1980s Latin America Debt Crisis - Essay Example

Latin American countries followed a heavy reliance on debt finance. First, increases in foreign debt in these countries were higher than the revenuesthey had derived from their annual exports. In 1976, Mexico exported oil which paved the way for excess imports since cheap loans can be readily tapped. Brazil implemented a program of industrial expansion. Argentina and Chile established an overvalued exchange rate policy as an integral part of anti-inflationary strategy. Diverse government policies led these Latin American countries to defective exchange rate policies and excessive dependence on external capital flows. Another factor for the persistent debt problem was the fact that state enterprises became the conduit for absorbing external resources. The government guarantee provided for foreign denominated loans was attractive to external lenders who had no information on the real risk profile of the debtors. Public enterprises implemented programs of investment which guaranteed direct control over the foreign exchange proceeds to the national government. (Wesson, 9) In the years after 1983, these countries suffered from capital outflows and from the persistent slide in primary commodity prices. From 1983 up to 1986, Latin American terms of trade declined by 15 percent. Increased exports were negatively affected by falling prices. Countries. Argentina and Peru were especially hard hit. Mexico went into crisis due to falling oil prices in 1986. The lingering imbalance in the U.S. balance of payments contributed to the disadvantage of Latin America. The United States buys manufactured imports from Asian Countries (NICs) while shutting off capital flows from Latin American countries. Japanese and European surpluses were sent to the United States to get higher rates of investment. Economic growth in Latin America was supported by an import-substitution industrialization which protected the domestic industrial economy by means of high tariffs, import duties, and government subsidies. The initial arrangement benefited the economy but by the late 1960s, it was beginning to negatively affect agriculture which provides the needed foreign exchange. The industry had expensive domestic inputs that resulted in making major Mexican agricultural exports uncompetitive. Government policies which controlled domestic food prices also discouraged the increase of food production. As the population increased, consumption rose, reducing the amount of food available for export. It became necessary either to generate more resources to satisfy the demands of the population, or to control or decrease such demands without undermining the peace of the ruling party. By 1970, Lus Echeverra Alvarez, was elected president. He implemented the policy of stabilizing development. Stabilizing development is the economic strategy which emphasized growth over equity. The assumption had been that these resources would trickle down to the poor. The Echeverra administration opted for a strategy of shared development. This policy would emphasize equity and growth by policies that channel a greater share of economic gains to Mexico's lower classes. Echeverra encouraged more aggressive trade unions and he rued that foreign investors and domestic businessmen for exploiting the country. As conflict increased and confidence in the administration's policies declined, capital flight began. The government was forced to devalue the Mexican peso twice. Echeverra's anger and dismay led him to expropriate vast tracts of private agricultural land to give them to landless peasants. The president's attempt to spend his way into growth and equity had clearly failed by 1976, when Jos Lpez Portillo succeeded him. Portillo assumed a conciliatory approach in the face of problems. He then decided to secure foreign funding using the vast petroleum reserves of Mexico. Finally, commercial bankers were lining up to lend Mexico money in an attempt to reinvest billions of petrodollars that Arab governments had placed on deposit. Investments were made in major infrastructure. The economy boomed, and there was considerable spending in education and health. The increase in available resources also resulted in an increase in waste and corruption. Mexico had traditionally relied on low interest, long term official loans from International organizations for its economic development effort. This changed in the 1970s when Commercial Banks from the More Developed Countries recycled the Oil Exporting Countries' Deposits (Petrodollars). The US banks such as Citibank and Bank of America pursued an aggressive policy of lending abroad. Mexico, which had just announced discoveries of large amounts of Oil reserves, became an attractive place to make loans. Although these loans were short term and their interest was LIBOR rate linked, Mexican borrowers were eager to accept. The Mexican borrowers consisted of public and private firms, and Commercial Banks. Parastatals such as PEMEX (Mexican Petroleum) and CFE (Federal Electricity Commission) were the biggest borrowers. Parastatales secured short term lending to finance investments whose maturities were in the long term. Grupo Alpha, a private company had borrowed short term to finance long term investments. Local commercial banks such as BANCOMER and BANAMEX sought funds internationally and lent locally. As the debt crisis unfolded, the overvalued peso and the high US interest rates made the dollar a better investment. Hence, Mexicans accumulated properties in the US, and deposited their liquid assets in the US banks as a way to hedge a forecasted devaluation of the Mexican peso. (Carreno 1) Within the time frame that its short term loans were, Mexico had used up all its international reserves. The country was in a liquidity crisis by August 1982. Mexico's foreign debt reached $85 billion. Lopez Portillo reacted to the crisis by blaming the commercial banks and causing the Mexican financial crisis. Thus, he nationalized them. Mexico sought assistance from the International Monetary Fund to meet their financial obligations towards their external creditors. The IMF applied a demand reduction stabilization policy. In addition, the World Bank recommended structural in the form of privatization. This strategy will open industries to private local and foreign entrepreneurs. Mexico made assets available to local and foreign private investment. (Carreno, 1) The objective of International Monetary Fund (IMF) austerity programs was the full and prompt interest payments on the $360 billion dollars of loans outstanding to Latin countries. Approximately 70 percent of this debt is due from Mexico, Argentina, and Brazil alone. The IMF is motivated by this fact: excessive government intervention in third world economies was the main culprit of their financial difficulties. Government intervention had suppressed the workings of the free market forces and made these economies inefficient and uncompetitive on the world market. The austerity programs involved the elimination of public enterprises, the reduction of government subsidies and deficit spending, and, the freeing of prices and exchange rates. (Pollin and Zepeda, 1) By 1984, all three major debtors chalked up huge trade surpluses, but these were achieved by forcing down aggregate purchasing power and hence the demand for imports. The costs incurred in attaining the trade surpluses were so great that the impact of austerity was toweaken these countries' capacity to service their loan. The general IMF perspective is that these policies had clamped down the purchasing power of all sectors of the economy. When the purchasing power drops, the demand for imports declines. These policies sought to generate falling prices for domestic products in order to make them more competitive as exports on the world market. With exports rising and imports falling, the IMF program cured a country's trade balance by substituting government for private enterprise and allowing mass living standards to drop. (Pollin and Zepedo, 1) These IMF interventions achieved only limited success. The Latin economies were privatized and living standards did fall. For the period 1981-84 real wages fell by 28 percent in Mexico and 43 percent in Brazil. Government deficits and consumption per capita declined progressively. These changes produced a massive drop in imports, a fall of 53 percent in Mexico, 37 percent in Brazil and 51 percent in Argentina between 1981 and 1984. Exports were less responsive to the austerity treatment. In Argentina, exports lowered by 11 percent; Mexico and Brazil increased exports by 21 percent and 16 percent,respectively. The severe reductions caused a degree of havoc on the domestic markets. The IMF argued that domestic firms adopt an export orientation after the public sector contracts. But this policy does not take into account the reality that getting export markets required time and promotional effort. The result was that Latin firms weak markets as consequence of severe government cutbacks. Total investment in the region plummeted by 44 percent in Mexico, 37 percent in Argentina, and 17 percent in Brazil between 1981 and 1984. Persistent and acute inflationary pressures were obtained through the successive currency devaluations and the elimination of price controls and government subsidies. In 1981-84, average annual inflation rates were 667 percent in Mexico, 362 percent in Argentina and 141 percent in Brazil. The economic crisis fostered social unrest and discontent, hence destroying investment opportunities. Capital flight from Mexico, Brazil, and Argentina between 1981 and 1984 peaked at around $60 billion, accounting for 60 percent of the increase in these countries' foreign debt over these years. (Pollin and Zepeda, 1) The IMF programs in the Latin American were a failure since it did not achieve the financial stabilization and enhanced debt-servicing capacity which it had initially tried to attain. What had actually occurred was a vicious cycle in which the Latin American debtor countries would accept the IMF program, fall out of compliance, then return again, only to fail eventually in meeting the IMF's demands. Latin American countries which financed their economic development with large amounts of short term capital and are placed in an international financial illiquidity position should be prepared for an imposed restructuring of their economies. Given the huge foreign debt crisis, the Latin economies must indeed be fully restructured. These countries need to undertake more equitable and democratic development paths, and to implement policies which are less tied to foreign loans and less vulnerable to external economic shocks. References Carreno, Eufronio. Latin America's 1980's and Asia's 1990's Debt Crisis: A Comparison. MACLAS Latin American Essays. 2001. Page Number: 91. Carreno, Eufronio R. "Mexico: The Debt That Did Not Need To Exist." Latin American Essays, Vol. I (1989), 119-134. Pollin, Robert and Eduardo Zepeda. Choices Ahead. Monthly Review. Volume: 38. February 1987. Page Number: 1. Wesson, Robert. Coping with the Latin American Debt. New York: Praeger Publishers, 1988. Read More