Economics Update (July-December 1996)

Calvo Says Recent Lessons Yield
Positive Latin Outlook

Guillermo Calvo is a Distinguished University Professor, Department of Economics, and Director of the Center for International Economics at the University of Maryland. As senior advisor, research department at the International Monetary Fund (IMF) between 1988-94, Calvo was one of the few to sound the alarm about a looming Latin American meltdown before the peso crisis. He offered these comments to a gathering of Atlanta Fed directors and local business and community leaders.

ptimistic. That's how Guillermo Calvo described his views on the future of Latin America. Calvo, a veritable "voice in the wilderness" regarding Latin America in the years before the Mexican peso crisis, was one of the few sounding the alarm—even amid the euphoria about surging capital inflows into many Latin countries following the "lost decade" of the less developed countries (LDC) debt crisis.

Calvo's upbeat assessment is primarily based on what he described as a fuller understanding of the dynamics that led to the peso crisis and the ensuing fears of a similar crisis that spread to other Latin American countries, like Argentina.

Guillermo Calvo, Director of the
Center for International Economics at the University of Maryland
Understanding the problem

What were the dynamics? In Calvo's view, the economic crisis experienced in Latin America was the result of a combination of external and financial factors. He argued that contrary to conventional wisdom, these were the elements that proved so deadly in the end, not mismanagement of public policy. Indeed, Calvo pointed out, this "traditional" view created a misguided sense of complacency in both policymakers and investors. He was also quick to note that by 1989 most Latin countries had enacted macroeconomic reform programs. And, because of reform, most Latin leaders believed that the capital inflows were primarily a response to shifts in policy.

While Calvo didn't deny the importance of the macroeconomic reforms, he said research indicates that adverse economic conditions in the advanced economies—which were accompanied by low interest rates—made relative interest rates in the Latin economies much more attractive to international investors. Calvo noted that these external economic and interest rate factors accounted for as much as 50 percent of the foreign money flowing into Latin America between 1989 and 1992.

However, the underlying economic situation in many of the Latin countries at this time remained remarkably similar to the circumstances that preceded the Mexican economic crisis of the early 1980s. Capital proved to be highly mobile. When U.S. interest rates did begin to rise, capital flowed out of the Latin economies just as quickly as it had flowed in.

Mixed national assessments

In an overview of the region's major economies, Calvo characterized Mexico as still vulnerable even though the peso has been stable for most of this year and credit and investment portfolios are again rising. Argentina's debt level is a concern to Calvo, despite what he described as a strong and liquid banking industry. He also argued that the single biggest risk for Argentina is Brazil. Calvo noted that Brazil attracts 35 percent of Argentina's exports, and adverse domestic economic developments in Brazil could prove harmful to the Argentinean economy. Accentuating the point, Calvo mentioned that Brazil's short-term debt levels are currently in excess of reserves. On the upside, he noted that much of this short-term debt is in the form of domestic assets. In his view, though, Brazil has proven it can live with high inflation. Calvo described the Peruvian economy as having few problems, despite a large current account deficit. And he suggested that Chile was relatively problem-free, regardless of recent public-sector strikes.

Policy prescriptions

Calvo laid out several policy prescriptions that he thinks would help strengthen the basis for optimism regarding the Latin economies. "It's time to clean up the banking industry," he argued, particularly in terms of continuing solvency questions and regulatory issues. He also suggested that the Latin countries should lengthen their debt maturities. "Once you're in the trap of short-term debt, even going to the markets to restructure can raise questions and concerns," he observed. However, Calvo noted that this maturity-lengthening process will likely take some time to accomplish.

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