Management wanted operational recommendations drawn from any direct parallels with earlier crises—notably in the 1990s—and from any differences. When the exercise proved useful, a second task force was put together, in the summer of 2002, to address similar questions for other Latin American countries that were beginning to face serious strains.
The task forces found a number of similarities between the then-current and previous crises. Like Asia, many of the affected countries in Latin America had a variety of soft-peg exchange regimes—or in the case of Argentina, an ostensibly very hard peg—that cracked under the strain. These economies had to find ways to reestablish a credible nominal anchor, and Asia offered relevant experience for how to do this.
A second parallel was that once the exchange rate began to move, and move substantially, the financial and corporate sectors suffered major balance sheet damage. This phenomenon was at the core of the deep economic disruptions in Asia, and we expected similar difficulties in Latin America—perhaps to a greater extent than in Asia.
But there were important differences, too. In Asia, the crises came after 10 years of rapid growth and low inflation. As a result, the markets had a basic belief in the ability of the authorities to pursue responsible macroeconomic policies. In Latin America, where hyperinflation in the 1980s was followed by persistent weaknesses in fiscal policy in the 1990s, it was much more difficult for the authorities to reestablish credibility.
The crisis in Argentina and its abandonment of its currency board has called this view into question, though it is still too early for firm conclusions.
Argentina’s experience does not necessarily mean that all currency boards are not viable, but it does underscore how important it is to have consistent policy support for those regimes, notably through appropriately flexible labor market policies, disciplined fiscal policy, and sustainable debt management.
This is the advice we gave to Argentina. Its exchange rate depreciated very rapidly for a time, but eventually the bottom was established after an overall tightening of financial policies, and now it is seeing much more stability—in fact, there has recently been a strong appreciation of the exchange rate. The authorities have begun to relax the controls they had introduced. There is even a concern that the appreciation might be moving too quickly.
Consequently, management asked the task force to look at spillover effects. The purpose was to make sure IMF mission chiefs were aware of possible channels of contagion transmission and various early-warning techniques. We did witness direct contagion to Uruguay and Paraguay. In addition, we saw questions being raised in the region about the choice of policy mix and the value of reforms.
Similarly, Brazil had followed and continued to follow basically good policies despite being hit by the uncertainty in the markets related to the political transition in October 2002. Eventually the continuation of those good policies, with timely and very large financial support from the IMF, helped Brazil survive those difficult times. Our judgment that Brazil had a basically sound policy framework was, in the end, vindicated by the outcome.
Sustainable public debt ratios are also much lower than many had previously thought. Indeed, staff work indicates that when debt ratios exceed 40 percent of GDP, the probability of running into debt difficulties increases rather sharply. Governments therefore need to pay more attention to their funding risks and avoid becoming too dependent on international capital markets, in part by developing domestic financial markets, giving them an alternative, and perhaps more secure, source of funding.
The task forces also examined past experience with debt restructuring, often using a two-track approach. One track dealt with household and corporate debts issued under domestic law, and the other track tackled sovereign debt restructuring under foreign law. In the first track, the most effective approach combined elements of a credit-driven, debtor-by-debtor process with a government-led, across-the-board process that could be tailored to each country’s circumstances. In the second track, the finding was that the economic costs of default were reduced the sooner the restructuring occurred. Drawing on previous country experience, the task forces developed a step-by-step roadmap to debt restructuring.
The IMF’s surveillance of program countries is a topic that our Executive Board has discussed extensively, and more discussions can be expected. Various experiments are under way to increase the fresh surveillance perspective in program countries, including having different staff from the area department or from other departments conduct the surveillance discussions.
Argentina also raised questions about the use of exceptional IMF access in capital account cases. The IMF Board agreed in September 2002 to more clearly defined criteria for such exceptional access and to strengthened procedures, including raising the burden of proof and formalizing early Board consultations on these requests.
We have not yet learned all the lessons. We therefore look forward to the report by the Internal Evaluation Office on capital account crises and Argentina.
Photo credits: Denio Zara, Michael Spilotro, Pedro Márquez, and Denio Zara for the IMF. Jae-Ku Choi for AFP, page 137.
Illustration: Massoud Etemadi, pages 148-9.
The value of a rapid and decisive response has been illustrated recently in Bolivia. In February, the IMF had a mission in the field negotiating a three-year adjustment program financed under the PRGF [Poverty Reduction and Growth Facility]. Those negotiations were taking time because PRGFs are very complicated. Unfortunately, there was a sudden outbreak of violence and a tragic loss of life. The mission had to be evacuated, and, amid all this turmoil, Bolivia had a run on its heavily dollarized banking system that could have very quickly led to an unraveling of its macroeconomic situation.
This also happened to be the weekend of the massive East Coast snowstorm. The IMF’s headquarters were closed and the mission team was stuck overseas because Washington’s airports were shut down. But via e-mail, phone, and teleconference, we managed to rethink the situation, discuss it with management, and develop a new approach jointly with the Bolivian authorities. It was decided to step away from the PRGF for the interim and try to negotiate a streamlined Stand-By Arrangement that could stabilize the situation. We negotiated a stabilization program with a Bolivian team in Washington by the following weekend. Other bilateral and multilateral creditors had also stepped in to increase and rephase their financial support. The combined effort of the authorities and the international community helped stabilize the situation in Bolivia. I am pleased to say that things are now much calmer, and we have since returned to La Paz to negotiate the PRGF.
Occasional Paper No. 217, Managing Financial Crises: Recent Experience and Lessons for Latin America, edited by Charles Collyns and G. Russell Kincaid, includes an overview by Collyns and Kincaid and chapters on
• assessing vulnerabilities in Latin America, by Javier Hamann, Kalpana Kochhar, Timothy Lane, Guy Meredith, Jürgen Odenius, David Ordoobadi, Hélène Poirson, and David Robinson;
• macroeconomic consequences of a financial crisis, by Kochhar, Lane, and Miguel Savastano;
• reestablishing a credible nominal anchor, by Andrew Berg, Sean Hagan, Christopher Jarvis, Bernhard Steinki, Mark Stone, and Alessandro Zanello;
• dealing with banking crises in dollarized economies, by Anne-Marie Gulde, David Hoelscher, Alain Ize, Alfredo Leone, David Marston, and Marina Moretti;
• public debt dynamics and fiscal adjustment, by Richard Hemming and Teresa Ter-Minassian;
• corporate debt restructuring, by Hagan, Eliot Kalter, and Rhoda Weeks-Brown; and
• applying the Prague Framework in crisis resolution, by Cheng Hoon Lim and Carlos Medeiros.
Copies of the Occasional Paper are available for $25.00 each (academic rate, $22.00) from IMF Publication Services. See page 141 for ordering details.