Stephany Griffith-Jones outlines Latin American governments' attitudes towards the changing international financial architecture.
Broadly, Latin American governments welcome the large growth of private capital flows that occurred in much of the 1990s, as they see external savings as a complement to domestic savings. They particularly also welcome the contribution that foreign capital can make to the transfer of state-of-the-art technology and management know-how, that is particularly linked with foreign direct investment (FDI).
Having suffered from costly and frequent currency and banking crises, Latin American governments are deeply concerned with volatility and reversibility of private flows. A second concern is the lack of sufficient long-term private flows to finance long-term investments in areas such as infrastructure. A third concern is excessive concentration of those capital flows into the larger, relatively richer Latin American countries.
Though Latin American governments welcome the return of private flows to the region in the wake of the Asian, Russian and Brazilian crises, they are concerned that the scale of private flows now entering the region is insufficient, and their costs are very high. A recent report by the Economic Commission for Latin American and the Caribbean (ECLAC) shows that for the year 2000 (except for FDI, which continues at high levels), for all categories of private capital to Latin America, net flows have still been negative. A further source of concern is the still high cost and short maturities of foreign borrowing, as well as the reportedly weak link between the cost of such borrowing and countries' macro-economic fundamentals.
The main aim of Latin American governments is therefore for a new IFA to be created that will provide sufficient and sufficiently stable private flows to the different economies, and that will prevent costly currency crises, as well as managing them better if they do occur. To put it succinctly, a new IFA should address the two major problems relating to private flows to developing countries: volatility and concentration.
To help facilitate, encourage and sustain private flows, as well as to complement them when there are market gaps or major reversals of flows, Latin American governments stress the importance of large international financial institutions (IMF and development banks) to provide liquidity and development finance, as well as help catalyse private flows.
Progress so far
Latin American governments welcome the progress achieved on reform of the IFA made so far. This includes the approval of new credit IMF lending facilities (such as the supplemental reserve facility (SRF) and the contingency credit line (CCL)) and the expansion of IMF resources; the more preventive focus of IMF surveillance; the special impetus to international efforts to strengthen codes and standards of prudential regulation and supervision, information, as well as in other areas, which should make developing countries less vulnerable to crises; the recognition that capital account liberalisation in developing countries generates risks and must be carefully sequenced. Latin American governments also welcome institutional innovations, such as the creation of the Financial Stability Forum (FSF), to identify vulnerabilities and sources of systemic risk, to fill gaps in regulations and to develop consistent financial regulations. In particular, the larger Latin American governments welcome the creation of the G-20, a body to discuss international financial reform that includes both developed and developing economies.
There are, however, four major concerns from a Latin American perspective about progress on international financial reform. The first is whether the changes made – important as they are – are deep and significant enough to create an international financial system that supports and does not undermine growth and development in the new context of large, but very volatile and concentrated capital flows. More concretely, has enough been done to prevent future crises, and to assure sufficient private flows? For example, Latin American economists and government officials, though welcoming the large financing packages arranged during recent crises, are concerned whether sufficient efforts have been made to provide required international official liquidity in future distress conditions.
A second concern is that the process of reform is asymmetrical; far more progress has been made on measures taken by Latin American countries, which are being asked to introduce a very large number of codes and standards (even though broadly most see this as very positive) and far less progress is being made on equally important and complementary international measures. As Jose Antonio Ocampo, Executive Secretary of ECLAC and former Colombian Finance Minister puts it: “There is a paradox in that the new international financial architecture consists mainly of national measures taken by developing countries.”
As the G-24, the body representing developing countries including Latin American ones, pointed out in its statement at the Annual Meeting in Prague in September 2000, standards in the area of transparency are being pressed upon developing countries to improve information for markets without equal corresponding obligations for disclosure by financial institutions, including highly leveraged ones such as hedge funds who have no reporting obligation. Better information on financial markets would be of great value to policymakers, especially in developing countries. Indeed, it would be interesting to explore further what kind of information would be particularly useful for policymakers of developing countries and how such information can be made readily available to them. Transparency should not be a one-way street. Furthermore, while valuable progress is being made in attempting to improve regulation of domestic financial systems in developing countries, there is painfully slow progress in filling important gaps in international regulation of institutions such as mutual funds or hedge funds, or of modifying regulations, as of banks, where current regulations may have contributed – rather than prevented – greater short-termism of flows. The Basle Accord is being revised, but the changes suggested do not totally overcome the regulatory bias towards short-term lending. Furthermore, they have not yet been implemented, almost four years after the Asian crisis started. Thus in the field of international regulation, progress is very slow, particularly in the field of implementation.
A third concern, which is particularly widespread amongst Latin American governments (even amongst those officials who are otherwise very supportive of the current reforms) is their lack of participation in key policy fora. As one senior official put it: “The architecture is totally irrational in these aspects. Latin American officials (including from systematically important countries) participate in the FSF Working Groups; however, they are excluded from the decision-making forum, the FSF, which is basically a G-7 body. The decisions taken in G-7 or other G-10 fora (such as the Basle Committee) are then communicated via the G-20 to the major LA countries; the IMF – which is a global institution – then encourages and assesses implementation by LA countries of decisions made by the FSF or other G-7 bodies.” This concern would become even stronger, should measures adopted within fora where Latin American governments are excluded become explicitly part not only of IMF surveillance, but also of IMF conditionality. Even those Latin American governments most supportive of the importance of codes and standards stress the need for these to remain as voluntary, and not become part of IMF conditionality.
A final concern of Latin American senior officials is the fear that progress on international financial reform could not only slow down even more, as developing countries recover from recent crises, but that it could be reversed. As Enrique Iglesias, President of the Inter-American Development Bank, put it: “The LA region could become even more vulnerable to crises, if the will to grant large official financial packages, as were granted in recent crises, is absent in practice when the time comes. These packages have been so extraordinarily successful in containing crises and allowing a rapid recovery (as in Mexico and Argentina in 1995 and Brazil in 1998), but, in spite of this, they have lost official support in developed countries in the context of a new doctrine, which wishes to eliminate moral hazard. Our research shows that, at least in our region, there is no evidence that moral hazard is an important factor; for this reason, I dare say that any tendency to diminish official assistance to countries in difficulties would, if it took place, have a negative effect.” The type of reversal of progress achieved that Iglesias and other senior policymakers in Latin America fear would thus relate to the concern that recommendations would be implemented that would scale down lending – and several important functions and facilities of the IMF and World Bank. As Iglesias suggests, recommendations are based on the incorrect diagnosis that government failures (both in developing countries and in the granting of large packages by the IFIs) and, in particular, moral hazard, played a key role in causing recent crises.
Emergency financing in times of crises
From a Latin American perspective, the enhanced provision of emergency financing during crises is one of the pillars of the system to prevent and manage financial crises.
More specifically, Latin American governments welcome both the creation of the SRF and the CCL. The SRF was relatively successfully used in Brazil in 1999, and seems to have contributed to making the Brazilian crisis less deep and less developmentally costly. As regards the latter, Latin American executive directors were very active in the modifications to make the CCL more attractive, announced before the IMF-World Bank 2000 Annual Meeting, so as to encourage countries to start using it.
There are several suggestions by senior Latin American officials on how the CCL could be further improved. The key remaining barriers towards Latin America applying for the CCL seem to be that:
There are several suggestions on how such obstacles could be overcome. Latin American senior officials for example suggest that several countries join at the same time, and that ideally the group of countries that join together first should also include some developed countries (indeed, reportedly countries like New Zealand, Australia and Ireland have been suggested, but as yet with no positive reply). This approach could not only ‘take out the stigma of joining the CCL' but could even make having a CCL similar to joining an elite club. Alternatively, a very interesting suggestion made by Latin American senior officials as well as by others would be to make the CCL far more automatic and widespread; the ‘trauma' of applying could be taken out by granting more or less automatically the right to a CCL to countries that have successfully completed their Article IV consultation, and that have been deemed by the IMF to be following good policies. As a result, many countries would have a right to the CCL, and any possible negative signal of having a CCL would be eliminated. The problem of ‘exit' would also be reduced, as most countries could remain in the CCL.
Though there may not be appetite for further changes of the CCL so soon after the previous revision, this may become urgent if countries continue not to use it. There is a particularly strong case for listening to developing and transition countries' suggestions in the case of CCL. Another reason for further changes of the CCL, if it remains unused, is due to greater emphasis by the World Bank on cyclical and contingent lending, with even the likely creation of a new facility for this purpose. Even though this World Bank lending would provide medium-term support, its disbursement could be linked to the CCL. For this additional reason, it would be important to have an activated CCL.
As regards provision of emergency financing in times of distress, more ambitious proposals have been made by Latin American officials and economists to deal with the issue of scarceness and unreliability of IMF resources during crises, given the large scale of resources required to deal with 21st century-style capital account led crises. Limitations of IMF resources (and the need for packages to be painstakingly and slowly assembled during crises bilaterally with large industrial countries) risk reducing the stabilising effects of rescue packages, as the market may deem that the package will not supply funds in quantities required and promptly enough; this could deepen and/or spread crises unnecessarily. To overcome this, several Latin American economists, as well as the UN Regional Economic Commission for Latin America and the Caribbean, argue that the most appropriate response would be to allow the temporary allocation of Special Drawing Rights (SDRs) to member countries during episodes of world financial stress. These temporary allocations could later be destroyed once conditions normalise, in order to avoid generating permanent liquidity; this would create an anti-cyclical element in world liquidity management.
Latin American governments feel that private capital flows can and should play not only an important, but hopefully a growing, role in international development finance. However, their experience indicates that there are clear and important gaps in private lending and investing in developing countries, which can be only filled by multilateral lending. Brazilian senior officials, drawing on the experience of their recent crisis, particularly stressed “that support by multilateral development banks was fundamental to show markets the strength of the country's position.”
Other market gaps stressed by Latin American officials, where multilateral bank lending could play a valuable role in filling are:
Particularly valuable has been post-crises multilateral lending to help fund social safety nets. The role of development banks in supporting social safety nets should be seen as part of the counter-cyclical role that multilateral institutions are increasingly seen as needing to play; Latin Americans see strong safety nets as particularly essential to manage the social repercussions of crises. The proposed World Bank Committed Loan Facility (CLF), that would be negotiated ex-ante and available to help protect core programs for the poor in times of financial distress or reduced market access, would seem potentially a valuable tool for this purpose. A very positive feature would be its flexibility in terms of the timing of its disbursements as well as the hope for speed of disbursement. It would be particularly useful if the scale of the facility would be fairly significant, given the large needs at times of crises.
Latin American governments stress the central role that multilateral banks can play more broadly in the provision of counter-cyclical financing as a complement to balance of payments financing by the Fund; financing from these banks is the only long-term financing available during crises. At the time of crises, when there is strict credit rationing from private lenders, World Bank lending becomes particularly valuable to middle-income countries, which normally have good access to the markets. The CLF would therefore provide valuable insurance to these countries, which would be cheaper than other insurance mechanisms these countries could use (very high reserves, contingency credit lines from the private sector).
Some Latin American governments point to a difficult dilemma relating to some current practice in multilateral lending. On the one hand, multilateral banks encourage cuts in government spending, so as to ensure smaller fiscal deficits. On the other hand, they promote and support new projects that imply an increase in government spending. (The latter is understandable, given the large needs for investment in the countries, and the difficulty to turn down new and important projects that are additional to those existing in the budget.)
A suggested way forward is the creation by the multilateral banks of new products, for example a credit line that would help to finance fiscal spending as a whole, based on a good programme and broad policies that work well. Latin American government officials stress the need for this support to broad good policies, avoiding excessive or new conditionalities.
Such proposals seem broadly in line with the thinking that is emerging in the Middle Income Task Force at the World Bank, which stresses that in the MICs the most effective way that poverty reduction can be promoted is by providing program loans to support good policies and overall budget priorities.
An additional point stressed by Latin Americans is the value of World Bank guarantees, especially if – as in loans to Argentina and Colombia – they provide additional leverage. A very useful mechanism is that whereby the World Bank guarantees on a rolling basis one-year interest payments for private loans. This lowers the cost of such borrowing for middle-income countries.
Private sector involvement (PSI)
Latin American governments strongly support PSI as a measure to prevent crises through mechanisms such as contingent financing arrangements from commercial banks that can be drawn on in times of difficulty. In fact, both Argentina and Mexico were amongst the first developing countries to arrange such bank contingent financing after the Mexican peso crisis. Mexico used its private contingent loan from the banks during the Asian crisis; however, the use was problematic, as banks claimed the situation in Mexico was not serious enough to justify its activation, and put pressure on Mexico to pre-pay it (partly due to its low cost). Other measures that Latin American countries support in preventive PSI include embedding call options in inter-bank lines to allow for extending maturities and structured bonds linking payment to economic developments (e.g. prices of main exports). However, it seems unlikely that banks and investors will accept such clauses at present; on the contrary they prefer put options, which allow them to demand early pre-payment under certain conditions, e.g. of reduced credit worthiness of the debtor.
Latin American governments are also broadly supportive of measures to ensure private sector involvement during crises, as a way both of ‘burden sharing' costs of such crises and to help reduce the frequency of crises, by discouraging excessive surges. However, Latin American governments are broadly sceptical of ex-ante fixed rules for PSI during crises, preferring a more flexible approach. In particular, they are seriously concerned that any framework designed and measures taken for PSI during crises should not excessively discourage future private flows and/or increase their costs, both to the country taking the measure and to other emerging countries. This is an important consideration especially in the current conjuncture, as all categories of non-FDI net private flows to Latin America remain negative, and conditions of the flows (e.g. maturities and costs of loans and bonds) remain fairly unfavourable. In addition, they should be carefully devised so as to avoid creating further instability, as ‘making it easier for borrowers to prevent the exit of lenders once a crisis is underway is likely also to make investors more sensitive to the possibility of being locked in the event of a crisis, and thus quicker to run in anticipation of one.'
As regards suspension of payments or debt restructuring in serious crises, Latin American governments stress:
Some Latin American governments also stress that the negotiations for restructuring should be carried out just by creditors and debtor governments. They emphasise that the IMF should not put pressure on debtor governments, nor act as some informal umpire for such negotiations. However, the IMF is seen by Latin American governments to play two very valuable roles:
Latin American governments also tend to emphasise ex-ante measures that will facilitate co-operative restructuring of debt, by ex-ante measures to improve communications between debtors and creditors and y the inclusion of collective action clauses (CACs) that help overcome the problem of co-ordination among large numbers of bondholders, in future crises. The Argentinean authorities are the ones that seem most keen to use collective action clauses (Argentina has placed bonds both in London with CACs and in New York without CACs and notes that there is practically no difference in their cost), though even they stress “that international organisations should not force emerging countries to introduce these clauses” for fear that the market could penalise them.
Other Latin American governments have even stronger fears that CACs would make access more expensive. They also argue that the G-7 should start using them first; there seems to be some lack of knowledge (and ignorance of recent developments) in both beliefs. Firstly, there is a great deal of evidence that inclusion or not of CACs does not increase costs. Secondly, even in the New York market, recently creditors have broadened their acceptance of CACs, while in London they have broadly been accepted for some time. Thirdly, G-7 countries have been issuing bonds with CACs for some time, with the UK Treasury even issuing short-term notes with CACs in early 2000 just to set a clear precedent for several emerging economies.
As regards crises prevention, two categories of measures can be distinguished:
Several Latin American authorities attach great relevance to the latter. Thus the IADB President, Enrique Iglesias, emphasises that “it is important that contagion is controlled also in its source, the developed countries, via financial regulation. In particular, via a flexible regulation, that is less tight in difficult times, which could be effective to prevent the spread of contagion.” Arguing along similar lines, the former Governor of the Central Bank of Chile, R. Zahler, wrote that “the institutional framework, including supervision and regulation of financial and assets markets at the international level, is crucial as these markets present a higher degree of imperfections than at the national level – recent experience suggests that these international swings need to be brought under certain control... The biggest challenge appears to be how to improve prudent regulation in the creditor countries, particularly in relation to short-term bank loans as well as on portfolio flows.” Indeed, as mentioned, Latin Americans see that in the preparation of FSAPs on developed countries, it would be very desirable that an important issue to be examined is whether their financial sector contributes to volatility of capital flows to developing countries, and what measures could be taken in the source country to reduce this volatility. They also stress that transparency should not be a one-way street, and that better transparency should also be applied to international financial institutions, with far better and more frequent disclosure on banks' positions, and especially on opaque institutions, exposure, such as that of hedge funds; this would be useful for Latin American policymakers.
As regards crisis prevention measures, at a national level, there are now a number of important areas, including: sound macro-economic policies, appropriate and more prudent policies on liberalisation of the capital account and on regulation of the financial sector.