Latin America has endured more financial crises than any other part of the world in the past six decades. It's learned lessons important now for the euro zone, which is coping badly with financial wildfire, The Wall Street Journal reported in an analysis.
Although the two regions have very different levels of wealth, there are important similarities. Financial woes in both regions skip from country to country via trade, finance and group psychology. Many Latin countries tied their currencies tightly to the dollar, leaving their monetary policy in the hands of the Federal Reserve, similar to how euro-zone countries ditched their own currencies in favor of the euro and the European Central Bank.
How to fight a financial crisis that's threatening to spin out of control? The traditional recipe of cutting budgets and slashing social programs to pay down debts, bolstered by International Monetary Fund loans, can work, Latin America's experience shows. Partly that's because the IMF essentially rolls over loans for countries that make progress in meeting the cost-reduction targets. In Europe, it is working with a European fund to craft rescue loans.
When investors abruptly pulled money out of Brazil in 1998, threatening to bankrupt it, the IMF extended a loan that year, one in 2001 and another in 2002. The last IMF loan didn't expire until 2005—giving Brazil seven years to get its affairs in order, avoid default and set it on a path to growth. Even so, countries resist turning to the IMF for loans because it requires big spending cuts and often tighter monetary policy in exchange.
But other Latin American examples also show that default, which euro-zone countries are struggling to avoid, can have a big upside. "Restructuring can be less painful than it appears provided it is done cleanly and quickly," says Harvard economist Ricardo Hausmann, who has long worked on Latin debt problems. "There have been restructurings that have had salutary effects" by reducing debt burdens.
Structuring a deal is tricky. Andrew Powell, a senior researcher at the Inter-American Development Bank, distinguishes between "market friendly" defaults and "aggressive" defaults. Jamaica—the Caribbean is considered part of the Latin American region— this year persuaded more than 99% of creditors to accept a reduced interest rate on its domestic debt and later repayment. That reduced the government's yearly interest payments by about one-third, Mr. Powell estimates. The IMF and multilateral development agencies provided a $2.2 billion loan to support banks, which held much of the debt. The most prominent example of an aggressive default is Argentina, which has been essentially shut out of international financial markets since 2001, when it committed the world's biggest sovereign-debt default, on $95 billion of bonds. In 2005, it crammed down creditors' throats a 70% hit to the debt's face value, and it still has many holdouts who are trying to pressure Buenos Aires into paying more.
The downside: The market-friendly solution didn't reduce Jamaica's overall debt level of 140% of gross domestic product, because the face value of domestic debt wasn't touched and foreign debt wasn't included in the plan. "It gives you time to do the adjustment, but you still have to do it," Mr. Powell says.
The upside: Argentina's debt load shrank by one-third after the default, and it shifted into high growth. Part of the reason for that is the surge in demand for Argentine wheat, meat and other commodities, thanks to China. But partly, it's because the economy's growth wasn't stalled by overly burdensome debt payments. Read more. (Subscription required.)
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