International Monetary Fund Topic B: Colombia in Crisis Chair: Ho Jin Sun Moderator: Michael Rühl-Wolfe Vice Chairs: Surbhi Mahamwal, Mike Wang April 10 13, 2014 Rühl-Wolfe 1
Colombia in Crisis Preface: The following paper on economic crisis in Colombia primarily contains fictional elements, which may not reflect the state of affairs in Colombia or Latin America. It is imperative that you have read the following guide in its entirety as merely researching Colombia and its economy will not give you the necessary background to effectively debate this fictitious scenario. The most convincing delegates will likely have conducted background research on the economics of currency crises. In particular, an understanding of the balance of payments accounts and how currency crises occur will be far more helpful than extensive background research focusing exclusively on Colombia. Researching other crises, such as the Argentine peso crisis, the Peruvian crisis of 1986 or the 1997 Asian financial crisis would provide an understanding of what is at stake for the IMF and how currency crises have been addressed in the past. Introduction: Colombia is facing a currency crisis. For decades, the Colombian peso has been pegged to the dollar at a 1:1 exchange rate and is now likely to break. Colombia has taken on copious amounts of foreign debt and foreign direct investment in Colombia has been high. If the peg breaks, the government is likely to default on its debt and it will be difficult to reestablish trust in the Colombian peso. The IMF is now highly concerned with stabilizing the economic situation in Colombia as contagion (the spread of economic depression to neighboring countries) is likely. As previous currency crises have Rühl-Wolfe 2
shown, widespread collapse could lead to financial markets freezing up globally. Nonetheless, it is questionable to what degree the IMF should intervene in Colombia, if at all. The IMF will therefore be discussing possible rescue packages for Colombia (effectively a bailout) as well as structural adjustment packages, which would mandate that Colombia undergo concrete changes. The IMF may, however, decide to allow Colombia to default on its debt. While this would be economically devastating to Colombia, the IMF may wish to focus on bolstering neighboring countries first and decide that Colombian default is the cheaper alternative. The aim of this committee, therefore, is to decide what the IMF ought to do in response to this currency crisis. It is entirely likely that the committee will decide on a step-by-step procedure, including provisions on Colombia s obligations as well as what the IMF will do if the situation becomes worse. Delegates will want to consider the extent of the aid provided (if any) and how successful implementation will be measured (perhaps as a condition to receive further assistance). Delegates should also be aware that voting rights in the IMF are distributed by monetary contribution to the Fund (e.g. the U.S. has 16.75% of the vote while Albania has 0.05%). Decisions will require 85% of the vote, however, and the Fund typically decides by consensus, making debate and behind-the-scenes machinations during our caucuses all the more important. Background and Current Situation: Colombia is one of Latin America s stronger economies, having experienced a recession in 1999, followed by a lengthy recovery. More recently, Colombian growth rates increased significantly, reaching over 8% and a GDP of around $511 billion (2012, PPP). There is concern, however, that this may be fueled by a credit bubble and that a recession is imminent. Much of Colombia s Rühl-Wolfe 3
economy is heavily reliant on exports, especially because Colombia is rich in natural resources. Oil exports in particular make it vulnerable to drops in global oil prices. Given Colombia s rural history, it may not be surprising that many of its primary exports include agricultural products. Its primary trading partners include the United States, China, Mexico, Brazil, Chile, Ecuador and the European Union. Inadequate infrastructure still poses a threat to the Colombian economy and recent floods in 2011 have only exacerbated the problem. Widespread inequality, corruption and drug trafficking also pose significant challenges politically and for sustained economic growth. Colombia s unemployment rate of 11% is one of Latin America s highest and continues to rise as Colombia faces economic downturn today and confidence in its peso is crumbling. Politically, Colombia is an electoral democracy with president Juan Manuel Santos as its head of government and state. Several scandals have plagued the political arena in recent years relating to corruption and parapolitics involving politicians collaborating with paramilitary groups such as the FARC. Nonetheless, security improvements have been made although paramilitary conflict has not been completely resolved. Though constitutional liberties of freedom of assembly and speech are guaranteed, several killings in recent years still indicate that government opposition is repressed by violence. While there is a high risk of Colombia defaulting on its debt, IMF delegates should consider the possibility of bailout payments being misused or appropriated by government actors. Moreover, economic crisis may exacerbate paramilitary violence and act as a destabilizing influence on the domestic government and the wider geopolitical region. Rühl-Wolfe 4
Today, Colombia faces an exchange rate crisis, which means that it is expecting a large depreciation of its currency. It is estimated that the Colombian peso may lose around 55% of its value against the dollar. Earlier crises indicate that the economic cost of this happening is likely large. Furthermore, emerging economies tend not to bounce back as quickly as advanced countries and experience much larger and lasting GDP growth rate depression. For Colombia, this would have serious economic and social consequences as it is likely to exacerbate the already high unemployment rate and result in financial ruin, poverty and hunger. IMF members should be aware that exchange rate crises are typically accompanied by other crises. Colombia s banking system may come under severe strain as its financial institutions experience the adverse shocks of the currency devaluation and may become insolvent or declare bankruptcy. This would result in a banking crisis. (possible research topic) The government may also have to default as it becomes unwilling or unable to pay the principle or interest on its debts, thereby resulting in a sovereign debt crisis. (possible research topic) To achieve its significant increases in GDP, Colombia has taken on foreign debt in US dollars. Moreover, as the economy has recovered, significant foreign investment from the United States has bolstered the private sector. Should the currency peg of one peso per dollar break, however, this could become highly problematic. Since many of its debts are in dollars, a devaluation of the peso would increase the amount owed on each loan. For instance, a 50% devaluation of the peso would double the amount owed on a loan. Default would then be likely. Colombia s current account balance has been in deficit for several years now and is rapidly declining. In order to fix its exchange rate to the dollar, Colombia must buy or sell currency to balance out the demand for its own currency. If creditors lose confidence in the Colombian economy and attempt Rühl-Wolfe 5
to withdraw their money, the Colombian central bank would have to intervene. To do so, it would have to buy up the excess pesos that would flood the market by using its foreign reserves. It is clear that this is not sustainable for very long. With just $30 billion in reserves, Colombia would not be able to withstand this withdrawal for very long. In addition, Colombia currently has a negative current account balance of around $13 billion. This is the sum of net trade in goods and services, earnings from rent, profits, interests and dividends as well as net transfer payments such as pension funds between Colombia and the rest of the world. If Colombia experiences such a dramatic recession, several Latin American countries could experience contagion. In all likelihood, South America in general would be adversely affected and an international economic crisis may ensue. Should the IMF choose to intervene in Colombia, assistance could come in two forms. First, the IMF may extend loans in order to improve Colombia s balance of payments account and to temporarily finance changes that may be necessary to remedy the underlying problem. Second, the IMF provides technical assistance, providing the economic expertise to remedy the underlying problems. The IMF may setup a loan schedule, such that loans are paid out conditionally and the target country has to meet certain criteria to receive aid in the future. Additionally, the Fund may directly mandate structural changes, such as the expansion of infrastructure, capital regulations, etc. Delegates would do well to think of such restructuring possibilities. Beyond Colombia, the IMF will also want to consider the risk of economic crises across Latin America and how a Colombian currency crisis or sovereign debt crisis would affect other countries. Also, many of Colombia s major trading partners would also be concerned. For example, Colombia Rühl-Wolfe 6
is the largest exporter of emeralds to the United States and several countries buy Colombian oil. All delegates should therefore research their trade relations with Colombia and consider the impact of a global economic meltdown. Latin American delegates in particular should consider the risk of the crisis spilling over into their economies. Bloc Positions: Latin American delegates are likely to be concerned with Colombia s economic crisis spilling over into neighboring countries as well as the general economic downturn of the region. In particular, countries such as Venezuela, Ecuador and Chile may fear contagion, while even larger economies such as Brazil will want to avoid recession. Colombia will clearly argue for as much unconditional aid as possible, as quickly as possible. North America and Europe may be concerned with trade relations to Colombia and with a global economic crisis. Both regions, however, will likely want to avoid excessive costs to the IMF and will want guarantees that the Colombian economy will indeed improve. This may mean that these regions will more heavily emphasize giving conditional loans and may wish to reduce the total amount granted. Asia, Africa and the Middle East are likely concerned solely with global economic downturn and may readily support aid programs to Colombia. More developed regions may, however, wish to limit the cost of such loans and also only grant them on the basis of conditionality. Korea in particular faced harsh IMF measures during the Asian Crisis and may wish to impose strict conditions on Colombia as well, especially since the conditions imposed on Argentina during its Peso Crisis were Rühl-Wolfe 7
largely viewed as too lenient. Less developed countries may wish to avoid imposing such restraints to set a precedent. China, as one of Colombia s major trading partners, may wish to assess the extent of IMF measures. Questions to Consider: The following list includes several general questions to guide further research. Please be aware that this list is by no means all-encompassing and that you should consider additional research, especially with regards to your country s position. Use these questions as a potential starting point for your research. Questions have been divided between general economic considerations and specific research on Colombia. Note, however, that the most successful delegations will know both. A possible strategy for delegations of two would be to have an expert on Colombia as well as the country you are representing and a second expert on the IMF, the economics of such a crisis and its impact on Colombia as well as the country you are representing. Economic questions: How does a currency crisis occur? (You will want to understand this as much) What is the balance of payments account and what does it mean if it is in deficit? How does one go about improving the balance of payments? What does the IMF typically do? What are some of the conditions the IMF typically imposes when granting loans? How does the IMF typically set up its loan schedule for a country (i.e. when and how much is granted)? Research the Argentine peso crisis, the Asian crisis of 1997, the Peruvian crisis of 1986 Case questions: Rühl-Wolfe 8
Is Colombia a trading partner and, if so, how reliant are you on its products? To what extent does your country face the risk of contagion? What would an economic downturn in Latin America mean to your country? What are some of Colombia s economic strengths? What are its weaknesses? What would it mean for Colombia politically if it defaulted? (Consider the fact that the current government is often wildly unpopular for years to come.) To what extent would this destabilize Colombia or the region? (Also consider paramilitary activity, e.g. FARC) What conditions may be imposed on Colombia to grant loans? (Think specific solutions to underlying problems. You may want to look up some of the conditions the IMF has imposed previously.) How will we measure the success of IMF policy implementation and what should the IMF do if it does not work? Recommended Sources: IMF homepage briefly look up how the IMF works, useful for IMF reports on previous crises and the actions taken in response, several reports also outline economic strengths and weaknesses of every country You are strongly encouraged to consult an economics teacher if possible CIA World Factbook for basic economic data on your country as well as its trading statistics Investopedia for any financial terms that may be unfamiliar as well as simple explanations of economic concepts (e.g. see Rühl-Wolfe 9
http://www.investopedia.com/articles/economics/08/currency-crises.asp for an explanation of what causes a currency crisis). Textbooks on international finance (E.g. international macroeconomics by Robert C. Feenstra and Alan M. Taylor. While this will be far too advanced for the purposes of this debate similar works may provide some useful insight. These books explain balance of payments and how currency crises occur.) Freedom House for an assessment of Colombia s political and civil liberties and how these may be threatened Webpage of the economics ministry of your country this should give insight into trade relations with Colombia (please be aware that the relevant agency may differ by country) Rühl-Wolfe 10