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Latin American Nations Scramble to Contain Effects of Global Economic Crisis

By Carlos Navarro and Robert Sandels, Latin America Data Base, NotiSur, Vol. 8 no. 32, 4 September 1998

Latin America has been particularly vulnerable to the effects of the Russian economic crisis that has sent markets into a tailspin around the world. Analysts fear that, if the situation in Russia worsens, investors could become even more cautious about putting money into Latin America and other emerging markets. Amid growing jitters, the International Monetary Fund (IMF) called Latin America's finance ministers to Washington to strategize about the growing crisis. Meanwhile, some analysts are questioning the role of the prevailing neoliberal model in the region's troubles.

Latin America has relied on cheap international credit over the past few years to finance budget deficits and investment and to prop up overvalued currencies. Nevertheless, just a month ago many economists thought the region could escape relatively unscathed from the effects of the free-falling Russian economy. Now, however, they predict rough times ahead.

The world is moving toward 1929 instead of the 21st century, said Brazilian economic analyst Celso Furtado. He said the spread of the global-markets crisis "has made it clear that recession is inevitable." One possible positive effect could be "a review of the reigning model of development, a shift in direction."

US analysts warn that credit could dry up altogether for Latin American countries if Russian President Boris Yeltsin abandons unpopular market reforms in a compromise with anti- reform leaders in parliament.

"Anybody who buys Latin debt right now is going to be much poorer in the next few months," said Joe Petry, head of Latin American sovereign analysis at Citicorp Securities. "Russia has proven that sovereign default is back on the table as a policy option and that the IMF cannot be counted on as a safety net."

Russia's problems are a greater threat to Latin America than were the Asian ills, and any serious problems in Latin America will be felt in the US. The US sells 21% of its exports to Latin American countries, compared with 14% to Asia and a much smaller amount to Russia.

Venezuela, Brazil, and Argentina are the Latin American countries most vulnerable to the turmoil. The Venezuelan bolivar has been under attack amid speculation the country will devalue the currency. Like Russia, Venezuela has been hit by a sharp decline in world oil prices (see other article in this edition). A collapse of the bolivar could undermine the Brazilian real and other currencies.

"This is something to get worried about," said David Wyss, chief financial economist for DRI McGraw Hill, a forecasting firm. "These countries are hurting because commodity prices are down," Wyss said. "Their economies are in better shape than they were in the 1980s--substantial foreign currency reserves, currencies in good shape--but a crisis still could be painful."

IMF calls Latin Americans to Washington

IMF officials met Aug. 28 to examine Russia's economic decline and how to salvage the US$23 billion international bailout. At the same time, IMF director Michel Camdessus invited Latin America's finance ministers and central bank officers to Washington Sept. 3-4 to discuss the crisis. Camdessus proposed that the officials try to reach a coordinated response to "shore up investors' confidence."

Some Latin American economists said the region was in better shape to resist the latest turbulence than during the Mexican peso crisis that began in late 1994 and that the IMF meeting was unnecessary. That view changed on Sept. 2 when Colombia announced a de facto devaluation, which analysts called the first significant change in any Latin American country's exchange-rate policy since Asia's financial crisis began last year.

More currency devaluations feared

Colombia announced it would allow the peso to drop by a maximum of 26.6% against the dollar in 1998, compared with a previous maximum of 16%. The surprise move was expected to increase pressure on Venezuela and Ecuador to follow suit. Other regional currencies were also under pressure. Mexico's peso tumbled to a historic low despite central bank efforts to prop it up. The government also placed restrictions on the money in circulation (see Sourcemex, 09/02/98).

Argentine President Carlos Menem froze public spending on Sept. 1 to reduce the impact of the crisis. Brazil, estimated to have lost US$9 billion in foreign currency reserves this month, made loans converted into direct investment and fixed- income funds tax-exempt. The central bank had already authorized advance expiration of loans and greater flexibility for attracting foreign capital.

If Brazil were to devalue its currency, Argentina-- because of economic and trade relations--would suffer the greatest negative impact, but the rest of the region would also be affected. Brazil's huge deficit and regulated currency-exchange market make it attractive to speculators.

Stock markets plunge

Since the beginning of the year, the major Latin American stock markets have fallen sharply. The Bovespa in Sao Paulo is down to a 20-month low, the Mervel index in Argentina is at a 34-month low, while in Mexico the IBC index is down 47% this year. Worst hit so far is the Venezuelan market, down 63% this year.

In mid-August, rumors of a Venezuelan devaluation, denied by the central bank, sent its market into a tailspin--losing 22% in a week. Brazil fell 11%, and Mexico 10% in sympathy.

The recent selloffs have increased fears that investors will withdraw from all emerging markets.

David Bain, senior economist at Schroder Investment Management Ltd., said the Asian and Russian turmoil had made Latin America a new uncertain area for foreign fund managers.

"We begin to see cracks in some Latin American countries like Venezuela and Brazil," said Bain. "I think Latin America is more a concern than Russia."

World Bank chief economist for Latin America Guillermo Perry was among the few untroubled by the crisis in Latin America.

"This time there was a drop in stock market prices, an increase in spreads, a reduction of Brady bond prices, and there has been some outflows of capital, but this was compensated to a large extent by the very strong influx of long-term capital in foreign investment and in privatizations," Perry said.

"Pressures on the currencies have been moderate, and there have been increases in domestic interest rates, but not very substantial and much less than what was needed in October," Perry said. He said both Venezuela and Brazil have a "very comfortable level" of reserves and should have no trouble in meeting foreign payment obligations.

Concern that the model is not working

Accentuating Latin America's vulnerability to global fluctuations are its dependence on foreign investment, political instability despite the preponderance of "democratic" governments, and huge trade deficits.

In many countries the percentage of market shares held by foreigners is growing--in Mexico it is now one-third. Development is also highly dependent on foreign capital, increasing the impact from any skittishness by investors.

Both Venezuela and Brazil have elections this fall, following recent balloting in Ecuador, Colombia, and Paraguay. Opposition to privatization, frustration at high unemployment, and growing discontent by those "excluded" from the economic process have been issues throughout the region.

Trade deficits have increased as commodity prices have fallen. Drops in oil prices have hit Venezuela and Ecuador, while the fall in copper prices has been a blow to Chile.

The worsening world financial situation is once again raising questions about causes and remedies, states the latest Bank for International Settlements (BIS) report.

The BIS, a sort of world central bank based in Basel, Switzerland, generally follows neoliberal economic thinking. Although neoliberal guidelines oppose controls, the BIS says recent events underline the need to reconsider the "architecture" of the world financial system, which is increasingly beyond the reach of national regulatory powers.

The financial meltdown questions the benefits of "unbridled" capitalism and its suitability for developing countries undergoing economic turmoil, said the BIS. The IMF has already been criticized for applying rigid policies to economies suffering large capital outflows. Increasingly, economists are arguing that IMF-defined capitalism may not be suitable for all countries.

"The raison d'etre of governments everywhere is their ability to protect citizens from insecurity," said John Gray of the London School of Economics. "A regime of global laissez-faire that prevents governments from providing this protection is creating conditions for still greater political and economic instability."

Critics say global capitalism has taken on the trappings of a casino, with investors rapidly shifting funds around the globe to profit from the latest crisis or escape its consequences. They question whether free markets are worth holding on to at all costs if they breed turmoil and economic insecurity for a country's citizens.

"As difficult as it may be for me to accept, some form of capital controls may become necessary for many of these economies," said one European monetary official.

Nevertheless, within institutions like the IMF, any call for restrictions on the flow of capital will likely be seen as a step backward in the development of emerging economies.

Meanwhile, the world is entering the second phase of the financial crisis, "the worst part," said Hernan Cortes, foreign adviser to Chile's Finance Ministry. What can be expected now is a slowdown in growth and an increase in inflation, unemployment, and "the discontent of the citizenry, which will give rise to new political pressures."

[Sources: BBC, 08/25/98; Associated Press, 08/27/98, 08/28/98; Notimex, 08/17/98, 08/29/98, 08/30/98; Inter Press Service, 08/28/98, 08/30/98; Reuters, 08/27/98, 08/28/98, 08/31-09/03/98; PRNewswire, Spanish news service EFE, 08/31/98]