LatinFinance - Special Edition - August 2013 - 74

2
THE
FUTURE
OF LATIN
FINANCE

Latin America’s resilience to the global financial crisis may have been little more
than a fluke. As a period of rapid expansion draws to an end, its fundamentals are
now weaker than in 2008 – and the region more vulnerable. By Guillermo Calvo

Economic policy
A matter of choice

L

atin america’s resilience to the 2008 global financial crisis was as
surprising as the crisis itself. it seemed an improbable outcome, especially given the fate of
emerging markets following the 1998 Russian crisis. Back then, it took roughly five years for
spreads to return to their pre-crisis levels, and that episode involved only emerging market
economies – relatively minor players in global capital markets.
a reasonable inference was that the emerging market turmoil in the wake of the Russian
crisis was a function of weak market institutions in the emerging world. So, one might have
reasonably assumed that the impact on emerging markets of a major crisis in the developed
world would be armageddon.
Yet, latin america sailed through the 2008/2009 episode virtually unscathed and has
since grown at an unprecedented rate. there are, however, a number of important reasons to
be less sanguine today about the prospects of emerging markets and latam, in particular.
Granted, latam faced the lehman episode with much stronger fundamentals than in
1998. for instance, the region boasted a positive current account balance – a phenomenon
that began in 2003 and which had not been seen since 1980. this gave the region space to
partially offset the external blow and, in sharp contrast to 1998, to implement counter-cyclical
measures.
However, this stronger stance also coincided with a period of skyrocketing terms of trade.
although the terms-of-trade trend has not yet reversed, the region’s current account has
already plunged into negative territory.
latam’s resiliency may therefore have been little more than a fluke – a lucky turn of events
in which strong fundamentals arose from expenditure that lagged an unexpected terms of
trade bonanza. But spending will eventually catch up with income and the region will return
to business as usual. Studies by the iDB show that latam’s fiscal deficit is unsustainable,
except under the most optimistic scenarios.
another important factor is that the aftermath of the lehman episode saw developed
world central banks undertake unprecedented counter-cyclical measures, which led to a
rapid recovery of financial indicators. indeed, the rapid recovery of latam’s financial indicators following the lehman episode was to a large extent down to the largesse of developed
world central banks.
today, external conditions are becoming riskier. china’s growth slowdown suggests that
terms of trade are unlikely to keep rising. the US economy is starting to pick up and interest
rates on 10-year treasury bonds have risen beyond expectations. Historically, this has been
bad news for the region.
the change in the global environment has already been reflected in currency devaluation
and tighter financial conditions across the region. this appears to have exacerbated already
declining growth rates and fueled inflationary pressures.

74 l atinfina nce.com - 25 Years - August 2013

in addition to weaker emerging
market fundamentals relative to 2008,
persistently low policy interest rates in
the developed world may have given rise
to capital flows in search of liquid assets
in the emerging markets. Such demand
would, therefore, be highly sensitive to a
change in US monetary policy.
Under these conditions, US monetary
tightening raises the serious risk to emerging markets of a sudden stop – an abrupt
contraction in capital inflows. Such a risk
was most starkly illustrated in mexico’s
1994/1995 tequila crisis. moreover, because such an episode would occur amid
improving US economic prospects, it is
unlikely that there would be any easing of
US monetary policy, as in 2008.
this all suggests that a period of buoyant expansion for latin america may have
come to an end.
this is a low-saving region: even in a
relatively benign scenario where there is
no sudden stop, lower access to foreign
savings is nevertheless likely to stall
growth –and fuel social unrest.
this raises serious questions about the
nature and quality of the ensuing political response. Will populism prevail? are
political leaders prepared to adopt or
sustain pro-poverty growth policies based
on higher saving and investment rates?
Will a new generation of leaders be able to
convince their constituents that this is the
way to go?
to do so will require tough short-run
adjustments that governments were
unable to implement during the boom
years. the region’s prospects for the years
ahead depend on the answer to these
questions. LF
Guillermo Calvo is professor of economics and international and public affairs at
Columbia University
http://LATINFINANCE.COM
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