1. LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo Columbia University

2. Medium-term cycles of capital flows to emerging markets: 1975-81 -- Recycling of petrodollars, via bank loans, to oil-importing EMs 1982, Aug.-- Mexico unable to service its debt on schedule, defaults => Start of the Latin American debt crisis, 1982-89 1990-97 -- New capital flows to EMEs following 1989 Brady Plan 1994, Dec. -- Mexican peso crisis 1997, July -- Thailand forced to devalue and seek IMF assistance => Start of East Asia crisis 1998, Aug. -- Russia defaults on much of its debt => Contagion to Brazil. 2001-02 -- Turkey and Argentina currency & debt crises 2003-07 -- New capital flows into developing countries 2008, Sep. – Lehman Brothers collapse => Beginning of North Atlantic Financial Crisis 2009-13 -- Post-crisis surge in capital flows to emerging markets, 2013, May -- May 2013 U.S. Fed tapering began the contraction phase But, so far, financing conditions have continued to be good 1. 2. 3. 4.

3. Net resource transfers to Latin America Source: Authors’ estimates based on ECLAC data 3

4. Major phases of liberalization and regulation 1950-75 -- Extensive FX and capital account regulations in all LA ▫Exceptions: Mexico and Venezuela 1975-81 -- Capital account liberalization in Argentina, Chile and Peru, but Brazil and Colombia remain relatively closed; Domestic liberalization in Argentina and Chile ▫1982-89 -- Closing of the capital account during LA debt crisis 1990-98 -- Broad-based capital account liberalization in LA, including Brazil and Colombia, but with new instruments to regulate capital flows: ▫Taxes on capital flows in Brazil, and URRs in Chile and Colombia. ▫Regulations on FX transactions, e.g. restrictions on domestic financial deposits in FX. -- Semi-dollarized systems in Argentina and Peru, hyperinflations of 1989 and 1990; but not in Brazil despite its hyperinflation in early 1990s 2000-06 -- Further liberalization in Brazil, Colombia, Chile (FTA with U.S.), but reversal of liberalization in Venezuela and Argentina ▫2004-13 -- Peru used differential RRs on deposits in dollars and short-term external borrowing by domestic banks vs. deposits in the domestic currency ▫2007-08 -- Colombia used URRs before FTA with U.S. ▫2009-11 -- Brazil used taxes on capital inflows after the North-Atlantic crisis 4 1. 2. 3.

5. Comparison of capital account restrictiveness of Latin America vs Emerging Market Economies 5

6. Capital flow regulations in Latin America 6

7. Lessons from capital account liberalization and regulation Surges in international capital flows generate pressure to adopt pro- cyclical macroeconomic management and to liberalize capital account and financial regulations, with large destabilizing effects: ▫Both the liberalization of the 1970s/early-1980s and that of the 1992-97 ended up in major crises. However, not all booms end up in crises: The critical issues are current account deficits and associated currency appreciation. ▫Reduction of external debts and accumulation of reserves serve as additional buffers against capital flow volatility. ▫The domestic counterpart of the current account deficit is important: the experience of the Southern Cone during the first boom and of a broader group of countries during the second was problematic, since external financing was essentially consumed. Maintaining some capital account regulations to directly manage capital flow volatility is important. ▫Brazil, Chile, Colombia and Peru used some of these tools effectively. ▫But these regulations should be used as a complement, not as a substitute for domestic financial regulations – in some cases, their use as a substitute has made crises unavoidable and more severe. 7

8. Current conditions in Latin America: what can we expect?  The recent boom in external financing generated a strong recovery of investment, for the first time since the boom of the 1970s.  An additional strength was the reduction in external debt ratios, both gross and net of foreign exchange reserves: More macroeconomic policy autonomy. Better access to external financing  But Latin America spent –in fact, overspent— the terms of trade boom  Significant vulnerability to the deterioration of the terms of trade…  … and therefore to the Chinese slowdown.  However, so far, access to financing has continued to be good:  Almost unaffected by successive euro crises  Marginally so by FED tapering  Somewhat more by the fall in commodity prices. 8

9. Investment as a share of GDP 9 Source: ECLAC

10. External debt as a share of GDP 10 Source: Authors’ estimates based on ECLAC data

11. Current account balance has deteriorated since 2002 when adjusted by terms of trade 11 Source: Authors’ estimates based on ECLAC data

12. But, so far, access to external financing looks good (1) 12 Source: ECLAC

13. But, so far, access to external financing looks good (2) 13 Source: JPMorgan

14. LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo Columbia University