Latin America Debt Crisis

Prelude  To finance ISI Latin American countries borrowed from international markets  Nations were betting on investment projects that, unfortunately, did not pay off  Borrowing continued in the late 1970’s  Oil prices generated current account deficits for Latin American countries  To finance the deficit they borrowed

What went wrong?  Unsustainable domestic policies Populism: promoted growth and income distribution but ignored risks of increasing debt, inflation, and external constraints. CorruptionPopulism: promoted growth and income distribution but ignored risks of increasing debt, inflation, and external constraints. Corruption i.e. Juan and Eva Peron in Argentina i.e. Juan and Eva Peron in Argentina OvercapacityOvercapacity Budget deficitsBudget deficits Low interest rates discouraged savingLow interest rates discouraged saving

 External shocks Latin American countries borrowed at historically low rates, but then interest rates increased sharplyLatin American countries borrowed at historically low rates, but then interest rates increased sharply Most of the debt was US dollar denominated. Hence, to pay for the debt, LA nations needed US dollars. They could have obtained them from exports, but they currencies were overvalued.Most of the debt was US dollar denominated. Hence, to pay for the debt, LA nations needed US dollars. They could have obtained them from exports, but they currencies were overvalued. As capital began leaving the countries domestic interest rates were increased, decreasing investment.As capital began leaving the countries domestic interest rates were increased, decreasing investment. Central Banks engaged in seignorage, creating inflationCentral Banks engaged in seignorage, creating inflation

The Crisis  High global interest rates  Global recession  Drop in commodity prices  Borrowing to cover interest payment stopped.  August 1982, the Mexican Finance Minister announce a payment moratorium

The Scope

Intervention  IMF Absortion approach: decrease personal and government consumption and increase exportsAbsortion approach: decrease personal and government consumption and increase exports Decrease government spendingDecrease government spending Privatize industriesPrivatize industries Eliminate subsidiesEliminate subsidies Contractionary monetary policyContractionary monetary policy Indexed wagesIndexed wages Devaluate the currencyDevaluate the currency

 The Baker Plan Long-term structural changeLong-term structural change  The Brady Plan Decrease the debt value of debtDecrease the debt value of debt Restructuring time periodRestructuring time period New moneyNew money Long-term Brady bonds were consistent with the Baker ideaLong-term Brady bonds were consistent with the Baker idea IMF and World bank raised fundsIMF and World bank raised funds From 1989 to 1994 about 32% of the debt was forgivenFrom 1989 to 1994 about 32% of the debt was forgiven