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Submitted To: - Mr Numair Sulehri

Submitted By: - The Stellers

MBA- 15/ C

Date : December 24, 2009

Latin American Debt Crises


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.


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.

5. 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.


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.

External Debt
Rank Country - Entity Date of information
(million US$)

22 Brazil 211,400 30 June 2005 est.

24 Mexico 174,300 30 June 2005 est.

29 Argentina 119,000 June 2005 est.

39 Chile 44,800 31 October 2005 est.

43 Venezuela 39,790 2005 est.

45 Colombia 37,060 30 June 2005 est.

50 Peru 30,180 30 June 2005 est.

65 Ecuador 17,010 31 December 2004 est.

73 Cuba 13,100 2005 est.

79 Uruguay 9,931 30 June 2005 est.

81 Panama 9,859 2005 est.

85 El Salvador 8,273 30 June 2005 est.

88 Dominican Republic 7,907 2005 est.

95 Bolivia 6,430 2005 est.

98 Guatemala 5,503 2005 est.

103 Honduras 4,675 2005 est.

108 Nicaragua 4,054 2005 est.

110 Costa Rica 3,633 30 June 2005 est.

112 Paraguay 3,535 2005 est.


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.

b. Decreased Exports and High Interest Rates in the Early

1980s Caused Debtor Countries to Default on Their Foreign


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


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.

("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-to-

government 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 longer-

term 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


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.

e. The Brady Initiative in 1989 Focused on Debt Reduction


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 below-

market 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

debt crisis was over for major Latin American debtor countries.


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.



9. 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


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.


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 "neo-

liberalism" which international finance capital is imposing on countries

throughout the world is discussed in the succeeding paras: -

12. 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. removal of restrictions on foreign imports;

e. currency devaluations.

15. 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

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

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.

20. 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.


22. 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.

b. 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.

c. 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.