Latin American Financial Crises and Recovery Jan Kregel, Senior Scholar, Levy Economics Institute of Bard College and Distinguished Professor, Center for.

Latin American Financial Latin American Financial Crises and RecoveryCrises and Recovery

Jan KregelJan Kregel, , Senior Scholar, Levy Economics Institute of Bard College Senior Scholar, Levy Economics Institute of Bard College and Distinguished Professor, Center for Full Employment and Distinguished Professor, Center for Full Employment and Price Stability, University of Missouri, Kansas City and Price Stability, University of Missouri, Kansas City

Remarks Prepared for the Conference:Remarks Prepared for the Conference:

A Decade After: Recovery and Adjustment since A Decade After: Recovery and Adjustment since the East Asian Crisis, the East Asian Crisis,

Organised by International Development Economics Associates Organised by International Development Economics Associates (IDEAs), Good Governance for Social Development and the (IDEAs), Good Governance for Social Development and the

Environment Institute (GSEI), Action Aid and Focus on the Global Environment Institute (GSEI), Action Aid and Focus on the Global South South

July 12-14, 2007, Bangkok ThailandJuly 12-14, 2007, Bangkok Thailand

Asia & LA: Similarities and DifferencesAsia & LA: Similarities and Differences SimilarilitySimilarility: Capital Reversals caused crisis: Capital Reversals caused crisis DifferencesDifferences in causes of the capital inflows and the in causes of the capital inflows and the

capital reversals In Asia capital reversals In Asia • savings and investment rates were extremely high and stable savings and investment rates were extremely high and stable

growth at double digit rates, stable prices and exchange rates growth at double digit rates, stable prices and exchange rates with contained fiscal and external balances. with contained fiscal and external balances.

• countries did not need additional financial resources from capital countries did not need additional financial resources from capital inflows, inflows,

• foreign investors were attracted by what appeared to be a foreign investors were attracted by what appeared to be a successful long-term growth process with stable returns.successful long-term growth process with stable returns.

In Latin America In Latin America • savings and investment rates low, chronic fiscal and external savings and investment rates low, chronic fiscal and external

deficits, hyperinflation and exchange rate volatility. deficits, hyperinflation and exchange rate volatility. • Little in performance to attract foreign investors. Little in performance to attract foreign investors. • Inflows induced by the Brady Plan and the structural adjustment Inflows induced by the Brady Plan and the structural adjustment

policies that accompanied it. policies that accompanied it. • Expectation of quick profits from the liberalization, privatizing Expectation of quick profits from the liberalization, privatizing

state-owned companies, market-led liberalization and state-owned companies, market-led liberalization and deregulation brought inflows. deregulation brought inflows.

• Inflows were primarily into financial rather than real assets.Inflows were primarily into financial rather than real assets.

Policy Induced Flows Reversed in 1990sPolicy Induced Flows Reversed in 1990s Mexico 1994-5 Tequila crisisMexico 1994-5 Tequila crisis Brazil exchange-rate crisis of 1999 Brazil exchange-rate crisis of 1999 Argentina Default crisis of 2001 Argentina Default crisis of 2001 Confirmation of the failure of the policies to provide Confirmation of the failure of the policies to provide

sustainable recovery from the 1980’s debt crisis. sustainable recovery from the 1980’s debt crisis. Brazil and Mexico Brazil and Mexico

• persisted with previous policiespersisted with previous policies• maintained price stability, this has come at the cost of a maintained price stability, this has come at the cost of a

lower trend growth rate. lower trend growth rate. Argentina made a break with previous policiesArgentina made a break with previous policies

• defaulting on its foreign debt, defaulting on its foreign debt, • increase in its trend growth rate and employment, increase in its trend growth rate and employment, • evidence of emerging inflationary pressures and supply evidence of emerging inflationary pressures and supply

bottlenecks, especially in energy. bottlenecks, especially in energy.

Lessons from Latin AmericaLessons from Latin America

The lessons to be drawn from The lessons to be drawn from Latin America must be viewed in Latin America must be viewed in the context of the context of •the different causes that the different causes that

attracted the inflows and the attracted the inflows and the subsequent reversal, subsequent reversal,

•in particular the failure of post-in particular the failure of post-crisis adjustment policies.crisis adjustment policies.

Latin America --Policy-Induced Capital Latin America --Policy-Induced Capital FlowsFlows

Brady Plan shifted solution of debt problemBrady Plan shifted solution of debt problem• from repayment via large current account surpluses from repayment via large current account surpluses • to restoring access to international capital markets in order to to restoring access to international capital markets in order to

refinance their outstanding debt to banks refinance their outstanding debt to banks • by shifting it to the private sector institutional lenders in by shifting it to the private sector institutional lenders in

those countries. those countries. Latin American countries were to introduce price Latin American countries were to introduce price

stability and investor-friendly policiesstability and investor-friendly policies• Stabilisation of exchange rates and rapid return to full Stabilisation of exchange rates and rapid return to full

convertibility of currencies at a targeted exchange rate or convertibility of currencies at a targeted exchange rate or fluctuation band. fluctuation band.

• Mexico and Brazil introduced regimes with tight fluctuation Mexico and Brazil introduced regimes with tight fluctuation bandsbands

• Argentina a fixed dollar rate of exchange through the Argentina a fixed dollar rate of exchange through the Convertibility Law. Convertibility Law.

All experienced substantial real exchange rate All experienced substantial real exchange rate appreciations appreciations

Support of Exchange StabilitySupport of Exchange Stability Policies to introduce market-based resource allocation Policies to introduce market-based resource allocation

• reduction in the role of government in the economy reduction in the role of government in the economy • privatization of state-owned enterprises, privatization of state-owned enterprises, • creation of (primary) government budget surpluses. creation of (primary) government budget surpluses. • restriction on expansion of the domestic money supply restriction on expansion of the domestic money supply • open domestic markets to foreign competition to reinforce open domestic markets to foreign competition to reinforce

price stabilisation price stabilisation Financial market deregulation, capital account Financial market deregulation, capital account

liberalisation and creation of domestic financial liberalisation and creation of domestic financial markets to encourage capital inflows to purchase markets to encourage capital inflows to purchase domestic financial assets and provide foreign domestic financial assets and provide foreign exchange to repay, and the opportunity to refinance exchange to repay, and the opportunity to refinance debt.debt.

Privatization of state enterprises through domestic Privatization of state enterprises through domestic equity markets drew foreign portfolio investors to equity markets drew foreign portfolio investors to “emerging markets” as an asset class. “emerging markets” as an asset class.

Reasons for Inflation SuccessReasons for Inflation Success After years of failure, success in fighting inflation did not produce a After years of failure, success in fighting inflation did not produce a

balance of payments crisis as capital inflows more than covered balance of payments crisis as capital inflows more than covered external deficits, increasing reserves reinforce market perceptions of external deficits, increasing reserves reinforce market perceptions of successful recovery. successful recovery. • The Brady Plan and the structural adjustment policies brought the The Brady Plan and the structural adjustment policies brought the

capital inflows that would be produce the reversal and the crisis capital inflows that would be produce the reversal and the crisis of the 1990s.of the 1990s.

• The failure to deliver long-term increases in growth and The failure to deliver long-term increases in growth and profitability that produced the eventual reversal. profitability that produced the eventual reversal.

A number of factors that were crucial to the success in fighting A number of factors that were crucial to the success in fighting inflation were also important in preventing a return to sustained inflation were also important in preventing a return to sustained growth. growth. • real appreciation of exchange rates, real appreciation of exchange rates, • excessively high real interest rates and weak domestic demand excessively high real interest rates and weak domestic demand • caused deterioration in external accounts and dampened caused deterioration in external accounts and dampened

incentives to invest to increase domestic productivity. incentives to invest to increase domestic productivity. • Capital inflows had little impact on domestic savings, and were Capital inflows had little impact on domestic savings, and were

primarily in portfolio assets rather than real assets. primarily in portfolio assets rather than real assets. While Latin American countries were praised for their good While Latin American countries were praised for their good

“macroeconomic fundamentals” they have not been able to harness “macroeconomic fundamentals” they have not been able to harness trade as an engine of stable growth in per capita incomes. trade as an engine of stable growth in per capita incomes.

Good Macro Policy, Bad Micro Policy?Good Macro Policy, Bad Micro Policy?

The good macroeconomic fundamentals – The good macroeconomic fundamentals – • low inflation, low inflation, • primary budget surpluses and primary budget surpluses and • control of the money supply, control of the money supply,

Overlooked more traditional macro Overlooked more traditional macro economic fundamentals economic fundamentals • high levels of aggregate demand, high levels of aggregate demand, • low real interest rates low real interest rates • competitive real exchange rates. competitive real exchange rates.

As a result they created an overall As a result they created an overall macroeconomic environment that impeded macroeconomic environment that impeded the required structural changes at the micro the required structural changes at the micro level. level.

Bad Micro PolicyBad Micro Policy

Five areas can be identified in which Five areas can be identified in which the structural adjustment policies the structural adjustment policies undermined the stability of the undermined the stability of the macroeconomic fundamentals and the macroeconomic fundamentals and the adjustment of the production structure. adjustment of the production structure. • overvaluation of the exchange rate, overvaluation of the exchange rate, • the high level of real interest rates, the high level of real interest rates, • composition of the fiscal budget, composition of the fiscal budget, • the composition of the external account the composition of the external account • the failure of adjustment of the industrial the failure of adjustment of the industrial

production structure to reduce the dependence production structure to reduce the dependence of increased investment and increased export of increased investment and increased export capacity on imported inputs.capacity on imported inputs.

Post-Crisis Recovery Brazil, Mexico and Post-Crisis Recovery Brazil, Mexico and ArgentinaArgentina

Common characteristics of the recovery Common characteristics of the recovery • the crisis forced countries to abandon their exchange the crisis forced countries to abandon their exchange

rate policies and the need for the highly restrictive rate policies and the need for the highly restrictive money and fiscal policies necessary to attract the money and fiscal policies necessary to attract the external inflows to keep rates stable or fixed. external inflows to keep rates stable or fixed.

• The possibility to relax policy provided an opening for The possibility to relax policy provided an opening for recovery and higher growth that was experienced in recovery and higher growth that was experienced in all countries. all countries.

Brazil and Mexico took measures to restore their prior Brazil and Mexico took measures to restore their prior policy stance with nominally flexible exchange rates. policy stance with nominally flexible exchange rates. • Their expansions were short-lived and soon Their expansions were short-lived and soon

experienced a return of capital inflows, exchange experienced a return of capital inflows, exchange rate overvaluation, and low trend growth. rate overvaluation, and low trend growth.

Argentina rejected a return to externally financed Argentina rejected a return to externally financed growth and used low interest rates and a policy of growth and used low interest rates and a policy of stabilization of the real exchange rate to support stabilization of the real exchange rate to support growth. growth. • It has experienced higher than trend growth on a It has experienced higher than trend growth on a

sustained basis since 2002.sustained basis since 2002.

Brazil’s 1999 Exchange rate crisis and recoveryBrazil’s 1999 Exchange rate crisis and recovery After Recovery -- restrictive policies were quickly reintroduced. After Recovery -- restrictive policies were quickly reintroduced. Cardoso re-election run on the premise of maintaining control Cardoso re-election run on the premise of maintaining control

of inflationof inflation• -price stability depended on stability of exchange rate. -price stability depended on stability of exchange rate.

Despite deterioration of the external and fiscal balances, tight Despite deterioration of the external and fiscal balances, tight monetary and fiscal policy maintained to generate the external monetary and fiscal policy maintained to generate the external capital inflows to defend Real in the face of rising capital inflows to defend Real in the face of rising unemployment and falling growth. unemployment and falling growth. • Real interest rates went from 20 per cent Real Plan over 40 Real interest rates went from 20 per cent Real Plan over 40

per cent end 1998. per cent end 1998. • Unemployment rose from under 5 per ce3nt in 1995 to over Unemployment rose from under 5 per ce3nt in 1995 to over

8 per cent in 1998, 8 per cent in 1998, • growth fell from a Real Plan average of over 3 per cent to growth fell from a Real Plan average of over 3 per cent to

near zero in1998. near zero in1998. Policy reinforced by an over $35 billion IMF support loan, Policy reinforced by an over $35 billion IMF support loan,

requiring maintaining current policies. requiring maintaining current policies. • Nonetheless net capital movements fell from $26 billion in Nonetheless net capital movements fell from $26 billion in

1997 to less than $16 billion at the end of 19981997 to less than $16 billion at the end of 1998• Foreign exchange reserves fell from nearly $75 billion in Foreign exchange reserves fell from nearly $75 billion in

April of 1998 to around $36 billion in January 1999. April of 1998 to around $36 billion in January 1999.

Against a CA deficit over $30 billion in 1997 and Against a CA deficit over $30 billion in 1997 and 1998 and no signs of improvement in fiscal or 1998 and no signs of improvement in fiscal or external balance, after re-election exchange rate external balance, after re-election exchange rate abandoned in January of 1999. abandoned in January of 1999.

The Real surpassed 2 Reis to the US dollar and The Real surpassed 2 Reis to the US dollar and then stabilized. then stabilized.

Against conventional expectationsAgainst conventional expectations• inflation pass-though was moderateinflation pass-though was moderate

Arminio Fraga introduced a policy of guiding Arminio Fraga introduced a policy of guiding interest rates downward, while the government interest rates downward, while the government persisted in its policy of running primary persisted in its policy of running primary surpluses. surpluses.

The result was a short-term spurt in growth in The result was a short-term spurt in growth in 2000 that was quickly reversed by the 2000 that was quickly reversed by the contractionary policies at the end of the Cardoso contractionary policies at the end of the Cardoso administration and the speculation surrounding administration and the speculation surrounding the incoming Lula administration.the incoming Lula administration.

Brazil Contributions to GDP Growth

-4.0000

-3.0000

-2.0000

-1.0000

0.0000

1.0000

2.0000

3.0000

4.0000

5.0000

6.0000

7.0000 GDP

Final Consumption

Net Exports

Gross Fixed Capital

Final Government Consumption

The Recovery from the Mexican Crisis of 1994-5 The Recovery from the Mexican Crisis of 1994-5 Mexico followed exchange rate band, and capital inflows more than Mexico followed exchange rate band, and capital inflows more than

sufficient to cover its rising external and internal imbalances. sufficient to cover its rising external and internal imbalances. End 1994 NAFTA treaty and political turmoil caused foreign investor loss of End 1994 NAFTA treaty and political turmoil caused foreign investor loss of

confidence confidence Short-term government liabilities could not be renewed and the peso Short-term government liabilities could not be renewed and the peso

collapsed. collapsed. The IMF + other governments produced largest aid packages ever granted.The IMF + other governments produced largest aid packages ever granted. Mexico required to implement adjustment package, Mexico required to implement adjustment package,

• Restrictive fiscal and monetary policy and wage controls Restrictive fiscal and monetary policy and wage controls • The result --a deep decline in output and employment of over 6%, and over 5%, with inflation The result --a deep decline in output and employment of over 6%, and over 5%, with inflation

around 51% in 1995around 51% in 1995. . The crisis was quickly reversed and the economy started to recover in the The crisis was quickly reversed and the economy started to recover in the

third quarter of 1995, and in 1996 GDP grew over 5% and by over 6% in third quarter of 1995, and in 1996 GDP grew over 5% and by over 6% in 1997. 1997.

The immediate trigger was the fall in private expenditureThe immediate trigger was the fall in private expenditure Non-oil exports responded quickly and robustly to the large depreciation of Non-oil exports responded quickly and robustly to the large depreciation of

the peso, and the domestic receipts from oil exports also rose. the peso, and the domestic receipts from oil exports also rose. The large improvement of the trade balance from the downward adjustment The large improvement of the trade balance from the downward adjustment

of imports and the growth of exports supported the level of demand and of imports and the growth of exports supported the level of demand and economic activity.economic activity.

The decline in government expenditure reversed -- the growth rate from the The decline in government expenditure reversed -- the growth rate from the quarter prior to the crisis until the upper point of the recovery exceeded the quarter prior to the crisis until the upper point of the recovery exceeded the rate of growth of GDP. rate of growth of GDP.

Private expenditure did not recover from its downswing level, and Private expenditure did not recover from its downswing level, and consumption and fixed investment were lower at the top of recovery than consumption and fixed investment were lower at the top of recovery than prior to the crisis.prior to the crisis.

Although employment was restored to its pre-crisis level, average real Although employment was restored to its pre-crisis level, average real (manufacturing) wages did not recover. In fact they were 23% lower at the (manufacturing) wages did not recover. In fact they were 23% lower at the upper point of the recovery than in the quarter prior to the crisis.upper point of the recovery than in the quarter prior to the crisis.

The government Contribution to RecoveryThe government Contribution to Recovery Demand by government on the domestic market, is equal Demand by government on the domestic market, is equal

to government expenditure on goods and services, plus to government expenditure on goods and services, plus government transfers and wages, plus domestic interest government transfers and wages, plus domestic interest payments. payments.

Deficit refer to government expenditures above those Deficit refer to government expenditures above those financed with taxes which in Mexico includes government financed with taxes which in Mexico includes government revenues from oil industry. revenues from oil industry.

Thus a rise in the price of oil allows the government to Thus a rise in the price of oil allows the government to increase domestic expenditure without changing the deficit, increase domestic expenditure without changing the deficit, but nonetheless creates a net additional demand.but nonetheless creates a net additional demand.

According to estimates made by Julio Lopez Mexico has According to estimates made by Julio Lopez Mexico has maintained a positive domestic deficit of around 17% of maintained a positive domestic deficit of around 17% of GDP in the 1980s, and 6% in the 1990s.GDP in the 1980s, and 6% in the 1990s.

Government expenditure and domestic deficit fell until the Government expenditure and domestic deficit fell until the IIIQ 1995 and from then both recovered to a relatively high IIIQ 1995 and from then both recovered to a relatively high level during 1996. level during 1996.

We can conclude that both the domestic deficit and total We can conclude that both the domestic deficit and total government expenditure played an important role in government expenditure played an important role in recovery sustaining the domestic demand and private recovery sustaining the domestic demand and private profits.profits.

Argentina’s Recovery from the 2001 Argentina’s Recovery from the 2001 DefaultDefault

The political stalemate that followed the The political stalemate that followed the resignation of the government and the Christmas resignation of the government and the Christmas Eve default of Argentina’s sovereign debt meant Eve default of Argentina’s sovereign debt meant that there was little time for a formal change in that there was little time for a formal change in economic policy. economic policy.

However, the elimination of external and internal However, the elimination of external and internal debt service automatically created a less debt service automatically created a less restrictive policy that was reinforced by the restrictive policy that was reinforced by the market-led devaluation of the exchange rate and market-led devaluation of the exchange rate and the increase in the terms of trade of Argentina’s the increase in the terms of trade of Argentina’s main agricultural exports main agricultural exports

Thus, the initial response was a sharp increase in Thus, the initial response was a sharp increase in exports and a collapse in imports due to the exports and a collapse in imports due to the deepening recession. deepening recession.

Cuenta Corriente Devengada y Caja (ult. 4 trim, en % del PIB)

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

IV.94

I.95

II.95

III.95

IV.95

I.96

II.96

III.96

IV.96

I.97

II.97

III.97

IV.97

I.98

II.98

III.98

IV.98

I.99

II.99

III.99

IV.99

I.00

II.00

III.00

IV.00

I.01

II.01

III.01

IV.01

I.02

II.02

III.02

IV.02

I.03

II.03

III.03

IV.03

I.04

II.04

III.04

IV.04

I.05

II.05

III.05

IV.05

I.06

Comercial (Bienes y Servicios)

Cuenta Corriente Devengada

Cuenta Corriente "Caja"

Desde II.05 la cuenta caja y devengada coinciden

Importaciones por Uso Económico

1000

3000

5000

7000

9000

11000

13000

15000

17000En

e-98

Abr-9

8

Jul-9

8

Oct

-98

Ene-

99

Abr-9

9

Jul-9

9

Oct

-99

Ene-

00

Abr-0

0

Jul-0

0

Oct

-00

Ene-

01

Abr-0

1

Jul-0

1

Oct

-01

Ene-

02

Abr-0

2

Jul-0

2

Oct

-02

Ene-

03

Abr-0

3

Jul-0

3

Oct

-03

Ene-

04

Abr-0

4

Jul-0

4

Oct

-04

Ene-

05

Abr-0

5

Jul-0

5

Oct

-05

Ene-

06

Abr-0

6

mill

ones

de

U$S

Grupo1: Bs de Capital + Piezas y Accesorios

Grupo2: Bs Intermedios + Combustibles

Grupo3: Bs de Consumo + Vehículos

Policy ChangePolicy Change?? Newly government concentrate don domestic recovery and Newly government concentrate don domestic recovery and

thus did not seek a rapid conciliation with creditors. thus did not seek a rapid conciliation with creditors. Rapid reconciliation had been Fund objective to allow Rapid reconciliation had been Fund objective to allow

Argentina to borrow to meet arrears in debt service a la Argentina to borrow to meet arrears in debt service a la BradyBrady

IMF declined to support the government program, -- O’Neill IMF declined to support the government program, -- O’Neill doctrine that the past history of IMF supported bailouts of doctrine that the past history of IMF supported bailouts of debtor countries has created moral hazard amongst debtor countries has created moral hazard amongst creditors creditors

As a result, not only did the IMF withdraw support, it failed As a result, not only did the IMF withdraw support, it failed to provide support for the Argentine recovery program as to provide support for the Argentine recovery program as had been the case of Brazil and Mexico. had been the case of Brazil and Mexico.

Government argued only return to sustained growth could Government argued only return to sustained growth could support debt repayment. support debt repayment.

Question --- whether the surplus target would maximize Question --- whether the surplus target would maximize probability of sustained growth or the amounts received by probability of sustained growth or the amounts received by creditors. creditors.

In response to Fund insistence on the latter Argentina noted In response to Fund insistence on the latter Argentina noted that the Fund was supposed to remove moral hazard but by that the Fund was supposed to remove moral hazard but by supporting interests of creditors it was creating moral supporting interests of creditors it was creating moral hazard at the expense of Argentina to forego growth in hazard at the expense of Argentina to forego growth in order to repay debt at 100 per cent of its face value.order to repay debt at 100 per cent of its face value.

Demanda Agregada como % del PIB Serie Desestacionalizada

63%

64%

65%

66%

67%

68%

69%

70%

71%

I-97

II-97

III-9

7IV

-97

I-98

II-98

III-9

8IV

-98

I-99

II-99

III-9

9IV

-99

I-00

II-00

III-0

0IV

-00

I-01

II-01

III-0

1IV

-01

I-02

II-02

III-0

2IV

-02

I-03

II-03

III-0

3IV

-03

I-04

II-04

III-0

4IV

-04

I-05

II-05

III-0

5IV

-05

I-06

-5,0%

0,0%

5,0%

10,0%

15,0%

20,0%

25,0%

Consumo

Exportaciones Netas (eje derecho)

IBIF (eje derecho)

Inversión Bruta Interna Fija Serie Desestacionalizada

20,8%

22,0%

10%

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

21%

22%

23%

I-97

III-9

7

I-98

III-9

8

I-99

III-9

9

I-00

III-0

0

I-01

III-0

1

I-02

III-0

2

I-03

III-0

3

I-04

III-0

4

I-05

III-0

5

I-06

% d

el P

IB

Equipo Durable como % de la IBIF(a precios de 1993)

30%

32%

34%

36%

38%

40%

42%

44%

I-97

II-97

III-9

7IV

-97

I-98

II-98

III-9

8IV

-98

I-99

II-99

III-9

9IV

-99

I-00

II-00

III-0

0IV

-00

I-01

II-01

III-0

1IV

-01

I-02

II-02

III-0

2IV

-02

I-03

II-03

III-0

3IV

-03

I-04

II-04

III-0

4IV

-04

I-05

II-05

III-0

5IV

-05

I-06

PIB Tasas de Variación Interanual

5,4%

7,7%

10,2%

11,3%

7,1%

8,7%9,3%

8,0%

10,4%

9,2% 9,0%8,6%

11,7%

0%

2%

4%

6%

8%

10%

12%

14%

I-03

II-03

III-0

3

IV-0

3

I-04

II-04

III-0

4

IV-0

4

I-05

II-05

III-0

5

IV-0

5

I-06

Financiamiento de la inversión por origen del ahorro

-5%

0%

5%

10%

15%

20%

25%

93 94 95 96 97 98 99 00 01 02 03 04

IBIF + discr. est. Ahorro Nacional Ahorro Público

Período 1993– 2005. Base caja. % del PI B

Ahorro externo Cta cte (-)

Desahorroexterno Cta cte (+)

Ahorro privado