Latin
American Soverign Debt-crisis ( 1982-1989)
Period also referred as lost decade “many
Latin American countries became unable to pay their foreign debt.”
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The Origins of the Debt
Crisis-
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During
the 1970s, two large oil price shocks created current account deficits in many
Latin American countries. At the same time, these shocks created current
account surpluses among oil-exporting countries.
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With
the encouragement of the US government, large US money-center banks were
willing intermediaries between the two groups, providing the exporting
countries with a safe, liquid place for their funds and then lending those
funds to Latin America.
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Latin
American borrowing from US commercial banks and other creditors increased
dramatically during the 1970s. At the end of 1970, total outstanding debt- $29
billion, 1978- $159 billion and 1982- $327 billion.
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The
nine largest US money-center banks held Latin American debt amounting to 176
percent of their capital; total less-developed country (LDC) debt was nearly
290 percent of capital.
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Initially,
the near-zero real rates of interest on short-term loans along with world
economic expansion made this situation acceptable in the early part of the
1970s.
o
By
late in the decade, however, the priority of the industrialized world was
lowering inflation by tightening of monetary policy in the United States and Europe.
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Nominal
interest rates rose globally, and in 1981 the world economy entered a
recession.
o
Commercial
banks began to shorten re-payment periods and charge higher interest rates for
loans. The Latin American countries soon found their debt burdens
unsustainable.
o
August 1982, when Mexican Finance Minister informed the Federal Reserve chairman, the
US Treasury secretary, and the International Monetary Fund (IMF) managing
director that Mexico would no longer be able to service its debt, which at that
point totaled $80 billion. Other
countries quickly followed suit. Ultimately, sixteen Latin American countries rescheduled their debts, as well
as eleven LDCs in other parts of the
world.
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In
response, many banks stopped new overseas lending and tried to collect on and
restructure existing loan portfolios. The abrupt cut-off in bank financing
plunged many Latin American countries into deep recession and laid bare the shortcomings of previous economic policies
based on “high domestic consumption, heavy borrowing from abroad, unsustainable
currency levels, and excessive intervention by government into the economy”.
o IMF and Central Bank Involvement- In August,
the Fed convened an emergency meeting of central bankers from around the world
to provide a bridge loan to Mexico. Fed officials also encouraged US banks to
participate in a program to reschedule Mexico’s loans.
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As
the crisis spread beyond Mexico, the United States took the lead in organizing
an “international lender of last resort,” a cooperative rescue effort among commercial
banks, central banks, and the IMF. Under the program-
§ Commercial banks agreed to restructure
the countries’ debt,
§ IMF and other official agencies lent the LDCs sufficient funds to pay the interest, but not principal,
on their loans. In return, the LDCs
agreed to undertake structural reforms of their economies and to eliminate
budget deficits.
§ The hope was that these reforms would enable the LDCs to increase exports and generate the trade
surpluses and dollars necessary to pay down their external debt.
o
Although
this program prevented an immediate crisis, it allowed the problem to fester. As,
many LDC countries, instead of eliminating subsidies to state-owned
enterprises, instead cut spending on infrastructure, health, and education, and
froze wages or laid off state employees. The result was high unemployment,
steep declines in per capita income, and stagnant or negative growth—hence the
term the “lost decade”.
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US
banking regulators allowed lenders to delay recognizing the full extent of the
losses on LDC lending in their loan loss provisions. This forbearance reflected
a belief that had the losses been fully recognized, the banks would have been
deemed insolvent and faced increased funding costs.
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After
several years of negotiations with the debtor countries, however, it became
clear that most of the loans would not be repaid, and banks began to establish
loan loss provisions for their LDC debt. The first was Citibank, which in 1987
established a $3.3 billion loss provision, more than 30 percent of its total
LDC exposure. Other banks quickly followed Citibank’s.
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By
1989, it was also clear to the US
government that the debtor nations could not repay their loans, at least not
while also rekindling economic growth.
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Secretary
of the Treasury Nicholas Brady thus proposed a plan that established permanent reductions in loan principal and
existing debt-servicing obligations.
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Between
1989 and 1994, private lenders forgave $61 billion in loans, about one third of the total outstanding
debt. In exchange, the eighteen countries that signed on to the Brady plan
agreed to domestic economic reforms that would enable them to service their
remaining debt.
