F REIGN TRADE - 中国国际贸易促进委员会

INVESTMENT
Latin America Lessons for Euro zone
to Avoid Lost Decade
By Komal Sri-Kumar
Despite a €110bn bail-out programme that the European
Union and the International Monetary Fund
arranged in early May, Greek debt yields remain
elevated. Ten-year Greek debt yielded around 11.5
per cent on December 13, 2010, 8.5 percentage points over
comparable German obligations.
The Greek bail-out has been followed by a surge in
yields on Irish, Portuguese and Spanish debt as investors
shunned those obligations as well. In understanding this “debt
contagion,” it is useful to examine the characteristics of the
region’s debt crisis, as well as compare it with the experience
of Latin American economies through most of the 1980s.
Today, many of the once debt-ridden countries such as Brazil
are growing rapidly, have ample foreign exchange reserves,
and have become significant creditors to other countries.
How did this transformation occur?
The euphoria following the formation of the euro zone
led some lenders to believe that there was no greater sovereign
risk in Greece than in Germany, significantly increasing
exposure to the weaker economies. Similarly, in the 1970s,
foreign banks believed global capital market integration had
eliminated Latin American country risk. Symptomatic of the
era was the oft-quoted statement by the then chairman of
Citicorp, Walter Wriston: “Countries don’t go bust.”
I followed the situation closely as a country risk analyst
as loans made at f loating interest
rates became unserviceable after
global interest rates doubled after
1979. In August 1982, Mexico was
the first to declare that it could not
make principal and interest payments
as scheduled. Brazil, Argentina and
most of the region followed. The
IMF and the US Treasury attempted
to defuse the debt contagion by imposing
austerity and adding to the
countries’ debt. However, the situation
worsened with sharp devaluations
and a deep recession. The ratio
of Mexico’s net public debt to GDP
surged from 34 per cent in 1981 to
81 per cent by 1986.
The situation started to improve
only when Nicholas Brady, US
Treasury Secretary, offered a plan in
March 1989 for creditors to accept
“haircuts”, either through a principal
reduction but maintaining market
interest rates, or by keeping the face value of the loans but
substantially lowering interest rates. Mexico repaid the “Brady
Bonds” in full in 2003, some 15 years ahead of schedule.
The Latin American crisis was a solvency issue rather
than a liquidity issue. A significant portion of the loans the
nations received in the 1970s was used to finance wasteful
consumption, or eventually landed in Miami and New York
based banks due to capital flight. They were no longer available
to service debt. We also learned that these countries
could not generate sustainable economic growth, or create
jobs, until the debt levels were reduced.
Both these conclusions are relevant to resolving problems
that southern Europe and Ireland face today, and call
for a similar programme to reduce the level of debt. Irish real
estate developers borrowed at low interest rates because of the
perception that euro zone membership eliminated risk of default.
The developers, and the Irish banks which lent to them,
can no longer service debt since building values have crashed.
With Ireland due to pay a relatively high average interest rate
of 5.8 per cent on the new funds, its debt is projected to rise
from 99 per cent of GDP this year, to 108 per cent in 2013.
The budget measures will likely lead to negative growth in
2011 following three successive years of GDP declines.
In the case of Greece, the €110bn programme announced
in May requires it to lower the public sector budget
deficit from over 15 per cent of GDP in 2009 to less than 9
per cent this year. The unemployment rate will rise to almost
15 per cent by 2012 according to the IMF, and could eventually
jump to 20 per cent.
The Latin American experience also suggests that
there will be adverse implications for
European debt and equity markets.
The deterioration in debt ratios will
discourage voluntary lending to the affected
euro zone countries and, in the
absence of functioning capital markets,
those governments will become
permanent supplicants for official aid.
Poor economic growth prospects will
dampen equity market performance as
well since an increasing percentage of
savings will be destined toward debt
service rather than domestic investments.
The vicious cycle of austerity,
declining GDP and worsening debt
ratios means that there will be no selfcorrecting
cure for the malaise in debt
and equity markets.
In the absence of debt reduction,
the 2010s could become a “lost
decade” for some euro zone countries,
much as the 1980s turned out to be for
Latin America. (Financial Times)
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