When investors choose Mexico as a safe haven, it’s clear the world has changed profoundly. The collapse in Asian markets and the robustness (so far) of Latin America have sent economists into a huddle. With policy regimes as different as Chile and Argentina proving successful, drawing firm conclusions will be tough. Eventually fully-formed economic theories may emerge.
Fundamentals
Right now a few things are obvious: a strong banking system is the backbone of development, democracy works better than dictatorship over the long term and capital controls are back in favour. But nothing can take the place of strong fundamentals. It is these more than anything that have saved Latin America and led analysts to heap praises on Mexico and to a lesser extent Brazil.
|
Net money flows in (+) and out (-) of equities (All flows are net in $ million ) |
||
| Money flow week ending January 29 | Money flow week ending February 5 | |
| Argentina | ||
Major ADRs |
12.8 |
33.8 |
Underlying local shares |
16.3 |
5.2 |
Remainder of local shares |
-4.9 |
8.4 |
| Brazil | ||
Major ADRs |
17.0 |
73.5 |
Underlying local shares |
690.3 |
1,042.4 |
Remainder of local shares |
187.9 |
666.5 |
| Mexico | ||
Major ADRs |
-23.2 |
89.1 |
Underlying local shares |
-1.3 |
4.3 |
Remainder of local shares |
-1.2 |
27.9 |
| Chile | ||
Major ADRs |
-2.5 |
9.9 |
| Source: Salomon Smith Barney | ||
As economists argue about what it all means, investors are delivering their own positive verdict on Latin America by putting their money back in. Figures released by Salomon Smith Barney show strong inflows into the American Depositary Receipts (ADRs) and local equities of Brazil, Mexico, Chile and Argentina in early February (see chart). In Brazil, for example, $1.7 billion went into the underlying shares of ADRs in the fortnight straddling the end of January and the beginning of February. In the first half of last month $2.5 billion entered Brazil making good the impact of Asian-inspired panic last year. “We have seen the flowback from the flight to quality,” says Jerome Booth, a director of ANZ Investment Bank. “The current mentality of the US investor is to buy on dips.” Have investors taken leave of their senses? Mexico remember is the country that only three years ago gave us the tequila crisis with knock-on effects worldwide. Tequila gained notoriety as the first major disaster of global capitalism and showed how capital flowing into an emerging market could depart even faster. Latin America is also the continent that produced the 1980s debt crisis that pushed even some international banks to the edge and led the region into its so-called “lost decade of development”. Not until the invention of the Brady bond did it show signs of recovery.
What then, if anything, has changed about Latin America?
“Crises are a fantastic opportunity for upgrading policies. We [in Latin America] are one, or maybe two, crises ahead of Asia,” says Ricardo Hausmann, chief economist at the Inter-American Development Bank (IADB). Speed of reaction of Latin politicians, in contrast to Asian tardiness in even recognizing their difficulties, also served the region well this time around. But ultimately it must be the policies themselves that held up and saved Latin America from the Asian backlash.
Starkly different approaches in each of the countries make a mockery of any easy understanding of what is working. Chile, Colombia and Brazil, for example, favour capital controls on short-term flows while Mexico and Argentina have none. Argentina has the strictest of exchange-rate systems with its currency board, yet Brazil and Chile have crawling pegs and Mexico has a free float. Argentina’s government is a heavy user of the international capital markets while Chile’s stays on the sidelines. The savings rate is high in Chile but lower in the other countries. Privatization is advanced in Argentina but behind the curve in Brazil. Trade as a percentage of GDP is high in Chile, low in Brazil.
No wonder economists are confused with even IMF managing director Michel Camdessus, in a recent interview with the Financial Times, coming out in favour of Chilean-style capital controls.
Victor Bulmer-Thomas, director of the Institute of Latin American Studies in London, expects profound changes in development economics following the troubles in Asia. He stresses that the latest turnaround does not signify the death of the Asian miracle (other economists argue that there never was one) or that Latin American ascendancy among emerging markets is assured or even likely. “In absolute terms Latin America’s performance is not good. We have had a whole decade in which output per head didn’t rise. We still don’t have a regional economy that is growing rapidly, pulled along by exports with improving distribution. We are a million miles from that. It’s just that it surprised the sceptics when economies didn’t collapse [in the current crisis].”
Risk of backsliding
And Latin America is not in the clear yet. There are concerns about the build-up of short-term, dollar-indexed government debt in Brazil (echoes of Mexico’s infamous tesobonos which were at the centre of the 1994 peso crisis) and the weaknesses in Mexico’s banking system. The devaluation of the Brazilian real, considered overvalued, would be a disaster for the region prompting a completely different verdict on where it is headed. With 30% of Argentina’s exports destined for Brazil, a slump in Brazil would quickly move south.
In the bleakest of outlooks, large capital outflows from Argentina could wreak economic havoc leading to abandonment of the currency board. More than one economist thinks Argentina got very close to this predicament in 1995 when post-tequila unemployment hit 18.5%.
Latin America will only move forward if policy makers continue to be as humble, vigilant and flexible as they have been in the past few years. Any backsliding to the “we know better than the markets” type of mindset, prevalent in Asia, would be highly damaging.
Says Hausmann of the IADB: “Caution is essential. Successful countries will be cautious countries.” Peter West, chief economist with BBV LatInvest Securities, makes the comparison between the import-substitution-led, protectionist Latin America of the past and the globally-linked situation now whereby “Brazil is affected by a Chinese devaluation”. It makes economies permanently vulnerable.
But there are lessons to be learned from recent Latin experience and many are in the detail of what has been done. This shows that different polices and different policy mixes can be successful provided they are internally consistent. Essential, however, is proactive management and adjustment to new circumstances. The few general conclusions to be drawn are that a strong, well-regulated banking system underpins all other kinds of reform and that democracy is a better guarantor of long-term success than dictatorship.
Drawing from the Latin casebook the most interesting examples of innovation are not Mexico and Brazil whose main achievement has been to survive. They are Chile with its capital controls and Argentina with its currency board and accompanying fine-tuning of the economy, especially of the financial sector. Since Argentina’s critics complain the currency-board system puts the economy on “autopilot”, with government ducking its executive responsibilities, evidence of continuous innovation in Buenos Aires is interesting.
The starting point for Argentine reform were government institutions and a central bank discredited by the hyperinflation of the 1980s. Dollars were widely used in preference to the local currency and it was a short but important step to establish the currency board whereby in theory a country’s monetary base is entirely backed by foreign reserves.
“The credibility of the Argentine monetary authorities went to zero so they had to find [an institution] with better credibility, which was effectively the US federal reserve,” says Isaac Tabor, director of emerging-markets research at WestMerchant Bank. “It was an admission that they couldn’t run their own monetary policy. To their credit they knew their limitations.”
Bank discipline
Argentine economic policy is largely guided by the idea that outside, often foreign, institutions and markets are better guardians of resources and policy than government. For example 80% of Argentine banks’ reserve requirements can be held in Deutsche Bank in New York and not by the central bank. Analysts often miss these when calculating Argentina’s total reserves which are $30 billion, $8 billion higher than commonly stated.
The banks are required to get an external rating from a rating agency and to have the agency look carefully at a sample of individual loans on a quarterly basis. This costs a bank around $75,000, three times the price of a standard rating. “It means you have to send in a team of auditors to go through the loan file. They don’t go through every one but they make a reasonable cut,” says bank analyst Paul Warme who recently left Duff & Phelps Credit Rating to join Paribas. Argentine banks must also issue subordinated debt to the value of 2% of assets. The trading price of the debt provides a market gauge of a bank’s health. With its strong downside risk subordinated debt performs this task better than equity.
A strong banking system is essential under a currency board because banks take the strain of economic adjustments and the central bank cannot provide them with liquidity. The central bank is prohibited from expanding the money supply beyond what foreign reserves allow. So when capital flows out, the monetary base shrinks bringing on a sharp recession. Such situations are the great test of currency boards and surviving the 1995 tequila crisis has provided the Argentine one with enormous credibility. Investors are less concerned about it in the current situation as a result. But to put one together in Indonesia where the banking system is weak, as has been proposed, would be courting disaster.
“There is no lender of last resort [with a currency board] which is a handicap in the middle of a crisis,” says Alfonso Prat-Gay, an economist with JP Morgan Securities in Buenos Aires. “However you are less likely to have a [very serious] crisis if you don’t have a lender of last resort because you are taking care of some of the moral-hazard issues that the IMF has recently been criticized over.”
The lender of last resort in Argentina is effectively the foreign banks which through a series of acquisitions now account for 35% of local deposits and, presumably, would not allow their operations to fail. The strength of the banks has been increased by raising reserve requirements at the rate of 100 basis points every six months for the past two years, dependent on deposits growing at 20% a year. Reserve requirements are now up at 20% from 15% in June 1996. Provisions for non-performing loans are required to be raised in line with interest rates, recognizing that corporate bankruptcies may follow. It’s these additional measures on top of the currency board that make Argentina so solid.
Flexible enough?
Critics of the Argentine system complain that policy makers leave too much to the system’s self-correcting mechanisms. “Despite all that has happened, the Argentine government continues to be too complacent and doesn’t do things until the last moment,” says Walter Molano, director of economic and financial research for SBC Warburg Dillon Read in Stamford. “It has not taken steps to decelerate the economy in the current environment. There have been no fiscal cuts. Action is needed because the government wants to be able to tap the international capital markets as aggressively as last year. But it continues to follow this autopilot type of policy. As a result the country will face extreme pressures at the end of the year.”
JP Morgan’s Prat-Gay rejects this view. “The favourite way to criticize the team here is to say they are on autopilot. So far the government has been good at preventative measures rather than just reactive measures.”
Efforts to strengthen the banking sector are a key example. In addition, the currency board itself contains more flexibility than is widely appreciated. Currently up to 33% of the reserves backing the monetary base can be in the form of dollar-denominated Argentine government bonds. This allows considerable leeway in providing liquidity during a crisis. During the tequila crisis, the percentage of such bonds in the reserves backing the currency rose from 5% to 20%, the then limit.
The real achievement of currency boards is to provide confidence when it is lacking. If this evaporates no amount of foreign reserves can save the local currency. And if unprepared nations like Indonesia try and fail with currency boards that could undermine confidence in the concept generally. It could be bad news for Argentina.
A currency board also aggravates trade deficits because the exchange rate cannot adjust to bring exports and imports into line. If savings and foreign investment are limited, a government will have to borrow overseas to bridge the inevitable current-account deficit. Analysts calculate the Argentine government will have to borrow $17.4 billion abroad this year (mostly roll-over of existing borrowings but including about $3.5 billion net issuance). This pressure spurred it back into the marketplace soon after the Asian crisis. “Everything booms [in Argentina] when foreign money is available and goes into a downturn when it isn’t,” says BBV LatInvest’s West. Says Tabor of WestMerchant: “Argentina has to go to the international markets as it has limited domestic savings. But they seem to be right on target for their needs.”
Adds JP Morgan’s Prat-Gay:”[Argentina’s] business policy cycle maker is not Mr Whoever at the ministry of finance but Mr Whoever in Iowa looking at his computer. Capital flows are king. You are exposed to changes in mood in capital flows and capital flows are very moody.”
Things could not be more different in neighbouring Chile where the aim has been to deter short-term capital inflows and restrict overseas borrowing by Chilean corporations. Not only have speculative inflows been discouraged, capital inflows are “sterilized” by the central bank by issuing peso-denominated paper. This prevents flows from going into bank deposits and starting a credit boom of the type that caused problems in Asia.
Chilean model
The Chilean government knows all about this type of crisis it had one in the early 1980s causing a 15% drop in GDP and requiring government aid to the banks worth 20% of GDP. In contrast to state indebtedness elsewhere in the region, Chile’s traumas stemmed from foreign borrowing by the private sector taking advantage of a fixed exchange rate. The natural solution was to better regulate private-sector activities in the form of capital controls and banking supervision rather than go further down the fixed-exchange path which had already got the country into trouble.
The linchpin of the capital controls is that one-third of incoming flows whether in the form of bank credit, debt financing for foreign investment, bond financing and ADRs must be placed in a non-interest-bearing deposit at the central bank for one year. This amounts to a tax of several per cent. Foreign direct investment (FDI) is exempt but recent evidence of the FDI route being used to channel in portfolio flows led the central bank to increase its already considerable discretionary powers so it could veto applications.
Baring Asset Management fund manager Nancy Curtin knows all about the central bank’s powers. Her funds sold $20 million of equity stock at the end of last year and the central bank took several weeks to release the money. This worried her enough to sell all her Chilean stock, another $40 million worth. “It spooked me. I didn’t know whether the central-bank governor said: ‘Don’t give Barings its money,’ or what was going on.” Afterwards the equities and the peso fell.
Chilean institutions are as restricted as foreign ones in their flow activities. Only highly-rated corporations are allowed to borrow offshore and pension funds can not invest more than 12% of their funds abroad and no more than 6% in equities. As a result Chilean external debt is relatively low, totalling some $27 billion (33% of GDP) of which only $5 billion is public sector and $1.6 billion is short term (split evenly between private and public sectors).
But such a tough regime has not deterred inflows – some $6 billion came in last year into an $80 billion economy. The central bank managed to sterilize about $3 billion giving it a fiscal deficit as large as the treasury’s surplus. It’s an expensive operation because higher-yielding peso-denominated paper is being swapped for lower-yielding dollars. But Chile’s foreign reserves are among the highest in the world. Crucial to the system’s success is Chile’s famous compulsory private pension scheme which holds 60% of its $30 billion assets in government paper.
“Interestingly, the IMF is now considering the Chilean capital control scheme as a model to avoid a future Asia-style financial crisis, to be used as a transitional phase until the financial system of a country is sufficiently strong to deal with surges in short-term loans from abroad,” says a report on Chile released last month by JP Morgan Securities. The next message from Camdessus to president Suharto of Indonesia might be: you can’t have a currency board but you can have capital controls.
But was it the capital controls that worked in Chile or was it more to do with banking supervision, high savings rates, fiscal surpluses and low current-account deficits? Or simply that Chile has been reforming itself longer than most countries, including other Latin ones?
“Some of the large Chilean banks are the most creditworthy in the region,” says bank analyst Warme. “It comes back to the operating environment, the strict regulations and the fact that you can trust what they tell you…. The banks have had 15 years since the last crisis to develop internal credit cultures that other banks in the region don’t have.”
Not copper-bottomed
Says Jose Valente, a partner in the Santiago-based consultancy Econsult: “The government usually mentions the controls as the most important reason for isolating Chile from the tequila effect. Now it is saying the economy is avoiding the Asian crisis because of the controls. I tend to disagree. It’s not just the controls, it’s more to do with the high savings rate and the low current-account deficit.”
Adds Valente on the central bank’s sterilization efforts: “It’s a very expensive way of managing these inflows. There has been criticism of that. The central bank has been losing money every year and its balance sheet does not look good.”
Ironically, in light of Chile’s exemplary record, the Asia crisis is hurting it more than previous periods of volatility and more than other Latin American countries except Brazil. Chile’s trade amounts to roughly 40% of GDP and 35% of exports go to Asia. In addition, copper makes up 40% of total exports and the commodity’s languishing price will take its toll. One analyst estimates this will cause the loss of 3% of GDP and is equivalent to Argentina being hit by three Brazils – calculated by the equivalent effect on the Argentine economy of the loss of the Brazilian export market. But Econsult’s Valente says that Chilean copper producers will cut their profit margins and the impact will be on earnings not output.
IADB’s Hausmann says: “Chile and Venezuela have seen the largest hits because of the adverse movements in the terms of trade [oil and copper prices have fallen]. But El Nino [a climate effect] is at least as much responsible for the decline in oil prices as Asia. In the case of copper, stocks have been accumulating for some time. It would be a stretch to say these hits have been caused by Asia.”
Whether the Asian crisis falls harder on Chile than Argentina is less important than the fact that two previously troubled economies now have resilient systems of a very different nature. But while development agencies attempt to study their salient features and recommend them to others, it may be that history is the only real teacher of economic management.
Latin miracle
Remember that Latin America went through its own golden era, equivalent in some ways to the so-called Asian miracle, and responsible for the same kinds of distortions. High growth rates in Latin America from the late 1940s to the early 1970s were based on import-substitution industrialization. This was the favoured route because major markets such as the US and Europe were less open to developing-country products, especially manufactured goods, than when Asia began its export-led growth. Both strategies involved heavy state direction of the economy, both produced fast growth as initial bottlenecks were unblocked, both were presided over by dictatorships, both threw up ideological hubris such as the Asian-values-are-superior thesis, and both culminated in prestige projects such as the building of Brasilia and the world’s tallest building in Malaysia. Similarly, both strategies fell asunder as what economists call “allocative inefficiencies” built up because special-interest groups rather than markets were directing resources. The ensuing crisis produces major political as well as economic changes. This was the case in Latin America and will be too in Asia.
Says ANZ’s Booth: “This is a process that doesn’t happen again. Once you have lived through it it’s over. That’s why it won’t spread from east Asia to Latin America. At the same time the crisis has to happen to bring about much needed changes.”
Democracy versus cronyism
Key differences between the two regions are the failure to translate growth into more equal income distribution in Latin America, something which did happen more in Asia, and the democratic tradition in Latin America (dictatorships were a relatively recent historical exception in many countries) which is missing in Asia. This bodes well for Latin America now. Cronyism, as opposed to corruption, also seems more an Asian phenomenon than a Latin one. Going forwards, Latin America’s other development advantages are its degree of urbanization and its low population growth.
“What one forgets about [Latin America’s] authoritarian regimes is that they themselves were quite new,” says Bulmer-Thomas of the Institute of Latin American Studies. “Military authorities have not been the norm in Latin America. Argentina for example had universal suffrage as early as 1912 and contested elections up to the 1930s. Even Peronism was democratic…. And Chile throughout the twentieth century had a functioning democracy. The problem is explaining Pinochet [Chile’s former military dictator] not democracy.”
In economic terms, dictatorships often appear fine in producing results, in some ways better than democracies because of their speed of movement. But they fail when the economy needs reinventing, and especially when that reinvention threatens their own economic interests, as currently in Asia. Dictatorships usually don’t have much capacity for self-assessment and appropriate policy changes.
Democracies by contrast move slowly and have to balance the needs of a vast array of interest groups in order to build a consensus for reform. By the time legislation reaches the statute book, after many amendments, it can be a pale reflection of the original. Yet whatever is achieved by this method is more sustainable than reforms made under dictatorships.
In Latin America the best example of a creaking democracy is Brazil where reform has moved at a snail’s pace as congressmen from all over the country have argued and debated its implications. “Brazil has to be cornered into economic reform and it has been,” says WestMerchant’s Tabor. “The problem is the fragmented political structure. It takes years to achieve anything.”
In February key votes in favour of pension-fund and civil-service reform made it plain that Brazil was finally making progress. The Asian crisis with its capacity to undermine the Brazilian economy is providing pressure to keep reforms on track and may accelerate the privatization programme. The government badly needs the revenues to stop its 4% fiscal deficit expanding further and unnerving foreign investors.
Among Latin politicians no-one has come through the recent crisis looking better than Brazil’s president Fernando Henrique Cardoso and his economics team. A speedy response to attacks on Brazilian markets brought about desired stability. And the economic costs – doubling of interest rates to over 36% a year and fiscal cuts of $15 billion – have been accepted by the Brazilian electorate as the price of not returning to hyperinflation and chaos. Cardoso, credited with ending inflation, remains the frontrunner to win the presidential elections later this year.
Yet Brazil remains the great worry in Latin America because of its deficits, its debts, a currency that seems overvalued and, owing to its size, the magnitude and ramifications of a crash if one happened.
On the valuation of the real, Demosthenes Madureira De Pinho Neto, international affairs director of the central bank, is adamant it is not overvalued. “When you move from hyperinflation to stabilization, the equilibrium rate has to move so economists don’t really know what the equilibrium rate is for Brazil,” he says. “It’s true that the real has been appreciating but it doesn’t mean it’s overvalued. In fact, it’s difficult to argue that a currency that produced export growth of 14% last year, driven by manufacturing exports, is overvalued.”
Brazil’s leveraged banks
Madureira adds that if the real is overvalued the correction should not be through one sharp devaluation but by slow depreciation as has been practised by Brazil over the past two years.
Another concern is unstable debt structures. In October’s panic $9 billion in foreign reserves was drained from the system as banks deleveraged. Says an SBC Warburg Dillon Read report, entitled Surviving the Asian crisis: “The absence of a banking-sector problem is the main characteristic that distinguishes Brazil from the Asian economies. The Brazilian financial sector, however, did suffer during the crisis since it is highly leveraged. It was forced to go through a deleveraging process as international creditor banks issued margin calls.”
The report notes that the government has assisted the financial sector by increasing the range of hedging instruments in the market such as the stock of NTN-Ds (dollar-indexed treasury notes). But it’s the increase in NTN-Ds and their central-bank equivalent NBC-Es which are the worry. As short-term dollar-linked instruments, the notes display some characteristics of the Mexican tesobonos which played a fateful role in the Mexican peso crisis of 1995. Panic sales of tesobonos depleted Mexican reserves.
The rise in the total stock of Brazil’s dollar-linked notes from $23.8 billion on October 15 to $30.1 billion on December 17 set alarm bells ringing. Volumes have edged up further since then to $36 billion though the rate of growth has slowed. Could dollar-linked NTNs break Brazil?
Madureira argues that things are very different from the tesobonos situation. First, the amount of tesobonos in Mexico was three times the size of reserves while Brazilian dollar-linked NTNs are considerably less than reserves. Second, 90% of tesobonos were in the hands of US fund managers whereas the Brazilian notes are 90% owned by residents, he says.
SBC Warburg’s Molano also believes the notes are safe. “They are dollar linked not dollar denominated,” he says. “At delivery time this is not an obligation on central-bank reserves, it’s a liability on the federal government on the fiscal side. They don’t have to deliver dollars. It seems like a nuance but it’s an important nuance.”
The Brazilian notes are used by banks to hedge their dollar exposures which analysts say is preferable to the search for yield that was going on in Mexico. Many Brazilian corporations are playing an arbitrage game, however, in quantities unknown, by borrowing abroad and investing the proceeds in domestic debt of various kinds. Molano points out that the Brazilian arbitrage game is being played by underleveraged corporates, unlike those in Asia, with the proceeds going into government securities rather than property speculation.
Still the doubts linger. Brazilian banking sources say that internal central-bank guidelines are that the amount of notes maturing over six months should not exceed 10% of reserves and over one year 20% of reserves. In fact, with current reserves of $53 billion, the $6.5 billion due between February and July amounts to 12% and the $14 billion due up to January 1999 is equal to 26%. The idea that resident holders are less likely to sell than foreigners has been turned on its head in recent emerging-market panics.
Madureira says that the Brazilian economic model is closest to the Chilean one with capital controls on short term flows. Pension funds cannot invest abroad, shorting the real is made difficult and there is a 2% upfront tax on purchases of short-term fixed-income securities. “The Chilean model is an attractive one,” he says. “Certain capital flows are destabilizing and we have to be careful of that. The Argentine currency-board system is too rigid for our requirements.”
Yet the difficulties of imposing the Chilean system on a huge country like Brazil are considerable. It’s hard for the authorities to police the regulations and stop them being bypassed. Highly agile banks, used to surviving in conditions of hyperinflation, are one step ahead of the regulators.
“Our impression is that regulators are more used to checking whether the banks understand the regulations rather than looking at asset quality. We still think Brazil is risky,” says a New York-based analyst with a major rating agency. One example of how Brazilian banks are working around the regulations is the growth of mutual funds. The analyst says that because reserve requirements are so high banks offer customers mutual funds as an alternative to deposits. Off-balance-sheet liabilities have built up that would have to be made good in a crash. On the plus side total bank lending is 30% of GDP in comparison to the high proportions – more than 100% in Thailand – that led to the Asian crisis. The number-one lesson from Latin America’s survival is that banks must be well regulated and excessive credit growth curbed. “Latin American central bankers are very cautious about credit expansion,” says IADB’s Hausmann. “In the past the question of credit expansion might not have arisen in the context of discussions about monetary policy. Now when they see credit expanding they quickly move to raise reserve requirements and capital ratios.”
Mexican mystery
The mystery is why Mexico is stable with a weak banking system. Mexico’s economic regime is completely different from Chile’s or Argentina’s. The currency floats freely and there are no capital controls. The answer is strong fundamentals and, once again, the confidence and credibility gained by the government’s handling of the tequila crisis. “The Mexican government did the right things in the right way,” says James Barrineau, Latin equity strategist of Salomon Smith Barney.
Despite the costs of the post-crash banking bail-out (estimated at 13.5% of GDP) and of a new pension system, the fiscal deficit should only be 1.25% this year. The net external debt burden has been halved since 1994 to what Standard & Poor’s refers to as a “manageable” 96% of exports in 1997. Public external-debt service (including short term) has fallen to 31.0% of exports in 1997 from 61% in 1994, says the report issued late last year by the agency’s sovereign ratings service, adding that private short-term debt remains high at an additional 33% of exports. Growth for 1998 is estimated by Santander Investment at around 5%.
Analysts point out that Mexico had limited choices in the policies it could adopt after the tequila crisis. “Chile and Columbia could have capital controls because these countries have higher amounts of internal savings than Mexico does. This gives them the luxury of imposing taxes on investment. If Mexico did that it would not have the funds to finance investment,” says Victor Herrera, a managing director in Standard & Poor’s office in Mexico City.
Says West of BBV LatInvest Securities: “Mexico has a different scheme to deter short-term capital flows: it’s called a floating exchange rate and it’s the best system, particularly for a large economy integrated into the world economy. Mexico is being described as a safe haven because Mexico has very strong fundamentals.”
This allows investors to overlook the flaws in the Mexican banking system which may take several more years to sort out. “[Mexico] is still paying to clean up the banking sector which suggests that the Asian crisis will take a number of years to resolve itself,” says Barrineau of Salomon Smith Barney. Of great concern is the moral hazard of government backing for the banks. But overall a weak system that is not providing the economy with needed credit is preferable to a stronger system doling out too much credit. “Most banking crises are preceded by credit booms,” says Hausmann of the IADB.
More significant in Mexico’s survival than any economic factor is the political system. The first competitive national elections in modern Mexican held last July were a milestone in the country’s political transformation. Analysts go so far as to blame the policies which led to the peso crash and other failures on the previous dominance of the Partido Revolucionario Institutional, the concentration of power in the executive and the six-year presidential terms that caused instability during transitions. Checks and balances now being put in place are providing smoother government. The comparison with Asia is instructive.
“As is the case in China and Indonesia, but virtually nowhere else in rated Latin America, economic policy [in Mexico] and other decisions of overwhelming national importance were made by a handful of men behind closed doors,” says the Standard & Poor’s report.
In the past few months, Asians have become frequent visitors to Latin America. They have been studying everything from capital controls to banking reform. Unfortunately, the single most important item – the political system – is the one they will most likely ignore. That, at least, will make development slower in Asia and faster in Latin America in the near future.
