Volume 4

Number 2

Brave Past, Unknown Future

Just weeks before defaulting on its debt, and much like the management of Enron, the US energy trader, the Argentinean government stated that its economy was fundamentally sound.  And, contemporaneously, the International Monetary Fund had voiced in similar Enronesque tones the view that although there was a short-term fiscal problem, Argentina did not have either a fundamental economic or currency problem.  The IMF had previously given its backing to the fatally-flawed Argentinean currency board regime and its tacit support, which preceded its actual role as lender of last resort, had encouraged an inflow of private external funds.  But the party ended in December, 2001, when Argentina couldn’t get any more loans from the IMF.

Jorge Luis Borges, Argentina’s renowned writer, once said that the tango gives Argentines the belief in a brave past, in having met the demands of honour and bravery.  Both these virtues will surely be in demand now as the economy lies in ruin in a country which remains part of the first world but has third world management.  The breakdown of the economy may well herald the end of a political system which harks back to the 19^th century and the ideology of Juan Domingo Peron who first ruled the country from 1946 to 1955.  Certainly, the illusion that the accumulation of external debt can secure economic growth and development has been shattered.  Events underscore the fact that economies should not be managed by bureaucrats who, it is alleged in the case of Argentina, were part of an overstaffed and overpaid clique representing the country’s power centre.  There have been general concerns that, as in the past, financial contagion will spread and, in varying degrees, will affect all of Latin America.  The impact, however, on other countries in the region might not be as significant as some suspect it will be.  Brazil sends just 10 per cent or so of its exports to Argentina and Mexico even less.  Chile’s dependence on copper sets it apart from the rest of the region (much like the canal does Panama from the rest of Central America) and markets such as Peru and Venezuela have no more in common with Argentina’s economy than with the African or Asian markets.  Some economists have argued that Argentina should have ditched its overvalued peso and adopted the US dollar ages ago with US dollar bank deposits in Argentina making up some two-thirds of the financial system.  Perhaps this would have accomplished something that successive governments in Argentina have failed to do since the beginning of the last century:  protect the value of the country’s currency.

Fatal Attraction

Argentina’s sovereign default has highlighted Latin America’s biggest banking weakness:  too great a reliance on making money by lending to cash-starved governments rather than to companies or individuals.  Governments that are heavily indebted have to pay a higher premium in order to borrow funds on the open market which has translated into juicy returns for Latin American banks.  But the attraction of this, clearly, can prove deadly.  Spain, which earned two-thirds of its revenues from Mexico in the 18^th century, today finds its banks having a large presence in Latin America.   Spanish banks have one-third of their assets there and the continent is the source of up to 50 per cent of their earnings.  Although Argentina has delivered a severe blow to investors, two of Spain’s leading banks feel that Latin America will eventually provide considerable profits. 

In Central America, which, if you exclude Mexico and Belize, has a population similar in size to that of California, but with a combined GDP smaller than that of Mississippi in North America, investors also believe that attractive profits can be made.   Recently, the corporate and sovereign bond market in Central America, south of Mexico, has been seen as an attractive alternative to the rest of the Latin American market, particularly in the case of Argentina; this at a time when emerging markets in general appear to have come back in fashion after the European and North American markets floundered.  Panama, for instance, is the only country in this regional grouping with Brady bonds; it was also found this year to be the most globalized country in the whole of Latin America, according to Foreign Policy magazine.  The survey undertaken covered eight countries in Latin America, namely, Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.  Despite market conditions seeing no marked increase in Panama’s canal revenues in 2001, tourism increased by nearly 23 per cent over last year.  Plans are afoot to build on this encouraging stimulus to the economy.  In addition to Panama, Costa Rica and El Salvador have returned to the international bond market and as a result of these overseas offerings domestic fixed income and share activity in the region have been encouraged. 

Central America appears to be turning into a US dollar zone.  Panama and El Salvador have already dollarised and Guatemala finally agreed last year to allow US dollar transactions.  In Nicaragua 60 per cent of bank deposits and in Costa Rica around 50 per cent of loans are in US dollars.   But no matter how prevalent the greenback becomes in Latin America, one wonders if it can ever compete with the continent’s existing common currency:  uncertainty.