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The Global Crisis and its Impacts on Latin America
Pedro A. Palma
Wharton School, University of Pennsylvania
Philadelphia: October 26, 1998
Fiscal discipline (solid fiscal surpluses)
Low inflation
High savings ratios
Significant gross domestic investment
Sustained high growth rates
Liberalized trade and financial markets
High capital inflows and robust local stock and fixed
asset markets
THE ASIAN TIGERS SHOWED SOLID ECONOMIC
FUNDAMENTALS
Weak banking system
-over-lending to related industrial conglomerates
-highly leveraged financing of low return projects (real estate, infrastructure)
-massive speculative borrowing
High and growing private external debt
Overvalued currencies and shrinking competitiveness
-currencies pegged to the appreciating dollar
-low cost competitors (China and India)
-depreciation of the yen
Growing current account deficits
BUT, SOME WEAKNESSES MADE THEM
VULNERABLE
Devaluation expectations in the South-East Asian
countries
Collapse of local capital markets due to massive sales of
stocks and bonds
-need of local liquidity to buy dollars
-need of funds to cover margin calls
Massive capital flight
-speculative movements
-hedging of private foreign liabilities
Devaluations
THE OUTBREAK OF THE ASIAN CRISIS
Asian Stock Markets Indexes(Jan 2th 1997=100)
20
30
40
50
60
70
80
90
100
110
120
Jan 2
, 1997
Apr 1
1, 1
997
Apr 2
9, 1
997
Jun 1
2, 1
997
Jun 2
7, 1
997
Jul 1
4, 1
997
Jul 2
9, 1
997
Aug 1
3, 1
997
Aug 2
8, 1
997
Sep 1
2, 1
997
Sep 2
9, 1
997
Oct 1
4, 1
997
Oct 2
9, 1
997
Nov 1
3, 1
997
Nov 2
8, 1
997
Dec 1
5, 1
997
Dec 3
0, 1
997
Jan 1
5, 1
998
Feb 1
6, 1
998
Mar 3
, 1998
Mar 1
8, 1
998
Apr 2
, 1998
Apr 1
7, 1
998
May 4
, 1998
May 2
0, 1
998
Jun 4
, 1998
Jun 1
9, 1
998
Jul 7
, 1998
Jul 2
2, 1
998
Aug 6
, 1998
Aug 2
4, 1
998
Sep 2
, 1998
Sep 1
7, 1
998
Oct 2
, 1998 Indonesia Thailand Malaysia Philippines
Source: Bloomberg
Devaluation expectations in the South-East Asian
countries
Collapse of local capital markets due to massive sales of
stocks and bonds
-need of local liquidity to buy dollars
-need of funds to cover margin calls
Massive capital flight
-speculative movements
-hedging of private foreign liabilities
Devaluations
THE OUTBREAK OF THE ASIAN CRISIS
Asian Exchanges Rates Indexes (Jan 2th, 1997=100)
75
100
125
150
175
200
225
Ja
n 2
, 19
97
Ap
r 15
, 19
97
Ap
r 30
, 19
97
Ma
y 15
, 19
97
Ma
y 30
, 19
97
Ju
n 1
6, 1
99
7
Ju
l 1, 1
99
7
Ju
l 16
, 19
97
Ju
l 31
, 19
97
Au
g 1
5, 1
99
7
Se
p 1
, 19
97
Se
p 1
6, 1
99
7
Oct 1
, 19
97
Oct 1
6, 1
99
7
Oct 3
1, 1
99
7
No
v 17
, 19
97
De
c 2
, 19
97
De
c 1
7, 1
99
7
Ja
n 1
, 19
98
Ja
n 2
0, 1
99
8
Fe
b 4
, 19
98
Fe
b 1
9, 1
99
8
Ma
r 6, 1
99
8
Ma
r 23
, 19
98
Ap
r 7, 1
99
8
Ap
r 22
, 19
98
Ma
y 7, 1
99
8
Ma
y 22
, 19
98
Ju
n 8
, 19
98
Ju
n 2
3, 1
99
8
Ju
l 8, 1
99
8
Ju
l 23
, 19
98
Au
g 7
, 19
98
Au
g 2
4, 1
99
8
Se
p 8
, 19
98
Se
p 2
3, 1
99
8
Oct 8
, 19
98
Thailand Malaysia Philippines
Source: Bloomberg
Asian Exchanges Rates Indexes(Jan 2th, 1997=100)
0
100
200
300
400
500
600
700
800
Jan 2
, 1997
Apr 1
5, 1
997
Apr 3
0, 1
997
May 1
5, 1
997
May 3
0, 1
997
Jun 1
6, 1
997
Jul 1
, 1997
Jul 1
6, 1
997
Jul 3
1, 1
997
Aug 1
5, 1
997
Sep 1
, 1997
Sep 1
6, 1
997
Oct 1
, 1997
Oct 1
6, 1
997
Oct 3
1, 1
997
Nov 1
7, 1
997
Dec 2
, 1997
Dec 1
7, 1
997
Jan 1
, 1998
Jan 2
0, 1
998
Feb 4
, 1998
Feb 1
9, 1
998
Mar 6
, 1998
Mar 2
3, 1
998
Apr 7
, 1998
Apr 2
2, 1
998
May 7
, 1998
May 2
2, 1
998
Jun 8
, 1998
Jun 2
3, 1
998
Jul 8
, 1998
Jul 2
3, 1
998
Aug 7
, 1998
Aug 2
4, 1
998
Sep 8
, 1998
Sep 2
3, 1
998
Oct 8
, 1998
Indonesia Thailand Malaysia Philippines
Source: Bloomberg
Tight monetary policies and high interest rates
Local banking crises
-deposit contractions
-increase in non-performing assets
-enlargement of foreign currency exposure
Difficulties of debtors
-higher local debt services (higher interest rates)
-need to cover their creditors margin requirements
-higher foreign currency prices
Recession or slowdown
THE OUTBREAK OF THE ASIAN CRISIS
(cont.)
Japan has severe internal problems
-crisis in the banking system
-recession
-lack of proper economic policies
South-East Asian crises became contagious
-Korea suffered similar problems (devaluation, high interest
rates, recession and weak stock market )
-Hong Kong kept its exchange rate fixed but at a very high price
(high interest rates, recession, severe contraction of stock
prices)
OTHER ASIAN ECONOMIES EXPERIENCE ADVERSE
SITUATIONS
High repercussion on the financial sector
-higher country risk perceptions and devaluation expectations
(overvalued currencies)
-decline in stock markets
profits taken in Latin America to compensate Asian losses
need of local liquidity to buy dollars
-net capital outflow and contraction of international reserves
-deceleration of foreign investment
-limited access to international capital markets
IMPACTS OF THE ASIAN CRISIS ON LATIN AMERICA
Latin American Stock Market Indexes (March 16th,1998=100)
30
40
50
60
70
80
90
100
110
120
Mar 1
6, 1
998
Mar 2
0, 1
998
Mar 2
6, 1
998
Apr 1
, 1998
Apr 7
, 1998
Apr 1
4, 1
998
Apr 2
0, 1
998
Apr 2
4, 1
998
Apr 3
0, 1
998
May 6
, 1998
May 1
2, 1
998
May 1
8, 1
998
May 2
2, 1
998
May 2
8, 1
998
Jun 3
, 1998
Jun 9
, 1998
Jun 1
5, 1
998
Jun 1
9, 1
998
Jun 2
5, 1
998
Jul 1
, 1998
Jul 7
, 1998
Jul 1
3, 1
998
Jul 1
7, 1
998
Jul 2
3, 1
998
Jul 2
9, 1
998
Aug 4
, 1998
Aug 1
0, 1
998
Aug 1
4, 1
998
Aug 2
0, 1
998
Aug 2
6, 1
998
Sep 1
, 1998
Sep 7
, 1998
Sep 1
1, 1
998
Sep 1
7, 1
998
Sep 2
3, 1
998
Sep 2
9, 1
998
Oct 5
, 1998
Oct 9
, 1998
Oct 1
5, 1
998 Brazil Venezuela Mexico Argentina Peru Chile
Source: Bloomberg
High repercussion on the financial sector
-higher country risk perceptions and devaluation expectations
(overvalued currencies)
-decline in stock markets
profits taken in Latin America to compensate Asian losses
need of local liquidity to buy dollars
-net capital outflow and contraction of international reserves
-deceleration of foreign investment
-limited access to international capital markets
IMPACTS OF THE ASIAN CRISIS ON LATIN AMERICA
Negative effects on trade
-contraction of exports volumes to Asian economies
-deterioration of terms of trade due to commodity price
reductions
-lower competitiveness due to the devaluations of Asian
currencies
Fiscal deterioration
-lower fiscal revenues from commodity export activities
-reduction of tax collection due to economic slowdown
-higher internal debt service due to higher local interest rates
-adverse external borrowing conditions
IMPACTS OF THE ASIAN CRISIS ON LATIN AMERICA (cont.)
Oil Prices (WTI) US$/B
10
12
14
16
18
20
22
24
26
Jan 9
7
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Se
pt
Oct
No
v
De
c
Jan 9
8
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Copper Prices US$/mt
1500
1700
1900
2100
2300
2500
2700
Jan 9
7
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Se
pt
Oct
No
v
De
c
Jan 9
8
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Metals and Minerals Prices Index
(World Bank 1990=100)
70
75
80
85
90
95
Jan 9
7
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Se
pt
Oct
No
v
De
c
Jan 9
8
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Raw Materials Prices Index
(World Bank 1990=100)
80
90
100
110
120
130
Jan 9
7
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Se
pt
Oct
No
v
De
c
Jan 9
8
Fe
b
Mar
Ap
r
May
Jun
Jul
Aug
Selected Commodity Prices Indicators
Source: World Bank, Commodity Prices Data
Negative effects on trade
-contraction of exports volumes to Asian economies
-deterioration of terms of trade due to commodity price
reductions
-lower competitiveness due to the devaluations of Asian
currencies
Fiscal deterioration
-lower fiscal revenues from commodity export activities
-reduction of tax collection due to economic slowdown
-higher internal debt service due to higher local interest rates
-adverse external borrowing conditions
IMPACTS OF THE ASIAN CRISIS ON LATIN AMERICA (cont.)
Tight monetary policies in response to speculation against local
currencies
-higher interest rates
-liquidity contractions
Restrictive fiscal policies
-higher taxes
-cuts in expenditures
-limited amounts of additional borrowing due to financial market
restrictions
Anti-dumping and safeguard measures to protect local
producers from Asian products
Production cuts in oil exporting countries in order to reinforce
international prices
POLICY MEASURES TO COPE WITH THE CRISIS
Economic slowdowns
Higher unemployment and worsened social conditions
Negative effects on the banking systems
-contraction of deposits due to capital flight
-portfolio deterioration due to high interest rates
- limited access to central bank financing
-higher reserve requirements
-higher costs and lower earnings
Halt or deceleration of important investment projects
THOSE POLICIES HAD IMPORTANT CONSEQUENCES
The origins of the Russian crisis were multiple
-decline of export commodity prices, particularly oil and gas (Asian crisis
effect)
-political instability
-recurrent and growing high fiscal deficits
-massive borrowing to finance fiscal deficits causing interest rates to soar
-high exposure of local banks to government bonds
Confidence on government securities and the ruble waned in spite of
some initial help from the IMF
-capital flight
-decline of security prices
-fast drop of international reserves
THE RUSSIAN CRISIS WORSENED THE LATIN
AMERICAN SITUATION
On August 17, 1998 dramatic decisions were taken
-devaluation of the ruble
-default on domestic debt
-capital account restrictions, including moratorium on repayment of
foreign financial obligations such as forward exchange contracts
THE RUSSIAN CRISIS WORSENED THE LATIN
AMERICAN SITUATION (cont.)
A GENERALIZED ACUTE CONFIDENCE
CRISIS DEVELOPED
Ruble Exchange Rate
(R/US$)
5.000
7.000
9.000
11.000
13.000
15.000
17.000
19.000
21.000
23.000
Ju
l 1, 1
99
8
Ju
l 6, 1
99
8
Ju
l 8, 1
99
8
Ju
l 10
, 19
98
Ju
l 14
, 19
98
Ju
l 16
, 19
98
Ju
l 20
, 19
98
Ju
l 22
, 19
98
Ju
l 24
, 19
98
Ju
l 28
, 19
98
Ju
l 30
, 19
98
Ag
o 3
, 19
98
Ag
o 5
, 19
98
Ag
o 7
, 19
98
Ag
o 1
1, 1
99
8
Ag
o 1
3, 1
99
8
Ag
o 1
7, 1
99
8
Ag
o 1
9, 1
99
8
Ag
o 2
1, 1
99
8
Ag
o 2
5, 1
99
8
Ag
o 2
8, 1
99
8
Se
p 2
, 19
98
Se
p 4
, 19
98
Se
p 8
, 19
98
Se
p 1
0, 1
99
8
Se
p 1
4, 1
99
8
Se
p 1
7, 1
99
8
Se
p 2
2, 1
99
8
Se
p 2
4, 1
99
8
Se
p 2
8, 1
99
8
Se
p 3
0, 1
99
8
Oct 2
, 19
98
Oct 6
, 19
98
Oct 8
, 19
98
Oct 1
2, 1
99
8
Oct 1
4, 1
99
8
Oct 1
6, 1
99
8
Source: Bloomberg
Russian International Bond Price (Ian)
0
10.000
20.000
30.000
40.000
50.000
60.000
70.000
80.000
Jan 9
, 1998
Jan 1
6, 1
998
Jan 2
3, 1
998
Jan 3
0, 1
998
Feb 6
, 1998
Feb 1
3, 1
998
Feb 2
0, 1
998
Feb 2
7, 1
998
Mar 6
, 1998
Mar 1
3, 1
998
Mar 2
0, 1
998
Mar 2
7, 1
998
Apr 3
, 1998
Apr 1
0, 1
998
Apr 1
7, 1
998
Apr 2
4, 1
998
May 1
, 1998
May 8
, 1998
May 1
5, 1
998
May 2
2, 1
998
May 2
9, 1
998
Jun 5
, 1998
Jun 1
2, 1
998
Jun 1
9, 1
998
Jun 2
6, 1
998
Jul 3
, 1998
Jul 1
0, 1
998
Jul 1
7, 1
998
Jul 2
4, 1
998
Jul 3
1, 1
998
Aug 7
, 1998
Aug 1
7, 1
998
Aug 2
4, 1
998
Sep 1
, 1998
Sep 8
, 1998
Sep 1
5, 1
998
Sep 2
2, 1
998
Sep 2
9, 1
998
Oct 6
, 1998
Oct 1
3, 1
998
Source: Bloomberg
The collapse of Russian bonds made international investors lose
heavily
Investors’ risk tolerance waned, particularly in the emerging markets
Massive capital flight from Latin American economies took place
-selling of high risk local securities in order to avoid further loses
(contagious effect)
-devaluation expectations
-higher country risks (vulnerability of regional economies to external
pressures)
THE RUSSIAN CRISIS AFFECTED GLOBAL FINANCIAL
MARKETS AND EMERGING REGIONS, LATIN AMERICA
AMONG THEM
This situation has had negative consequences on these economies
-stock prices have plummeted
-international bond prices collapsed limiting international financing
-international reserves contracted
-monetary restriction and high interest rates had negative effects on
banks
-economic activity slowed down
The situation has been particularly critical in Brazil (inevitable severe
adjustment)
THE RUSSIAN CRISIS AFFECTED GLOBAL FINANCIAL
MARKETS AND EMERGING REGIONS, LATIN AMERICA
AMONG THEM (cont.)
Latin American Stock Market Indexes (March 16th,1998=100)
30
40
50
60
70
80
90
100
110
120
Mar 1
6, 1
998
Mar 2
0, 1
998
Mar 2
6, 1
998
Apr 1
, 1998
Apr 7
, 1998
Apr 1
4, 1
998
Apr 2
0, 1
998
Apr 2
4, 1
998
Apr 3
0, 1
998
May 6
, 1998
May 1
2, 1
998
May 1
8, 1
998
May 2
2, 1
998
May 2
8, 1
998
Jun 3
, 1998
Jun 9
, 1998
Jun 1
5, 1
998
Jun 1
9, 1
998
Jun 2
5, 1
998
Jul 1
, 1998
Jul 7
, 1998
Jul 1
3, 1
998
Jul 1
7, 1
998
Jul 2
3, 1
998
Jul 2
9, 1
998
Aug 4
, 1998
Aug 1
0, 1
998
Aug 1
4, 1
998
Aug 2
0, 1
998
Aug 2
6, 1
998
Sep 1
, 1998
Sep 7
, 1998
Sep 1
1, 1
998
Sep 1
7, 1
998
Sep 2
3, 1
998
Sep 2
9, 1
998
Oct 5
, 1998
Oct 9
, 1998
Oct 1
5, 1
998 Brazil Venezuela Mexico Argentina Peru Chile
Source: Bloomberg
External Debt Prices (Index 1990=100)
40
50
60
70
80
90
100
110
Mar 1
6, 1
998
Mar 2
0, 1
998
Mar 2
6, 1
998
Abr 1
, 1998
Abr 7
, 1998
Abr 1
3, 1
998
Abr 1
7, 1
998
Abr 2
3, 1
998
Abr 2
9, 1
998
May 5
, 1998
May 1
1, 1
998
May 1
5, 1
998
May 2
1, 1
998
May 2
7, 1
998
Jun 2
, 1998
Jun 8
, 1998
Jun 1
2, 1
998
Jun 1
8, 1
998
Jun 2
4, 1
998
Jun 3
0, 1
998
Jul 6
, 1998
Jul 1
0, 1
998
Jul 1
6, 1
998
Jul 2
2, 1
998
Jul 2
8, 1
998
Ago 3
, 1998
Ago 7
, 1998
Ago 1
3, 1
998
Ago 1
9, 1
998
Ago 2
5, 1
998
Ago 3
1, 1
998
Sep 4
, 1998
Sep 1
0, 1
998
Sep 1
6, 1
998
Sep 2
2, 1
998
Sep 2
8, 1
998
Oct 2
, 1998
Oct 8
, 1998
Oct 1
4, 1
998 Bra27 Ven26 Mex26 Arg26
Source: Bloomberg
This situation has had negative consequences on these economies
-stock prices have plummeted
-international bond prices collapsed limiting international financing
-international reserves contracted
-monetary restriction and high interest rates had negative effects on
banks
-economic activity slowed down
The situation has been particularly critical in Brazil (inevitable severe
adjustment)
THE RUSSIAN CRISIS AFFECTED GLOBAL FINANCIAL
MARKETS AND EMERGING REGIONS, LATIN AMERICA
AMONG THEM (cont.)
Globalized world economy makes emerging markets very vulnerable
to external crises (contagious effect)
The presence of internal imbalances substantially increases that
vulnerability
It is critical for these economies to keep economic fundamentals in
check
Some type of safeguard mechanisms should be developed in order
to reduce the exposure of emerging economies to those external
crises
LESSONS TO LEARN
A SUGGESTION
Some sort of sovereign insurance mechanism, provided by a multilateral
organization that would protect foreign and local investors of acute losses of
their assets in these economies, should be studied. The premium of that
insurance, to be paid by the different affiliated nations, would be established in
line with some predetermined standards of economic performance, making
that premium the higher the farther the economic reality is from those
standards. The basic objective of such insurance is to strengthen the
confidence of investors, thereby reducing the possibilities of destabilizing
massive speculative actions to take place. In addition, such a facility would
reinforce the response capacity of emerging economies to external adverse
situations, therefore minimizing the very negative contagious effects of the
recent economic crises or of those to come.