Latin American Crises. Presentation 2 - EC/EIB 230 International Finance Mathew Cravens Venkatesh Ramamoorthy Jiong Zhou

Transcription

1 Latin American Crises Presentation 2 - EC/EIB 230 International Finance Mathew Cravens Venkatesh Ramamoorthy Jiong Zhou

2 Agenda Background of crisis - Economical & Political Transmission & Impact of crisis Control measures Mexico 1994 crisis Argentina crises Brazil crisis

3 Why this crisis is important?

4 Countries in crisis (Reinhart & Rogoff (2009))

5 Quick facts on crisis Mother of all crisis Timeline late 1970s and early 1980s Still echoing! 16 Latin American countries and 11 other less-developed countries Major reasons Foreign debt > Earning potential Fiscal indiscipline (Socialism) Global imbalances

6 Global imbalances

7 Flow of surplus Debt for Latin American countries Payment for oil US Current Account surplus from Oil banks exporting countries Developed/Developing countries Current Account deficit from Oil importing countries

8 Oil shocks in 1970s

9 Latin American debt proportion

10 Exacerbating factors Enhance growth Oil payments Latin American crisis Non-viable projects Favorable loan terms

11 Transmission mechanism Low interest rates & overall expansion Monetary tightening in US/Europe Banks increased interest rates No evergreening

12 Interest rate situation outside Latin America

13 Negative loop Worsening CAD reduced reserves Capital flight HNIs and corporates No new lending No restructuring

14 Impact of crisis Lack of investment in infrastructure Drop in GDP Impact of crisis Increased rates for less developed countries No new lending

15 Mitigating measures

16 Mitigating measures (1/2) IMF Austerity measures, abandoned import substitution Perceived as outside interference Baker plan Planned to fund debt from surplus countries like China alongside reforms No consensus was reached

17 Mitigating measures (2/2) Brady plan Convert loans to bonds with haircuts which can be traded reduces concentration risk Collateral was by US bonds, Reserves of affected countries Ended in 1990s but used for Russia, Ecuador Mexico, Phillippines, Colombia, Venezuela, Brazil have retired the bonds HIPC Joint IMF-World Bank initiative special relief package for indebted countries Conditional on social/economics reforms and fiscal targets

18 Political reasons

19 Political culture Political culture Corruption Weak Democracy Populism

20 Political instability (Huntington 1976) Equalization Political participation Dictatorship Economic stagnation Political instability

21 Populist leaders

22 The Mexican stories Consistent growth from 1954 to 1971 The Oil Boom, the following turbulent 1980s and the Peso Crisis A look back from 2011: 40 years of lag in income The Sub-Prime Crisis The Peso Crisis The Oil Boom Crisis

23 Background before the Oil Boom Good Time Consistent growth from 1954 to 1971 GDP 6% and inflation 3% Mexican Economic Miracle and Stabilizing Development Consisted in an Import Substitution Industrialization (ISI) model. Stable fixed exchange rate of Pesos per USD for 22 years (1956 to 1976) Bad Time International financial uncertainty caused by rising US trade deficit Mexico s response: more public investment to sustain growth Fully new printed money financed investment caused inflation 1973 oil shock A 58% devaluation of Peso in 1976 ceased panic The Turnaround The discovery of Cantarell Field, the Oil Boom

24 A shaky foundation of Oil Boom From 1977 to 1981 Average 9% annual growth in the GDP Massive job creation calmed the 20% plus inflation However, the shaky foundation Indebtedness mounted with expansionary fiscal policy financed by higher foreign borrowing denominated in USD against the future oil revenue Highly overvalued Peso hurting non-oil industries which caused reliance on import Raised tariff hampered modernization and competitiveness of Mexican industries

25 When the dance stopped The oil demand and price eased causing Rising interest rate Rising inflation Disappearance of international reserves

26 When the dance stopped The oil demand and price eased causing Rising interest rate Rising inflation Disappearance of international reserves

27 When the dance stopped The oil demand and price eased causing Rising interest rate Rising inflation Disappearance of international reserves

28 1982 crisis and recovery Rising interest rate Rising inflation Disappearance of international reserves } Default & Capital Flight Policy Responses Devaluation to fulfill international payment Nationalization of private sectors Contractionary fiscal policy: cutting public spending and raising tax Contractionary monetary policy: raise interest rate to stop capital flight Signing up the commitments of the IMF Market Responses Fear of sovereign default Foreign investment was deterred Capital flight deteriorated causing more inflationary pressures Local competitiveness was hampered by high tax rate Lost Decade

29 Another one: 1994 Mexico Peso Crisis Sparked by sudden devaluation of Peso against USD Strikingly characterized with political influence and decisions Triggered by both structural weakness of Mexican economy and political instability Violent Zapatista uprising in the state of Chiapas The assassination of the presidential candidate Luis Donaldo Colosio Capital flight

30 Before the crisis Incumbent Administration: Carlos Salinas de Gortari (In office from 1988 to 1994) Neoliberalism Encouraging private investment through denationalization and deregulation NAFTA Expansionary fiscal and monetary policy by issuing short-term debt instruments denominated in domestic currency with a guaranteed payment in USD Political instability of 1994 presidential election season Violent Zapatista uprising in the state of Chiapas The assassination of the presidential candidate } High risk premium on Mexican Downward pressure on Peso Central Bank Intervention Issuing dollar-denominated public debt to by Pesos Purchasing treasury securities using dollar reserves to maintain its money supply

31 When the crisis hit Massive job loss Value of Peso vapourized Inflation Drop in reserves

32 When the crisis hit Massive job loss Value of Peso vapourized, from peg to float Inflation Drop in reserves

33 When the crisis hit Massive job loss Value of Peso vapourized Inflation, hyperinflation Drop in reserves

34 When the crisis hit Massive job loss Value of Peso vapourized Inflation Drop in reserves, again and sharp

35 1994 crisis and recovery Higher risk premium caused by political instability Unable to refinance through issuing new debt Hyperinflation } Capital Flight Policy Responses Contractionary fiscal policy: cutting public spending and raising tax, again Contractionary monetary policy: raise interest rate to stop capital flight, again $50 million bailout by the US, IMF and BIS Market Responses Fear of default Local competitiveness was hampered by high tax rate Mutual funds started liquidating emerging market assets Tequila Effect

36 Argentina Pt. 1: Pre-Crisis , President Carlos Menem Fixed exchange rate: Economy Minister Domingo Cavallo introduces 1 peso : 1 USD peg Helped tame extraordinary inflation

37 Argentina Pt. 1: Pre-Crisis Strong economy: deregulation and privatization of key industry sectors Brief recession: contagion from Mexican peso crisis leads to brief recession in Argentina Strong economy returns Wall Street financiers begin loaning huge amounts of USD to Argentinian government, thus heavily increasing Argentinian external debt denominated in USD

38 Argentina Pt. 2: Crisis The IMF warns Argentina that they are susceptible to the same kind of financial crisis ravaging emerging Asian economies Argentina essentially ignores IMF warning given high inflow of foreign investment and continues course unabated 1999 Financial crisis breaks out in Brazil leading to a devaluation of the Brazilian real Contagion: Brazilian financial crisis spreads to Argentina as state workers strike in demand of back pay Recession sets in

39 Argentina Pt. 2: Crisis Argentinian recession continues, interest rates are high, external debt reaches 50% of GDP Domestic political turmoil leads to increased interest rates as capital flight occurs IMF steps in with loan package totaling $14B plus $6B from other lenders 2001 Turmoil in Turkey leads to investor lack of confidence for emerging economies in general and Argentinian economic troubles increase To resume economic growth and reduce Argentinian pressure to service debts, a nearly $30B mega-swap program for Argentinian bonds is implemented Mega-swap program does not end financial crisis and the Argentinian market continues to worsen, return to IMF for help External pressure on Argentina, particularly from New York bankers, to restructure debt Argentina receives an additional $8B from the IMF to service debt Argentina announces a partial debt restructuring program Capital controls: deposit withdrawal restrictions imposed to halt capital flight Riots ensue, President Fernando de la Rua and Economy Minister Domingo Cavallo forced to resign

40 Argentina Pt. 3: End of crisis After a series of presidents, President Eduardo Duhalde comes into office 2 January May 2003 End of exchange rate peg of 1 peso : 1 USD Floating exchange rate led to immediate devaluation to 3.06 peso : 1.00 USD Formal default on unserviceable debt 2003 Argentina not back to pre-crisis health, though: Peso appreciated some Economy grew some Inflation remained similar

41 Argentina 2003

42 Unemployment

43 Argentina Pt. 4: Period of Growth

44 Argentina Pt. 4.a: Kirchnerism Named after President Nestor Kirchner Strong focus on human rights Politically affiliated with left-wing populism Historical roots in the Argentinian Peronism party persecuted during the Dirty War of the mid-1970s to early 1980s Overturned policies of past administrations, particularly the Menem administration, that gave immunity to those accused of human rights violations and/or other crimes during the Dirty War Economic focus: industrialist developmentalism Opposed to past neoliberal economic policies of previous administrations in favor of protectionism No imports of goods that are and/or can be produced in Argentina Opposed free trade agreements, especially those concerning the Americas Favored regional South American and general Latin American cooperation instead

45 Argentina

46 Unemployment

47 Argentina Pt. 4.b.: The Continuation of Kirchnerism under Cristina Fernandez de Kirchner, Continuation of husband s economic policies Innovations Controlled exchange rate and Argentinian protectionism Social policies Capital Controls Restriction of access to USD to protect central bank reserves necessary to prop up the Argentinian peso Export taxes on grains Debt swap with some of the remaining crisis creditors that initially refused debt restructuring offers Complications 2014, financial: technical default after U.S. Supreme Court refuses to hear case requiring Argentina to repay $15B USD to creditors 2015, political: investigation into alleged Iran trade deal to cover up Iranian involvement in the bombing of a Jewish community center in 1994

48 Argentina

49 Unemployment

50 Argentina Pt. 5: Present President Mauricio Macri Elected in 2015 in response to perception of failed Kirchnerism policies, economic and otherwise Politically conservative Macri reforms Cut export taxes and restrictions Ended currency controls Settled dispute with remaining debtors from the crisis Argentina returned to international market Central bank raised interest rates to 25% to help combat inflation Continuation High fiscal expenditures Complications Previous Kirchner administrations relied heavily on expansionary monetary policies Money creation Selling bonds to domestic banks Macri: Return to external financing Fiscal deficit worsened Fiscal expenditures increased Current account imbalances increase

51 Return to Crisis: Present Crisis: Return to 1998 Fiscal deficit Continuation of excessive fiscal expenditures relative to GDP to maintain political support Foreign debt increase Return to external borrowing to finance fiscal expenditures and debt servicing once more made Argentina vulnerable to external shocks, namely interest rate hikes of the borrowed currency, in this case USD U.S. Federal Reserve increased interest rates in 2017 Pressures forced a depreciation of the Argentinian peso Weakened peso made it more difficult to service debts, especially those denominated in USD U.S. Federal Reserve continues to raise interest rates Investors moved away from Argentinian bonds Reduced investment combined with selling of Argentinian bonds Inflation Increasing inflation and increased fears of continual exceptional increases Money printing Environmental Drought

52 Crisis Present

53 Unemployment

54 2018 Crisis Response Goal: balance fiscal expenditure Initial increase of interest rates Return to IMF for assistance $50B aid package in exchange for Argentinian fiscal expenditure balance $15B initial payment Remainder discretionary Second increase of interest rates May: 40% August: 60% Request for increase of IMF assistance to $57.1B

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56 Brazilian Economics Crisis in 2014 Coupled with impeachment of president Dilma Rousseff GDP, fell by 3.9% in 2015 Unemployment average from 6.8% to 8.5%

57 Brazilian Economics Crisis in 2014 Commodity price cycle From expansionary to contractionary

58 Any questions? Thank you!