Tweet
Playing dominoes
Jun 24th 2002
From The Economist Global Agenda
International investors appear to be losing confidence in Brazil as the fall-out from the economic collapse in Argentina threatens to damage economic prospects in several Latin American countries. Is the region heading for a new financial crisis?
IT IS known as the domino effect. Once used to describe the spread of communism, the phrase now more commonly refers to the spread of international financial crises—especially in emerging-market economies. But even there, the domino theory was until recently beginning to look dated: the catastrophic collapse of Argentina’s financial system, currency and even government at the end of last year appeared to have virtually no effect on other countries in the region.
All that has now changed. As Argentina’s struggle to get to grips with its economic problems has dragged on, doubts are emerging about neighbouring economies. Brazil, the largest economy in Latin America, has seen its currency fall, and the cost of servicing its foreign debts has soared. On June 20th, Uruguay abandoned its currency peg and floated its peso—which promptly sank by nearly 10% in two days. Ecuador, whose finance minister resigned (perhaps to pre-empt sacking) on June 23rd in the wake of a bribery scandal, is finding its own corruption problems more difficult to handle because of nervousness about the region as a whole.
The extent to which the mood has shifted was underlined on June 20th, when remarks made by the Mexican finance minister sparked a minor panic in the markets. Francisco Gil Diaz was urging on congress the need to get public finances in order. In doing so, he likened Mexico to Argentina, and its failure to tackle its public finances before the crisis erupted. Mr Gil Diaz was using the comparison to put pressure on congress, but his comments had much wider repercussions, prompting President Vicente Fox to issue a statement saying the Mexican economy was “solid”.
Smaller economies, such as Uruguay and Ecuador, will always be much more vulnerable to changes in investor sentiment. Uruguay was forced to abandon its currency board—a system which fixed in law the level of its domestic currency against the American dollar—because the collapse of confidence in Argentina had made deposit-holders in Uruguay, a large proportion of whom are Argentines, increasingly keen to switch their money into dollars. This created such pressure on the central bank, whose reserves had fallen by around 40%, that the currency peg became unsustainable. Like Argentina’s, Uruguay’s—much smaller—economy is in the fourth year of a painful recession, with high unemployment and many banks weakened by large-scale withdrawals by jittery depositors.
Many Argentines, dismayed by the collapse of their economy, have blamed the outside world for its failure to help. Another team from the International Monetary Fund (IMF) left Buenos Aires last week with no comment, suggesting that a rescue package is no nearer. The resignation of Mario Blejer, the widely respected central-bank governor, which was announced last week and takes effect at the end of the month, has further undermined hopes that a settlement with the IMF can be reached before repayments of loans from the Fund fall due over the coming months.
Much of the problem lies with Argentina’s politicians, who remain reluctant, often for electoral reasons, to push through the reforms needed. Mr Blejer’s resignation is attributed in part to the difficulties he found in working with the economy minister, Roberto Lavagna, and to the reluctance of the president, Eduardo Duhalde, to take tough and potentially unpopular decisions.
Arguably, the international community could have taken a more sympathetic approach to Argentina’s problems. But outside the country, there is relatively little support for the provision of greater financial assistance, and none among the IMF’s principal paymasters, the G7 rich countries. American and European governments have repeatedly emphasised the importance of Argentina’s confronting its economic problems and making the necessary reforms.
Electoral politics lie behind many of Brazil’s current difficulties. On June 21st, the country’s currency, the real, fell to its lowest level since its creation in 1994 and investors grew nervous about the outcome of the presidential elections in October. The risk premium on Brazilian government bonds over the interest rate paid on American treasury securities rose to levels last seen during the country’s currency crisis in early 1999 (which ended with a sharp devaluation of the real). Investors are concerned by the country’s public debt, now more than 55% of GDP: interest payments account for 9% of GDP.
But the man who makes them really nervous is Luiz Inacio Lula da Silva, a member of the Brazilian Workers’ Party. He is the leading leftist candidate in the elections and is currently ahead in opinion polls by a substantial margin. There have been fears that Mr da Silva would abandon the conservative fiscal stance of President Fernando Cardoso and place more emphasis on social spending.
Not true, said Mr da Silva, in a statement on June 23rd. He insisted he would fulfil the country’s international obligations and maintain whatever budget surplus was necessary to control the rise of government debt. He also reaffirmed his commitment to low inflation. But some market analysts have drawn little comfort from Mr da Silva’s open letter to the Brazilian people: such moderate statements make his election more likely, said one.
With the exception of Uruguay there is, as yet, little firm evidence of regional contagion, at least in the sense of a general flight of capital. Investors and analysts alike appear to have learned that it makes sense to look at each emerging-market economy on its merits. In Latin America’s case, though, that might now bring little comfort as Brazil’s impending election gives investors pause for thought.
But it is also increasingly clear that changes in sentiment can have an important impact on how investors judge risk in a particular economy. The disastrous collapse of Argentina, coupled with the government’s failure to implement reforms acceptable to the international community, has made investors more risk-averse elsewhere. It is striking that the Argentine president has urged the IMF to provide more help for Brazil: Mr Duhalde can see that a full-blown crisis in Brazil won’t help Argentina at all. Unfortunately, his own failure to deliver only makes things worse for both countries.
Jun 24th 2002
From The Economist Global Agenda
International investors appear to be losing confidence in Brazil as the fall-out from the economic collapse in Argentina threatens to damage economic prospects in several Latin American countries. Is the region heading for a new financial crisis?
IT IS known as the domino effect. Once used to describe the spread of communism, the phrase now more commonly refers to the spread of international financial crises—especially in emerging-market economies. But even there, the domino theory was until recently beginning to look dated: the catastrophic collapse of Argentina’s financial system, currency and even government at the end of last year appeared to have virtually no effect on other countries in the region.
All that has now changed. As Argentina’s struggle to get to grips with its economic problems has dragged on, doubts are emerging about neighbouring economies. Brazil, the largest economy in Latin America, has seen its currency fall, and the cost of servicing its foreign debts has soared. On June 20th, Uruguay abandoned its currency peg and floated its peso—which promptly sank by nearly 10% in two days. Ecuador, whose finance minister resigned (perhaps to pre-empt sacking) on June 23rd in the wake of a bribery scandal, is finding its own corruption problems more difficult to handle because of nervousness about the region as a whole.
The extent to which the mood has shifted was underlined on June 20th, when remarks made by the Mexican finance minister sparked a minor panic in the markets. Francisco Gil Diaz was urging on congress the need to get public finances in order. In doing so, he likened Mexico to Argentina, and its failure to tackle its public finances before the crisis erupted. Mr Gil Diaz was using the comparison to put pressure on congress, but his comments had much wider repercussions, prompting President Vicente Fox to issue a statement saying the Mexican economy was “solid”.
Smaller economies, such as Uruguay and Ecuador, will always be much more vulnerable to changes in investor sentiment. Uruguay was forced to abandon its currency board—a system which fixed in law the level of its domestic currency against the American dollar—because the collapse of confidence in Argentina had made deposit-holders in Uruguay, a large proportion of whom are Argentines, increasingly keen to switch their money into dollars. This created such pressure on the central bank, whose reserves had fallen by around 40%, that the currency peg became unsustainable. Like Argentina’s, Uruguay’s—much smaller—economy is in the fourth year of a painful recession, with high unemployment and many banks weakened by large-scale withdrawals by jittery depositors.
Many Argentines, dismayed by the collapse of their economy, have blamed the outside world for its failure to help. Another team from the International Monetary Fund (IMF) left Buenos Aires last week with no comment, suggesting that a rescue package is no nearer. The resignation of Mario Blejer, the widely respected central-bank governor, which was announced last week and takes effect at the end of the month, has further undermined hopes that a settlement with the IMF can be reached before repayments of loans from the Fund fall due over the coming months.
Much of the problem lies with Argentina’s politicians, who remain reluctant, often for electoral reasons, to push through the reforms needed. Mr Blejer’s resignation is attributed in part to the difficulties he found in working with the economy minister, Roberto Lavagna, and to the reluctance of the president, Eduardo Duhalde, to take tough and potentially unpopular decisions.
Arguably, the international community could have taken a more sympathetic approach to Argentina’s problems. But outside the country, there is relatively little support for the provision of greater financial assistance, and none among the IMF’s principal paymasters, the G7 rich countries. American and European governments have repeatedly emphasised the importance of Argentina’s confronting its economic problems and making the necessary reforms.
Electoral politics lie behind many of Brazil’s current difficulties. On June 21st, the country’s currency, the real, fell to its lowest level since its creation in 1994 and investors grew nervous about the outcome of the presidential elections in October. The risk premium on Brazilian government bonds over the interest rate paid on American treasury securities rose to levels last seen during the country’s currency crisis in early 1999 (which ended with a sharp devaluation of the real). Investors are concerned by the country’s public debt, now more than 55% of GDP: interest payments account for 9% of GDP.
But the man who makes them really nervous is Luiz Inacio Lula da Silva, a member of the Brazilian Workers’ Party. He is the leading leftist candidate in the elections and is currently ahead in opinion polls by a substantial margin. There have been fears that Mr da Silva would abandon the conservative fiscal stance of President Fernando Cardoso and place more emphasis on social spending.
Not true, said Mr da Silva, in a statement on June 23rd. He insisted he would fulfil the country’s international obligations and maintain whatever budget surplus was necessary to control the rise of government debt. He also reaffirmed his commitment to low inflation. But some market analysts have drawn little comfort from Mr da Silva’s open letter to the Brazilian people: such moderate statements make his election more likely, said one.
With the exception of Uruguay there is, as yet, little firm evidence of regional contagion, at least in the sense of a general flight of capital. Investors and analysts alike appear to have learned that it makes sense to look at each emerging-market economy on its merits. In Latin America’s case, though, that might now bring little comfort as Brazil’s impending election gives investors pause for thought.
But it is also increasingly clear that changes in sentiment can have an important impact on how investors judge risk in a particular economy. The disastrous collapse of Argentina, coupled with the government’s failure to implement reforms acceptable to the international community, has made investors more risk-averse elsewhere. It is striking that the Argentine president has urged the IMF to provide more help for Brazil: Mr Duhalde can see that a full-blown crisis in Brazil won’t help Argentina at all. Unfortunately, his own failure to deliver only makes things worse for both countries.
Comment