Latin America and the Credit Crisis
Submitted by: Juan Pajuelo, Latin American-Iberian Research Team Leader
The global credit crisis has affected Latin American markets to a lesser extent than those in North America and Europe, primarily due to the fact that the region's financial institutions have not invested significantly in U.S. mortgage-backed securities and the main international banks operating in the region are considered sound.
However, two factors present an immediate risk to the region’s growth: a dependence on overseas bank borrowing to finance foreign trade; and the stagnant growth of the G-7 countries and emerging Asian economies, which have served as markets for Latin American commodities.
“The financial markets are practically closed to emerging markets, and sooner rather than later, businesses and governments will have to study that alternative,” said Ricardo Hausman, an economics professor at Harvard University, at the Ibero-American Summit held in El Salvador on Oct. 29, according to the France 24 news service.
Latin American leaders are taking steps to reduce the impact of the crisis on their respective economies. Although some measures are not investor-friendly, such as Argentina's nationalization of private pension funds, most governments have tried to mitigate inflationary pressures by modifying monetary and fiscal policies to inject greater liquidity into their markets.
Latin American countries also will be impacted by the reduction in global demand for their exports and a decrease in commodity prices. Growth vulnerability in the region varies greatly between countries; yet despite facing the same economic storm, not every nation is in the same boat.
Unlike in the United States and Europe, there have been no calls by Latin American leaders for companies to limit executive severance payments or to curb incentive compensation that may lead to excessive risk-taking.
In Argentina, the government announced a pension reform plan on Oct. 21 that consists of the nationalization of up to $23 billion in private pension funds to protect retirees and workers. Cristina Kirchner, Argentina’s president, proposed the move after pension fund assets suffered losses from the collapse of stock and bond markets.
The investment community reacted to the nationalization plan by sending the Argentine Stock Market down 11 percent. The move also highlighted institutional weakness and sparked fear that the government was desperate to tap funds to avoid a default. The Argentine peso fell to its lowest value in six years and the government’s bonds lost almost 27 percent.
“Although the proposal, if approved, would provide the government with greater financial flexibility in the short term, it undermines the government’s already weak policy credibility and adds to negative perceptions about Argentina’s institutional integrity, particularly governance and respect of contracts,” Mauro Leos of Moody’s Investor Service said in a statement.
According to the Reuters news service, about 55 percent of the funds held by the Argentine pension system are invested in Argentina’s sovereign debt; 11 percent is in local stocks; and the rest is in short-term deposits, foreign assets, and other investments.
In addition, the country’s National Securities Commission (Comision Nacional de Valores), has relaxed rules on share buybacks, so companies can sustain their share prices.
Although Argentina's economy has recovered significantly over the past three years, uncertainty remains as to whether the current growth and relative stability are sustainable. Economic indicators show that the economy remains fragile due to high unemployment and inflation rates; limited availability of long-term fixed rate loans; high public debt; and very limited access to the international capital markets. Argentina has not had access to international debt markets since its 2001 default on $95 billion in bonds.
Chile
Chilean President Michelle Bachelet has announced a $500 million injection into the country’s state bank, BancoEstado, in order to increase the availability of mortgages for low- and middle-income families.
At a meeting with industry leaders, Finance Minister Andres Velasco presented an $850 million plan to aid exporters and small businesses. Further, the minister announced in October that the government would guarantee up to $1.7 billion in bank deposits with Chilean lenders.
Chile’s robust institutions should offer a strong shield to moderate the adverse effects of the credit crisis. However, the country is affected by the deflation in export-sensitive commodity prices and a decline in regional equity markets given that Chilean pension funds have a significant exposure to international equities.
Mexico
Mexico “is highly exposed to the risks resulting from the financial crisis, given the dependency on the U.S. market for its exports and its strong financial ties,” noted Nora Lustig, a professor at George Washington University and former chief of the Poverty and Inequality Unit at the Inter-American Development Bank.
In response to the crisis, Mexican President Felipe Calderon announced five measures to promote growth and employment: 1) increasing public spending, particularly in infrastructure; 2) streamlining the process for spending these funds; 3) building a new refinery; 4) creating an emergency program to support small and medium businesses; and 5) establishing a new program of deregulating tariffs to make the Mexican productive apparatus more competitive.
Peru
President Alan Garcia has stated that Peru’s economic policies guarantee stable growth despite the international financial crisis. However, in order to guarantee liquidity in the financial market, Peru's central bank decided Oct. 21 to lower deposit requirements for lenders in an effort to keep credit flowing.
Garcia believes that Peru is one of the best positioned markets to bounce back once the storm passes and notes that various reputable organizations, like the International Monetary Fund (IMF), have attested to Peru’s readiness and stability.
“Peru’s economy has the fastest growth rate compared to other countries in Latin America, and this represents a safe and stable environment for the IMF, in order to face this international crisis,” John Lipsky, a first deputy managing director at the IMF, said in a Nov. 5 press release.
Looking Ahead
The financial markets of Latin America are influenced, to varying degrees, by economic and market conditions in other markets. Although economic conditions vary from country to country, investors’ perceptions of the events occurring in one country may substantially affect capital flows into other markets.
As Arthur Levitt, a former chairman of the U.S. Securities and Exchange Commission (who now is a board member at RiskMetrics Group), has stated, “If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere.”
To ensure future economic growth, Latin American countries will have to continue to implement strong governance practices that are supported by strong enforcement policies. Good governance reduces uncertainty and increases public confidence in the securities markets and adds liquidity, which increases the returns for institutional investors. Although the region has adopted some governance reforms, more needs to be done to continue value creation and reduce risk.
New governance initiatives in response to the global crisis will be discussed at the OECD Latin American Roundtable in Mexico City in early December. Among the matters to be discussed include: the recent trend among stock exchanges to demutualize and enhance cross-border trading; enforcement priorities in the region; and the development of a proactive agenda to anticipate risks and overcome obstacles to better governance.
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