Understanding the Latin American Debt Crisis
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The Latin American debt crisis of the 1980s was triggered when Mexico defaulted on $80 billion of sovereign debt in 1982. Several other Latin American countries also defaulted. The crisis had its roots in the 1970s when high oil prices led to petrodollar recycling, with US banks lending large amounts to Latin American countries. Rising US interest rates in the early 1980s made debt repayments unsustainable as rates Latin American countries had to pay increased. The crisis was addressed through IMF and World Bank led austerity programs and debt restructuring under the Brady Plan and Baker Plan, focusing countries on export-led growth and trade liberalization. Long term impacts included shifts away from import substitution industrialization and a push for greater economic openness across
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Understanding the Latin American Debt Crisis
- 2. 2AN INTERNATIONAL FINANCE (F405) PRESENTATION PREPARED FOR SYEDA MAHRUFA BASHAR ASSISTANT PROFESSOR INSTITUTE OF BUSINESS ADMINISTRATION UNIVERSITY OF DHAKA
- 3. 3THE TEAM GROUP 05, BBA 21st BATCH SHATABDI BISWAS (RH-12) TAUSIF AHMED (ZR-42) MUHTASIM SAROWAT RAYED (ZR-61) SAZID AHMAD (ZR-65) SARWATH HAFIZ MUMU (RH-70) SHARMILI ROWSHON KABIR (RH-30)
- 7. 7 INTRODUCTION BRAZIL ARGENTINA MEXICO THE LOST DECADE Late 70s/Early 80s COUNTRIES AFFECTED 16 Latin American countries and 11 other LDCS DEBT UNSUSTAINABILITY Foreign debt exceeded countries’ earning power
- 8. 8BACKGROUND PETRODOLLAR RECYCLING $0.00 $20.00 $40.00 $60.00 $80.00 $100.00 $120.00 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 CRUDE OIL PRICES, 1970-1981 Nominal Price Inflation Adjusted Price Yom Kippur War- OPEC cuts production Iranian Revolution TWO LARGE OIL PRICE HIKES IN 1970S Created current account surplus in oil exporting countries and current account deficits in many Latin American countries
- 9. 9BACKGROUND PETRODOLLAR RECYCLING US MONEY CENTER BANKS OPEC COUNTRIES DEVELOPED COUNTRIES DEVELOPING COUNTRIES Surplus Funds Sovereign Debt US Money-Center Banks became intermediaries between the two parties Financed sovereign debt in Latin American Countries Provided the oil exporting countries a safe, liquid place to store their surplus funds
- 10. 10BACKGROUND PETRODOLLAR RECYCLING $75 BILLION $12 BILLION $315 BILLION $66 BILLION 1975 1982-83 Latin American External Debt Debt Service Payments 27.02% CAGR 40.63% CAGR
- 11. 11BACKGROUND CRISIS OVERVIEW A Good Illustration of Interdependence between Balance Of Payments And Macroeconomic Indicators Change in Current Account positions lead to rise in sovereign debt Shifting global fortunes lead to changes in interest rates and inflation These changes negatively impacted the debt sustainability of Latin American countries
- 13. 13ECONOMIC REASONS FOR LATIN AMERICAN SOVEREIGN DEBT TO ENHANCE ECONOMIC STABILITY AND REDUCE POVERTY average real GDP growth 6% during 1970s and 4-5% in early 1980s FAVORABLE LOAN TERMS Collateral free with near zero interest rates Loan roll over when principal was due WHITE ELEPHANT PROJECTS Appeased interest groups but did little for the economy TO KEEP UP WITH HIGHER OIL PAYMENTS After the two price hikes
- 14. 14FINANCIAL REASONS WHY US BANKS INVESTED IN LATIN AMERICAN DEBT INFLUX OF NEW FUNDS FROM OIL EXPORTERS INTERNATIONAL EXPANSION OF BANKING SERVICES GROWTH OF EURODOLLAR MARKET GAVE GREATER ACCESS TO FUNDS
- 15. 15FINANCIAL REASONS OVEREXPOSURE TO LATIN AMERICAN DEBT 1977 1978 1979 1980 1981 1982 1983 1984 1985 $32 BILLION $36 BILLION $40 BILLION $44 BILLION $54 BILLION $55 BILLION $56 BILLION $59 BILLION $58 BILLION In the 70s, over 50% of money center banks’ paper profits came from Latin American sovereign debt Loan capital coefficient of 180%
- 16. 16ECONOMIC REASONS WHY THE DEBT SITUATION WORSENED US INTEREST RATE HIKE TO CURB INFLATION In July 1980, federal funds rate increased from 10% to near 20% This trigged global recession DEBT SERVICING PAYMENTS GREW SIGNIFICANTLY Loans were tied to LIBOR, which rose with US interest rates LESSER DEMAND FOR LATIN AMERICAN EXPORTS Slower world economy lead to worse ‘terms of trade’ for Latin American countries
- 17. 17FINANCIAL REASONS WHY THE DEBT SITUATION WORSENED WORSENING CURRENT ACCOUNT DEFICIT DUE TO FALL IN EXPORT This depleted foreign exchange reserves BANKS WERE NOW LESS KEEN ON LATIN AMERICAN DEBT Domestic investments were now safer and more profitable T-bill yields were close to 16% MASSIVE CAPITAL FLIGHT Private individuals and entities funneled money out of Latin American countries FEWER EXTENSIONS WITH SHORTER PAYMENT PERIODS Eventually, when Mexico asked for another extension, the banks refused.
- 18. 18THE TRIGGER POINT HOW THE CRISIS CAME TO BE In August 1982, Mexico defaulted on its sovereign debt, which at that point totaled $80 BILLION
- 19. 19 OTHER LATIN COUNTRIES ALSO DECLARED LOAN DEFAULT THREAT OF US BANKS’ BANKRUPTCY Overexposure to Latin American debt threatened global financial collapse THE TRIGGER POINT THE IMMEDIATE FALLOUT
- 21. 21 SHORT TERM IMPACT DECREASE IN INCOME AND STANDARD OF LIVING Real wage dropped by 20-40% in the ten years following the crisis LACK OF INVESTMENT ON INFRASTRUCTURE Funds were now diverted to paying off debt service payments and supporting export-led industries FINANCIERS BECAME MORE CAUTIOUS ABOUT LENDING TO LDCS HIKE IN INTEREST RATES FOR LDC SOVEREIGN DEBT Interest rates for poor countries were 4 times higher than rich countries More focus on credit ratings and international exchange rate movements
- 23. 23 1982-84 1985-89 1989- 1996 IMF AUSTERITY Rescheduling and New Lending BAKER PLAN New lending ; pro-growth BRADY PLAN Debt Reduction HIPC Debt Reduction CONTROL MEASURES 4 STAGES OF ADJUSTMENT Brady and Baker Plans were most effective
- 24. 24CONTROL MEASURES BAKER PLAN . Loans were provided to cover interest payments. Some of the strings attached included: PRIVATISATION OF STATE ENTERPRISES END OF GOVERNMENT SUBSIDIES OPENING ECONOMY TO FDI These loans were provided to 15 debtors and comprised 20% of all World Bank Debt
- 25. 25CONTROL MEASURES BRADY PLAN COLLATERIZATION OF SOVEREIGN DEBT Brady bonds shifted debt burden from the government to the taxpayers DEBT FORGIVENESS 80s’ boom refinanced the US banks, who were now better equipped to absorb loss from sovereign debt
- 26. 26CONTROL MEASURES OTHER MEASURES DEBT-EQUITY SWAPS Chile and Mexico used asset to offset debt. The lender acquired a tangible asset a discounted price DEBT-FOR-NATURE SWAPS Government exchanged development rights of environmentally valuable lands for debt forgiveness JUBILEE 2000 An international coalition movement that aimed to relieve LDC debt by 2000
- 28. 28 LONG TERM IMPACT 1982 DEBT CRISIS SHIFT FROM IMPORT SUBSTITUION INDUSTRIALISATION TO EXPORT LED INDUSTRIALIZATION The latter was heavily encouraged by IMF and often a condition of the debt rescue loans 1982- 1985
- 29. 29 LONG TERM IMPACT NAFTA was established in 1994, encouraging MNCs to set up production in countries like Mexico PUSH FOR TRADE LIBERALIZATION1986- 1994 1990s HOLLOWING OUT EFFECT US manufacturing sector suffered as firms located overseas Mexican workers eventually lost out to cheaper Asian labor
- 30. 30 LONG TERM IMPACT 2000s Greater focus on free trade lead to rise of emerging markets like BRICS countries THE COMMODITY BOOM China in particular contributed to the rising demand for commodities
- 32. 32 OUR TAKEWAYS INTERDEPENDENCE BETWEEN BOP AND MACROECONOMIC FACTORS Feedback loop between current account positions, sovereign debt, interest rates and inflation THE CRISIS EXACERBATED DUE TO OVEREXPOSURE Overexposure to specific loan markets should be avoided Due diligence must be done to determine debt sustainability Heavy indebtedness (especially from short term debt) signals that the country may be unable to pay it back
- 33. 33 OUR TAKEWAYS A BLUEPRINT FOR DEALING WITH FINANCIAL CRISES Many of the methods employed, such as slashing short term interest rates, austerity and debt collateralization, were later used to deal with the 07/08 credit crisis CONTRIBUTION TO TRADE LIBERALIZATION Debt rescue and rescheduling efforts by IMF and World Bank allowed more influence on national trade and development policies Facilitated globalization but at the expense of many stakeholders
- 34. 34 THANK YOU!