But it is at the policy
level that Europe faces its biggest challenges. Eurozone
leaders have been found badly wanting by the crisis. Jerome
Booth, head of research at Ashmore Investment Management, says:
"The ability and the willingness of a sovereign to change its
debt ratios, and so alter market perceptions towards itself, is
not a function of numbers: it’s a function of
policymakers and political constraints. What
Europe’s crisis has brought into stark relief is
that its policymakers have proved to be inflexible and unable
to react to events in real time. In some ways this is
unsurprising, since policymakers in Europe have little
experience of dealing with crises, in contrast with many of
their emerging market peers."
The history of sovereign
defaults in emerging markets provides little comfort to those
tasked with solving Europe’s deep-seated fiscal
and structural problems. Of those sovereigns that have
restructured their debts or defaulted, only a handful have
recovered their previous country risk scores. The lengthy
recovery times illustrate both the damage default can have on
investor sentiment and the lengthy recessions that have
frequently followed financial crises.
External factors have
frequently played a strong role in post-crisis recoveries.
Russia, which remains the only country that has defaulted to
recover its previous ranking, is an obvious example. Following
its disastrous default on short-term treasuries in 1998,
Russia’s ECR score fell by 30 points,
leaving it ranked 161 globally. The default destroyed the
domestic banking sector, but where smaller countries without
its resources would have required international assistance,
Russia benefited from the turnaround in global energy prices.
"There was zero foreign investment in Russia in the period
immediately following default," says George Nianias, manager of
Denholm Hall Russia Arbitrage Fund. "Instead, Russia used the
state banks to finance the economy, while Russian private
investors appeared out of nowhere to finance SMEs and
start-ups." Swollen by oil revenues, Russia ran trade surpluses
in 1999 and 2000, and had recovered its previous ECR
score in 2004.
When a series of
political disasters in early 1994 sapped investor confidence in
Mexico, events quickly span out of the
government’s control. But by 2000 Mexico had an
investment-grade rating and was judged the best sovereign
borrower in North America by Euromoney. How was such a
rapid transformation engineered?
growing current account deficit, which had been increasing for
a decade, reached 8% of GDP in 1994, and was mostly financed
short-term. When investors became reluctant to take on Mexican
currency risk, the government issued the infamous tesebonos,
dollar-indexed short-term securities, through which it took the
currency risk off their hands. A large volume of maturities at
the end of 2004 led to a bungled devaluation of the peso in
December, and default looked inevitable. Mexico’s
country risk score, which had peaked at 62 points that year,
plunged to 57.
Mexico, thanks to a $50
billion international rescue package spearheaded by the US in
March 1995, did not default. That year, Mexico suffered its
worst recession in 60 years, with GDP dropping some 7% as
resources were switched from domestic needs to meeting
short-term debt obligations and closing the yawning
current-account deficit. Real living standards plummeted and
more than a million Mexicans were thrown out of work.
|The end of
|Periphery ECR scores,
1994 to 2011
|ECR scores, 1994 to
|Source for both:
GDP recovered strongly in the following two years, growing by
5.1% and 6.8% in 1996 and 1997. During the recovery, the
proportion of growth provided by exports fell but the level of
fixed investment increased, and continued to provide a large
share of growth in the post-crisis period.
Mexico’s policy response and the swift
intervention succeeded in quickly encouraging investment.
In the aftermath,
Mexico’s policy response focused on strengthening
lax banking sector regulations. Unsustainable exchange rate
policies were removed, and the country’s weak
fiscal policy, which had been largely determined by the
political cycle, was strengthened with larger foreign exchange
reserves. "In Mexico, policymakers focused on the diseases
rather than the symptoms of the crisis," says Richard Segal, an
economist at Jefferies.
Furthermore, the country
benefited from a wave of investment by US companies through the
recently ratified North American Free Trade Agreement, becoming
a low-cost export platform for multinationals selling into the
US and Latin America. "Intelligent macro-policy was at the
heart of Mexico’s economic recovery, although the
economy also benefited from devaluation," says Robert Parker, a
senior adviser at Credit Suisse.
In 1999, while other
Latin American sovereigns were experiencing deep recessions,
Mexico, buoyed up by strong links with the US and a rising oil
price, achieved growth of 2.5% in the first half of the year
compared with the same period in 1998.