Sovereign debt default and financial crisis in Argentina 2001

Seminar Paper, 2010

17 Pages, Grade: 1,7


Table of contents

1. Introduction

2. Definitions linked to a sovereign debt default
2.1 Reasons for a sovereign debt default
2.2 External debt default versus domestic debt default
2.3 Banking crises, currency crashes, inflation crises

3. Mechanisms of the sovereign debt default in Argentina 2001
3.1 Preamble of the crisis
3.2 Causes for the crisis
3.3 The crisis itself
3.4 Aftermath of the crisis

4. Conclusion


1. Introduction

In the past centuries banks and states have faced economic upturns and downturns. The causes for the economic ups and downs differed throughout the time. This paper focuses on sovereign debt defaults with a detailed example of Argentina in 2001 and the change of state and bank relationships in times of upcoming crises.

In the beginning of banking systems, banks were often used to finance a state’s interest. Usually the state needed money to maintain warfare, which could lead to banking collapse and thus to a sovereign debt default. With rising awareness, the banks started to charge higher loan rates to the sovereign than to commercial entities.[1] However, the past two centuries have shown a different side of the state - bank relationship. States became the lender of last-resort to the banks. A state has to secure a stable social environment within a country to prevent disturbances in the public or a run on the banks. Furthermore, bank insolvencies would possibly exceed the costs of an intervention before a bankruptcy takes place. In the latest crisis most governments gave different insurances to their citizens and banks to maintain a robust financial structure.

These three insurances provided by the state to ensure a calming down of the turbulent financial markets were liquidity insurance, deposit insurance and capital insurance.[2] Liquidity insurance is usually provided by the central bank as a form of last-resort lending.[3] In this case, low capital ratios make banks vulnerable when return on equity holds off. Therefore, to gain capital, banks are willing to take higher risks in order to increase their returns on equity. As a result, if a bank reaches an unhealthy financial situation due to losses from risky businesses, the state or more precisely the central bank will provide capital to rescue the bank from bankruptcy.

Deposit insurance and capital insurance were used for the first time during the Great Depression. To avoid a bank run the state guarantees deposit insurance for the money that the owner has in its bank account. Capital insurance is provided by the state to let the banks recapitalize themselves. All three types of insurances are actions taken by the government to prevent the state from higher costs, if the financial situation in the banking sector worsens, which leads, in the worst case to a sovereign debt default.

Chapter two of this paper provides useful definitions to analyze the Argentine crisis in 2001. For example, there are different reasons to default. Is it simply the unwillingness or the inability to pay the debts? In a lot of cases, a sovereign debt default occurs together with other crises, namely banking crises, currency crashes, and inflation crises. Furthermore, a country can default on its external and/or its domestic debt. It is important to distinguish both types of default to show the differences and the actions that can be taken against it.

Finally, chapter three gives an insight of the Argentine crisis before, during and after 2001. In the conclusion the Argentine crisis will be compared against other crisis for example the financial crisis of 2007 and the most recent events taking place in Greece.

2. Definitions linked to a sovereign debt default

2.1 Reasons for a sovereign debt default

Countries with financial problems might suffer at some point a sovereign debt default. It is therefore important to give empirical answers to the question: is a country then simply unwilling or unable to pay its debts? Statistical evidence shows that over half of defaults by middle-income countries occur at levels of external debt relative to GDP below 60 percent.[4] Unambiguously this shows a tendency towards unwillingness to pay. Over time it seems that repayment of the debts is possible for such countries. Even though these countries refuse to try, there are reasons to repay their creditors.

It is always beneficial to be able to borrow money at the international capital markets. If a country is not willing to pay the liabilities its reputation suffers. This in turn makes is difficult for a country to refinance themselves at the capital markets. However this approach is rather theoretical because it does not involve any institutions or legal rights system.[5]

Without the absence of legal rights systems and institutions the creditor banks are probably able to confiscate the borrower’s assets at home. Furthermore, it is also possible to seize assets in foreign countries with a highly developed legal rights system.[6] As a consequence, it will also be complicated for the struggling country to receive loans from other foreign creditors. The reason can be found in the eventuality that other creditors expect the first creditor claims its loans before them.

Domestic and international trade is depending on short term loans that finance goods during shipments before the delivery actually takes place. Thus, countries that are unwilling to amortize their long-term loans can be pressured by creditor banks. In addition, creditors could by court order seize goods or assets of the defaulting country when imported into the creditors’ country.

To understand the differences of illiquidity and insolvency problems one has to understand that countries borrow money either short-term or long-term. Usually the short run loans have a smaller interest rate than the ones in the long run. If a country borrows short-term every now and then it has to roll over its credits. In other words, the country has to take out a new loan to repay the old one.

In the case of illiquidity a country is willing and able to repay the long run debts, but is temporarily unable roll over its debts.[7] This situation is solvable for example by the International Monetary Fund (IMF). The IMF is able to lend short-term loans to help the struggling country over its period of possible defaulting.

When it comes to insolvency the country is unwilling or unable to handle long run loans. Without a serious consolidation of the expenses and an austerity within the default country it does not seem trustworthy. If the country fails to engage in such a program the creditors will demand higher interest rates for loans, as a result the total debts increase. Furthermore, countries might have financial problems because of macroeconomic deficits, which result from a combination of weak economic growth and relatively fixed exchange rates.[8]

2.2 External debt default versus domestic debt default

A state can raise their domestic debt for example by issuing bonds thus the government can persuade its citizens to lend money to their country. Domestic debt averages two-thirds of total public debt, which are usually offered at market interest rates.[9] If a country reaches high levels of domestic debt it could increase the money supply with the result of inflation. There are several reasons to refrain from an expansionary monetary policy. Firstly, inflation assists a weakening of the domestic currency and thus leads to imbalances in the banking system and the financial sector.[10] Secondly, the government might consider that the expected costs of not paying the debt are cheaper than the consequences of inflation. Under the circumstances of short term and indexed debts the potential costs of inflation can be even more problematic, because the government has to inflate much more aggressively to achieve a significant real reduction in debt service payments.[11]


[1] See Alessandri, P./Haldane, A.G. (2009), p. 1

[2] See loc. cit., p. 3

[3] See loc. cit., p. 4

[4] See Reinhart, C.M./Rogoff, K.S. (2009), p. 54

[5] See loc. cit., p.55

[6] See loc. cit.

[7] See Reinhart, C.M./Rogoff, K.S. (2009), p. 60

[8] See Abberger, K. (2010), p. 38

[9] See Reinhart, C.M./Rogoff, K.S. (2009), p. 103

[10] See loc. cit., p. 111

[11] See Reinhart, C.M./Rogoff, K.S. (2009)

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Sovereign debt default and financial crisis in Argentina 2001
Otto-von-Guericke-University Magdeburg  (Internationale Wirtschaft)
Seminar on financial crisis
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sovereign debt default, financial crisis, argentine crisis
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Bachelor of Science Mark Schopf (Author)Bachelor of Science Daniel Zimmer (Author), 2010, Sovereign debt default and financial crisis in Argentina 2001, Munich, GRIN Verlag,


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