GROWING WITH DEBT: STRATEGIES FOR ARGENTINA.
Juan C. Rego
CEMA-CONICET
Virrey del Pino 3210
(1426) Buenos Aires
ARGENTINE
ABSTRACT
Argentina’s economic growth is seriously
threatened by the service of the external
debt, when this is compared with Argentina’s
payment capacity. The difficulties in. the
accomplishment of the mentioned payments has
caused the decrease of the value of the
Argentine debt’s bonds in the secondary
markets. This has carried on to_ the
formulation of repurchase strategies of the
debt, proposed by Fernandez( 1987) and
Rodriguez (1988, 1990), which are examined
here. For this purpose a simple growth model
type Harrod-Domar is coupled to the debt,
which grows in function of the unpaid service.
Meanwhile, the market price of the debt is
governed by a behaviour equation, formulated
by Rodriguez (1990). A resulting System
Dynamics model, which continues a previous
work (Rego 1988), permits to simulate
alternative scenarios for the economic growth
and debt management.
1. Introduction.
The acceleration of the Argentine indebtedness process is
observed towards the end of the decade of the seventies, situation
which reaches crisis point in 1982, and lasts up until now. The
Argentine tragedy lies in the evident imbalance that exists between
the rate at which the debt grows, let us say, a 6 percent annual,
taking into account the accomplished payments, and the growth rate
of the country, practically void in the last decade. Its immediate
consequence is the depletion of the investment process. The
imperative need of not to continue with diverting resources
allocated for the investment, on to interest payment, added to the
impossibility to -comply fully with the service of the external
debt, compels to consider alternative management of the debt
proposals, using the debt’s important discounts in the secondary
markets.
Page 484
System Dynamics '91 Page 485
2. Genesis of the external debt.
In Argentina’s indebtedness process can be distinguished:
the acquisition stage of the debt, at negative real interest rate,
which ends with the 1981-82 payments suspension; from the growth
stage, by simple refinancing of the unpaid interest. In the first
stage, when to contract obligations was inexpensive because the
inflation paid the debt, the Argentine debt jumped from 9.7
billions to 40.7 dollar billions, in the period 1976-82. The
inflection point coincides with the jump of the LIBOR rate -to
which was stipulated the debt- from about zero percent, after to
discount the inflation, in the years 70-80, up to real interest
rates of the 4-6 percent order, in 1981-86. Concurrently, in 1987,
the terms of the exchange had fallen a 30 percent, compared with
the period 1980-84. After 1982, Argentina almost does not receive
anymore fresh money. In 1990, the Argentine debt climbed to 60.4
American dollar billions. Regrettably, the acquired debt did not
produce an equivalent increase in real investments in the country.
It is estimated that 60.7 percent from the funds which came to the
country during the period 1979-83 -about 22 dollar billions- it was
apparently used to finance capital flows not declared abroad
(Rodriguez 1986, 4).
3. Effects of the debt on the economic growth.
The Argentina, during the period of the Model Agro
Exporter (1860-1930s) grew to the 6 percent annual. During the
three later decades up to the 1950s, the rate is of the 3 percent,
while in the 1980 decade the growth of the national revenue has
been practically void. The most serious consequence of the debt
crisis is that Argentina stopped its investments. More serious yet,
the deterioration of investment éfficiency results. In these
circumstances, it should not astonish that the situation worsens as
time goes by, compared with that of 1982. The Argentine government
had to devaluate iterated times its currency, issuing, to acquire
dollars which were transferred to the external creditors. This fact
has twice pushed Argentina to the edge of the hyperinflation,
promoting heedlessly the flight of national capital to the
exterior. The debt problem, far from being solved, is aggravated by
the unpaid interest accumulation.
4. Formulation of the Debt-Growth Model.
The model is composed of three differential equations,
which rule, respectively, the dynamical behavior of the national
revenue, the external debt and the market price of the latter. The
first of the equations is a very simple interpretation of the
growth process -though good enough for the purposes of this work-
known as Harrod-Domar Theory of growth. One of the ideas behind the
mentioned theory is an investment function, known as_ the
acceleration principle, which is based on the hypothesis that the
Page 486 System Dynamics '91
wished investment depends on the demand level of the product which
such investment creates. Or, simply, the net investment, or
increase of the capital stock, it is linked to the growth of the
national revenue. The accelerating coefficient v is defined as the
capital-product relationship: .AK=AY. Supposing that the capital
stock is not depreciated, the acceleration principle can be
rewritten as:I=vx*xdY/dat. On the other. hand, the macro-economic
balance condition requires that the aggregate planned investment be
equal to the planned saving: I=S. Supposing that the saving be
Proportional to the revenue, the balance condition can be written
as: I=v*@Y/dt=s*Y, which implies that daY/dt=(s/v)*Y. Taking into
sccount the external debt presence, a portion of saving should be
allotted to the debt service. If, furthermore, it is admitted the
capital devaluation, the resulting differential equation remains
thus:
. oY | sY-Kd-T
y- 9. 3¥-Kd-T a)
The second differential equation involves the external
debt B, and regulates the accumulation of the unpaid interest. The
said stock B acts as the countable sector of the model. The owing
interest results from the differences which exist between the
annual interest flow that is owed according to contract (B*i), and
the annual payments T actually accomplished. If there is a quantity
A of additional cash available to allocate to the purchase of the
debt securities in the secondary market, the amount of the debt
would decrease, ina quantity that it is inversely proportional to
the price p of the same. The corresponding differential equation
results then:
aB ‘ _A
Ze > ((ien)-11.- 3 (2)
The meaning of these two first differential equations, in
Systems Dynamics terms, is quite clear. The equation 1 is
represented by nested negative and positive. feedback loops which
control the growth of the national revenue. They appear in the
Tower part of figure 1. The second differential equation -equation
2- is represented in the central part of figure 1 by a. positive
feedback loop, that makes the debt grow in so far as the interest
of the same remains unpaid. Furthermore, purchases of the debt,
exogenous respect of the loop, reduce the magnitude of the owing.
The third differential equation refers to the behavior of
the debt price in the secondary market. According to Rodriguez
(1990), the owner of a debt bond -whose contractual interest is
represented by i and whose par value is-a dollar- has two
alternatives: either sells it or keeps it. Market’s balance
requires that the owner of the bond be indifferent to anyone of the
two possibilities. If the owner sells its bond, whose nominal value
is a dollar, at the market price p, and.invests it at the rate i of
the monetary market, purportedly equal to.the contractual rate of
the debt, receives an annual flow that jt is equal to (p*i). If, on
System Dynamics '91 Page 487
the other hand, the owner keeps its bond, he is beneficiary of the
sum of three flows. In the first place, he receives, during the
year, ~by its bond whose nominal value is a dollar- a quantity that
results from dividing the debt real service T by the number B of
bonds which represent the total of the debt B. Such quantity should
have been larger, according to the contracted rate. In the second
place, he receives, also during the year, -instead of the unpaid
interest- a quantity (i-B/T) of new bonds of the debt, which sold
in the market at the prige p, will produce a funds flow that it is
equal to (1-B/T). Finally, the owner is benefitted also with
contingent increases in the bond price that occur during the year:
(dp/dt).
The mentioned balance condition of the market demands
that the return of the investment, in both cases, will be equal
supposing rational expectations, to perfect forecast. In such a
case the following equation 3 is fulfilled.
ip = (T/B) + p*(i-T/B) + 2 (3)
From the equation 3 the following differential equation
is obtained:
$e ~ isp - (1/8) ~ p+ ti-7/B)] - Z (p-2) (4)
The meaning of the equation 4, in System Dynamics terms,
is turned clearer if the subtraction (p-1) is interpreted as the
difference between the nominal and real value of a debt bond. Then,
a price gap can be defined that accelerates the action of a
feedback loop which acts on the bond price. The larger the gap, the
quicker will fall the bond price in the secondary market.
Furthermore, the bond price is affected by two others external
factors to the loop: the amount B of the debt and the real service
T of the same. It is obvious that the debt growth makes its price
fall. Also, it is natural that larger services of the debt improve
its price in the market. What it is not that obvious is the
multiplying character of the relationships between B, T and the
factor (p-1). Such assumption is imposed on the model from the
economic theory. This third equation is represented in the upper
part of figure 1.
5. Confirmation of the model.
The available empirical data confirms what is anticipated
by the outlined model, with regard to the behavior. of the debt
price in the secondary markets. In absence of repurchase debt
programs, if the annual payments of the indebted countries do not
reach thorough satisfaction of the external debt services, this
will grow as time passes, simultaneously with the decrease of its
price. In the case of Argentina, illustrated in figure 2, it is
quite clear the deterioration process of its debt price.
Page 488
System Dynamics '91
Figure 4:
Causal Diagram of the Model,
Market Price per §
Par Value
— Debt Price +
of face value
of debt
(p)
> wp
— _ Interest + | Debt sa Current cash 4.
* unpald b (B) buyback
+
+
Contractual
Interest g* Additional
service due Cash (A)
a Market interest
rate (1)
— +
+ Sustainable = _ Excess
> Debt * Debt
- Net capital/output ratio
Investnent
+
| Consumption ia
+
Debt Interest =, Capa Income
8 Depreciation
ervics Average
ate froseestty “oat *
Consumption
Fraction of Incone
Devoted to Service of Dabt
i = = on
System Dynamics '91 Page 489
The purchase operations occur in secondary markets which
are not formally organized. In the period about which there is
known data regarding private operations of Argentine bonds,
1985-90, the external debt grew from. 50 up to 60 billiones of
American dollars. Its price fell in-the secondary market, from 62.5
percent in 1985, to 13.4 percent, in 1990.
PRICE AND MAGNITUDE OF ARGENTINA'S DEBT
#3 (Source: Berz y otros 1990; CARTECO)
ao
604 ™
60-85 Ray
@ v4 ~~ 87
w
G
x
4
3 304
q 88 —e
20 ae 89
~s_90
“eI
2 NR a aa
19 St 53 55 $7 59
Chousande) SS
ARGENTINA EXTERNAL DEBT (US$ BILLIONS)
ANNUAL AVERAGES
2
6. Alternatives to the Economic Growth and Debt Management of
Argentina.
Yet, in such a simple: model - almost scholastic- as this
which has been outlined here, it is possible to test policies in
the double front of the development and of the indebtedness. With
regard to the growth, it is urgent to improve the gain of the
feedback loop which dominates the economic growth... This can be
achieved, if there is a firm political decision to bend social
resistances, improving the productivity and decreasing the tendency
to consumption, until the historical levels of the long term are
reached. With regard to the debt, the “snow ball” mechanism which
dominates its growth should be dismantled. To pay half what should
be paid drives to nothing, unless it be exposed perilously to
hyperinflation. Therefore, bold measures should be tested, in order
either to reduce the owing stock or to limit the services flow, or
both simultaneously.
Page 490 System Dynamics '91
A) Extrapolation of the current trends.
This scenario conserves the magnitude of the main
parameters of the model, the nearest possible to the magnitude
reached by them in the last years of the 1980 decade and produces
zero growth of the national revenue. To follow through, the
magnitude assigned to the parameters to generate the basic run of
the model is mentioned. The marginal productivity of the investment
is of the 4 percent order. Certainly, it is a very pessimistic
assumption, but reflects the current Argentine situation. The level
of the consumption is about 80 percent of the national revenue,
magnitude that it is more typical of already industrialized
countries, as the United Kingdom (83%) or United States of America
(85%). In the five year period 1982-87, 55 percent from the
interest paid to the Argentine creditors was paid by own resources.
This amount equals to allocate annually 3 percent of the national
production to service of the debt.
B) Suspension of the debt service.
In spite of the fact that constitutes an almost obliged
slogan for some political customers, while the electoral campaigns
elapse, nobody wants to break formally with the creditors. Apart
from this, some politicians, being already in the government, have
discontinued the debt service as a matter of fact, paying symbolic
sums by its service. This usually happens when there is little to
gain by the accomplishment of these obligations.
C) Increase of the Productivity, Decrease of
the consumption and Repurchase of the Debt in
the Secondary Market.
This scenario simulates the consequences of decreasing
gradually the consumption, from 80 percent to 72 percent of the
product, value that emerges from statistics estimates, for the long
period (1950-1984). Such a magnitude is in line with those
corresponding to recently industrialized countries, as Brazil
(79%), Mexico 77, Korea (73%), Malaysia (71%), etc. Concurrently,
it is supposed that the productivity of the investment improves,
also progressively, recovering the historical average, 12,percent,
of the long series 1951-1984. Gradually, seeing the irrefrenable
deterioration of the debt, the creditor countries have opened the
repurchase possibility of the external debt by the indebted
countries, relaxing the accomplishment of the objectives pursued by
the application of the “sharing clause" (Rodriguez 1990, 27).
However, Rodriguez (1988, 1990) shows that the repurchase strategy
only would be effective if the annual available money is superior
to the part of the services that should be refinanced. But, if this
occurs, the debt owners should be able to anticipate that the bonds
will reach its par value in the future, thus, they would only sell
the same at its nominal value. This would cause a jump of the bonds
price in the markets, immediately after Argentina announces a
repurchase program of the debt. The external debt, B, at the
beginning of the simulation run, exceeds the bearable volume of the
System Dynamics '91 Page 491
r =
Figure 3: INCOME CUS$ Millions/Year)
188.¢ T T T
™ Business-as-tsual
mmm = Horator ium
i-r4~t Ronubchasing the Debt and Servicing It
106.e3- ~“""~"~ Repurchasing the Debt without Servicing It
184,03
102.e
188.e3
1998, 1992.5 1995. 1997.5 2068.
TIME
3
same. The said sustainable debt is defined as that stock (B*=T/i),
which is consistent with the flow T of funds that the indebted
country is actually in conditions of paying, according to the
stipulated rate i. The excess of the debt is defined as the
difference between both. Any negotidtion policy of the external
debt, would have to aspire, at least, to annul such excess.
D) Improvement of the Macro-economic.Dynamics,
Repurchase of the Debt and Suspension of the
Payment of the Services.
This scenario simulates the same decrease of the
consumption and the same increase in the productivity that occurs
jn the previous one. Furthermore, it supposes amortization of the
principal without interest payment. Fernandez (1987) warned that
the countries which impel capitalization proposals of the external
debt, would not: be benefitted from a contingent generalized
condonation of the debt and, furthermore, they should not use the
gap between the nominal value and the market value, since. such
capitalization programs accept the debt at its par value. Because
of this Fernandez proposed to allocate the whole commercial balance
to repurchase the owing capital, at market prices, without
servicing the expired interest, which have to be refinanced. The
factors that intervene in the definition of the change rate of the
market price act as multipliers, as is observed in the equation:
dp/dt=(T/B)*(p-1). Therefore, the annulment of some of the factors,
Page 492 System Dynamics ‘91
Figure 4: DEBT CUS$ Millions)
208.¢. 1 T T
————— Business-as-usual
on ome == Hopator ium
~ttt—iepurchasing the Debt and Servicing It a
158.e7 ~~~" 7 "Repurchasing the Debt without Servicing ta
\-
108, €3 |
50.e
petered archer bretoetss
8.
1990. 1992.5 1995. 1997.5 2800.
TIME
4
T in this case, turns void such rate, thus the price of the debt
titles stay intact, in the level that possessed before the
application of such program. If this policy is applied for very low
levels of the debt price, as the Argentine case is, it can be
quickly repurchased, in order to reach the sustainable debt level,
Bx. When such a thing occurs, the repurchase program of the debt is
discontinued and the service of the same is resumed. This strategy
tends to solve the debt problem in the shortest possible term.
7. Consequences on the Economic Growth.
Argentina does not reverse significantly its decadence
process (see figure 3). The policies designed to increase the
productivity and to reduce the consumption almost achieve to
overcome the void growth of the previous decade. In the best case
the economy only achieves to grow a 0.5 percent annual. It does not
reach to accompany the vegetative growth of the population. The
consumption by inhabitant declines in all the cases, between 13 and
10 percent approximately in the decade, because of the fact that
the population grows at an annual net rate of the 1.65 percent. It
is interesting to underline that to continue doing as up to now:
paying half the debt service, it does not stop the indebtedness and
the country continues without growing. To solve nothing results
rather expensive. Yet, it is a scenario that tends to be
maintained,
System Dynamics '91 Page 493
The efficiency of the repurchase policies of the debt is
remarkable (see figure 4). In the case of repurchase without
suspension of the services, the debt falls gradually, and is
reduced to half the amount, in the decade. This generates smaller
service, which compensates the extra effort required by the
repurchase program. The objective reached, the country begins to
grow again. From the political point of view, the country has to
sustain almost the same decrease of the revenue by inhabitant, 12
percent in the decade, in the basic stage, with the advantage that
to the end of the decade, ‘the economy can turn to grow. If there is
repurchase with services suspension, the same almost occurs, but
more rapidly.
REFERENCES.
Fernandez, R. 1987. Negociacién y capitalizacién de la deuda
externa argentina. Serie Documentos de Trabajo del Centro de
Estudios Macroeconémicos de Argentina. 57.
Rego, J., Vega, J. 1988. Probabilistic Generation of Scenarios for
Argentina, using an Elemental Harrod-Domar Model of Growth. System
Dynamics: An International Journal of Policy Modelling, 1(1):32-42
Rodriguez, C. 1986. La deuda externa argentina”. Serie Documentos
de Trabajo del Centro de Estudios Macroeconémicos de Argentina. 54
Rodriguez, C. 1988. Un andlisis teérico sobre la recompra de la
deuda en mercados secundarios. Serie Documentos de Trabajo del
Centro de Estudios Macroeconémicos de: Argentina. 63
Rodriguez, C.. 1990. Managing Argentina’s External Debt: The
Contribution of Debt Swaps. Serie Documentos de Trabajo del Centro
de Estudios Macroeconémicos de Argentina. 68.
