All good things must come to an end, and so it is with Argentina and the International Monetary Fund. It seems the multilateral lending organisation is about to approve another loan. It is under pressure from members to lend enough to maintain the illusion that no one defaults on IMF loans. But if it does lend - most think an agreement will be signed by Friday - it will be committing a big mistake.

Since it took office in December of 2001, the government of Eduardo Duhalde has done little to alleviate Argentina's deep crisis. In fact, it has done much to make it worse. Unemployment is still around 20 per cent. More than a million people have emigrated, a sure sign that they have given up hope of a return to stability and growth. Forty per cent of those who remain are impoverished. Provinces continue to pay their bills by printing their own money. Although 40 per cent of daily consumer purchases are cash transactions, the government restricted access to money, sharply limiting these transactions.

Joseph Stiglitz, professor of economics at Columbia, speculated that the IMF cut off support for Argentina in 2001 because the country defaulted. This is nonsense. The government has not made the reforms needed for recovery. The previous government wrecked the banking system. Devaluation strengthened the export sector, so the current government increased export taxes, reducing exports. The courts gave people who sued the right to withdraw their bank deposits, so the government threatened to replace the judges to prevent withdrawals. It wasted scarce foreign exchange managing its exchange rate, instead of letting it fall to a market level. Despite these destructive policies, deep devaluation allowed the economy to stabilise at its current low level.

For decades, Argentina's biggest problem has been a political system that cannot maintain credible, pro-growth, non-inflationary policies. It has not kept promises to the IMF or other international lenders. Without political reform, there is little prospect that new promises will be kept, so renewed assistance will almost certainly waste yet more taxpayer money.

Instead of negotiating assistance in exchange for promises, the IMF should withdraw from Argentine domestic policy and accept once and for all that it cannot solve the country's problems. Political reform would come faster, if it comes at all, once Argentines know that they cannot expect any assistance until reforms are implemented, not just promised. These reforms should be part of an Argentine plan to establish a political system that is responsive, transparent, open, honest and capable of solving economic and social problems, as responsible governments elsewhere do.

Then come economic reforms. The current government broke private contracts unilaterally. It forced the public and banks to accept pesos in place of dollars, a move the Argentine courts declared unconstitutional. It revalued liabilities and assets at different exchange rates, driving an enormous hole in the banks' net worth. Unilaterally, it changed contracts with utility companies. These contracts had proved to be excessively generous. Renegotiation, not unilateral dictate, would have been the appropriate response.

In these and other ways the Argentine government emphasised sovereignty and ignored the rule of law and the sanctity of contracts. Unfortunately for the Argentine people, this is likely to have a long-term effect on capital investment and the ability to borrow.

Where the IMF can help Argentina is in helping it return to the debt market so that it can finance trade. The IMF should support an Argentine effort to settle its outstanding debts to foreigners - about $45bn at face value and worth about $9bn at current prices.

As Adam Lerrick, director of the Gailliot Centre for Public Policy at Carnegie Mellon University, and I have proposed, Argentina should offer to negotiate an exchange into new debt. Its initial offer would be about 20 cents on the dollar, the current (illiquid) market price, supported by its increased export earnings. This would allow holders to liquidate their holdings and rebalance their portfolios.

The IMF can help by offering to buy the debt for cash at 15 cents while the exchange offer remains outstanding. The total cost to the IMF in the worst possible case would be $6.8bn, if everyone took cash. This is far less than the amount of the loans the IMF will make if it returns to supporting Argentina. By offering a floor of support, the IMF would make the now illiquid bonds tradeable and give an incentive for the market to find a solution. And Argentina should use some of its export earnings to reduce its debts to international institutions. The IMF will have contributed to a solution of the international part of the problem. It should leave the rest to Argentina. Freed of its default, and with a much smaller debt, Argentina could borrow again, at least at short term. When it has a political system that makes wise choices, it can begin to resolve its banking, financial and fiscal problems.

The Duhalde government has called for presidential elections on April 27. A new Argentine government could then concentrate on getting agreement to implement the political and economic reforms that Argentina needs.

The writer is professor of political economy at Carnegie Mellon University, and a visiting scholar at the American Enterprise Institute

Source: Financial Times