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Submitted To: - Mr Numair Sulehri Submitted By: MBA- 15/ C Date : December 24, 2009 The Stellers
Latin American Debt Crises ORIGINS 1. In the 1960s and 1970s many Latin American countries, notably Brazil,
Argentina, and Mexico, borrowed huge sums of money from international creditors for industrialization; especially infrastructure programs. These countries had soaring economies at the time so the creditors were happy to continue to provide loans. Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent. This heightened borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP). Debt service (interest payments and the repayment of principal) grew even faster, reaching $66 billion in 1982, up from $12 billion in 1975. BEGINNING OF THE DEBT CRISES AND EFFECTS 2. When the world economy went into recession in the 1970s and 80s,
and oil prices skyrocketed, it created a breaking point for most countries in the region. Developing countries also found themselves in a desperate liquidity crunch. Petroleum exporting countries – flush with cash after the oil price increases of 1973-74 – invested their money with international banks, which 'recycled' a major portion of the capital as loans to Latin American governments. As interest rates increased in the United States of America and in Europe in 1979, debt payments also increased making it harder for borrowing countries to pay back their debts. While the
dangerous accumulation of foreign debt occurred over a number of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans. This occurred in August 1982 when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. In the wake of Mexico's default, most commercial banks reduced significantly or halted new lending to Latin America. As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced were now due immediately. 3. However, some unorthodox economists like Stephen Kanitz attribute
the debt crisis neither to the high level of indebtedness nor to the disorganization of the continent's economy. They say that the cause of the crisis was leverage limits such as U.S. government banking regulations which forbid its banks from lending over ten times the amount of their capital, a regulation that, when the inflation eroded their lending limits, forced them to cut the access of underdeveloped countries to international savings. 4. In response to the crisis most nations abandoned their import
substitution industrialization (ISI) models of economy and adopted an export-oriented industrialization strategy, usually the neoliberal strategy encouraged by the IMF, though there are exceptions such as Chile and Costa Rica who adopted reformist strategies. A massive process of capital outflow, particularly to the United States, served to depreciate the exchange rates, thereby raising the real interest rate. Real GDP growth rate for the region was only 2.3 percent between 1980 and 1985, but in per capita terms Latin America experienced negative growth of almost 9 percent. 3
The debt crisis is one of the elements which contributed to the
collapse of some authoritarian dictatorships in the region, such as Brazil's military regime and the Argentine bureaucratic-authoritarian regime.
CURRENT LEVELS OF EXTERNAL DEBT 6. Since the 1980 several countries in the region have experienced a
surge in economic development and have initiated debt management programs in addition to debt relief and debt rescheduling programs agreed to by their international creditors. However, the debt crisis continues to have enduring effects, including the USD 2.94 trillion of Latin American and Caribbean debt traded globally in 2004, accounting for 63.2 % of total emerging markets debt traded worldwide that year. The following is a list of external debt for Latin America based on a March 2006 report by The World Factbook.
Rank Country - Entity
External Debt (million US$) 211,400 174,300 119,000
Date of information
22 24 29
Brazil Mexico Argentina
30 June 2005 est. 30 June 2005 est. June 2005 est.
39 43 45 50 65 73 79 81 85 88 95 98
Chile Venezuela Colombia Peru Ecuador Cuba Uruguay Panama El Salvador
44,800 39,790 37,060 30,180 17,010 13,100 9,931 9,859 8,273
31 October 2005 est. 2005 est. 30 June 2005 est. 30 June 2005 est. 31 December 2004 est. 2005 est. 30 June 2005 est. 2005 est. 30 June 2005 est. 2005 est. 2005 est. 2005 est. 2005 est. 2005 est.
Dominican Republic 7,907 Bolivia Guatemala 6,430 5,503 4,675 4,054
103 Honduras 108 Nicaragua
Costa Rica Paraguay
30 June 2005 est. 2005 est.
AN OVERVIEW OF THE DEBT CRISES 7. Let's begin with a brief overview of the debt crisis and the measures
taken to resolve it. a. Petrodollar Recycling by Commercial Banks to Developing Countries Gave Rise to the Debt Crisis. Most observers believe the "petrodollar recycling" of the 1970s gave rise to the debt crisis. During that period, the price of oil rose dramatically. Oil-exporting countries in the Middle East deposited billions of dollars in profits they received from the price hike in U.S. and European banks. Commercial banks were eager to make profitable loans to governments and state-owned entities (as well as private companies) in developing countries, using the dollars flowing from the Middle Eastern countries. Developing countries, particularly in Latin America, were also eager to borrow relatively cheap money from the banks.
Decreased Exports and High Interest Rates in the Early 1980s Caused Debtor Countries to Default on Their Foreign Loans. The frenzied lending and borrowing came to a halt with the global recession in the early 1980s. The significant drop in debtor countries' exports, combined with a strong dollar, (i.e., the value of the dollar increased relative to the value of other currencies) and high global interest rates, depleted foreign exchange reserves that debtor countries relied upon for international financial transactions. Debtor countries consequently began to feel the strain of having to make timely payments on their foreign debt, which became much more expensive to pay off because the loans carried floating interest rates that increased along with global rates. These problems were compounded by massive capital flight - outward transfers of money by private individuals and entities in developing countries. In August 1982, Mexico stunned the financial world by declaring that it could no longer continue to pay its foreign debt. Not long after Mexico's declaration came similar announcements from other Latin American debtor countries, such as Brazil, Venezuela, Argentina, and Chile. The prospect of massive defaults posed grave problems for creditor countries, such as the United States. Government regulators discovered that commercial bank creditors, particularly the big U.S. 7
("money center") banks, had dangerously low levels of capital that could be used to absorb losses resulting from massive loan defaults. Policymakers were also worried that there was no central authority or forum that could oversee an orderly resolution of the crisis, such as a global bankruptcy system. c. Case-by-Case Debt Restructuring Negotiations Saved the International Financial System from Collapse. Yet the principal players in the crisis - governments, banks, the IMF and the World Bank - averted a collapse of the international financial system by resorting to case-by-case debt restructuring negotiations, popularly known as the "muddling through" approach. The approach entailed engaging in a series of work-outs with hundreds of commercial bank creditors throughout the world via Bank Advisory Committees or Steering Committees, which were composed of banks with the greatest exposures to debtor countries. (Work-outs for government-togovernment lending took place under the auspices of the Paris Club, a forum open only to sovereign states.) Under this approach, commercial banks agreed to (i) provide new loans to debtor countries, and (ii) stretch out external debt payments. In return, debtor countries agreed to abide by IMF and World Bank stabilization and structural adjustment programs intended to correct domestic economic problems that gave rise to the crisis. IMF stabilization programs typically
included drastic reductions in government spending in order to reduce fiscal deficits, a tight monetary policy to curb inflation, and steep currency devaluations in order to increase exports. World Bank structural adjustment programs focused on longerterm and deeper "structural" reforms in debtor countries. d. "Debt Fatigue" Appeared in the Mid-1980s. After a few years of repeated restructuring deals, "debt fatigue" began to appear. New loans to debtor countries plummeted as commercial bank creditors contemplated the possibility that debtor countries were facing insolvency rather than a temporary drop in their ability to pay back the foreign debt. In October 1985, U.S. Treasury Secretary James Baker proposed a strategy, dubbed the Baker Plan, that attempted to alleviate the debt fatigue. The plan was designed to renew growth in fifteen highly indebted countries through $29 billion in new lending by commercial banks and multilateral institutions in return for structural economic reforms such as privatization of state-owned entities and deregulation of the economy. The strategy failed, however, because the projected financing did not materialize and, to the extent it did, the new lending merely added to debtor countries' already crushing debt burden. During this period, Latin American debtor countries were making massive net outward transfers of resources.
In light of what appeared to be an intractable problem, government officials, academics, and private entities began to propose plans that would provide debtor countries with debt
relief rather than debt restructuring. In the meantime, various
debtor countries suspended debt payments and fell out of compliance with, or otherwise refused to adopt, IMF adjustment programs. This eventually prompted the big creditor banks to admit publicly (by adding to "loan loss reserves") that many of the loans to debtor countries would not be repaid.
The Brady Initiative in 1989 Focused on Debt Reduction Strategies. The Brady Initiative, announced in March 1989 by U.S. Treasury Secretary Nicholas F. Brady, marked a change in U.S. policy towards the debt crisis. Given the persistently high levels of foreign debt, the Initiative shifted the focus of the strategy from increased lending to voluntary, market-based debt reduction (reduction of outstanding principal) and debt service reduction (reduction of interest payments) in exchange for continued economic reform by debtor countries. Debtor countries obtained significant (but not massive) debt relief under the Brady Initiative through: (i) direct cash
buybacks; (ii) exchange of existing debt for "discount bonds" (bonds issued by the debtor country with a reduced (discounted) face value but carrying a market rate of interest); (iii) exchange of existing debt for "par bonds" (bonds that carry the same face value as the old loans but carry a belowmarket interest rate); and (iv) interest rate reduction bonds (bonds that initially carry a below-market interest rate that rises eventually to the market rate). Commercial bank creditors that did not wish to participate in a debt or debt service reduction option could choose to give debtor countries new loans or receive bonds created from interest payments owed by debtor countries. Debtor countries sweetened the deals by providing "enhancements," such as principal and interest collateral (U.S. Treasury bonds). f. Brady Deals Combined with Economic Reforms and Increased Flows of Capital to Debtor Countries Led Some Observers in the Early 1990s to Declare that the Debt Crisis was Over. Commercial bank creditors agreed to Brady deals with a good handful of countries, including Argentina, Costa Rica, Mexico, Nigeria, the Philippines, Venezuela, Uruguay and Brazil. In the meantime, Latin American countries implemented substantial economic reforms. In 1991, the region registered capital inflows that exceeded outflows for the first time since the onset of the debt crisis. This led some observers to proclaim that the 11
debt crisis was over for major Latin American debtor countries. STABILIZATION AND ADJUSTMENT PROGRAMS 8. The IMF's stabilization programs applied short-term "emergency"
measures intended to reduce domestic demand for goods and services (IMF stand-by arrangements). The World Bank engaged in policy-based lending through structural adjustment loans (SALs) and sector adjustment loans (SECALs), medium- to long-term loans that supported structural changes to improve supply and prevent the recurrence of a crisis. The distinction between IMF and Bank programs often blurred in practice, however, because of the close collaboration between the two institutions and the complementary nature of their programs. Both programs carried "conditionality," releasing funds in installments and requiring recipients to meet performance criteria for each installment. a. IMF Stabilization Measures Tried to Cool Down Overheated Economies. The idea behind stabilization is that a drop in demand will result in a reduction of the current account deficit (more imports than exports), which the IMF believed was one of the major causes of the financial crises in debtor countries. In most cases, governments reduced demand by cutting public expenditures, devaluing the country's currency, and reducing the money supply. The expenditure-cutting included drastic cuts in infrastructure (e.g., roads, bridges, and dams), freezing
state employees' wages or laying off state employees, reducing consumer subsidies, and cutting health and education expenditures. Central banks devalued the currency in part to reduce imports and increase exports. Authorities reduced the money supply to check inflation. b. World Bank Structural Adjustment Measures Promoted Market-Based Reforms to Increase Efficiency. World Bank structural adjustment programs complemented stabilization efforts by seeking to increase economic efficiency, which, in turn, would increase the domestic supply of goods and services. Although such programs differed among countries, they shared two themes: liberalization of domestic and foreign trade, and privatization of often large and inefficient public enterprises. Domestic liberalizations included abolishing price controls, freeing interest rates, ending credit rationing, and establishing a capital market. Liberalization of external trade typically included reduction of high tariffs, elimination of quotas on imports and import licenses, abolition of export duties and licenses, devaluation of the currency, and product diversification. Public enterprises were also subject to market discipline via privatizations, reduction or abolition of subsidies, and other streamlining measures. THE SOCIAL COSTS OF THE DEBT CRISES: THE LOST DECADE OF DEVELOPMENT
A great number of observers criticized the IMF and the World Bank
for their handling of the debt crisis. Indeed, the criticisms of that crisis resemble much of what we have heard about the Asian financial crisis: the IMF and World Bank stabilization and structural adjustment programs (SSAPs) imposed great costs on the poor and vulnerable in developing countries while "bailing out" foreign players such as banks and investors. a. The Debt Crisis Brought Debtor Countries' Economies to a Halt and Wiped Out Gains in Social Welfare. It is not hard to find evidence showing that the poor, women, children and other groups (indigenous peoples) suffered disproportionately as a result of structural adjustment programs during the 1980s. As Latin America's economies stagnated (experiencing zero or negative economic growth), per capita income plummeted, poverty increased, and the already wide gap between the rich and the poor widened further. The debt crisis seriously eroded whatever gains had been made in reducing poverty through improved social welfare measures over the preceding three decades. These developments led policymakers to label the 1980s "the lost decade of development." b. Post-Crisis Studies have Shown that Stabilization and Structural Adjustment Programs have had Mixed Effects on Poverty and Income Distribution.
Post-crisis studies of the impact of SSAPs have helped policymakers evaluate whether such programs have had a negative impact on poverty and income distribution. The studies show that SSAPs have had mixed effects. Some studies indicate that SSAPs have adversely affected the poor and increased the gap between the rich and the poor in developing countries. This is because SSAPs have resulted in lower wages for laborers and increased unemployment. Funds earmarked by governments or the World Bank for "social safety nets" have fallen short of the amount required to prevent overall increases in poverty. 10. As one might expect, other studies have shown that SSAPs are not as
detrimental as critics have claimed. Some have pointed out that the impact of SSAPs varies from country to country--they are not uniformly detrimental across developing countries. Others have shown that the plight of the poor can be improved after the implementation of SSAPs. For example, an overvalued exchange rate can reduce agricultural exports by making them more expensive for foreign consumers, thereby impoverishing people in the agricultural sector. A devaluation may improve those exports by making them less expensive and may indirectly increase the income of the rural poor. Still other studies have shown that avoiding adjustment or implementing adjustment policies that depart from IMF/World Bank criteria have resulted in skyrocketing inflation, which disproportionately hurts the poor who use most of their income for consumption.
THE DEBT CRISES AND NEO-LIBERALISM 11. Today, the developing countries are more than $2 trillion in debt to
the big bankers in the U.S., Europe and Japan. Of course, over the years these countries have already paid hundreds of billions to the bankers in interest payments alone. But the debt keeps mounting and the bankers keep bleeding the peoples dry. Some background information on the debt crisis and the program of "neoliberalism" which international finance capital is imposing on countries throughout the world is discussed in the succeeding paras: -
By the 1980's, the developing countries were $700 billion in debt to
U.S., European and Japanese bankers. This mountain of debt, combined with economic recession and a dramatic drop in prices for raw materials (the main export of many developing countries), presented the big international bankers with the danger that countries could no longer make their exuberant interest payments and would default on their debt. 13. In this situation, the Reagan administration - with the help of the
International Monetary Fund (IMF) and the World Bank - came forward with a "rescue program." Although widely advertised as a way to "unleash the free market" and increase economic growth in the developing countries, the real aim and effects of the Reaganite "rescue" were to 1) dramatically increase the transfer of wealth from the developing countries to the big U.S. and international bankers through massive interest payments and ever increasing
debt and 2) increase the direct imperialist take-over of the economic infrastructure of the dependent countries through "debt-for-equity" swamps, privatization of state-owned enterprises and removal of restrictions on both foreign investment and foreign trade. 14. This intensified plunder and domination of the dependent countries
was implemented through "Structural Adjustment Loans" (SALs). To receive new loans, the debtor countries were required to put their budgets and economies under the supervision of the IMF and the World Bank. The following conditions were generally imposed: a. austerity budgets which drastically cut back government expenditures for health, education and welfare in order to insure that the maximum amount of government funds went to servicing its debt to foreign bankers. b. privatization of the state sector and the removal of restrictions on foreign ownership. c. gutting of social and labor legislation in order to increase the rate of exploitation of the workers. d. e. 15. removal of restrictions on foreign imports; currency devaluations.
During the 1980's, more than 70 debtor countries (including Brazil,
Mexico, Argentina, Chile, Peru, Philippines, India, Bangladesh, Indonesia, South Korea, Egypt, Morocco, Senegal, Ghana, etc.) were forced to accept 17
Structural Adjustment Loans. The sovereignty of these countries was thoroughly undermined and their economies brought under the direct control of the IMF and World Bank. 16. Rather than eliminating the crises and accelerating economic growth,
as the public relations men for the "free market" had advertised, this structural adjustment further devastated the economies of the dependent countries and imposed untold hardship on the peoples. In Latin America, for example, GNP per capita decreased by 10% during the 1980's while the number of people living below the official poverty line increased from 130 million to 180 million; in sub-Sahara Africa (one of the main regions subjected to IMF structural adjustment programs), the number of people living in poverty has jumped to 300 million, nearly 50% of the population. 17. But while economic growth stagnated and poverty increased, the
international bankers reaped unprecedented profits. In the words of Morris Miller, a former director of the World Bank. "Not since the conquistadores plundered Latin America has the world experienced a [financial] flow in the direction we see today.. From 1984-1990, for example, the developing countries paid $178 billion in interest and amortization on debt to U.S. and European commercial banks. By 1997 (before the Asian financial crisis), the total accumulated debt of the dependent countries reached $2 trillion dollars. In 31 of these countries, the foreign debt exceeded the country's yearly gross domestic output, in many cases by a scale of 200-400%. Many of these countries devote 1/3 to 2/3 of their governmental budgets to interest payments on the debt. Every year, the governments in sub-Sahara Africa pay four times more in servicing their foreign debt than they spend 18
on health care and education combined. In addition, the neo-liberal structural adjustment programs have all-but-destroyed the state sectors of the economy in many developing countries and led to the massive take-over by the foreign monopolies. 18. In Mexico, for example, 886 state enterprises (out of a total of
1,155) were privatized between 1982 and the early 1990's. Foreign, especially U.S., monopolies gained control of such vital sectors as telecommunications, airlines, banking, mining, steel and even parts of the oil industry. This privatization was also a means to step up the exploitation of the Mexican workers by firing state employees, breaking unions and tearing up union contracts, changing work rules, etc. It is estimated that at least 200,000 jobs were wiped out through privatization. Neo-liberalism in Mexico has led to a 60% fall in average real wages over the last 15 years. 19. Similarly in Chile between 1975 and 1989, the Pinochet government
privatized 160 corporations, 16 banks and 3,600 agro-industrial plants, mines and real estate. The vast majority of these enterprises went to foreign monopolies and/or a handful of the biggest Chilean capitalists, closely allied with the international banks and monopolies. In nearly every case, the government enterprises were sold for a fraction of their book value, immediately producing windfall profits for the capitalists. For example, Chile's national steel industry, valued at $700 million was sold for $72 million; government-owned sugar refineries worth $81 million went for $34 million, etc., etc.
In short, a mountain of debt has been forced onto the backs of the
working people throughout the world. Every year, the U.S. and other international bankers extract tens of billions in tribute through interest payments alone. A handful of the international financiers and capitalist monopolies are literally strangulating the entire globe. 21. In country after country, people are rising against this international
robbery and the program of neo-liberalism. In general strikes and other movements, hundreds of millions of people are already in motion resisting the IMF-imposed austerity budgets and raising demands for a moratorium on interest payments and cancellation of the foreign debt. In these struggles, the workers and people are organizing themselves politically and taking the field against international imperialism and the capitalist system. They are raising positive demands for a pro-social agenda which recognizes and guarantees the economic and human rights of the people and which returns economic and political sovereignty to the oppressed nations. Through these struggles the workers and people are advancing towards the goals of national liberation and social emancipation.
This paper has analysed information problems between investment
banks and investors during sovereign debt crises, by studying the structure of the primary sovereign bond market. 23. The findings of this paper are the following. a. First, we cannot reject the hypothesis that investment banks price sovereign default risk well before crises emerge and even before investors do. This result suggests that investment banks hold an information advantage over investors, and are the only ones compensated to cover the risk of sovereign debt crises. On average, countries with public finances difficulties (PFD) had to pay on average 1.10 per cent of the amount issued to investment banks between one and three years prior to the onset of crisis, almost twice the emerging countries’ average during the period 1993‐2006 (0.56 per cent). In contrast, when we compare the level of primary sovereign bond spreads before the crisis with respect to the total for emerging countries, we find that the former on average is only slightly higher than the latter (385 bp vs. 319 bp) and well lower than the primary sovereign spread at the onset of a crisis (603 bp). The robustness of this result is verified through panel data analysis. We find that there is an additional fixed cost for crisis countries prior the onset of a sovereign debt crisis with respect to other events. On average, prior to a sovereign debt crisis, countries paid a surplus on the underwriting fee.
Second, investment banks’ behaviour differs depending on the type of sovereign debt crisis. By differentiating among types of sovereign debt crises, we find that prior to crises investment banks charged on average higher fees to countries with public finances vulnerabilities compared to other sovereign debt crises countries.
Finally, there is a dichotomy between investors’ perceptions concerning the “investment value” of the fee and the results presented above. This is a puzzle in that it appears that investors are not using potentially useful (and public)
information in order to allocate efficiently their portfolios of emerging fixed incomes assets. 24. The major policy implication that follows from this research is that
fees paid by governments to investment banks during sovereign bond issues should be closely followed by policy makers and actors in capital markets. This information has been neglected during past sovereign bond crises, while it may have served as an early warning market indicator of sovereign bond crisis, and one perhaps more relevant than standard indicators such as secondary sovereign bond spreads.
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