Indebted in Latin America Carlos Vigil Cruz Sarah

Indebted in Latin America Carlos Vigil Cruz, Sarah Kearns, Wendy Loveland, Armondo Tautiva

Debt Crisis When a country fails to meet their interest payments External payments financing sources: n Non interest current account (Export-Import) n Net increase in debt (New lendings) Other net capital inflow (foreign investment) n

Reasons for Debt Crisis n n Domestic Fiscal & Political Disorders: Deficit noninterest current account World Economic Shock to a country’s terms of trade: Hurt export earnings or increased import costs Sudden suspension on non debt capital flow: No money to finance payments and trade deficits Loss of confidence in world capital market These tend to come together Interruption of debt payment

1980’s Debt Crisis: International Conditions n n n Oil shock: bankers with excessive liquidity, new credits for Latin America Unusually high commodity prices: L. A. countries borrowed to avoid adjustment U. S. A. and other OECD countries dramatically raised interest rates: ä increased Latin American debt ä recession in OECD countries, depressing export earnings

1980’s: Local Conditions n n Budget Deficits increased vastly Exchange Rates overvaluation ä ä ä n Capital Flight ä ä ä n avoid exchange depreciation or fixing exchange rate real appreciation led to a current account deterioration availability of credit made policy errors possible inflation/exchange rate risk foreign currency political risk shift assets out of the country tax reasons Ways to do it ä ä Central Bank allows transfers abroad at official exchange rate Misinvoicing trade transactions (over import-under export)

Solutions: The IMF Approach Blaming internal consumption, illiquidity n Absorption approach: Y-A=B n The IMF Rx: austerity n ä ä ä decreased government spending contractionary monetary policy to lower inflation devalued exchange rate to make exports cheaper liberalized markets - reduced tariffs & quotas involuntary lending - no new money

Solutions: The IMF Approach n Unfortunate results ä ä ä ä massive layoffs, increased unemployment companies can’t compete in world market export prices lower than expected G cuts hurt infrastructure devalued exchange rate shocks import prices interest rates still high, no domestic investments Continued bad reputation in world market

Solutions: the Secondary Market n Debt-for-equity swaps A foreign firm wishing to build a factory in Latin America buys a debt note in the secondary market Firm pays $50, 000 for $100, 000 worth of debt Firm presents claim to Central Bank for payment in local currency Proceeds used for investment in debtor country CB pays firm $90, 000 worth of pesos (depends on CB’s leverage) $90, 000 worth of pesos invested locally

Solutions: the Secondary Market n Debt-for-Equity: Benefits ä ä n Debtor bank sells off a claim for dollars less hard currency (dollars) now needed to pay external debt. Foreign Firm has an asset in debtor country. CB reduced dollar liability. Can induce new investments, finance purchase of existing firms, aid in privatization (ex: in 1990 the Argentine telephone company was sold to groups led by Telefonica and Bell Atlantic). Debt-for-Equity: Disadvantages ä ä ä Inflationary risk: increased supply of local currency Demand for Equity investments is unpredictable Investment might have taken place anyway Exchanged external debt for internal debt: is the rate at which the bank redeems the debt > the cost of the new domestic debt? Are foreign firms taking advantage of cheap capital to compete with local entrepreneurs?

Solutions: the Secondary Market n Debt-for-Nature Swaps ä ä n Reduce debt while saving the environment Int’l environmental groups buy discounted debt turn it over to the government who commit local currency for parks, etc. Small % of overall debt, difficult to manage, “paper parks” result What next? Debt-for-health swaps, Debt-for-education, etc. Creation of a Debt Facility ä ä Facility organized by creditor governments to take over LDC loans at a discount in exchange for creditor government guarantee Claims would be renegotiated with debtor country, passing on the discount and restructuring the debt in terms of maturity Risk: inability or unwillingness of debtor country to meet debt obligations Banks currently holding debt lose negotiating power

Solutions: the Secondary Market n Interest relief ä ä Seek relief on interest payments, rather than principal – Through capitalizing interest payments automatically, or – Provide for payment of interest in local currency which would be available for creditors to invest in debtor country’s economy Problems – Works better for temporary debt service problems, not for insolvency – Adding to the debt does not help with credit-worthiness issue

Solutions: The Baker Plan n Baker Plan – 1985 ä ä ä In contrast to IMF plan of austerity, proposed infusion of $29 billion of new money ($20 b from commercial banks and $9 b from IMF) to induce growth of Latin economies. Proposed structural adjustment to existing loan terms to better align them with the repayment sources, i. e. , long term loans for long term capital and infrastructure projects. Baker Plan was not well received by the banking community. “Why throw good money after bad? ”

Solutions: The Brady Plan n Brady Plan – 1989 ä ä ä Offered three options: Decrease face value of debt, extend the term of obligations, or infusion of new money. Decreasing the face value of debt through buybacks in the secondary market were officially allowed. Terms of loans were extended by swapping old loans for 30 -year bonds (Brady Bonds) with fixed rates. Debtors had option of a 30%-35% discount on the face value or a reduced rate. Guarantees offered to lenders in event of default encouraged investor confidence. Guarantees were usually US. Treasury Bonds. Infusion of new money is facilitated by the reduction of risk.

A Final Question n Will Latin America ever get out of debt? ?