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, with Britain as the main creditor and the growing newly settled countries (the United States, Canada, Argentina, Australia) as the main borrowers. To a large extent this international lending fit the well behaved model as lending sought out high returns (although defaults were also common). During the 1920s, a large number of foreign governments issued foreign bonds, especially in New York, as the United States became a major creditor country. But in the 1930s, the depression led to massive defaults by developing countries, which frightened away lenders through the 1960s. Lending to developing countries remained very low for four decades. The oil shocks of the 1970s led to surge in private international lending to developing countries. Between 1970 and 1980, developing country debt outstanding increased almost eightfold, with debt rising from 10.6 percent of the countries national product in 1970 to 21.4 percent in 1980. The oil shocks quadrupled and then tripled the world price of oil, and these shocks caused recessions and high inflation in the industrialized countries. How did the shocks also revive the lending? Four forces combined to create the surge. First, the rich oil-exporting nations had a high short-run propensity to save out of their extra income. While their savings were piling up, they tended to invest them in liquid form, especially in bonds and bank deposits in the United States and other established financial centers. The major international private banks thereby gained large amounts of new funds to be lent to others borrowers. The banks had the problem of “recycling” or reinvesting the “petrodollars”. But where to lend? Second, there was widespread pessimism about the profitability of capital formation in industrialization countries. Real interest rates in many countries were unusually low. One promising area was investment in energy-saving equipment, but the development of these projects took time. For a time the banks’ expanded ability to lend was not absorbed by borrowers in the industrial countries, which encouraged banks to look elsewhere. Attention began to shift to developing countries, which had long been forced to offer higher rates of interest and dividends to attract even small amounts of private capital. Third, in developing countries, the 1970s was an era of peak resistance to foreign direct investment (FDI), in which the foreign investor, usually a multinational firm based in an industrialized country, keeps controlling ownership of foreign affiliated enterprises. Banks might have lent to multinational firms for additional FDI, but developing countries were generally hostile to FDI. Populist ideological currents and valid fears about political intrigues by multinational firms brought FDI down from 25 percent of net financial flows to developing countries in 1960 to less than 10 percent by 1980. To gain access to the higher returns offered in developing countries, banks had to lend outright to governments and companies in these countries. Fourth, “herding” behavior meant that the lending to developing countries acquired a momentum of its own space once it began to increase. Major banks aggressively sought lending opportunities , each
Federal Reserve shifted to a much tighter monetary policy to reduce U. Mexico declared that it was unable to service its large foreign debt. it was usually able to receive new private lending immediately. Smaller banks (those holding small shares of all loans) headed for the exits and eliminated their exposure by selling off their loans or getting repaid. Interest rates had increased sharply in the United States. it became clear that the debtor countries were suffering low economic growth and lack of access to international finance. U. they concluded that it was imprudent to lend more. First. Treasury officials crafted the Brady Plan (named after U. Governments were opening up opportunities for financing profitable new investments as they deregulated industries. The debt crisis that began in 1982 was effectively over. low U. The debtor’s ability to repay fell dramatically.S. the size and scope of the Brady Plan led investors to believe that the previous crisis was being resolved. and encouraged production for export with outward-oriented trade 2 . But everyone was doing it. As the debt crisis wore on through the 1980s. Developing countries’ exports declined and commodity prices plummeted. The longterm debt of developing countries nearly doubled between 1980 and 1985. Much of the lending went to poorly planned projects in mismanaged economies. Several factors explain why the crunch came in 1982.S. each debtor country could reach a deal in which its bank debt would be partially reduced. Second. most of the bank debt had been reduced and converted into bonds. Dozens of other developing countries followed with announcements that they also could not repay their previous loans. In response. to 24 percent. with most of the remaining loans repackaged as “Brady bonds.S. declined some-what in 1983 and 1984. the ratio of debt to national product rose from 21 percent in 1980 to 33 percent in 1985.S. The Debt crisis of 1982 In August 1982.showing eagerness to lend before competing banks did. The United States and other industrialized countries sank into a severe recession. The larger banks could not extricate themselves without triggering a larger crisis. and the share of export revenues that was committed to service the debt nearly doubled. which were most of the private lending to developing countries in the early 1980s. At first the responses of the bank creditors depended on how much each bank had lent. Four forces converged to drive this new lending. privatized state-owned firms.S. The net flows of bank loans to developing countries became small in 1985 and remained low until 1995. but that this cost was not leading to repayments that would end the crisis. and they hoped that the problems were temporary. while real interest rates remained high. as the U. As each debtor country agreed to a Brady deal. the developing countries were becoming more attractive places to lend as governments reformed their policies. Beginning in 1989. The Resurgence of Capital Flows in the 1990s Beginning in about 1990.” By 1994. lending to and investing in developing countries began to increase again. They rescheduled loan payments to establish repayment obligations in the future. As large banks reassessed the prospects for developing country debtors. interest rates again led lenders to seek out higher returns through foreign investments. inflation. and they loaned smaller amounts of new money to assist the debtors to grow so that repayment would be possible Bank loans. Treasury Secretary Nicholas Brady). Third.
Mexico’s banking system was rather weak. but that lower interest rates actually lowered the share of exports of goods and services that had to be devoted to debt service. by altering the form of the government debt. were looking for new forms of portfolio investments that could raise returns and add risk diversification.indexed government debt called tesobonos. but Mexican holdings of official reserves had declined to about $6 billion. with a modest government budget deficit. mostly by Mexican residents who feared currency devaluation and converted out of pesos. By the end of 1994. the fiscal authorities made the change that became the center of the crisis. The majority of this money went to a small number of developing countries viewed as the major emerging markets – Mexico. 1994 – 1995 A series of crises punctured the generally strong flows of international lending to developing countries since 1990. so its holdings of official international reserves fell. while the Mexican inflation rate was higher than that of the United States. as did defaults on these loans. Brazil. It shows that developing country debt outstanding rose as a percentage of national product from 36 percent in 1990 to 40 percent in 1995. The crisis was touched off by a large flight of capital. its main trading partner. The types of investments were different from those that drove the lending surge in the late 1970s. In December the currency was allowed to depreciate.policies. But strains also arose. as investors sought high returns and were impressed with Mexico’s economic reforms and its entry into the North American Free trade Area. Mexico received large capital inflows in the early 1990s. The peso came under some downward pressure. there were about $28 billion of tesobonos outstanding. as well as the rapidly growing mutual funds and pension funds. The government used sterilized intervention to defend its exchange rate value. With the capital inflows adding funds to the Mexican banking system. The Mexican Crisis. The current account deficit increased to 6 percent of Mexico’s GDP in 1993. The year 1994was an election year with some turmoil. bank lending grew rapidly. Still. South Korea and Thailand in Asia. Foreign portfolio investors’ net purchases of stocks and bonds rose from almost nothing in 1990 to nearly one third of total net financial flows in 1996. because the government permitted only a slow nominal peso deprecation. but even bank lending increased substantially from 1994 to 1997. The real exchange rate value of the peso increased. the government replaced peso-dominated government debt with short-term dollar . The rapidly growing flows on long-term investments into developing countries. Bank lending was less important. The first of these struck Mexico in late 1994. Beginning in early 1994. Fourth. Mexico’s fiscal policy was reasonable. although this was readily financed by the capital inflows. and Argentina in Latin America and China. including an uprising in the Chiapas region and two political assassinations. Developing countries became the emerging markets for this portfolio investment. as total net financial inflows increased every year from 1989 to 1997. The financial crisis arose as 3 . most maturing in the first half of 1995. Indonesia. individual investors. Malaysia. with inadequate bank supervision and regulation by the government.
and to lesser extents. Each investor wanted to be paid off in dollars . they pulled back on investments not only in Mexico but also in many other developing countries (the “tequila effect”). The currency depreciation and the financial turmoil caused rapid and painful adjustments in Mexico. the strong capital inflows provided financing for the deficits. much of the Mexican financial crisis of 1994-1995 was resolved quickly. government and the International Monetary Fund (IMF). the pure contagion that led investors to retreat from nearly all lending to developing countries calmed after the first quarter of 1995. With the exception of Thailand. Overall capital flows to developing countries continued to increase in 1995 and 1996. The Mexican government might not be able to repay all of them within a short time period. Venezuela and the Philippines. much of the foreign borrowing was by banks and other financial institutions. In Indonesia. Brazil. Still. The Mexican economy went into a severe recession. because it appeared that the government did not have the ability to make good on its dollar obligations. and it arranged a large rescue package that permitted the Mexican government to borrow up to $ 50 billion. Still. 4 . The Mexican government did borrow about $ 27 billion. as investors continued to pull out of Argentina. steady monetary policies kept inflation low. and trade policies were outward – oriented. The governments had fiscal budgets with surpluses or small deficits. The external balance of the countries also showed some problems. and the current account deficit disappeared as imports decreased and exports increased. the current account deficits were not large. As investors reassessed their investments in emerging markets. Most of the foreign debt was owed by private firms. mostly from the U. Government regulation and supervision were weak. The banks took on significant exchange rate risk by borrowing dollars and yen and lending in local currencies.S. The real exchange rate values of these countries’ currencies seemed to be somewhat overvalued. using the money to pay off the tesobonos as they matured and to replenish its official reserve buildings. 1997 In the early and mid – 1990s. The adverse tequila effect lingered for a smaller number of countries. and the growth of exports slowed beginning in 1996.a rush to the exit – but what was rational for each investor individually was not necessarily rational for all of them collectively. The U. In Thailand and South Korea.investors refused to purchase new tesobonos to pay off those coming due. not by the governments. which took on the exchange rate risk directly. The Asian Crisis. And the lending boom led to loans to riskier local borrowers and rising defaults on loans. As the rescue took hold. much of the foreign borrowing was by private nonfinancial firms. In these countries macroeconomic policies were solid. foreign investors looked favorably on the rapidly growing developing countries of Southeast and East Asia. A closer look showed a few problems. Thailand’s current account deficit rose to 8 percent of GDP in 1996. government became worried about the political and economic effects of financial crisis in Mexico.S.
but also to Malaysia and the Philippines.Crisis struck first in Thailand. However. Beginning in 1996. up to $ 42 billion to Indonesia ($11 billion borrowed). 2001 – 2002 In the late of 1980s. and as local borrowers scrambled to sell local currency to establish hedges against exchange rate risk. in an effort to allow Brazil to fight pressures pushing toward a crisis. the Brazilian government ended its pegged exchange rate. although the net capital flows to developing countries remained lower than they had been in 1997. and the baht was allowed to depreciate beginning in July 1997. the government failed to enact the fiscal reforms called for in the IMF loan. this situation did not escalate into a full crisis because the problems did not spread to the Brazilian banking system. 1999 Brazil was among the countries hit hard by the fallout from the Russian crisis. The Thai government could not maintain its defense. though not without costs. In a few years in the early 1990s everything changed. Argentina’s economy was a mess. as foreign investors lost confidence in local bank burrowers and the local stock markets. the expectation of declining exports led to large declines in Thai stock prices and real estate prices. In response. The currency depreciations and the recessions did lead to improvements in the current account balance. especially to Indonesia and South Korea. the IMF organized large rescue packages. By April 1999. and the government was defending its crawling exchange rate with intervention and high domestic interest rates. However. In November 1998. and the real depreciated. The exchange rate values of the currencies of Thailand. Throughout the rest of 1997 the crisis spread to a number of other Asian countries. Brazil had a large current account deficit. these countries also went into severe multiyear recessions. The Brazilian Crisis . with hyperinflation of over 2. and the Philippines during the second half of 1997 declined by 4050 percent. By mid-1997. However. Banks and other local firms that had borrowed dollars and yen without hedging rushed to sell baht to acquire foreign currency assets. Argentina’s crisis. Brazil and other developing countries were able to issue new bonds to foreign investors. As in Mexico. Malaysia. which was sound and well regulated. More generally. In January 1999. reduced its inflation rate to almost 5 . and up to $58 billion to South Korea ($27 billion burrowed). dollar using a currency board. Korea. The exchange rate value of the Thai baht came under downward pressure. the market prices of emerging market financial assets began to increase. largely through decreases in imports. Indonesia. with commitments to lend up to $ 17 billion to Thailand ($13 billion actually borrowed). as it fixed its peso to the U. these large rescue packages and policy changes did contain the crises.S. and capital outflows increased.000 percent per year and a currency whose exchange value was in free fall. the pressures had become intense. the IMF organized a package that allowed the Brazilian government to borrow up to $41 billion ($18 billion actually borrowed).
However. The IMF refused to make additional loans under the rescue package because the government had not met the conditions set by the Fund for improvements in government policies. The government defaulted on about $ 140 billion of its debt. and Argentinean withdrawals from their Uruguayan accounts increased. The country’s president resigned. The international price competitiveness of Argentina’s products declined and its current account deficit increased. but it was to be the last. After its holdings of official reserves plummeted defending Uruguay’s crawling pegged exchange rate. Its fiscal situation had been a weak point all along. within two weeks the currency had fallen by half. and the peso lost about 75 percent of its value in the first six months of the year. The tourism dried up. Beginning in 1997 the peso experienced a real appreciation. the Uruguay government floated its currency in June. since it has been widely expected. Still. It also strengthened its banking system and established sound regulation and supervision. much of it owed to foreigners.zero. Private capital inflows dried up. Rising interest rates in Argentina made the recession worse. But after a few months Argentina’s problems did spread to its neighbors. Argentina reached agreement for a package of official loans of up to $ 40 billion. In addition. Tata McGraw Hill 6 . withdrawals were severely limited. with real GDP declining by over 10 percent during the year. Uruguay relied on Argentina for tourism and banking business. and grew rapidly up to 1998. Angry protest spawned looting and rioting. things did not improve. When the banks reopened in December. and the fiscal deficit increased as the economy went through years of recession beginning in 1998. In early 2002 the government surrendered the fixed exchange rate. and then because Brazil’s currency depreciated by a large amount in 1999. and the fiscal deficit remained a problem. In September 2001 the IMF made an unusually large disbursement of $6 billion to Argentina. In late 2000. Foreign investors saw all this and they liked it – foreign capital flowed into Argentina. The Argentinean people began to fear for the continuation of the fixed exchange rate and the soundness of the banking system. In August Uruguay received an IMF rescue package and used it to stabilize its financial situation. with 23 deaths. At first it appeared that Argentina’s collapse would have few effects on other developing countries. especially Uruguay. first because the dollar strengthened against other currencies. with $ 14 billion committed by the IMF. it suffered a severe recession. In response to depositor runs on banks. the government closed the banks in November. and liabilities into pesos. and the banking system was nearly nonfunctional. During 2002 real GDP declined by 11 percent. the peso depreciation caused huge losses in the banks because of some mismatch of dollar liabilities and dollar assets. and Argentina then had for new presidents in two weeks. the largest default ever. A number of banks closed. a huge recession after the economy had already endured several previous years of recession. Much of the government debt was denominated in foreign currencies and owed to foreign lenders and bondholders. International Economics. 9Source: Thomas Pugel.
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