ProdukHukum BankIndonesia

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Addressing Financial Tsunami:

Latin American Experience

Domingo Cavallo

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Until the third quarter of 2008...

The financial crisis that started in the US in august The financial crisis that started in the US in august 2007, did not seem to have produced a strong

2007, did not seem to have produced a strong impact on Latin America

impact on Latin America impact on Latin America impact on Latin America

By then, it was argued that LA economies would be By then, it was argued that LA economies would be decupled from the crisis thanks to their much

decupled from the crisis thanks to their much improved fundamentals, in comparison with improved fundamentals, in comparison with previous crisis.

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Fiscal Balance in Latin America

(LAC-7; Overall Balance, % of GDP)

Public Debt in Latin America

(LAC-7; Public Debt, % of GDP)

44% 46% 48% 50% 52%

Russian Crisis

Beginning of 2000s Boom

US 2000s Boom

Latin America: Fiscal Balance and Public Debt

US Financial Crisis

* Taken from IDB (2009). Policy-Tradeoffs for unprecedented times. Izquierdo and Talvi

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1.5 1.6 1.7 1.8

International Reserves in Latin America International Reserves in Latin America

(LAC

(LAC--7, 7, in billions of USDin billions of USD))

250 300 350 400

450 _Russian

Crisis

Beginning of the Boom

US Financial Crisis

447

Latin America: International Liquidity Indicators

Liquidity Indicators in Latin America Liquidity Indicators in Latin America

(LAC-7*, International Reserves to External Public Debt Amortizations in the next twelve months plus Central Bank Short Term Liabilities)

Russian Crisis

Beginning of the

Boom US Financial _Crisis

1.8

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40% 45% 50% 55%

Latin America: Financial Dollarization

Credit Dollarization in Latin America

(LAC-7; Bank Credit in Foreign Currency , % of Total Credit)

50%

Public Debt Dollarization in Latin America

(LAC-7; Foreign Currency Debt, % of Total Debt)

55% 60%

65% 65%

10%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

35%

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But, by the fourth quarter of 2008...

The negative impact on LA economies of the global The negative impact on LA economies of the global crisis became quite large and strong

crisis became quite large and strong , mainly , mainly through trade channels.

through trade channels.

Nowadays the forecast for growth during 2009 is Nowadays the forecast for growth during 2009 is gloomy.

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The full effect over time will depend on whether the The full effect over time will depend on whether the global crisis in the advanced economies is V or L global crisis in the advanced economies is V or L--global crisis in the advanced economies is V or L global crisis in the advanced economies is V or L--shaped

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L

L--Shaped Shaped Scenario Scenario

500 600 700

Sovereign Bond Spread Sovereign Bond Spread

(EMBI +, bps) (EMBI +, bps)

V

V--Shaped Shaped Scenario Scenario

115 125 135

Global Commodity Price Index Global Commodity Price Index

(2006 = 100)

International Financial Conditions

Industrial Countries Growth

Two Hypotheses on the Global Economy

G7 Industrial Production G7 Industrial Production

(2006 = 100) (2006 = 100)

V

V--Shaped Shaped

105

2006 2007 2008 2009 2010 2011 2012 2013

Source: JPMorgan for Bond Spreads

Pre

Pre-- Asian Crisis LevelsAsian Crisis Levels

Trough Jun-07

Peak Jun-09

T-to-P 512

Recovery* Sep-10

V-Shaped

*Recovery to Pre-Asian crisis levels

L

L--Shaped Shaped Scenario

2006 2007 2008 2009 2010 2011 2012 2013 Source: IMF and Bloomberg*

Pre

Pre--Crisis LevelsCrisis Levels

V

*Recovery to Dec-06 levels G7 is the PPP-weihted average of the Canada, France, Germany, Italy,

Japan, United States, UK

V

Pre

Pre--Crisis LevelsCrisis Levels

97 99 101 103 105

2006 2007 2008 2009 2010 2011 2012 2013

*Recovery to pre-crisis levels of output

Source: Own calculations based on WEO and JPMorgan*, Oct-08.

L

L--Shaped Shaped Scenario

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And may differ in different countries depending on And may differ in different countries depending on local financial conditions

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Financial Conditions: Spreads and Central Bank

Reserves by country

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Confronting the Global Crisis in Latin America:

Policy Trade Offs

Mitigate Recessionary

Pressures

Trade - Off Weaken Liquidity

Position EXPANSIONARY FISCAL POLICY

ILR

expansionary policy and no liquidity crisis

Threshold expansionary policy

and liquidity crisis

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Krugman, comparing the US with Argentina in connection Krugman, comparing the US with Argentina in connection with Rubin’s opinion on Bush’s policies, NYT, Jan 2004

with Rubin’s opinion on Bush’s policies, NYT, Jan 2004

““Argentina retained the confidence of international investors Argentina retained the confidence of international investors

almost to the end of the 1990's. Analysts shrugged off its almost to the end of the 1990's. Analysts shrugged off its large budget and trade deficits; business

large budget and trade deficits; business--friendly, freefriendly,

free--large budget and trade deficits; business

large budget and trade deficits; business--friendly, freefriendly,

free--market policies would, they insisted, allow the country to market policies would, they insisted, allow the country to grow out of all that. But when confidence collapsed, that grow out of all that. But when confidence collapsed, that optimism proved foolish. Argentina, once a showpiece for optimism proved foolish. Argentina, once a showpiece for the new world order, quickly became a byword for economic the new world order, quickly became a byword for economic catastrophe.”

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Then, commenting on a paper coauthored by

Rubin, Orszag and Sinai, he adds:

“Substantial ongoing deficits," they warn, "may severely “Substantial ongoing deficits," they warn, "may severely and adversely affect expectations and confidence, which in and adversely affect expectations and confidence, which in turn can generate a self

turn can generate a self--reinforcing negative cycle among reinforcing negative cycle among

turn can generate a self

turn can generate a self--reinforcing negative cycle among reinforcing negative cycle among

the underlying fiscal deficit, financial markets, and the real the underlying fiscal deficit, financial markets, and the real economy. . . . The potential costs and fallout from such

economy. . . . The potential costs and fallout from such fiscal and financial disarray provide perhaps the strongest fiscal and financial disarray provide perhaps the strongest motivation for avoiding substantial, ongoing budget deficits." motivation for avoiding substantial, ongoing budget deficits." In other words, don’t cry for us, Argentina: we may be

In other words, don’t cry for us, Argentina: we may be heading down the same road.

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And he concludes:

““The point made by Mr. Rubin is that the traditional immunity of The point made by Mr. Rubin is that the traditional immunity of

advanced countries like America to third

advanced countries like America to third--worldworld--style financial style financial

crises isn't a birthright. Financial markets give us the benefit of crises isn't a birthright. Financial markets give us the benefit of the doubt only because they believe in our political maturity and the doubt only because they believe in our political maturity and in the willingness of our leaders to do what is necessary to rein in the willingness of our leaders to do what is necessary to rein in deficits, paying a political cost if necessary. And in the past in deficits, paying a political cost if necessary. And in the past in deficits, paying a political cost if necessary. And in the past in deficits, paying a political cost if necessary. And in the past that belief has been justified. Even Ronald Reagan raised taxes that belief has been justified. Even Ronald Reagan raised taxes when the budget deficit soared.”

when the budget deficit soared.”

But, But,

“If this kind of fecklessness goes on, (referring to the “If this kind of fecklessness goes on, (referring to the

persistence of fiscal deficits during the Bush Administration) persistence of fiscal deficits during the Bush Administration) investors will eventually conclude that America has turned into investors will eventually conclude that America has turned into a third world country, and start to treat it like one.“

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Gross and Net Fiscal Cost of Banking Crises Gross and Net Fiscal Cost of Banking Crises

(in Percent of GDP)

Brazil 1994 Philippines 1997Nicaragua 2000

Bulgaria 1996 Venezuela 1994Malaysia 1997 Mexico 1994 Uruguay 2002Ecuador 1998 Dominican Republic 2003Côte d’Ivoire 1988

Korea 1997 Turkey 2000Chile 1981 Thailand 1997Jamaica 1996

Argentina 1980

Indonesia 1997

Net Cost Recovery

Source: Laeven and Valencia (2008), Japan Deposit Insurance Corporation, Hoelscher and Quintyn (2003), and IMF staff estimates.

0 10 20 30 40 50 60

Ukraine 1998Brazil 1990 Estonia 1992 Argentina 1995Norway 1991 Latvia 1995 Lithuania 1995Sweden 1991 United States 1988Sri Lanka 1989

Colombia 1982Ghana 1982 Argentina 1989Russia 1998 Bolivia 1994 Colombia 1998 Czech Republic 1996Croatia 1998

Japan 1997 Argentina 2001Vietnam 1997