1UNDERSTANDING

THE LATIN AMERICAN DEBT CRISIS

2AN INTERNATIONAL FINANCE (F405) PRESENTATION

PREPARED FOR

SYEDA MAHRUFA BASHARASSISTANT PROFESSOR

INSTITUTE OF BUSINESS ADMINISTRATION UNIVERSITY OF DHAKA

3THE TEAMGROUP 05, BBA 21st BATCH

SHATABDI BISWAS (RH-12)

TAUSIF AHMED(ZR-42)

MUHTASIM SAROWAT RAYED (ZR-61)

SAZID AHMAD(ZR-65)

SARWATH HAFIZ MUMU(RH-70)

SHARMILI ROWSHON KABIR(RH-30)

4OUTLINE

01BACKGROUND

02REASONS

BEHIND THE CRISIS

03SHORT-TERM

IMPACT

5OUTLINE

04CONTROL MEASURES

05LONG-TERM

IMPACT

06OUR

TAKEAWAYS

6

01BACKGROUND

7INTRODUCTION

BRAZIL

ARGENTINA

MEXICOTHE LOST DECADE

Late 70s/Early 80s

COUNTRIES AFFECTED

16 Latin American countries and 11 other LDCS

DEBT UNSUSTAINABILITY

Foreign debt exceeded countries’ earning power

8BACKGROUNDPETRODOLLAR RECYCLING

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981

CRUDE OIL PRICES, 1970-1981

Nominal Price Inflation Adjusted Price

Yom Kippur War- OPEC cuts production

Iranian Revolution

TWO LARGE OIL PRICE HIKES IN 1970S

Created current account surplus in oil exporting countries and current account deficits in many Latin American countries

9BACKGROUNDPETRODOLLAR RECYCLING

US MONEY CENTER BANKS

OPEC COUNTRIES

DEVELOPED COUNTRIES

DEVELOPING COUNTRIES

Surplus Funds

Sovereign Debt

US Money-Center Banks became intermediaries between the two parties

Financed sovereign debt in Latin American Countries

Provided the oil exporting

countries a safe, liquid place to

store their surplus funds

10BACKGROUNDPETRODOLLAR RECYCLING

$75 BILLION

$12 BILLION

$315 BILLION

$66 BILLION

1975 1982-83

Latin American External Debt

Debt Service Payments

27.02%CAGR

40.63%CAGR

11BACKGROUNDCRISIS OVERVIEW

A Good Illustration of Interdependence between Balance Of Payments And Macroeconomic Indicators

Change in Current Account positions lead to rise in sovereign

debt

Shifting global fortunes lead to

changes in interest rates and

inflation

These changes negatively impacted the debt sustainability of Latin American countries

1202

CRISIS

REASONS BEHIND THE

13ECONOMIC REASONS FOR

LATIN AMERICAN SOVEREIGN DEBT

TO ENHANCE ECONOMIC STABILITY AND REDUCE POVERTY

average real GDP growth 6% during 1970s and 4-5% in early 1980s

FAVORABLE LOAN TERMS

Collateral free with near zero interest rates

Loan roll over when principal was due

WHITE ELEPHANT PROJECTS

Appeased interest groups but did little for the economy

TO KEEP UP WITH HIGHER OIL PAYMENTS

After the two price hikes

14FINANCIAL REASONS

WHY US BANKS INVESTED IN LATIN AMERICAN DEBT

INFLUX OF NEW FUNDS FROM OIL

EXPORTERS

INTERNATIONAL EXPANSION OF

BANKING SERVICES

GROWTH OF EURODOLLAR MARKET GAVE GREATER ACCESS TO FUNDS

15FINANCIAL REASONS

OVEREXPOSURE TO LATIN AMERICAN DEBT

1977 1978 1979 1980 1981 1982 1983 1984 1985

$32 BILLION

$36 BILLION

$40 BILLION

$44 BILLION

$54 BILLION

$55 BILLION

$56 BILLION

$59 BILLION $58

BILLION

In the 70s, over 50% of money center banks’ paper profits came from Latin American sovereign debt

Loan capital coefficient of 180%

16ECONOMIC REASONS

WHY THE DEBT SITUATION WORSENED

US INTEREST RATE HIKE TO CURB INFLATION

In July 1980, federal funds rate increased from 10% to near 20%

This trigged global recession

DEBT SERVICING PAYMENTS GREW SIGNIFICANTLY

Loans were tied to LIBOR, which rose with US interest rates

LESSER DEMAND FOR LATIN AMERICAN EXPORTS

Slower world economy lead to worse ‘terms of trade’ for Latin American countries

17FINANCIAL REASONS

WHY THE DEBT SITUATION WORSENED

WORSENING CURRENT ACCOUNT DEFICIT DUE

TO FALL IN EXPORT

This depleted foreign exchange reserves

BANKS WERE NOW LESS KEEN ON LATIN

AMERICAN DEBT

Domestic investments were now safer and more

profitable

T-bill yields were close to 16%

MASSIVE CAPITAL FLIGHT

Private individuals and entities funneled money out of Latin American countries

FEWER EXTENSIONS WITH SHORTER PAYMENT PERIODS

Eventually, when Mexico asked for another extension, the banks refused.

18THE TRIGGER POINT

HOW THE CRISIS CAME TO BE

In August 1982, Mexico defaulted on its sovereign debt, which at that point totaled

$80 BILLION

19

OTHER LATIN COUNTRIES ALSO DECLARED LOAN

DEFAULT

THREAT OF US BANKS’ BANKRUPTCY

Overexposure to Latin American debt threatened

global financial collapse

THE TRIGGER POINT

THE IMMEDIATE FALLOUT

20

03SHORT-TERM IMPACT

21SHORT TERM IMPACT

DECREASE IN INCOME AND

STANDARD OF LIVING

Real wage dropped by 20-40% in the

ten years following the crisis

LACK OF INVESTMENT ON INFRASTRUCTURE

Funds were now diverted to paying off debt service payments and supporting

export-led industries

FINANCIERS BECAME MORE CAUTIOUS ABOUT LENDING TO LDCS

HIKE IN INTEREST RATES FOR LDC SOVEREIGN DEBT

Interest rates for poor countries were 4 times higher than rich countries

More focus on credit ratings and international exchange rate movements

22

04CONTROL MEASURES

23

1982-84

1985-89

1989-

1996

IMF AUSTERITY

Rescheduling and New Lending

BAKER PLAN

New lending ; pro-growth

BRADY PLAN

Debt Reduction

HIPC

Debt Reduction

CONTROL MEASURES4 STAGES OF ADJUSTMENT

Brady and Baker Plans were most effective

24CONTROL MEASURESBAKER PLAN

.

Loans were provided to cover interest payments. Some of the strings attached included:

PRIVATISATION OF STATE ENTERPRISES

END OF GOVERNMENT SUBSIDIES

OPENING ECONOMY TO FDI

These loans were provided to 15 debtors and comprised 20% of all World Bank Debt

25CONTROL MEASURESBRADY PLAN

COLLATERIZATION OF SOVEREIGN DEBT

Brady bonds shifted debt burden from the

government to the taxpayers

DEBT FORGIVENESS

80s’ boom refinanced the US banks, who were now better equipped to absorb loss from sovereign debt

26CONTROL MEASURESOTHER MEASURES

DEBT-EQUITY SWAPS

Chile and Mexico used asset to offset debt. The

lender acquired a tangible asset a discounted price

DEBT-FOR-NATURE SWAPS

Government exchanged development rights of

environmentally valuable lands for debt forgiveness

JUBILEE 2000

An international coalition movement that aimed to relieve LDC debt by 2000

27

05LONG-TERM IMPACT

28LONG TERM IMPACT

1982DEBT CRISIS

SHIFT FROM IMPORT SUBSTITUION

INDUSTRIALISATION TO EXPORT LED

INDUSTRIALIZATION

The latter was heavily encouraged by IMF

and often a condition of the debt rescue

loans

1982-1985

29LONG TERM IMPACT

NAFTA was established in 1994, encouraging MNCs to set up production in countries like Mexico

PUSH FOR TRADE LIBERALIZATION1986-

1994

1990s

HOLLOWING OUT EFFECT

US manufacturing sector suffered as firms located

overseas

Mexican workers eventually lost out to cheaper Asian

labor

30LONG TERM IMPACT

2000sGreater focus on free trade lead to rise of emerging markets like BRICS countries

THE COMMODITY BOOM

China in particular contributed to the rising demand for commodities

31

06OUR TAKEAWAYS

32OUR TAKEWAYS

INTERDEPENDENCE BETWEEN BOP AND MACROECONOMIC

FACTORS

Feedback loop between current account positions,

sovereign debt, interest rates and inflation

THE CRISIS EXACERBATED DUE TO OVEREXPOSURE

Overexposure to specific loan markets should be avoided

Due diligence must be done to determine debt sustainability

Heavy indebtedness (especially from short term debt) signals that the country may be unable to pay it back

33OUR TAKEWAYSA BLUEPRINT FOR DEALING

WITH FINANCIAL CRISES

Many of the methods employed, such as slashing short term interest rates, austerity and

debt collateralization, were later used to deal with the 07/08 credit crisis

CONTRIBUTION TO TRADE LIBERALIZATION

Debt rescue and rescheduling efforts by IMF and World Bank allowed more influence on national

trade and development policies

Facilitated globalization but at the expense of many stakeholders

34

THANKYOU!