Studying macroeconomics is like studying medicine. The best lessons are learned from the sickest patients. Few countries provide so many examples of missed opportunities, short-lived revivals, financial crises and turnarounds as Argentina. More than 8, 000 miles away, the land romanticized by Evita provides a fertile ground for comparisons between the pre-2001 situation in Buenos Aires and the present situation in Ukraine.
An agricultural Spanish colony in the 1860s, Argentina had catapulted itself to the sixth-richest world economy by 1890. Thousands of Europeans immigrated across the pond in search of better opportunities. The inter-war depression, post-war Peronist totalitarianism, and the myriad of coups in the 1950-1980s finally brought Carlos Menem to power in 1989 following several years of instability and sporadic violence.
A decade of high growth and relative prosperity followed. In many ways, it resembles post-2000 Ukraine. Argentinean gross domestic product grew on average by 5 percent per year; private consumption, foreign investment and banking penetration all increased substantially. Confident in their future due to a fixed exchange rate, Argentineans bought foreign luxury goods, traveled across the Americas, and sent their children to the best schools in the United States and Britain.
Unfortunately, the Menem years were also characterized by leadership squabbles and massive social spending. Scandals within Menem’s party caused it to lose the 1999 elections but changed nothing in Buenos Aires’ political culture. Legislative gridlock, resignations, and protests followed.
The fixed exchange rate that had propelled Argentinean economy for nearly a decade proved to be a curse during tough times. Growing trade imbalances, caused by a global downturn and other factors, decreased confidence in the government’s ability to maintain the peg leading to a wave of deposit withdrawals and conversion of pesos into U.S. dollars, depressing the peso even further.
By December 2001, Argentina was in flames. But what pushed Argentina over the edge was not the drop in GDP, high unemployment, or arguably misguided International Monetary Fund policies. It was an old-fashioned bank run sparked by fears of frozen deposits and the general failure by the authorities to right the banking system in time. Twenty-two people died in riots. The entire government resigned. All deposits, even those in foreign banks, were frozen. Argentineans were again facing high unemployment, substantial loss of wealth, severe inflation and protracted political instability.
In the fall of 2008, Ukraine faced a similar situation.
A global downturn ended several years of impressive growth supported by a pegged exchange rate. The government’s ability to maintain this stable exchange rate was rightly questioned by analysts and the public in the face of rapidly decreasing exports. The collective desire of ordinary citizens to protect their savings resulted in a stampede to withdraw the hryvnia and buy dollars.
A collapse in the banking system seemed possible. Thanks to timely IMF assurances and cash injections, a panic was averted. However, Ukraine is not yet out of the woods.
Argentina’s experience teaches us that panics must be averted at any cost. A wrong decision on interest rates or an extra percentage point in a budget deficit may cause a prolonged recession. One misplaced signal about the institutional strength of the banking system may lead to panic and street protests with unpredictable consequences.
There are various ways governments can prevent bank runs. Those include temporarily suspending deposit withdrawals, giving the central bank greater capacity to issue emergency loans to banks, establishing deposit insurance and increasing regulation. While suspension of deposit withdrawals is the easiest to implement, it is also the most dangerous socially. When Argentina chose this path in 2001, mass protests and violence erupted. Instead, government-backed deposit insurance – combined with meaningful regulation, especially regarding proper capitalization levels – is commonly agreed to be the best mechanism since it assures depositors of the safety of their savings in event of a bank collapse.
The National Bank of Ukraine and the legislature should use the current respite to strengthen overall confidence in the banking system, paying special attention to the small retail depositors most susceptible to making rushed decisions. The limit on the amount of retail deposits insured by the state should be raised, as should the overall size of the deposit insurance fund. More importantly, this should be well communicated to the public along with specific announcements regarding the amount of time and the procedure required to claim deposits.
Further, the NBU should support consolidation, assisting better capitalized banks with greater liquidity cushions to buy banks with lower capitalization and potential asset quality and liquidity problems. Favorable tax changes and government guarantees are needed. A strong message of assurance from the government – emphasizing that the newly-consolidated banks are solid – should follow. Stress testing should be continuous. In the event of a liquidity problem, a recapitalization decision must be made immediately and enacted transparently. Better yet, the problem bank should be shopped around to healthier banks.
Finally, banks should be encouraged to be more aggressive in collecting their loans. A stronger banking system won’t result from bans on collateral repossessions. A hryvnia collected on a loan made a year ago is a hryvnia that can be used to honor a withdrawal tomorrow.
Panics are impacted by the velocity of information dissemination and worsened by conspiracy theories that tend to proliferate in cynical, non-transparent environments. Credibility is hard to win.
With most institutions in Ukraine having less than transparent decision-making, it will be challenging to earn public confidence for government assurances. However, nothing establishes credibility so much as a small victory.
With more banks developing problems in asset quality, Ukraine’s central bank must be ready. It cannot afford to fail the first test that comes its way. Hopefully, the central bank understands that it is not just clients or owners of any given bank whose savings and fortunes are at stake.
As in the trauma room, a cardiologist cannot allow the heart to stop beating. The physical therapist and the plastic surgeon will only be able to perform their duties if the patient survives. The cardiologist has not only the patient’s life, but also jobs of all other doctors in his hands.
Mark Khavkin is a senior associate at Horizon Capital, a private equity fund manager investing in Ukraine, Belarus, and Moldova. He holds a master’s in business administration degree from Harvard Business School and is a CFA Charterholder. He can be reached at [email protected]
