With high financing requirements, access to the international financial institutions will be a necessity for many Latin countries.
BY CLAUDIO LOSER
At the beginning of 2008, the prospects for Latin America looked good. There were concerns about the impact of a shallow recession in the United States, but the general perception was that Latin America was doing well. In a fundamental way, it was thought that it had broken its close links with the advanced economies of the world. At least this is what policy makers in the region wanted to believe. Commodity prices were expected to continue going up and there was no serious worry about financing. Foreign reserves were high and creditworthiness was solid. Problems were hitting only the United States and a few other developed countries.
The previous sense of strength and invulnerability is now gone. Commodity prices have declined by more than half from their peak, as reported by the International Monetary Fund (IMF), with sharp decreases for oil, food and metals. Stock market valuations also have declined by about one half as well, in local currencies. Currencies in many Latin American countries have depreciated as capital left the region, and those countries that did not allow the exchange rate to move are under pressure. Most governments were reasonably careful with their investments and policies, but private enterprises held “toxic” assets to an unexpectedly large extent, with serious effects for their own financial health as well as that of their countries. Estimated losses in asset values are large, in the order of $2 trillion since the end of 2007, or the equivalent of 60 percent of the annual GDP for the region. This does not even take into account the holdings of foreign assets by enterprises and individuals.
The crisis is only now starting to appear in the open, as the impact on the balance of payments and on domestic income becomes very serious. Such losses will have a very adverse affect on domestic activity. The adverse terms-of-trade effect will aggravate the situation, as it will reduce incomes and worsen the balance of payments by some $85-100 billion (2 ½-3 percent of GDP). Moreover, capital flows have reversed from the steady inflows observed in recent years. Thus, economic growth in 2009 may be only 1 ½ percent, or even less, which in practice is a recession; the region had grown at an average annual rate of about 4 percent from 2002 to 2008. In these conditions, policy makers will need to find a balance between economic stimulus and financial stability, but also will have to return to the international financial institutions (IFIs) to achieve adequate public financing and protect their external accounts.
The return to the IFIs may be a difficult pill to swallow for many of the possible clients in the region, which had made a point of breaking their previous close financial ties to the IMF, the World Bank and the Inter-American Development Bank (IADB), among others. Argentina, Bolivia, Ecuador, Venezuela and, to a lesser extent, Brazil and Colombia, had considered that their improved circumstances meant that they no longer needed the IFIs now that they had strong trade performances and much easier access to international financial markets. Both assumptions have been shattered, at least for the foreseeable future. Terms of trade have not improved on a permanent basis. Instead, they have collapsed. Financial markets are shunning anything resembling moderate risk, be it in the form of corporate or sovereign bonds.
With high financing requirements, access to the IFIs will be a necessity for many countries in the region. Such access, even if difficult from their point of view, will be eased by the fact that these organizations now seem willing to give greater representation to emerging economies and are showing greater lending flexibility. The recent revival of the G-20, a group formed in the 1990s to discuss international financial issues, is a good indication of the major changes occurring in the world political economy. Until now, many decisions had been taken at the level of the G-7/G-8, the important group formed by the largest advanced economies, in addition to Russia. The G-20 includes the G-8 and the largest emerging, newly industrialized economies, including China, India, Korea, South Africa, and, in Latin America, Brazil, Mexico and Argentina. This forum reflects better the growing importance of the emerging world and may also open the door to a more representative governance system at the world financial level. Over-represented countries in Europe and elsewhere will need to accept the realities of this new world and shift part of their voting power to the “new” countries. If that occurs, the perceived stigma of the IFIs may disappear for many countries in Latin America. This would make it politically easier for them to seek the urgent financing that they need and that the IFIs can provide.
The trend toward more flexible lending mechanisms by the IFIs will also help. The most controversial lending organization remains the IMF. According to its own information, the IMF has about $200 billion available for immediate lending. It can draw on an additional $50 billion in resources, based on borrowing from various member governments. The IMF, however, had played a major role in financing Latin America in the past. However, after lending to Latin America reached about $50 billion at the beginning of the decade, it had fallen to less than $1 billion in recent months. In the past, any borrowing had to be based on a wide-ranging adjustment program that was seen as imposing burdensome conditions. The IMF is now ready to deal with requests for assistance under what it defines as fast-track emergency financing procedures. The loans have conditions attached, but these conditions are focused on resolving core macroeconomic problems only. Dominique Strauss-Kahn, the head of the IMF, has emphasized the readiness to lend quickly to member countries that need help during the ongoing crisis. Conditions would be fewer and more targeted than in the past. There have already been several loans under these conditions, including to Bulgaria, Iceland, Hungary, Ukraine, and under a more doubtful eligibility, Pakistan.
The IMF Emergency Financing Mechanism is available for countries that are seen as having carried out reasonable policies and are willing to take the necessary measures to put their economics on track. Once agreement with the authorities has been reached on a lending program, the IMF Executive Board, which is kept informed of the negotiations, considers the request for a loan within 72 hours. This is in contrast to the six weeks to two months required under normal lending circumstances. If policy failures are significant, then the IMF would follow more traditional lending procedures. Countries that need financing most urgently in the region may be unwilling to engage in negotiations. They will, however, be attracted by the fact that the IMF will emphasize only a few basic macroeconomic conditions, as opposed to a wide array of issues, as had been the practice in the past.
WORLD BANK PROGRAMS
The World Bank in November 2008 also launched the debt management facility to help developing countries prevent future debt problems. It also called on donor countries to meet their debt relief commitments. According to the World Bank, the new facility will accelerate the implementation of debt management programs in partnership with several other organizations, with the objective of strengthening debt management capacity and institutions in developing countries. This will supplement the bank’s financial assistance for poor countries, but will have only a limited impact on Latin America because only very few countries in the region qualify for this type of help. However, it is most likely that countries will make increased use of World Bank resources to finance their programs of reform, as well as the public expenditure/investment programs that many of them are putting in place to deal with the current recession.
The Inter-American Development Bank also has announced plans to approve a record volume of loans in 2009 and is setting up a new fast-disbursing $6 billion liquidity facility to help Latin American and Caribbean economies. The IADB’s $6 billion liquidity program for growth sustainability will be made available to domestic firms via commercial banks that may face temporary difficulties in accessing foreign and inter-bank credit lines as a result of the financial crisis. In addition, the IADB will accelerate loans to finance projects and enhance social programs and approve up to a record $12 billion in 2009. The IADB notes that this will represent an almost 80 percent increase in lending, the largest and most rapid mobilization of resources in its history.
In conjunction with the IADB, the Andean Development Corporation (CAF) announced a liquidity facility of $1.5 billion, while also increasing loans to financial institutions among its 17 member countries. CAF has been extremely active in its lending among its South American member countries, and now plays a major role in the region. The Latin American Fund of Reserves (FLAR) offered $1.8 billion to Bolivia, Colombia, Ecuador, Peru, Uruguay and Venezuela, as part of its liquidity arrangements. Of course, these institutions will need to make sure that their access to financial markets allows them to expand to the extent expected.
These efforts on the part of the IFIs are very significant, but they will work only to the extent that the countries themselves are willing to draw down these funds and use them effectively. Many will recognize the advantages of these loans, as they are contracted on a longer-term basis and with relatively low interest rates. However, some countries may choose not to use these funds on ideological grounds. They may actually harm themselves, since they may end up having to make more drastic adjustments, or having to declare a default on their outstanding obligations with even worse consequences than availing themselves of help from the IFIs. Hopefully, the number of such countries will remain small, thereby avoiding a major contagion to the other, more responsible countries in the region.
Claudio M. Loser is visiting senior fellow at the Inter-American Dialogue in Washington, D.C. From 1994 until 2002, he was the director of the Western Hemisphere department at the International Monetary Fund. Dr. Loser is currently an adjunct professor of economics at George Washington University, and is also CEO and president of Centennial Latin America, associated with Centennial Group of Washington, D.C. In 2004, he participated in the development of the book Enemigos, which discusses the relations between the IMF and Argentina in the 1990s.
This column is based on an excerpt of a policy paper that was published by the University of Miami’s Center for Hemispheric Policy in its Perspectives on the Americas series. Republished with permission of the center.