Latin America’s Debt crisis

8/8/2019 Latin Americas Debt crisis

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By

Swapna Marka

Exe-PGDM


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` Why the region accumulated an unmanageable external debt?

` What factors precipitated the crisis?

` How sovereignties and international creditors responded to the crisis?

` What was the most important outcome of the crisis resolution and

afterwards?` Is Latin America vulnerable to new debt crises?


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` A. External factors

` The collapse of the Bretton Woods system was accompanied by the` reemergence of international capital markets and an increase in the` activity of international commercial banks.` In 1973 the OPEC quadrupled the prices of oil. Oil producers countries` deposited their surpluses of asses in international commercial banks.` Oil-importing nations in Latin America increasingly needed capital, in` part to finance the external deficits associated with oil inflation. The so` called Petrodollar recycling program allowed lesser developed nations to` purchase oil even as its price skyrocketed, and it was actively promoted` by the United States.` A drastic change in the source and composition of loans to Latin

` American in the 1970s, from long-term official loans with low interest` rates to short-term commercial loans with variable high interest rates` was a major factor which led to the debt crisis of the 1980s


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` B Internal factors

` A good part of Latin American debt went to finance the growing

` trade imbalances.

` Many LATAM nations kept the real exchange rate strong as a

`

measure against inflation, worsening th

e current account.` The continuous real exchange appreciation made international

` interest rates (low in nominal terms) to be negative in real terms.

` This exacerbated indebtedness.


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` The IMF Approach` The absorption approach: A way of understanding the` determinants of the balance of trade, noting that it is equal to income` minus absorption Y A = B.` If Y- A > 0 implies X-IM > 0 and NX>0 Trade surplus` A trade surplus, then, would help restore financial health by decreasing` the need to finance imports, leaving the balance to pay off the debt.` The IMF recommended contractionary policies aimed to decrease fiscal` spending and money emission.` Countries that signed agreements with IMF were signaling international` banks of their intentions to abide to the rules of the game. The notion of` conditionality emerged with its harsh consequences for the inhabitants`

of the debtor countries.

` Lending from the IMF and international banks were used for servicing` the debt. Resulting in a non-resolution of the problem.


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` There are at least three parties to the transaction.

` Example` 1. Citibank recognizes $100m of bad debt in Mexico.` 2. Chrysler wants to invest in Mexico. It needs the equivalent of $75m in` pesos. Chrysler could take US$75m and convert it to pesos at the` prevailing exchange rate.` 3.The Mexican central bank wants to help Citibank recoup some of the` $100 m bad loan. That way Citibank will be willing to lend to other` Mexican clients in the future.` 4.The Mexican central bank approaches Citibank and Chrysler and` arranges the deal. Lets say it arranges for Citibank to sell the debt at` a 40% discount and agrees to purchase it from Chrysler at 75% of` face value.` 5.Chrysler then gives Citibank $60 (40% discount off of $100m ) and is` given the $100m bad debt. Just a paper asset.` 6. Chrysler immediately runs to the central bank and swaps the bad debt` for the equivalent of $75m in pesos.` 7. Chrysler then invests the $75m in pesos in Mexico


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` Countries could not continue to service their debt through` contractionary policies, growth must be reassumed.` The Baker plan targeted fifteen less-developed countries for $29` billion of new money, $20 billion from commercial banks and $9` billion from the IMF and the World Bank.` Debt came to be understood as a development problem, and the` World Bank was charged with assisting in the management of the` adjustment process.` Too little too late. $29 billion will have no impact on obligations of` near one trillion dollars` The consensus was that the banks were prepared to take a realistic` position on developing country debt: it would never be repaid in full.`

Jump-starting growth

would not work until the debt burden was

` reduced two years later under the Brady plan.


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` It was aimed to debt reduction throughout 3 options:

` decreasing the face value of debt

` extending the time period of obligations

` Infusion of new money

` Mexico restructured $48 billion of its liabilities. This debt

` relief reduced net transfers by $4 billion per year, nearly

` 2 percent of the gross domestic product (GDP), from

` 1989 through 1994


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` Recovery from crisis long and painful

` Latin American debt crisis of the 1980s as a crucial dividing mark in theareas recent economic history (Rodrik, 2003).

` Strong economic fundamentals matter; countries must put attention toprice stability and budget constrains.

` The burden of adjustment to the debt crisis may have fallen

` disproportionately on women in particular andon the poorest people ingeneral.

` Rodriks (2003), sees the debt crisis as the explosive end of a period ofcontinued decline: the import substitution industrialization developmentmodel


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`THANK YOU !

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Latin America’s Debt crisis