Latin Finance - May 2008 - 111

Parting shot The Absence of Sufficient Temptation by Lee C. Buchheit* Lee Buchheit Sovereign restructurings have become much less frequent and more efficient. But they have not gone away, and the ubiquitous CDS may produce some nasty surprises. “ henever I hear the word ’culture’,” wrote the Nazi playwright Hanns Johst, “I release the safety-catch on my pistol.” I confess to having a somewhat similar reaction to the phrase “paradigm shift”, at least when it is applied to the behavior of emerging market (EM) sovereign borrowers. Readers with a clear and distinct memory of the last 30 years will recall several instances in which paradigms were alleged to have gone a-shifting. Commercial bank lending to sovereign borrowers in the 1970s was famously declared safe because sovereigns – unlike their fragile corporate counterparts – could never go bankrupt. A decade later, the wholesale conversion of bank loans into Brady bonds was said to guarantee safety and security for the creditors. Bank loans were susceptible to serial restructurings and eventual write-offs; sovereign bonds were pronounced to be senior, preferred, inviolable and unrestructurable debt instruments. Some commentators believe that EM sovereigns have permanently foresworn the errors of their past. Paradigms have not just shifted, this argument holds, they have reversed field. Economic mismanagement, fiscal irresponsibility, inadequate supervision of financial markets and sharp currency depreciations are, we are now told, characteristics associated with the US and a few other G7 countries – nothing that a decade or so of close IMF tutelage could not remedy. With a few exceptions, however, this view promotes the theory that modern EM sovereign borrowers are as sound as the dollar (to use a sadly archaic figure of speech). W refinance liabilities at fixed rates; interest rates that have hovered near historic lows. In addition, a number of countries have been able to satisfy much of their public borrowing needs by local currency issuances in their domestic markets. A few have even been able to issue local currencydenominated debt instruments in the international markets. It is a strong case, but not stainless. Hugo Chávez and his votaries elsewhere in the region are happily nationalizing foreign investments, subverting the independence of their central banks and embracing opacity in public accounts. But perhaps these can be brushed aside as exceptions or anachronisms. On the whole, the glass-half-full crowd would argue, the pattern of undisciplined, profligate and short-sighted LatAm borrowers has permanently changed. For the Prosecution As Mark Twain used to say, the only thing sadder than a young pessimist is an old optimist. Here is how a crusty cynic might respond. Virtue is the absence of sufficient temptation. Over the last five or six years, the temptation for EM sovereign borrowers to misbehave (by defaulting on their debts or visibly mismanaging their economies) has been remarkably weak. The prices for commodity exports – nearly across the board – have been high. The credit markets have been eager to buy sovereign paper, almost any sovereign paper. Interest rates and risk premiums have been low. There has been, in short, little to be gained and much to be lost in pursuing policies that would have alarmed the markets. The question of the hour, however, is whether virtue will retain her throne once the cost of prudence and sobriety becomes more irksome to the borrowers. Tightening credit markets, falling commodity prices – reflecting an economic downturn in the developed countries – rising interest rates, widening spreads, a general slowdown in exports or some combination of these factors, could quickly invert the virtue/temptation equation in some countries. The political flesh is notoriously flabby. Most societies have a word for a far-sighted political thinker and statesman; the kind that will steadfastly advocate policies to ensure the long-term prosperity of their countries, however politically unpopular those policies may be at the moment. That word is “philosopher”. It is not often “politician”. The policies of the Washington Consensus have taken something of a beating in several LatAm countries. Although this has not recently manifested itself in sovereign debt defaults, the explanation may lie in the For the Defense The case for the defense of this proposition runs along these lines. After 20 years of debt crises and currency crises, serial IMF adjustment programs, and after being force-fed the prescriptions of the Washington Consensus like a bunch of Périgord geese, EM sovereigns have finally learned their lessons. Current account imbalances have been adjusted. Inflation is under control in most countries. International monetary reserves are high. Domestic financial sector regulation is robust. Economies – like that of Mexico – are much more diversified than they were in 1982. Many of these countries have also taken full advantage of munificent market conditions over the last six years to reduce the size of their foreign currency debt stocks relative to GDP and to smooth out the maturity profiles of what is left. Unlike the bank lending of the late 1970s (which was Liborbased), the bond markets have given these countries an opportunity to 2008 May LATINFINANCE 111

Latin Finance - May 2008

Table of Contents for the Digital Edition of Latin Finance - May 2008