This paper analyzes the principal characteristics of capital flight in Argentina since the collapse of the convertibility regime and the macroeconomic consequences of this capital flight. Using data on the formation of foreign assets, this article researched the factors that played a role in the most significant episodes of capital flight, which in 2011 obliged the government to enforce strong currency exchange controls to curb the depletion of Central Bank reserves.

INTRODUCTION

Capital flight has constituted a structural restriction for Latin American development since the 1970s. In general terms, understood as the outflow of capital from the residents of a country, derived from a desire to evade state regulations or the effects of public policies (Epstein, 2005),¹ capital flight has generated harmful repercussions, both economically and socially. First, this capital is no longer invested in the origin country, and therefore neither its productive capacity nor its financial strength increases (Pastor, 1990). The consequences are further exacerbated by the fact that the principal entities affected by capital flight are underdeveloped economies, which frequently face challenges in boosting investment. As such, capital flight amplifies the need to take on foreign debt, as well as the costs of doing so (Cuddington, 1986; Basualdo and Kulfas, 2002).

Although not all capital flight is necessarily illegal, the evidence in Latin America points to a situation in which a significant portion is linked to illicit activities, or where they are legal, associated with some sort of tax evasion (Barkin and Alvarichevsky, 1989; Gunter, 1991). On the one hand, this is a disservice to the fiscal circumstances of these countries, and, on the other, it has a regressive effect on income distribution, as tax evasion by high net-worth corporations and individuals hinders government social policy that aims to improve primary distribution (Gaggero et al., 2007).

In Argentina, the issue of capital flight is especially pressing—perhaps more so than in other countries of the region—because the nation was chronically afflicted with episodes of external restriction (scarcity of foreign currency) throughout the second half of the twentieth century. Although capital flight played a role in the balance of payment crisis in Argentina in the mid-1970s, it was only after then-Ministry of Economy José Alfredo Martínez de Hoz (1976-1981) began to deregulate the financial sector that it became a structural problem, of special consequence during critical crisis periods, such as 1980-1982 and 1989.

The structural reforms at the beginning of the 1990s made Argentina much more financially open to the rest of the world, notably reducing the cost of entry (and exit) for capital into (and out of) the national economy. Peso convertibility was another central reform of the decade, which besides rigidly pegging the peso to the dollar by law, made it a requirement for the Central Bank reserves to back the money supply. This measure, alongside aggressive trade liberalization, led to a high deficit and a consequent currency exit. Counterbalancing this phenomenon, two inflows rose during the decade, compensating, to some extent, the loss of currency: foreign debt and, to a lesser degree, foreign direct investment.

Economic policymakers expected that financial liberalization would bring about foreign investment, which would resolve the issue of external restrictions that had plagued the country in decades prior. However, in the second half of the 1990s, capital flight played a central role in the convertibility regime crisis, as it dug the country into a deeper role. Uncertainty surrounding the sustainability of the economic model prompted an increase in capital outflows, peaking in 2001, when capital flight surpassed 20 billion dollars, in the end burying the convertibility regime once and for all.

In the first months of 2002, Argentina seemed poised for another period of high inflation and foreign exchange instability, the principal features of the economic crises of the 1980s in the region (the so-called “lost decade for Latin America”). However, the collapse of the convertibility regime gave rise to a macroeconomic scheme that managed to produce robust growth in the years to follow. Economic policy veered sharply away from the convertibility model and came to be based on a high exchange rate and significant "twin surpluses" (fiscal and trade).²

In the next five years, economic growth was compatible with prolonged exchange rate stability and the Central Bank reserves were rapidly replenished, an unprecedented occurrence in the past 30 years of an economy known for—as has already been mentioned—the chronic scarcity of foreign currencies and periodic exchange rate crises. However, in the latter half of the decade, capital flight became a key issue again. In 2007-2008 and 2011, there were two notable spikes in capital flight that led to the adoption of policies to restrict foreign currency acquisition and finally, a major currency devaluation in 2014. Unlike what happened when capital flight spiked over the two preceding decades, these episodes took place in a context of economic growth, with a trade surplus and low foreign debt levels.

This paper will analyze the main features of capital flight during the post-convertibility era and its macroeconomic consequences. To do so, a statistical series was created for foreign asset formation, measured through the Foreign Exchange Balance from the Central Bank of Argentina (BCRA).³

The text is organized as follows. The first section provides an overview of capital flight at the end of the convertibility regime and introduces the major macroeconomic changes that have taken place since the 2002 devaluation. The second section analyzes the capital flight that reappeared in 2007. The third addresses capital flight in 2011 and its macroeconomic effects and impact on exchange rate policy. Finally, this article offers some conclusions, summarizing the central features of this phenomenon over the past decade in light of earlier spikes in capital flight.

THE ROLE OF CAPITAL FLIGHT IN THE CONVERTIBILITY CRISIS

The convertibility regime and the structural reforms that accompanied it made the Argentine economy more dependent on international capital flows. Although the currency board ( caja de conversion) system in Argentina—the cornerstone of the economic policy implemented in the 1990s—did reduce and stabilize inflation, it led to a strong appreciation of the peso, which in turn has had a substantial impact on the economic structure. Convertibility tied monetary circulation to foreign exchange reserves held by the Central Bank.

In the early years, success in controlling inflation and the investment opportunities that came with the far-reaching privatization agenda managed to reverse the massive outflows that had prevailed in years prior. But the overvaluation of the peso and aggressive trade liberalization produced strong deficits in the trade balance, which led the country to become extremely dependent on foreign debt and capital inflows to sustain economic activity levels.

In the first half-decade of the 1990s, debt growth was driven primarily by the private sector, which accounted for 70% of the increase in external obligations (Damill, Frenkel and Rapetti, 2005), taking advantage of the recently-implemented financial deregulation and high international liquidity. The scheme reached a critical juncture halfway through the decade, when the Mexican crisis spread and led to massive capital outflows, showing for the first time the weakness of the macroeconomic regime in light of problems with access to the international financial market. As a result, Argentina's reserves contracted considerably, as interest rates rose and the economy entered an intense recession. However, the government managed to stabilize the situation relatively swiftly, thanks to an aid package agreed upon with the International Monetary Fund (IMF).

Once over the “tequila effect” and after two years of solid growth, the economy relapsed into recession in the second half of 1998. The Asian and Russian crises affected the financing of the fairly large current account deficit the country maintained. The devaluation pushed forward in Brazil, the principal destination for Argentine exports, exacerbated the trade deficit. On the financial side, the increased weight of interest on debt amped up the fiscal deficit, obliging the State to take on more debt, under less favorable conditions.

The choice made first by the Carlos Saúl Menem administration and later by Fernando de la Rúa was to maintain the convertibility regime at any cost. They therefore opted for contractive fiscal policy, aiming to balance the public accounts, under the pretext that this would in turn reduce the risk premium, raise capital inflows and, finally, reduce local interest rates. But spending cuts and tax hikes not only failed to reopen credit channels, they in fact further depressed economic activity. Simultaneously, debt continued to multiply—this time driven by the public sector—eventually representing 60% of the Gross Domestic Product (GDP) on the eve of the collapse of convertibility.

In 2001, capital flight began to rise exponentially, leading to emergency measures and, a few months later, the end of the convertibility regime. According to information gathered by a parliamentary commission, capital outflows during 2001 amounted to 29 billion dollars,⁴ drastically depleting international reserves. But the greatest destabilizing effect was felt in the financial system, where total deposits fell 16%, seriously compromising bank liquidity. To halt the flight, the government put in place the so-called corralito measure, limiting deposit withdrawals from the system. Despite this measure, bank liquidity fell permanently, "through leaks," so to speak, as many depositors found legal ways around the ban through wage accounts and other resources. In December 2001, in the midst of an acute political and economic crisis, the country announced that it would suspend payments for a significant portion of its foreign debt. A few weeks later, the provisional government of Eduardo Duhalde formally declared the end of convertibility, setting off a series of devaluations that would soon cause the peso to depreciate somewhere on the order of 200%.

Following this devaluation, the new economic management strategy sought to implement, in light of the scarcity of foreign currency, mandatory conversion of dollar deposits into pesos. In the early months of 2002, a relapse into high inflation and exchange rate instability, central features of the economic crisis of the 1980s, seemed imminent. On the contrary, though, the end of convertibility heralded a macroeconomic scheme based on a high real exchange rate, and greater fiscal and trade surpluses, which during the next five years contributed to high growth rates with low inflation. Stabilizing the exchange rate was fundamental to ensuring that prices would evolve reasonably, and this in turn was achieved thanks to a variety of measures, including the requirement for exporters to liquidate foreign currency in the domestic market and the reestablishment of controls over the inflow and outflow of capital.

Once the exchange rate market was stabilized, fears of further depreciation began to ease (Damill and Frenkel, 2009; Amico, Fiorito and Zelada, 2012). Starting in 2003, capital began to flow in from abroad, which together with the trade surplus, allowed the Central Bank to actively intervene to prevent the peso from appreciating, and rapidly accumulate reserves. Once the value of the dollar was stabilized, a single free exchange market was established with very few restrictions on acquiring foreign currency.

The 2001 default allowed the country to significantly reduce expenditures abroad that would have been paid in the form of interest in the years following the crisis.⁵ After bonds were issued by the State to compensate savers, debtors, and banks for the devaluation, total public debt in 2003 amounted to nearly 180 billion dollars (Damill, Frenkel and Rapetti, 2005: 217). Two years later, Argentina designed a restructuring agenda that cleaned up 60% of defaulted liabilities and offered a debt swap that brought three-fourths of its bond debt out of default. The process was so successful that total public debt fell by 67 billion dollars, going from 139% to 73% of GDP, while also reducing the exchange rate risk at the same time, as nearly half of new bonds were issued in national currency (Nemiña, 2012).

THE RETURN OF CAPITAL FLIGHT IN 2007-2008

The spike in capital flight following the period of macroeconomic stabilization began in the first quarter of 2007 and reached its full magnitude nearly a year later. Three factors can explain this phenomenon: one is related to the impact of the foreign context, while the other two are related to local problems.

The international crisis began in July-August of 2007 in the United States, when the first subprime mortgage issues came to light, although the worst was still to come in September 2008 when Lehman Brothers went bankrupt, Merrill Lynch was urgently sold to Bank of America, and there was a massive bank bailout. It was at this point that the crisis spread to the rest of the world. Global markets panicked, which further accelerated capital flight out of "emerging" countries as the idea to "flee to quality" spread (essentially the U.S. dollar and U.S. treasury bonds). This affected practically all of the countries in the region and in the Southern hemisphere. The portfolios of investors, on a global level, were quickly converted into dollars.

However, in Argentina, this spike in capital flight cannot be explained solely by the international crisis. In fact, at least in the first few months, the crisis was fairly "kind" to emerging markets⁶ —for example, it increased commodities prices—and the financial contagion mainly began starting in September 2008. The onset of the crisis does account for the capital flight increase in the third quarter of 2008, but it appears insufficient to explain the earlier 2007 jump. The price of Argentine bonds became detached from the rest of emerging market bonds, leading to an abrupt fall starting in April 2007; in other words, before the crisis had really spread to the rest of the world (Damill and Frenkel, 2009).

On the domestic level, the increase in inflation starting in 2007 reduced the return on investments in financial instruments in pesos, constituting an incentive to purchase dollars as a reserve of value. Here it should be mentioned that the price increases that year took place in an environment with relatively low interest rates.⁷

Moreover, the changes that the National Statistics and Census Institute (INDEC) introduced in early 2007 to the methodology to measure the Consumer Price Index (CPI) had an additional impact. In January 2007, the sampling design for the CPI was altered,⁸ leading to a situation in which official inflation measurements were systematically lower than those estimated by province-level statistics agencies (the latter group's CPI figures have evolved similarly to those calculated by INDEC). The way in which the official national index developed therefore significantly reduced the profitability of sovereign Argentine bonds and other indexed financial tools, which led to a decrease in peso deposits adjusted for inflation and a medium-term reduction in deposits (for example, Levy Yevati et al., 2012).

The third factor that contributed to the peak in capital flight is related to the social and political dynamics of Argentina, in particular, the confrontation between the government and associations representing a large majority of agricultural and livestock producers in the country. In response to the rising prices of exportable agricultural commodities in the second half of 2007, in March 2008, the government approved a new sliding tax rate system (known as retenciones móviles) for agricultural exports, tying the increase (or decrease) of exports to the evolution of international prices.

Active opposition to the measure from agricultural groups led to a lock-out, protests and blocked routes for nearly 100 days. These organizations managed to interrupt a good portion of agricultural product distribution, which drove up food prices and even led to shortages in some areas of the country. In July, the government sent a bill to Parliament to address the issue. Following a tie in the Senate, the deciding vote was cast by the Vice President, who voted against the initiative presented by his very own government. After this legislative attempt, the executive branch was forced to pull back on the proposal. This conflict created a climate of political confrontation and consequent uncertainty regarding the liquidation of foreign currency by agricultural producers—the backbone of the trade surplus and accumulation of reserves for the Central Bank—all of which prompted a poor outlook for the future of the economy and encouraged even more capital flight (Ferrer, 2008).⁹

An analysis of the group of individuals or companies that acquired freely available foreign assets during this time period signals that major economic actors played a big role in the capital flight spike in 2007 (see Table 1). However, as will be shown below, the importance of mid-level and small buyers—especially those purchasing between 1,000 and 20,000 dollars annually—tended to rise in subsequent years, eventually playing an important part in the capital flight spike of 2011.

In this case, the increase in capital flight did not drain reserves because the trade balance had a sufficiently large surplus. The ratio of capital flight to dollars flowing into the country as a result of the positive trade balance, however, jumped to 53% in 2007 and to 97% just one year later (see Figure 2). Strong foreign trade performance not only financed the flight, but in fact permitted Central Bank reserves to continue to rise throughout 2007, while a year later they would cease to grow, although remaining stable. As will be seen, this would not be the case of the 2011 spike.

The composition of assets through which capital flight was produced is striking here. Throughout the decade, the purchase of banknotes was always higher than all other forms of capital flight, which is a sign that capital flight has been associated with extremely liquid and low-risk assets (see Figure 1). In the 2008 spike in capital flight, "other investments" also played an important role, that is, portfolio investments abroad (stock participations, bonds, etc.).

CAPITAL FLIGHT IN EARLY 2010 AND THE ADVENT OF CONTROLS

Once capital flight reached eight billion dollars in the second quarter of 2008 (see Figure 1), it began to fall, although remaining at fairly high levels—above four billion dollars—until the middle of the following year. In the second half of 2009, capital flight dropped abruptly, before rising again in 2010, although at a more moderate pace.

Starting in the beginning of 2010, there was a marked increase in capital outflows, further exacerbated in 2011 when, in the third quarter, capital flight hit its apex (nine billion dollars). In 2011, total capital flight exceeded 25 billion dollars, obliging the government to implement a series of increasingly stringent controls over the foreign exchange market.

The 2011 spike was different from the 2007 and 2008 events, insofar as its origin was more closely tied to the domestic political and economic context; specifically, uncertainty about whether the currency would be devalued again in the future. The 2009 recession had substantially cut inflation and pushed up the inflow of dollars through the surplus, as imports fell. Once the country was over the dip in economic activity, it began a process of currency appreciation, starting with inflation rates well above the nominal devaluation rates (this gap was the widest in 2010, see Figure 3). Economic recovery also brought with it an increase in imports, which reduced the trade surplus, although it remained positive and above nine billion dollars.¹⁰ Facing this scenario, and given the lack of a plan to rein in price increases, the press began to circulate the "conviction" that the government would choose devaluation in the end.

Moreover, following the 2008 spike, the Central Bank managed to increase its reserves, but much slower than it was able to do so in the period prior. In fact, a considerable portion of the foreign currency entered the country thanks to the trade surplus: that year alone, the amount of capital flight was equivalent to nearly the entirety of the trade surplus, while in 2009, the figure was 73%, and in 2010, 49% (see Figure 2).

Beyond currency appreciation, 2010 also witnessed the reemergence of extremely negative real interest rates. This happened because, in response to the return of inflation—which, starting in that year, began to exceed 20%—the nominal interest rates received by depositors in the local financial system remained low at around a fixed-term rate of 10% annually in pesos for over a 60-day term (see Figure 3). In a situation in which the peso was increasingly appreciated, there was a strong incentive for the population to put their savings into foreign currency.

Another key difference with respect to the previous spike was that this time around, individuals and companies with greater purchasing power played a less relevant role. In 2008, 52% of foreign currency acquisitions were made by individuals or companies that bought over 100,000 dollars per month. Three years later, the share of this group fell to 37%. In the hypothesis proposed, the suspicion that the local currency would be devalued would have driven the "preventive dollarization" of savings, which spread over time to the upper-middle and middle classes. Macroeconomic conditions played a role in this, but so too did the population's experiences in previous exchange rate crises over the past decades. This produced an economic environment quite "sensitive" to the risk of abrupt variations in the exchange rate.¹¹

The political context was also a key factor, in combination with the aforementioned aspects, in the spike in capital flight. Presidential elections were held in October 2011 and President Cristina Fernández de Kirchner was re-elected, which caused a massive dollar exit in the months prior. The run-up to elections in Argentina is a time of financial and economic uncertainty, where the decisions of the most conservative investors prevail, in response to the potential for an abrupt shift in economic policy. Added to this, in the second half of 2011, the media was already trumpeting the idea that the currency was overvalued and that the government would take at least some sort of action—read: a "moderate devaluation," at minimum—after the elections. This environment contributed to the rise in the purchase of foreign currency, especially among small and mid-level savers. The consequences of the episode of accelerated capital flight in 2011 were more serious than those of its predecessors. First, the magnitude of this episode was practically double the trade surplus (184%) (see Figure 2), meaning that the Central Bank lost around five billion dollars of its reserves that year. Starting in June 2011, reserves fell steadily for the next 30 months. In December 2013, they hit 30.599 billion dollars, basically equivalent to the figure recorded in October 2006 during the build-up of reserves (see Figure 5).

The way that capital flight evolved and its impact on the Central Bank reserves led the government to enact, starting in October 2011, a series of regulatory changes to strongly limit the acquisition and use of foreign currency by individuals and companies, aiming to put the brakes on the outflow of currency abroad.¹² Four main types of measures were implemented: limits on the purchase of foreign currency for hoarding and tourism, regulations on foreign currency withdrawals abroad for the private sector, various controls on financial activities (related to mortgage loans and credit card use) and new regulations for stock market transactions (targeted mainly at controlling capital flight through transactions with bonds in dollars).

The set of standards and policies put in place during this time had the effect of reducing the volume of transactions conducted in the Single Free Exchange Market (MULC) by 25% and drastically lowered capital outflows through the formal market. As a result, the formation of foreign assets of residents changed sign starting in the third quarter of 2012. Capital flight subsequently plummeted from USD 25 billion in 2011 to only 600 million the next year. There was a corollary impact on the international reserves, which, although they continued to fall, began to do so at a slower pace.

It is worthwhile to note, however, that the controls also produced significant negative effects, mainly in terms of reigniting the illegal dollar market—which was practically non-existent in the decade prior—and the consequent emergence of a parallel exchange rate. The value of the illegal dollar rose as the controls were tightened (see Figure 6). By the end of the year, the gap between the two exchange rates had reached 40%, a figure that increased to 64% by September 2013.

It is also interesting that once restrictions on the acquisition of foreign currency were implemented, the demand for foreign currency for tourism and travel rose considerably, activities which, in turn, allowed individuals to obtain foreign currency through various loopholes in the control policy.¹³ In the first half of 2013, gross purchases in the foreign exchange market reached 5.4 billion dollars, significantly higher than a year earlier.¹⁴ At the same time, inflows of foreign currency to the Single Free Exchange Market for tourism fell considerably (amounting to 850 million dollars in the same time period) because a good portion began to be sold on the illegal market.¹⁵

Although these regulations managed to contain outflows by restricting the purchase of foreign currencies, this circumstance did not mean that all routes for capital flight were cut off, some of which included, for example, maneuvers using transfer prices and other tactics related to over- or under-invoicing for imports and exports, which are not recorded in the official foreign exchange market.¹⁶

In 2013, the Central Bank began to lose reserves at a faster rate. In the context of a deteriorating trade surplus, the decrease was exacerbated by the deficit of the tourism sector and the need to pay off maturities of both public and private foreign debt.¹⁷ The exchange rate gap and expectations that the currency would be devaluated among the most concentrated corporate sectors played a major role at the end of that year, when exporters started to delay payment of foreign sales of agro-industrial products and, as a counterpart to that, importers made advance purchases so as to accumulate a stock, speculating that there would eventually be a devaluation.

CONCLUSIONS

In Argentina, over the past 40 years, the most significant episodes of recurring capital flight have consistently happened right before major devaluations (1975, 1981-1982, 1989, 2001), in an economy marked by the "chronic scarcity of foreign currencies." Capital outflows have taken place in a context of trade deficits, the rapid depletion of foreign reserves, challenges in accessing international credit markets and, as a consequence of all of this, a lack of confidence from the most powerful economic agents—large companies and individuals with high purchasing power—in the State to sustain the value of the currency over time.

After more than a decade of exchange rate stability, there was a notable spike in capital flight in 2011, which led once again to the application of stringent foreign exchange controls and subsequently—after the attempt to maintain reserve levels failed—an abrupt devaluation of the currency. Once more, capital flight was a factor that tended to inflame the problem of foreign currency scarcity. However, this episode was unique in various ways that separate it from prior events in different historical contexts and, in particular, from the convertibility regime crisis.

First, while in 2001 the spike in capital flight was the final chapter of an economic crisis that had lasted for years, in the most recent decade, the accelerated capital exit took place in a context of sustained economic growth. In other words, while capital flight was the dénouement of the crisis in the first case, in the second, it became the trigger for instability in a moment when the country enjoyed both good economic activity levels and a surplus trade balance.

In the 1990s, the overvaluation of the peso led to a chronic trade deficit, one of the central factors that resulted in foreign currency scarcity. In the post-convertibility era, the high real exchange rate began to decline as inflation took off in 2007. This did not mean that the trade surplus was reversed, but it did have a strong impact on financial variables. In an environment where inflation exceeded 20%, real interest rates were negative, and there were no indexed savings tools, major investors and mid-level savers began to dollarize their assets. In 2007-2008, there were two additional phenomena that help explain the first spike in capital flight in a macroeconomic context that was at the time still rather favorable: the international financial crisis and the struggle between the government and major associations representing agriculture and livestock producers.

Once the country had overcome this first episode, rising inflation and real exchange rate appreciation played a key role in the acceleration of capital flight that began in 2010 and reached its pinnacle a year later. The lack of any sort of policy to control price increases, the consolidation of interest rates that surpassed, by a lot, nominal devaluation rates, and difficulties to maintain the trade balance added fuel to the rumors that the government would be left with no choice but to devalue the currency again. On the other side, price increases also meant the reappearance of real negative interest rates, encouraging investments in foreign currency.

Starting in 2010, capital flight picked up again and by the end of the year, Central Bank reserves began to fall. As they declined more sharply, the possibility that the government would devalue the currency following the presidential elections (October 2011) loomed large. In that context, the acquisition of foreign currencies "spread to the masses," so to speak—the role of small and mid-level savers became increasingly important— and capital flight hit a new peak of 10 billion dollars in the third quarter of 2011. Unlike what had happened a decade earlier, the government decided not to obtain financing through the global credit market, so this capital flight produced a sharp drop in Central Bank reserves, which would not be compensated by the inflow of foreign currency through international loans.

However, after the elections, the government did not devalue the currency. Rather, it opted to apply a series of progressively restrictive measures on the acquisition of foreign currencies. The decision was initially effective in reducing purchases in the formal market, but it drove the emergence of an illegal exchange market whose effects continue to exacerbate the foreign currency scarcity. The inability to slow the depletion of reserves finally compelled the government to devalue the currency in early 2014.

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