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Global Financial Crisis and Recession: How will Latin America Perform? LILIANA ROJAS-SUÁREZ October 2008.

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Presentation on theme: "Global Financial Crisis and Recession: How will Latin America Perform? LILIANA ROJAS-SUÁREZ October 2008."— Presentation transcript:

1 Global Financial Crisis and Recession: How will Latin America Perform? LILIANA ROJAS-SUÁREZ October 2008

2 Four Major Features of the Crisis with Potential Impact on Latin America 1.It is Now a Full-Blown Credit Crisis The crisis has spread from a sub-prime mortgage crisis to an overall credit crisis, involving consumer and corporate loans. The US$ 1,600 billion commercial paper market has shrunk severely as money market funds have curtailed lending to both banks and companies. The “TED” spread, a measure of credit risk for interbank lending has increased sharply in the last six weeks.

3 Four Major Features of the Crisis with Potential Impact on Latin America 2.The Crisis has Gone Global and is affecting European financial systems severely.

4 Four Major Features of the Crisis with Potential Impact on Latin America 2.The Crisis has Gone Global … and so have the rescue packages. Some Examples: Liquidity Injections by Central Banks Reductions in interests rates (most recently in a coordinated fashion: US- Europe-China) Provision of liquidity: US, Japan, Australia, UK Federal Reserve Term Auction Facility (TAF): banks could borrow against a wider range of assets used as collateral

5 Four Major Features of the Crisis with Potential Impact on Latin America 2.The Crisis has Gone Global Public Sector Bailouts and Guarantees Fannie Mae / Freddie Mac, with the US becoming a stakeholder (US$ 200 billion) IAG rescue (US$ 85 billion 2-year credit line – US$ 38 billion on October 9) TARP (Troubled Asset Relief Program) US$ 700 billion plan US deposit insurance expanded limits; Ireland blanket guarantee of deposits, covered bonds, subordinated debt Fortis partly taken over by governments of Belgium, Netherlands and Luxemburg Emergency Funds. Ex: Spain’s offer to buy assets from banks (40-70 billion dollars) Banks recapitalization in the UK (60-80 billion dollars) Change in Market Structure US investment banks not longer allowed to be independent institutions (without a commercial bank)

6 Four Major Features of the Crisis with Potential Impact on Latin America 3.The Financial Crisis has Expanded into the Real Sector The Credit Crunch is now squeezing corporates’ and consumers’ financing availability and a recession is forecasted in the industrialized world.

7 Four Major Features of the Crisis with Potential Impact on Latin America 3.The Financial Crisis has Expanded into the Real Sector In previous downturns, consumption has saved the day, offsetting declines in investment. NOT THIS TIME. Consumers have been hit by a triple whammy: Decline in the value of their houses (wealth effect) Decline in the value of their savings (through the stock market; other wealth effect) Increased unemployment Since consumption accounts for about 70 percent of GDP, the recession will be deeper than in other recent episodes.

8 Four Major Features of the Crisis with Potential Impact on Latin America 3.The Financial Crisis has Expanded into the Real Sector Net exports have been the driver of growth recently and will continue to do so, but at a slower pace in the face of a decreased global activity. However, the recession will only be over when the consumer recovers.

9 Four Major Features of the Crisis with Potential Impact on Latin America 4.The Depth and Length of the Crisis is Uncertain And this is due to a number of reasons: Industrial country authorities have taken too long in recognizing that this is a systemic crisis that needs a comprehensive (and global) resolution plan, rather than a case-by-case approach. The only way to solve a systemic crisis is to use public funds for the recapitalization of institutions assessed as solvent in the long run. Political interference has prevented the approval of “clean” fiscal packages for “recapitalization-purposes only”. The problems with TARP (tranches, added tax exceptions, purchase of assets rather than recapitalization) is the best example.

10 How will Latin America Perform? Main Message: In spite of significant improvements in macroeconomic management over the last few years, Latin America will be strongly affected by the crisis. And: Together with Eastern Europe, Latin America will be the region of the developing world with the slowest rate of growth (although positive) in The effects of the crisis will be felt in “stages”. There will be important differences among countries in the region. But: Policy reaction in some countries, although insufficient, is helping to ameliorate the adverse impact of the crisis. Although important concerns in the social/political areas are re- emerging.

11 How will Latin America Perform? As a region, Latin America growth will be strongly affected. Although at this time, no recession is expected, the significant slowdown reflects the impact of the crisis on some large countries in the region.

12 How will Latin America Perform? Growth will slowdown in all countries in the region. While the external shock is the common factor, idiosyncratic vulnerabilities (to be discussed later on) explain differences in performance. For example, while Argentina’s growth will sharply decline by almost 6 percentage points in the period , Chile is forecasted to decline only 1.5 percentage points in the same period.

13 How will Latin America Perform? The Effects of the Crisis is being Felt in overlapping stages Stage 1: First started. Increased risk aversion has resulted in a “flight to quality” by global investors that is affecting the emerging markets asset class. Perceptions of risk as reflected in the EMBI+ is affecting all emerging markets, with Asia being the least affected. At this time, the global credit crunch is mainly affecting financial variables:

14 How will Latin America Perform? Stage 1: And the deteriorated perceptions of risk is affecting all Latin American countries but especially those with more restrictions to the capital account: Argentina and Venezuela.

15 How will Latin America Perform? Stage 1: In terms of local stock markets, all emerging market regions have been affected (this is the market where international arbitrage occurs the fastest). Eastern Europe has experienced the largest percentage decline since the beginning of the sub-prime crisis (51%). In the last four months, the decline in Latin America has accelerated.

16 How will Latin America Perform? Stage 1: The local equity markets most affected have been: Argentina, Brazil, Mexico and Peru. In Brazil and Mexico, foreign investors are the largest investor base for local equities (in Mexico they account for about 50 percent of market capitalization). In Peru, foreigners account for about 90% of overall trading; but market liquidity is extremely concentrated: 3 stocks (Southern Copper, Buenaventura and Credicorp account for more than 95% of the overall volume). In Argentina, where local investors totally dominate, concentration in Energy and weakening fundamentals are at play.

17 How will Latin America Perform? Stage 1: The increase in risk perceptions and the associated decline in capital inflows to the region is also being reflected in depreciation of the local currencies against the US dollar.

18 How will Latin America Perform? Stage 2: Overlapping with Stage 1, it will Deepen through year-end and through 2009 All types of capital flows: bank loans, portfolio flows, FDI and remittances have started to decrease. For example: Syndicated net lending to banks from emerging markets is entering into negative territo ry. Global deleveraging implies that there will be less net capital flows to meet the financing needs of the region.

19 How will Latin America Perform? Stage 2: For Latin America as a whole, external financing needs, as reflected by the overall current account balances are not large, but deteriorating. While in much better position than Eastern Europe, Latin America is not as financially strong as Emerging Asia.

20 How will Latin America Perform? Stage 2: But aggregates disguise significant differences between Latin American countries. Although in contrast to previous periods of external shocks, accumulation of international reserves can easily cover payments on short-term external debt in all countries…

21 How will Latin America Perform? Stage 2: …Vulnerabilities remain in countries with twin deficits: current account and fiscal balances (actual and forecasted): Colombia, followed by Brazil and Mexico. Ex: Brazil is facing problems in the roll-over of credit lines –largely trade finance--. Interest rates have increased and maturity has declined.

22 How will Latin America Perform? Stage 2: In the current environment, current account deficits are extremely dangerous since even FDI, the most important source of external finance in Latin America tends to be pro-cyclical in the face of global slowdowns. In the 2001 US recession, global FDI dropped sharply.

23 How will Latin America Perform? Stage 2: In Colombia, Brazil and Mexico, overall fiscal deficits are fueling the current account imbalance, calling for prompt fiscal adjustments, if the effects of the global credit crunch is to be minimized.

24 How will Latin America Perform? Stage 2: As reflected in the EMBI+ spreads, Argentina and Venezuela, countries with very high, and increasing, rates of inflation are facing a deteriorated perception of risk, even in the context of significant reserve accumulation.

25 How will Latin America Perform? Stage 3: Overlapping with Stages 1 and 2, but perhaps with longer-term duration (due to lags) Export growth has suffered the most in periods of slowdowns. The decline in the growth of export volume is already forecasted. The global recession implies a decrease in aggregate demand for goods and services exported by the region. This might affect both volumes and prices.

26 How will Latin America Perform? Stage 3: Although the continuous growth of China will help to mitigate the impact of reduced aggregate demand from industrial countries, the price of some important commodities are forecasted to decline. There is an inverse correlation between the value of the dollar and the prices of commodities. The recent “flight to quality” has increased the demand for US- Treasury bills and reduced the demand for many commodities.

27 How will Latin America Perform? Stage 3: Particularly important is the decline in the price of oil. However, future markets call for an oil price still well above the levels of This is partly because there is an expectation of a production cut by OPEC. Forecasts on oil prices, however, tend to not be very accurate.

28 How will Latin America Perform? Stage 3: Prices of non-oil commodities such as copper, silver and food commodities are also expected to decline further.

29 How will Latin America Perform? Stage 3: The clear exception is gold, which together with US-Treasury bills is demanded as a save haven.

30 How will Latin America Perform? Stage 3: But the external developments and the current economic stance only tell part of the story. There are two additional factors: On the positive side: A number of countries are implementing some policies to deal with a more adverse environment. Examples: In Brazil, the Central Bank is lowering reserves requirements for banks that purchase loans from small financial entities, and providing liquidity through dollar repos. In Mexico, the Central Bank is auctioning up to 400 million dollars daily every time that the peso depreciates at least 2% in a day. Most other Latin American countries are also providing dollar liquidity.

31 How will Latin America Perform? On the negative side: More action is needed on the fiscal side, including incorporating the new commodity prices in the budget. As fiscal tightening is needed, social programs need to be protected to avoid political disruptions associated with lower growth. Anti-market forces led by the Venezuelan government run the risk to spread even further over the region in the context of slower growth. Political crises, such as the one just started in Peru (a good performer, in terms of economic fundamentals) might fuel credit concerns about the region.

32 In a nutshell: The crisis will adversely affect the region as a whole. Macroeconomic disequilibria built up over several years, like very high inflation, is affecting the creditworthiness of Venezuela and Argentina. Countries with twin-deficits: Brazil, Colombia and Mexico need prompt fiscal adjustments to mitigate the adverse effect of the global credit crunch. Social programs need to be protected in the region to avoid political disruptions.


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