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Economic reform in Latin America.

AN INCREASING number of the Latin American economies are poised for a period of sustained economic expansion. The worst of the debt crisis has passed. Economic restructuring and reform are in place. The benefits are beginning to show in the quickening pace of economic activity. In several respects, the recent success of Latin American reforms serves as a model for other countries undergoing restructuring.

Technological changes over the past few decades have enabled countries to use their resources more productively than ever before. Economic interdependence has increased due to the revolution in information and communications technology and to the global swing towards deregulation and' privatization of markets. Sustained economic expansion requires greater adherence to consistent policies, more coordinated among countries. "Go it alone" policies have resulted in relative economic decline.

This became clear during the 1980s when Latin America fell from 8 percent of world GDP to 7 percent while the world economy experienced steady expansion.

Latin America fell into heavy debt during the late 1970s and early 1980s. The debt crisis has governed its economic options. Significant reforms have been undertaken to redirect economies and catch up in the 1990s. The criteria for raising the development financing needed have tightened considerably. Capital market support for Latin American development will be tested in the next few years as the rising expectations of the region require increased domestic and international funding. A possible resuit will be higher long-term interest rates than the weakened state of the world economy requires to sustain recovery in the years ahead.


The decades of the 1960s and 1970s saw real annual economic growth averaging 6.0 percent in Latin America. Inflation ran between 30-45 percent per year. However, during the 1980s growth averaged barely 1 percent while inflation soared toward 300 percent per year. In contrast, worldwide growth in the 1980s averaged 3 percent with 5 percent inflation. While the U.S. and Europe averaged a 2 percent annual growth in GDP per capita and Japan a 3.5 percent rise, Latin American per capita income declined an average 1.2 percent per year during the 1980s. What happened?

Several studies have interpreted the evolution of economic events in Latin America.(1) All the economies have huge income inequalities that have led to significant political repercussions. Heavy public spending programs have meant sizeable government budget deficits, which have approached 50 percent of GNP in some countries, induding Argentina, Brazil and Mexico. The deregulation and liberalization of world financial markets and the OPEC price shocks in the 1970s resulted in a rapid expansion of bank lending to Latin America. At the same time, export revenues soared. As long as real interest rates on the debt remained below the growth of real exports, the debt-export ratios were manageable and the borrowing could continue.

At the end of the 1970s both the period of strong export growth and low interest rates came to an abrupt end. Funds could no longer be obtained to service debt without sharply increasing debt-export ratios. As creditworthiness deteriorated, foreign borrowing all but ceased. Increasingly, debt servicing had to come from domestic resources, which contributed to an enormous capital flight. Net inflows of foreign capital during the 1970s turned into net outflows during the 1980s.

Foreign borrowing had permitted short-term financing for burgeoning fiscal deficits without leading to severe inflation. Most of the borrowing, however, went for current consumption rather than for investment projects. Once the net capital inflow ceased, governments were obliged to make net payments abroad. Inflation soared as governments neither reduced their spending nor raised revenue to pay the bills. Therefore, the debt crisis had its origin in a combination of debtors' policy actions and external macroeconomic shocks, in conjunction with the burst of bank lending during 1979-81.

A common pattern of policy responses emerged in most countries: large budget deficits; overvalued exchange rates; trade policies biased against exports; and domestic policies biased against the agricultural sector. These provoked severe crises in most countries when combined with rising world interest rates to combat inflation, a rapidly strengthening dollar, and commodity price collapses during the 1980s. The crises were exacerbated by commercial bank lending, especially in 1979-81, followed by the cessation of new credits in early 1982. The inward direction of economic policies led to serious inefficiencies in the manufacturing sector, and therefore reduced future export opportunities.

The mounting financial problems created by the debt and the subsequent adjustment it forced upon the indebted countries resulted in a further reduction of investment levels. Table 2 shows that gross domestic investment fell from 30 percent of Latin American GDP in 1981 to 19 percent during 1990. The result was a sharp setback to living standards. During the 1980s, most of the industrialized world was abandoning policies leading to protectionism, multiple exchange rates, and savings disincentives caused by high inflation rates and negative real interest rates.


The adjustment process began on a broad scale in 1982 when external financing ended. International events clashed more and more with domestic policies, raising the need for pervasive economic restructuring and reforms. Generally, reforms were aimed at correcting macroeconomic disequilibria as well as the numerous product and factor market distortions. The reform process will take time to generate sustained improvements. A permanent change in the economic structure is necessary; otherwise Latin America will fall further behind the rest of the world economy.

Modernization and the sale of public enterprises are the core of policies to develop an efficient private sector. A shift toward a market economy emphasizes export expansion and requires: (1) a reduction of debt to manageable levels; (2) a realistic and unified exchange rate; (3) investment in the export-oriented industries; and (4) an array of financial incentives for exporters, perhaps including temporary subsidies and credit allocations.

After a decade of declining investment levels, Latin America urgently needs to revive and enhance its productive capacity to reach rising world standards. The Enterprise for the Americas Initiative includes an important component to support investment reforms through technical advice and financial support. Several countries have implemented investment reforms resulting from the Initiative. The reforms in place seek to open up closed markets and reduce tariffs and nontariff barriers. The tough economic medicine has voter support so far, even though public sector layoffs, a steep drop in real incomes and less public spending on social needs have been a result. All of Latin America except for Cuba has democratically elected governments and enlightened leadership.

Negotiations to reduce foreign debt have been successful in several countries, notably Mexico, and are continuing in others. Reforms continue to show progress. Mexican tariffs now average 10 percent vs. 16.4 percent in 1982. The government budget deficit has fallen to 6 percent of gross domestic product from 16 percent in 1982. Paperwork for foreign investment transactions has been reduced.

Chile got an earlier start on its debt-reduction and economic reform programs. Debt swaps through the sale of state companies paid off $10 billion in foreign commercial bank debt. Everything is for sale except the profitable state-owned copper company. The social security system is privately managed. Foreign investment amounted to $1.1 billion in 1990 and again in 1991, close to 13 percent of GDP. This investment is partly a result of new legislation gnaranteeing profit remittances and protecting investments.

Brazil is cutting tariffs in stages from 100 percent or more in 1990 to a maximum of 40 percent on some imports and zero for many by 1994. Import restrictions on chemicals and computer equipment are being liberalized.

Argentina, while modifying its reform programs numerous times, has remained on course toward total privatization or liquidation of state-owned companies. Numerous regulations have been eliminated by executive order.

One important outcome of successful restructuring and reform efforts will be to establish a basis for an Americas trading bloc, bigger in economic potential than either the European or Pacific groups being established. Even the proposed North America bloc will exceed the European Community with 360 million people and $5.9 trillion in GNP, compared to 325 million people and $4.4 trillion in GNP for the EC as presently constituted.


There is considerable evidence that the reform process is beginning to yield results. Inflation rates are declining, receptivity to foreign investment is improving and the role of the state in the economies is declining. Occasionally two steps forward lead to one step backward in response to the pain of shock therapy. But the thrust is inevitably forward.

The private sector became a net importer of capital in 1990 after experiencing net capital outflows for most of the 1980s. Inflows rose from $4 billion in 1980 to $14 billion in 1990. However, hot money inflows can easily be withdrawn if governments falter in their efforts to restructure and reform their economies. A greater challenge will be to stimulate stable equity investments in the region. It is relatively easy to float a high-yield bond issue when yields outside Latin America are declining. The challenge is greater on the equity side where there is a substantial and growing unfulfilled demand for financial support.

The role of banks is now far different than in the late 1970s and early 1980s when loans were issued directly to Latin America. The U.S. in the 1960s, OPEC in the 1970s and Japan in the 1980s had deep pockets. Now banking difficulties in the U.S. and Japan, and the demise of OPEC have reduced the banks' abilities to fund development. Lending by the international banking system declined by $5 billion in the second quarter of 1991, the first net fall in lending since records were kept in the mid1970s. The largest area of dedine was lending by the Japanese banks. The slowing in lending spread to all financial centers during the spring, reflected in the overall dedine in the mount of credit intermediated by the banking system. There is a welcome change in bank strategy away from balance sheet growth towards asset quality, prompted by the Basle guidelines on international bank capital adequacy. With a greater focus on return on assets, banks are serving more as intermediaries in the region, arranging financing deals, acting more like investment banks.

Table 3 indicates that creditworthiness measures are improving in Latin America. Debt service payments as a percent of exports are declining as world interest rates decline and debt is written down or converted to equity and other assets. Argentina is the notable exception. Liquidity ratios, measured by foreign exchange reserves relative to market borrowing requirements, have also been improving. Nearly a decade after the debt crisis enveloped the region, the ability to tap international capital markets is reviving. Since mid-1991 several countries, including some yet to restore normal relations with their bank creditors, have been able to float bond issues on capital markets.

Rising investor interest in Latin America is a response to the positive economic policy changes and lower interest rates in the U.S. that make the regions' debt more attractive. The trend began two years ago with Mexico and has accelerated recently, spreading to Venezuela, Argentina, and Brazil.

In September 1991 Argentina launched a $300 million Eurobond offering, three times the initial amount due to strong demand. This is noteworthy since Argentina owes nearly $6 billion in past-due interest on its existing commercial bank debt. Brazil, the largest Latin American debtor, also has been able to obtain financing. Petrobas, the state-owned oil company, submitted two issues in the Eurobond market totalling $450 million at the end of 1991.

Global privatization efforts generated $25 billion in each of 1989 and 1990 and are expected to total $30 billion in 1991. State divestments have been about evenly split between public flotations and private sales. A sizeable public deal was Mexico's $2.2 billion international offering of 15.7 percent of Telefonos de Mexico. Significant private sales included 51 percent of Mexican bank, Bancomer, to investors from the financial services group, Valores de Montetrey, for $2.55 billion, and 70.7 percent of Banamex for $3.2 billion to an investor group headed by executives from Accival. The sale of 75 percent of the Brazilian steel company Usiminas brought $1.2 billion -- although several of the buyers, including Banco do Brasil's pension fund Previ, are state-owned. The Mexican banks sold at four times book value. Mexico's divestiture of its stateowned banks is well advanced. The slack should be taken up by Argentina where President Menem wants all state companies privatized or liquidated by the end of 1992. These include state railroad, three electricity companies, a water utility and national oil group YPF -- perhaps $3.5 billion in total sales. Brazil still faces some political opposition to privatization. Several more sizeable companies, including steel maker Tubarao and a chemical company, will be sold if the political impasse is overcome. Venezuela may follow the sale of its telephone network with the sale of its water company and an airline. Colombia is selling its state-owned banks. Peru may invite private capital into the airline Aeroperu. Bolivia is selling its airline LAB. There is no turning back as success follows on success. The challenge will be to make the enterprises profitable.


Estimates of the capital needed to finance and support the restructuring efforts for the next few years vary over a wide range. In a recent IDB study in November 1990, the external financing portion was estimated.(2) With a scenario of continuous policy reform, aggregate growth will accelerate from 3.6 percent in 1991 to 4.9 percent in the year 2000. The current account deficit will expand from almost $5 billion in the first year to more than $30 billion in the final year of the decade. In both real and relative terms the deficit is significantly smaller than in the early 1980s, less than 10 percent of regional exports, and less than 2 percent of GDP. The moderate deficit level implies a much greater reliance than in the past on generating national savings for the financing of development.

The need for external financing must be a small part of the overall estimate of development financing needed. External financing capabilities are coming under increasing pressure. Germany has been borrowing as never before. Japan's financial sector is striving to meet international capital adequacy requirements. Its capital may not be available for export. The G-7 is under pressure to divert funds to the countries of the former Soviet Union. The U.S. budget deficit's drain on all sources of saving is worsening. World banks have adopted more restrictive lending standards to slow asset growth and bring capital ratios in line with new international standards. Focus is on asset quality. The financing that will flow into the region will command relatively high real rates of return, which cover appropriate risk and offset other attractive alternatives that will unfold during the rest of the decade.

Debt swaps have eased the financial problems in Latin America. Initiated in 1982, they amounted to $8 billion in 1990. Recent growth is due to new schemes allowing conversion of debt into equity or local currency.(3) The conversions underpin a secondary market where loans trade at substantial discounts to face value. Debt equity swaps involving conversion into equity and debt currency swaps that convert debt into local currency liabilities contribute if they attract additional foreign equity investment or bring about a return of flight capital. With expanding investment, debt swaps can replace some debt requiring immediate hard currency payments with liabilities that may be more favorably matched with the countries' balance of payments needs. Conversions enhance the privatization process, reducing the burden of a large state-owned sector.

The advantages of debt conversions may be offset by two drawbacks. First, conversions rely on preferential exchange rates that may distort trade and in the extreme lead to new capital flight. Second, they earmark capital inflows to repay external debt rather than provide foreign exchange for other uses. Without the "additionality" feature of swaps, these problems will outweigh the advantages. This market, therefore, is unlikely to reach sufficient size to meet Latin America's requirements. Other financing sources will be needed.

The continued return of capital flight is one area on which to build. It is estimated to amount to $170 billion, or one-third of the region's total external debt. Repatriation depends on the relative real rate of return on private investment. This has been improving in Mexico where the inflow of flight capital is estimated to be the equivalent of the nominal return on the accumulated assets held abroad.

Chile had little capital flight although there was a brief spurt in 1982. Chile has vigorously pursued a program of debt-equity swaps, aimed, in part, at repatriation of money held abroad. Colombia also had a program to encourage the return of funds held abroad.

Foreign direct investment will rise as barriers to foreign investment are removed and returns remain relatively attractive. Portfolio investment should follow, especially as financial markets expand and modernize. The benefits from economic integration opportunities will add to both capital inflows if these are tapped.

The gap remaining after all other sources of external financing runs to about $9 billion by 1993.4 That is why total external debt rises only modestly. Bilateral and multilateral disbursements are expected to fill most of the gap for the rest of the decade. The IMF, World Bank, Inter-American Development Bank, along with credits from export credit agencies will be involved in meeting the region's financing requirements.

As the fast growing economies of Asia and Mexico show, it is a high domestic saving rate that provides the investment capital to fuel growth. If Latin America can create the stability and confidence that will lead to its own population's willingness to save, they should have little trouble attracting substantial domestic funds for restructuring. An increase of 10 percentage points in the share of GDP going toward investment, from 19 percent to 29 percent as in the early 1980s, could generate as much as $65-70 billion more in capital investment per year. That could lead to steadier economic growth rates around 4-5 percent, making the region more competitive in world markets.


The restructuring process in Latin America began in 1982 as a result of the abrupt dedine in external financing for economic development. Debt burdens had reached intolerable levels, requiring a significant change in the direction of the economic development process. The correction and transition required resulted in nearly a decade-long drop in the rate of investment and a commensurate decline in living standards.

An impressive array of policy tools have been used to restructure the economy toward more efficient private markets, increasingly open to foreign competition. A principal objective of policy from 1985 onward has been to revive the economy while striving to increase the current account surplus by massive devaluations, at the same time trying to avoid an upsurge in inflation. Price stability has been an elusive goal until more recently, and has not been achieved in Brazil to date. Deregulation of economic activity, privatization of state-owned enterprises, more liberal trade policies, tighter, more unified exchange rates, and smaller state budgets are intended to control inflation, induce private investment, and generate a more consistent economic expansion.

To support the redirection of economic development, both external and internal financing mechanisms had to be revived. Neither internal nor external financing alone could generate the vast sums required to restructure, estimated at dose to $100 billion per year over the next few years. Debt reduction schemes in the form of buybacks and swaps have brought debt burdens to more manageable levels. The region's external sources of financing have reopened but in different forms. Capital repatriation began to increase as debt burdens declined. Various countries' bond flotations are being well received in world financial markets. Equity stakes in previously state-owned firms are attracting investor interest, but slowly. Banks are acting more as intermediaries, arranging financing rather than lending directly as in the past.

Finally, as policy begins to take hold, domestic savings are expected to recover to support private investment to grow as a share of gross domestic product. There is good reason to remain hopeful about Latin America's prospects if the political will holds firm and continues to receive voter support.


'For example: Jeffrey Sachs, editor., 1989, Developing Country Debt and the World Economy, Chicago and London, The University of Chicago Press; Inter'American Development Bank, October 1989, Seminar The World Economy, Latin America and the Role of the IDB, Washington, DC. Inter-American Development Bank, October 1991; Economic and Social Progress in Latin America, Washington, D.C., The Johns Hopkins University Press.

2 Ronar Le Berre and Lutz Kilian, "External Financial Requirements for Latin America in the Nineties: Two Alternative Policy Scenarios," Washington, DC., InterAmerican Development Bank, November 1990.

3 Richard A. Debs, David L. Roberts, and Eli M. Remolana, Finance for Developing Countries, Alternative Sources of Finance, Debt Swaps, New York and London, Group of Thirty, 1987, p. 27.

4 Le Berre and Kilian, op cit.

* Philip L. Swan is Director of International Economics, IBM Corporation, Armonk, NY.

This article discusses the evolution of the Latin American debt crisis, the ensuing economic reforms, and the sources of capital for Latin American growth. A substantial basis exists for the growing optimism in the region if it is willing and able to finance a large part of its own recovery and expansion in the years ahead.
 Table 1
 Average Annual Growth Rates
 Gross Domestic Product and GDP Per Capita
 1961-1970 1971-1980 1981-1990
 Per Per Per
 GDP Cap/ta GDP Capita GDP Capita
Argentina 4.4 2.9 2.5 0.8 - 1.9 -3.2
Brazil 5.4 2.5 8.6 6.1 1.3 -0.8
Chile 4.2 2.0 2.6 1.1 2.7 1.0
Mexico 7.0 3.6 6.7 3.6 1.5 - 0.8
Venezuela 6.3 2.7 4.3 0.7 0.4 - 2.3
America 5.4 2.5 5.9 3.3 0.9 - 1.2
U.S. 3.8 2.5 2.8 1.7 2.6 2.0
Europe 4.8 3.9 2.9 2.5 2.3 2.0
Japan 10.2 9.0 4.5 3.4 4.2 3.5
 Sources: Inter-American Development Bank, Economic and Social
Progress in Latin America, 1991 Report, October 1991,
Washington, DC.; OECD, National Accounts, various issues,
 Table 2
 The Growth of Investment
 and Its Share of GDP
 Growth (1988 $) Share of GDP
 1961- 1971- 1981
- 1970 1980 1990 1981 1985 1990
Argentina 4.8 3.7 - 12.1 21 12 9
Brazil 9.4 9.5 - 2.4 28 21 21
Chile 9.2 2.8 O. 6 30 16 22
Mexico 9.1 8.6 -2.1 36 23 23
Venezuela 7.2 4.6 - 7.1 28 24 13
America 7.4 7.4 - 3.2 29 20 19
U.S. 4.1 3.6 2.1 16 17 15
Europe 5.1 1.8 2.7 20 19 21
Japan 15.7 3.4 5.7 29 27 34
 Sources: Inter-American Development Bank, Economic and Social
Progress in Latin America, 1991 Report, October 1991,
Washington, DC.; OECD, National Accounts, various issues,
 Table 3
 Total External Debt: Interest Payments Due
 Divided by Exports of Goods and Nonfactor Services
 2981 1985 1990
Argentina 35.5 51.1 56.1
Brazil 40.4 40.0 27,8
Chile 38.8 43.5 18.0
Colombia 21.8 28.9 16.9
Mexico 37.3 37.2 23.5
Peru 24.2 27.9 17.1
Venezuela 12.7 26.4 14.4
 Source: Inter-American Development Bank, Economic and Social
Progress in Latin America, 1991 Report, October 1991, Wash
-ington, DC.
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Author:Swan, Philip L.
Publication:Business Economics
Date:Apr 1, 1992
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