Latin America’s resilience to the 2008 global
financial crisis was as surprising as the crisis itself. It
seemed an improbable outcome, especially given the fate of
emerging markets following the 1998 Russian crisis. Back then,
it took roughly five years for spreads to return to their
pre-crisis levels, and that episode involved only emerging
market economies – relatively minor players in global
Guillermo Calvo: A matter of choice
Latin America’s resilience to the global financial crisis may have been little more than a fluke. As a period of rapid expansion draws to an end, its fundamentals are now weaker than in 2008 – and the region more vulnerable. By Guillermo Calvo
A reasonable inference was that the emerging market turmoil
in the wake of the Russian crisis was a function of weak market
institutions in the emerging world. So, one might have
reasonably assumed that the impact on emerging markets of a
major crisis in the developed world would be Armageddon.
Yet, Latin America sailed through the 2008/2009 episode
virtually unscathed and has since grown at an unprecedented
rate. There are, however, a number of important reasons to be
less sanguine today about the prospects of emerging markets and
LatAm, in particular.
Granted, LatAm faced the Lehman episode with much stronger
fundamentals than in 1998. For instance, the region boasted a
positive current account balance – a phenomenon that
began in 2003 and which had not been seen since 1980. This gave
the region space to partially offset the external blow and, in
sharp contrast to 1998, to implement counter-cyclical
However, this stronger stance also coincided with a period
of skyrocketing terms of trade. Although the terms-of-trade
trend has not yet reversed, the region’s current
account has already plunged into negative territory.
LatAm’s resiliency may therefore have been
little more than a fluke – a lucky turn of events in
which strong fundamentals arose from expenditure that lagged an
unexpected terms of trade bonanza. But spending will eventually
catch up with income and the region will return to business as
usual. Studies by the IDB show that LatAm’s fiscal
deficit is unsustainable, except under the most optimistic
Another important factor is that the aftermath of the Lehman
episode saw developed world central banks undertake
unprecedented counter-cyclical measures, which led to a rapid
recovery of financial indicators. Indeed, the rapid recovery of
LatAm’s financial indicators following the Lehman
episode was to a large extent down to the largesse of developed
world central banks.
Today, external conditions are becoming riskier.
China’s growth slowdown suggests that terms of
trade are unlikely to keep rising. The US economy is starting
to pick up and interest rates on 10-year Treasury bonds have
risen beyond expectations. Historically, this has been bad news
for the region.
The change in the global environment has already been
reflected in currency devaluation and tighter financial
conditions across the region. This appears to have exacerbated
already declining growth rates and fueled inflationary
In addition to weaker emerging market fundamentals relative
to 2008, persistently low policy interest rates in the
developed world may have given rise to capital flows in search
of liquid assets in the emerging markets. Such demand would,
therefore, be highly sensitive to a change in US monetary
Under these conditions, US monetary tightening raises the
serious risk to emerging markets of a sudden stop – an
abrupt contraction in capital inflows. Such a risk was most
starkly illustrated in Mexico’s 1994/1995 Tequila
crisis. Moreover, because such an episode would occur amid
improving US economic prospects, it is unlikely that there
would be any easing of US monetary policy, as in 2008.
This all suggests that a period of buoyant expansion for
Latin America may have come to an end.
This is a low-saving region: even in a relatively benign
scenario where there is no sudden stop, lower access to foreign
savings is nevertheless likely to stall growth –and
fuel social unrest.
This raises serious questions about the nature and quality
of the ensuing political response. Will populism prevail? Are
political leaders prepared to adopt or sustain pro-poverty
growth policies based on higher saving and investment rates?
Will a new generation of leaders be able to convince their
constituents that this is the way to go?
To do so will require tough short-run adjustments that
governments were unable to implement during the boom years. The
region’s prospects for the years ahead depend on
the answer to these questions. LF
Guillermo Calvo is professor of economics and
international and public affairs at Columbia