By Taimur Ahmad
Memories of financial crises run deep in Mexico – perhaps for no one more so than Guillermo Ortiz.
Barely four weeks into his job as minister for communications and transport, Ortiz was given an unenviable task: to save Mexico from default.
It was December 1994. The peso had just collapsed, following a decision by the government to devalue the currency and let it float. Jaime Serra, the finance minister, promptly resigned. Mexico’s so-called ‘tequila crisis’ was now in full swing, as capital fled the country.
Then-president Ernesto Zedillo tapped Ortiz for the finance portfolio in a bid to calm markets. In that role, he would, in the months ahead, help pull Mexico back from the brink, securing and coordinating a $50 billion US-led bailout that eventually succeeded in restoring confidence.
The roots of the crisis are often attributed to policy blunders during the prior administration of Carlos Salinas, although the devaluation – and a miscalculation of its effects – proved to be the immediate trigger.
But the crisis also unfolded against a backdrop of sharply rising US interest rates, which exacerbated the outflow of capital from Mexico and which, according to Ortiz, were “a very important part” of that episode.
That year, US Federal Reserve chairman Alan Greenspan had embarked on an aggressive tightening cycle, raising the federal funds rate by more than 300 basis points over the year, in a bid to thwart inflation. The move triggered a bond market rout – and also upended the nascent emerging markets asset class.
That was then
Two decades later, as global financial markets brace for an inevitable rise in US interest rates, Ortiz, now chairman of Mexico’s Grupo Financiero Banorte, reflects on the rising market volatility with a degree of unease.
In an interview with LatinFinance, Ortiz says that developed world interest rates will inevitably edge higher – and when they do, that emerging markets will be in for a tough and prolonged slog as they compete for capital with their developed world counterparts.
“What we face now is an episode of a normalization of interest rates that will last for sure for several years, starting with the Fed,” he says. This, adds Ortiz, will inevitably mean “a pullback of resources from emerging markets”.
The “violent market reaction” in the early weeks of the summer is evidence that vast capital flows chasing yield make emerging markets vulnerable, he says.
While he doesn’t expect the worst, he says that Latin America, and Mexico in particular, would this time nevertheless be ready to withstand a sharp rise in US interest rates, should it occur. “Obviously we’re very prepared to confront volatility and a repetition of an episode like 1994/1995,” he says.
Whatever the case, he is clear that “central banks cannot keep the world flooded with money forever”.
But he warns that although markets stabilized following a sharp sell-off in emerging market assets in May and June on fears of an earlier-than-expected end to the US Federal Reserve’s bond buying program, that respite could prove short-lived.
“The markets are calmer today but the trigger can come at any point,” he says. “Emerging markets and Latin American countries will be well advised to prepare themselves for a difficult period in the next years.”
Fire with fire
Ortiz’s expertise as a crisis manager extended well beyond the finance ministry: he left that job in 1998 to take the helm at the Bank of Mexico, which he ran for 12 years, successfully banishing hyperinflation and bringing Mexico into a new era of financial stability.
During that time, he steered the emerging world’s first freely floating currency through the fallout of financial crises in Asia, Brazil and, most recently, the US. Indeed, during the global financial crisis, the central bank’s timely injection of dollars into the currency markets was credited with halting a potentially disastrous slide in the peso.
Mexico was not alone in adopting sound macro-policies over the past two decades. Ortiz says that the impact of any reversal in capital flows to Latin American economies should be milder than previous episodes, in large part because the macroeconomic conditions are much sounder across the region.
Of critical importance is the fact that many countries in Latin America “have adopted flexible exchange rates and inflation targeting which gives you a framework to deal with volatility,” he says.
Exchange rate flexibility will act as a partial buffer to external shock, minimizing the extent of domestic contraction. “The emerging markets, and Latin America in particular, are well prepared to face this period of a withdrawal of resources,” he says. “As long as they are not very violent, the consequences should be very manageable.”
Not all sound
Although Latin America is by and large “very well prepared” to face tighter liquidity conditions, Ortiz warns that economies and companies that require external financing are now “more vulnerable” to a reversal in capital flows.
Moreover, poor fiscal dynamics in some Latin American countries since the 2008 crisis means policymakers there will have less room for maneuver.
“The fiscal situation in several Latin American economies has deteriorated and so there’s not a lot of room there. Current account balances have also worsened. If you are a country today with a large current account deficit, with fiscal vulnerabilities and with the prospect of a change in world conditions implied by central banks’ gradual withdrawal of liquidity, you probably will suffer,” he says.
“It’s important for emerging markets and Latin American countries which are vulnerable in this respect to take the appropriate measures to mitigate these vulnerabilities and make them better able to cope with the volatility which I’m sure is going to be with us for a long time.”
Such countries are better advised to review their fiscal buffers and to be prepared for more volatility. “It’s never the case that when you have a change in liquidity conditions, that things are smooth,” he says. “The process of adjustment is never smooth, it’s always disruptive. One has to be prepared for that.”
Yet in the wake of the global financial crisis, a belief has taken hold that Latin America is better insulated than ever before against crisis. For a veteran crisis manager like Ortiz, such beliefs portend disaster. “The worst thing that you could do would be to become overly complacent,” he says.
“Latin America did very well during the 2008 crisis: counter-cyclical policies were used, which was not the case in previous episodes of financial turbulence. But it’s also true that a lot of ammunition was used,” he says. “During the crisis they had buffers. The difference today is that in some cases these buffers are gone. Latin America has to focus on these buffers.”
Ultimately, though, emerging markets have learned not just resilience through crises but also the ability to find opportunities in them. In this light, says Ortiz, a new world of slower growth in the big emerging markets, including China and Brazil, may not be such a bad thing.
“This is not a tragedy, to the extent that the emerging market world is able to cope with this new state of the world, with commodity prices that are not rising and with capital flows that are not so easily available,” he says. “We will adapt.”
One way to adapt, says Ortiz, is to focus on structural reforms to make economies more competitive. In Mexico, the government of president Enrique Peña Nieto, for example, has embarked on an ambitious program of economic reforms, which includes an overhaul of the infrastructure, financial and energy sectors. “Mexico’s overall prospects are quite good within the emerging markets sphere,” says Ortiz. “Things are much better aligned than they have been in a decade and a half.”
But even still, the main risk facing the country is in actually carrying out the reforms, he says.“It’s a huge accomplishment” to reach political agreement on reforms, he says. “But the risk for Mexico now is to implement them,” says Ortiz. “That is the main risk.” LF