Why is Latin America still prone to crises?

• Author: Paula De Masi
• Position: IMF Western Hemisphere Department
• Pages: 10

Page 10

With a number of Latin American countries experiencing financial difficulties, and others in outright economic and political crisis, the Bretton Woods Committee hosted a symposium on December 12 to examine turmoil in the region. The policymakers, business leaders, and representatives from the international financial institutions who met at the Inter-American Development Bank exchanged ideas on how economic growth could be restored, democracy preserved, and crises reduced in number and severity.

Enrique Iglesias, President, Inter-American Development Bank, set the stage for the conference with a review of the economic, social, and political turmoil in Latin America over the past year and the lessoften-highlighted bright spots in the region.Many countries had been experiencing weak growth or recession, rising unemployment, increasing poverty, a collapse in capital inflows, and high interest rates and levels of debt-which left little room to pursue countercyclical policies. Nonetheless, others-including Chile, Mexico, and Peru-had been recording moderate growth and were relatively untouched by the problems in the region. Foreign direct investment had also held up relatively well despite financial strains in the region.

Roots of financial crises

Why have the ghosts of crisis and volatility come back to haunt the region? And what policies are needed to put the region back on a more positive course? Harvard University's Ricardo Hausmann stressed that the key to understanding why Latin America is prone to repeated crises relates to sudden drops in capital inflows to the region and the inability of these and other emerging market countries to borrow internationally in their own currency-a condition he has dubbed "original sin."

With accumulated debt denominated in foreign exchange, foreign-currency-denominated liabilities far outweigh assets, so that countries' balance sheets suffer from a serious currency mismatch. Exchange rate depreciations then have seriously negative consequences.

To alleviate these problems, Hausmann proposed creating a synthetic basket currency based on a set of emerging market currencies. The international financial institutions, he suggested, could issue debt in this synthetic currency and offer loans denominated in the local currencies to each of the emerging market countries in the basket. The major industrial nations could also issue debt...