift ways, which led to the debt mountain. But the recent street riots show that many Argentines are in no mood for bitter medicine.

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Times wire services contributed to this story.