FYI.
---------------------- Forwarded by Jeffrey A Shankman/HOU/ECT on 11/17/2000 
05:16 PM ---------------------------


Robert Johnston
11/17/2000 09:15 AM
To: Gary Hickerson/HOU/ECT@ECT, Max Yzaguirre/NA/Enron@ENRON, Jeffrey A 
Shankman/HOU/ECT@ECT
cc: William Stuart/HOU/ECT@ECT, Shane Dallmann/LON/ECT@ECT, Pushkar 
Shahi/HOU/ECT@ECT, Ellen Su/Corp/Enron@Enron, Michelle D 
Cisneros/HOU/ECT@ECT, Trena McFarland/NA/Enron@Enron, Eric Scott/HOU/ECT@ECT, 
Paul Pizzolato/HOU/ECT@ECT, Aaron Armstrong/LON/ECT@ECT, Jurgen 
Hess/LON/ECT@ECT, Martina Angelova/LON/ECT@ECT, John Greene/LON/ECT@ECT, 
Scott Tholan/Corp/Enron@Enron 
Subject: Argentina and Emerging Markets

The crisis in Argentina has a lot of people talking about another emerging 
market crisis.  This source believes that such talk is overblown, at least 
for now.

RJ

ARGENTINA:THE UNPALATABLE CHOICE AMONG DEFLATING, DEFAULTING OR DEVALUING

Executive Summary
The recession in Argentina is deepening and the government faces painful 
choices in addressing it
While the current strategy of deflation is unpopular, default or devaluation 
could be even more painful
Deflation will remain the strategy of choice so long as De la Rua survives; 
if his government falls, both default
      and devaluation become likely
Mexico and Brazil are in a stronger position to face the fallout from a 
devaluation than they were in 1998

November 16, 2000

1. Argentina Recession

The question haunting observers of Argentina is whether the De la R?a 
administration will succeed
in stabilizing the country,s economy and pulling it out of its second 
recession in five years. Indeed,
the 11-month old administration has not lived up to expectations and is 
quickly losing market
confidence. Although the country has so far maintained the support of the IMF 
and Washington,
the outcome of the unfolding crisis is by no means certain. Argentina is 
trapped in a fixed
exchange regime that succeeded in taming inflation but is now impairing its 
competitiveness and
long-term prospects.

2. Deflate, Default, or Devalue?

The administration faces a number of unenviable choices as it tries to reduce 
the difference
between internal and external prices. It can continue with its present course 
of action, attempting
to cut its fiscal deficit amid a deepening recession and a growing debt 
crisis. The adjustment of
relative prices would thus be accomplished through continued deflation. A 
variant of this scenario
would be to renegotiate part of its external debt, in order to reduce the 
increasingly onerous interest
payments, or default on its sovereign bonds. This, however, would destroy the 
last shred of
confidence, jeopardize Argentina,s future access to international capital 
markets, and ruin the
country,s relations with major industrialized countries. Finally, the country 
could opt to devalue.
Arguably, the financial and social cost of this action would be high, but the 
country could recover
relatively quickly, as the cases of Mexico and Brazil suggest.

3. Recession Threatens De la Rua Survival

The outcome will depend on whether the De la R?a administration remains in 
power. The
government is committed to pursuing a deflationary adjustment, hoping that it 
will pay off by next
year, provided that the US dollar weakens and that its access to 
international markets is
maintained. However, if the deflation is more prolonged and the economic 
recession becomes
socially and politically untenable, the ruling coalition could disintegrate 
and the president could be
forced to resign. In that case, the new government would probably decide to 
devalue immediately
after taking power.

4. Brazil and Mexico Less Vulnerable to Contagion than in 1998

The Argentine crisis has raised the specter of emerging market financial 
instability, notably in
Brazil and Mexico. However, these fears may be unfounded given the progress 
made by the latter
countries in improving their fundamentals. Indeed, both Brazil and Mexico now 
feature a floating
exchange rate regime and have gone a long way in terms of balancing their 
fiscal accounts. Thus,
in the event of an escalation of Argentina,s difficulties, both countries are 
well equipped to
overcome temporary financial turmoil.