President's Resignation Leaves Argentina on the Brink

Argentine President Fernando de la Rua announced his resignation Dec. 20, after more than two days of riots, which claimed the lives of 22 people. The country's citizens have been protesting against the government's economic policies.

This essentially leaves Argentina without a government. De la Rua's vice president resigned in October 2000, taking his Frepaso party with him. Buenos Aires daily La Nacion reports that the opposition Peronists, who have a majority in both houses of Congress, will name the president of the Senate, Ramon Puerta, as de la Rua's provisional replacement. National elections will then likely be called for early 2002.

The government's rapid collapse will sharply accelerate the country's formal debt default. It will also accelerate a devaluation of the peso. This will devastate the economy, cause the banking system to collapse and destroy much of the country's middle class.

The violence this week is the culmination of public frustration over the economic course steered by de la Rua. In an attempt to avoid default, Buenos Aires followed IMF austerity prescriptions as far as it could, slashing public spending, cutting crucial payments to regional governments and imposing restrictions on bank withdrawals.

These measures resulted in more and more public pain without any tangible results at reviving the economy. Argentines have finally had enough and are now striking back.

De la Rua's options to quell the violence were limited by his own political weakness. Congress this week stripped the president of emergency powers he was granted earlier this year to deal with the economic crisis. To do anything substantial, he needed the political backing of the opposition Peronists, who control both houses of Congress.

The Peronists, however, were of two minds. Though they naturally covet the presidency, they were wary of taking control at such a volatile time. They appeared content to wait in the wings as de la Rua's government, which had two years remaining on its current term, imploded. De la Rua did not give them that luxury, however, and they will now be forced to lead Argentina out of its tremendous mess.

Two prominent Peronists who have both served as governor of Buenos Aires, Carlos Ruckauf and Eduardo Duhalde, will both likely vie for the presidency in the coming elections. No matter who wins, they will have to deal with the twin impacts of default and devaluation, as well as a popular backlash against a free-market economic model that could further derail Argentina politically and economically.

Dollarization was seen as the last available option to save the economy. But De la Rua put off dollarization and then failed to build a political consensus for it. Since December, Argentina's dollar reserves have deteriorated so much that dollarization is no longer feasible; that leaves devaluation as the only option.

The downward pressure on the Argentine peso has already pushed the currency far below dollar parity in informal exchange markets. This pressure will continue as people flee the peso for more stable assets. A devaluation will now happen in a matter of weeks or even days, with devastating effect.

Most domestic debt, both consumer and corporate, is denominated in dollars. A devaluation will make those debt obligations much more burdensome and, in many cases, unsustainable.

A rash of bad debts will undermine the banking system and will be exacerbated by increased deposit outflows as consumers worry about the safety of their deposits. Banks in turn will seize collateral assets from defaulting companies and consumers -- primarily Argentina's middle class -- in order to survive, resulting in a massive transfer of wealth. This will ripple out into the economy and society through increased unemployment and further social unrest.

Argentina's social turmoil could be transmitted to neighboring countries, where impoverished populations are witnessing the popular backlash against a previously shining example of a free-market Latin American economy. This could help shape the outcome of 2003 national elections in both Brazil and Ecuador, shifting the balance toward more populist, leftist candidates.

Lost in the domestic political maneuvering will be the government's previous focus both on the IMF and on foreign investors. The largest sovereign-debt default in history is now only a matter of time, and the process for a formal default on Argentina's external debt may already be underway.

Rigt now there are more questions than answers about Argentina's future after de la Rua. Probably the one sure answer is that 2002 is going to be a chaotic and, quite probably, painful year.

Mike Oakes is an analyst with STRATFOR, the global intelligence company. For more information about STRATFOR, click here.