Transcript Global Financial Turmoil: Is Latin America Sheltered?

Global Financial Turmoil:
Is Latin America Sheltered?
Ernesto Talvi
CERES
October 16th, 2007
Prepared for Presentation at the XXVI Meeting of the Latin American
Network of Central Banks and Finance Ministries, IADB, Washington DC
MAIN POINTS OF THE PRESENTATION

In every major episode of global financial turmoil Latin America suffered
a severe blow.
Global Financial Turmoil Episodes
in Perspective*
(Moody’s US Baa Spread over US Treasuries)
Tequila
Crisis
Debt
Crisis
Asian
LTCM /
Crisis Russian Crisis*
400
10y Mov.Avg. + 2s
350
10y Mov.Avg. + 1s
300
250
200
Subprime
Crisis
150
100
Jan-06
Jan-04
Jan-02
Jan-00
Jan-98
Jan-96
Jan-94
Jan-92
Jan-90
Jan-88
Jan-86
Jan-84
Jan-82
Jan-80
0
Jan-78
50
*A global financial turmoil episode is defined as an aggregate-spread window containing a spike in the US Baa spread exceeding two standard deviations
from its mean (which starts when the aggregate US Baa spread exceeds one standard deviation, and ends when it is smaller than one standard deviation).
If between the end of an episode and the beginning of the next there is less that one year, both are considered part of the same episode.
Global Financial Turmoil Episodes
and Sudden Stops in LAC-7*
(Moody’s US Baa Spread over US Treasuries and Gross
Capital Flows to LAC-7 in billions of 2006 US dollars)
Debt
Crisis
400
Spread on
Risky Assets
LTCM / Russian Crisis
350
10y Mov.Avg. + 2s
300
10y Mov.Avg. + 1s
250
200
150
100
50
129.5
126.5
-116.6
*LAC-7 includes Argentina, Brazil, Chile, Colombia, Mexico, Peru and
Venezuela, which represent 93% of Latin America GDP
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
-146.9
1978
Gross Capital
Flows to LAC-7
0
140
120
100
80
60
40
20
0
-20
-40
Global Financial Turmoil Episodes and
Output Performance*
(LAC-7 GDP, real index)
1980s: Debt Crisis
1990s: LTCM / Russian Crisis
Debt Crisis
105
LTCM/ Russian
Crisis
105
102
100
99
96
Avg. growth
1974-1980:
93
95
4.5%
Avg. growth
1981-1985:
90
Avg. growth
1991-1997:
Avg. growth
1998-2002:
4.6%
0.8%
90
0.5%
87
85
80
-1.3%
Recovery to
pre-crisis
peak levels
1 yr
2 yrs
*Talvi, E. (forthcoming), “Sudden Stops in the 80s and the 90s: a Fresh Look at Latin America’s Debt Crisis”
2002
2001
2000
1999
1996
1995
1994
1993
1992
75
1991
1985
1984
4 yrs
1983
1982
of
Peak to Duration
Trough Recession
Phase
1998
Recovery to
pre-crisis
peak levels
2 yrs
1981
1980
1979
1978
1977
-5.4%
1976
78
1975
of
Peak to Duration
Trough Recession
Phase
1974
81
75
Output Contraction
Output Contraction
1997
84
Global Financial Turmoil Episodes and
Investment Performance*
(LAC-7, Gross fixed capital formation, real indices)
1980s: Debt Crisis
105
1990s: LTCM / Russian Crisis
105
Debt
Crisis
LTCM/ Russian
Crisis
100
100
95
Avg. growth
1974-1980:
95
8.5%
6.8%
90
Avg. growth
1991-1997:
Avg. growth
1981-1985:
90
-4.3%
85
85
Avg. growth
1998-2002:
80
80
-4.0%
75
Output Contraction
75
of
Peak to Duration
Trough Recession
Phase
70
-27.6%
Output Contraction
70
Recovery to
pre-crisis
peak levels
Peak to
Trough
Duration of
Recession
Phase
-13.9%
1 yr
65
2 yrs
11 yrs
65
Recovery to
pre-crisis
peak levels
7 yrs
*Talvi, E. (forthcoming), “Sudden Stops in the 80s and the 90s: a Fresh Look at Latin America’s Debt Crisis”
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
60
Global Financial Turmoil Episodes and Social Impact:
An Ilustration from Argentina and Uruguay*
(% of people under the poverty line)
Uruguay 90s: LTCM / Russian Crisis
Argentina 90s: LTCM / Russian Crisis
55
Trough
to peak
50
30%
Recovery to
pre-crisis
trough levels
35
54%
9 yrs
Trough
to peak
16%
Recovery to
pre-crisis
trough levels
7+ yrs
32%
30
45
25
40
35
25%
LTCM / Russian
Crisis
LTCM / Russian
Crisis
20
30
15
25
17%
24%
23%
20
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
10
*Talvi, E. (forthcoming), “Sudden Stops in the 80s and the 90s: a Fresh Look at Latin
America’s Debt Crisis”
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
MAIN POINTS OF THE PRESENTATION

In every major episode of global financial turmoil Latin America suffered
a severe blow.

If recent episodes of capital market turbulence are any indication, the
unfolding of a full blown global financial turmoil episode, would be a
‘lethal combo’. Given past experience, it will send once again Latin
America diving.
Recent Episodes of Global Financial Turbulence
(US High Yield Spread, basis points)
LTCM / Russian Crisis
1100
1000
900
800
700
600
Greenspan’s
Conundrum
Testimony US Inflation
Scare
500
400
Expectations
of Fed
Tightening
300
China’s Stock
Market Sell Off
200
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
100
Subprime
Crisis
X-Ray of Recent Episodes of Global
Financial Turbulence
Bond Prices
Credit Spreads
(bond price equivalent*, peak to trough variation)
Latin America
US High Yield
(basis points, peak to trough variation)
-3.5%
EMBI
US High Yield
-3.1%
EM Europe
AAA Corporate
0.4%
Japan T-Bonds
0%
-5
Europe T-Bonds
1.0%
-1%
10
US T-Bonds
0.6%
Flight to Quality
-2%
23
AAA Corporate
US T-Bonds
-3%
50
BBB Corporate
-0.5%
-4%
56
EM Asia
-1.2%
Europe T-Bonds
64
EM Europe
-2.6%
BBB Corporate
66
EMBI
-2.7%
EM Asia
72
Latin America
-3.3%
-9
-10
Japan T-Bonds
1%
2%
Flight to Quality
-20
0
Commodity Prices
(peak to trough variation)
Industrial Metals
-10.5%
Gold
-8.1%
Goldman Sachs
Commodity Index
-4.2%
Agricultural
Products
-3.1%
-1.0%
Oil
-12%
Data Sources: JPMorgan, Bloomberg and MSCI
* Own calculations assuming an 11% coupon and 10-year maturity
-10%
-8%
-6%
-4%
-2%
0%
20
40
60
80
Simulation of a Global Financial
Turmoil Episode
(US High Yield Spread over US Treasuries)
Asian
Crisis
Tequila
Crisis
1100
LTCM / Russian Crisis
1000
10y Mov.Avg. + 2s
900
+ 480 bps
800
10y Mov.Avg. + 1s
700
600
500
400
300
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
200
“Combo Shock”: Simulation of Collateral
Damage of a Global Financial Turmoil Episode
Terms of Trade Dynamics
Shock to the US High Yield Spread
(LAC-7, 91.I = 100)
(bps, High Yield Spread over US Treasuries)
140
1050
135
950
+480 bps
130
850
125
750
120
650
115
550
450
105
350
Mar-09
Mar-10
Mar-09
Mar-10
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
G-7 Industrial Production Dynamics
95
Mar-00
Mar-09
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
100
Mar-00
250
-18%
110
10Y Treasury Yield Dynamics
(1991.I = 100)
(10Y T-Bond Yield)
140
-1.5%
138
6.5%
136
6.0%
134
132
5.5%
130
5.0%
128
4.5%
126
-35 bps
124
4.0%
122
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-10
Mar-09
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-00
Mar-00
3.5%
120
Booms and Busts in Latin America:
The Role of External Factors*
Estimation Strategy: Vector Error Correction Model (VECM)
Dyt = c + ab' yt -1 + GDyt -1 + ... + Gp -1 Dyt - p +1 + et
where
yt = ( gdp_latt ip_xt tot_latt
gdp_lat:
ip_x:
tot_lat:
financ_x:
risk:
financ_xt riskt )’
(log of) Simple average of GDP indices of LAC-7 countries
(log of) G-7 industrial production index
Principal component weighted average of (the log of )
terms of trade indices of LAC-7 countries
Return on 10 year US T-bonds
US High-Yield Bonds Spread
*A. Izquierdo, R. Romero and E.Talvi (2007), “Booms and Busts in Latin America: The Role of External Factors”.
Booms and Busts in Latin America:
The Role of External Factors*
(GDP LAC-7, annualized quarter on quarter growth rate)
A Vector Error Correction Model
External Factors
15%
Tequila
Crisis
Asian
Crisis
LTCM / Russian
Crisis
World Growth
10%
Actual
5%
Commodity Prices
0%
*A. Izquierdo, Romero, R., and Talvi, E. (2007), “Booms and Busts in Latin America: The Role of External Factors”.
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
-10%
Dec-93
Spread on US HY Bonds
Fitted
Dec-92
US T-Bond Interest Rate
-5%
Dec-91
International Financial
Conditions
Output Performance: Simulation of the Overall
Impact of a Global Financial Turmoil Episode
Output Response to “Combo Shock”*
Output Contraction
140
Recovery to
Duration of
Peak to
pre-crisis
Trough Recession Phase peak
levels
135
130
125
120
“Combo Shock”
-4.5%
1.5 yrs
3.3 yrs
Debt Crisis
-5.4%
2 yrs
4 yrs
LTCM / Russian
Crisis
-1.3%
1 yr
2 yrs
115
Steady State
GDP Dynamics
110
105
GDP Dynamics w.
“Combo Shock”
100
95
90
-4
-2
0
2
4
6
8
10
12
14
16
18
20
*Impulse response simulations based on the model by A. Izquierdo, Romero, R., and Talvi, E.
(2007), “Booms and Busts in Latin America: The Role of External Factors”.
22
24
26
28
30
MAIN POINTS OF THE PRESENTATION

In every major episode of global financial turmoil Latin America suffered
a severe blow.

If recent episodes of capital market turbulence are any indication, the
unfolding of a full blown global financial turmoil episode, would be a
‘lethal combo’. Given past experience, it will send once again Latin
America diving.

The analysis based on past experience is faulty, since the external
environment is less risky and Latin America’s fundamentals are much
stronger today. Thus, the region is less vulnerable to global financial
turmoil episodes than in previous expansions.
The ‘This Time is Different’ Hypothesis
 The World is a safer place
(“Great Moderation” period)
Growth, Inflation and Interest Rates Volatility in G-7 Countries
(standard deviation)
5.0%
4.0%
Economic
Growth
3.0%
2.1%
2.1%
2.0%
2.0%
1.6%
1.4%
1.0%
0.0%
7%
6%
5%
Inflation
3.9%
4%
3.7%
3%
2%
1.5%
1.5%
1%
0.6%
0%
5,0
Real Interest 4,0
Rates
(“perfect foresight” 3,0
real ex-ante rates
for long term
2,0
instruments)
3.0
2.4
1.6
Excluding Japan
1,0
1.3
1.2
0.9
0,0
60s
70s
US
UK
FRANCE
80s
GERMANY
ITALY
90s
CANADA
JAPAN
00s
The ‘This Time is Different’ Hypothesis
 The World is a safer place
( “Great Moderation” period)
 Latin America is more resilient than in
previous expansions
Latin America: Growth and Inflation
7%
Growth Performance
Inflation
(LAC-7, real annual growth rate)
(LAC-7, CPI annual variation)
90s Boom
LTCM / Russian
Crisis
6,2
6%
40%
Current Boom
6,0 6,1
03-06
LTCM / Russian Crisis
35%
Average:
5%
91-97
5,4%
Average:
30%
4,6%
4%
74-06
Average:
3%
25%
3,2%
Average 91.I-98.II: 20.3%
2%
20%
1%
15%
0%
Average 98.II-02.IV:
6.2%
10%
-1%
5%
-2%
4.1%
-3%
Source: WEO
*Median
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-00
Mar-99
Mar-98
Mar-97
Mar-96
Mar-95
Mar-94
Mar-93
Mar-92
Mar-91
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
0%
Latin America: External Balance and
International Reserves
External Balance
International Reserves
(LAC-7, current account, in millions of USD and % of GDP)
(LAC-7, billions of US dollars)
55,000
3.5% 5%
LTCM / Russian
Crisis
LTCM / Russian Crisis
375
345
35,000
Aug.07/Jun.98
3%
Mexico
Peru
Brazil
Colombia
LAC-7
Argentina
2.4
2.3
2.3
2.2
2.1
1.9
Venezuela 1.8
Chile
1.0
315
285
1%
-5,000
-1%
% of GDP
Millions of USD
% of GDP
Millions of
USD
15,000
363
255
225
Dec.02Aug.07
Variation:
147%
195
173
-25,000
Jun.98-Dec.02
Variation:
-15%
165
-3%
-45,000
Jan.91-Jun.98
Variation:
271%
135
105
-5%
-65,000
-4.9%
75
45
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
2006
2005
2004
2003
2002
2001
2000
1999
1997
1998
1996
1995
1994
1993
1992
1991
1990
15
1990
-7%
-85,000
Latin America: Fiscal Stance and
Debt Management
Fiscal Balance
(LAC-7, % of GDP)
Public Debt Level*
Dollarization of Publc Debt
(LAC-7, % of GDP)
(LAC-7, foreign currency debt, % of total debt)
1,5%
60%
1.0%
65%
LTCM / Russian Crisis
61%
1,0%
60%
55%
0,5%
55%
50%
0,0%
50%
45%
-0,5%
45%
-1,0%
40%
40%
39%
40%
-1,5%
34%
35%
35%
-2,0%
30%
30%
-2,5%
-2.7%
-3,0%
25%
25%
20%
20%
*Adjusted by Argentina’s debt exchange
Source: Cowan, Levy, Panizza, Sturzenegger (2006)
and own calculations based on official data.
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
2004
2005
2006
2003
1997
1998
1999
2000
2001
2002
1993
1994
1995
1996
2006
2005
2003
2004
2002
2001
1999
2000
1997
1998
1996
1995
1994
1993
1991
1992
1991
1992
LTCM / Russian Crisis
-3,5%
Latin America: Credit Ratings
(LAC-9** excluding Ecuador, Standard & Poor´s Credit Ratings)
Numerical Transformation
of Credit Ratings*
11,0
BB+
10,5
Investment Grade
10,0
Chile
Colombia
Mexico
9,5
9,0
8,5
Investment Grade
8,0
Chile
Mexico
B+
*A. Powell and J.F. Martinez, (2007), “On Emerging Economy Spreads and Ratings” (forthcoming)
** LAC-9 includes the Latin American countries currently covered by JPMorgan EMBI
Jun-07
Feb-07
Oct-06
Jun-06
Feb-06
Oct-05
Jun-05
Feb-05
Oct-04
Jun-04
Feb-04
Oct-03
Jun-03
7,5
AAA
21
AA+
20
AA
19
AA-
18
A+
17
A
16
A-
15
BBB+
14
BBB
13
BBB-
12
BB+
11
BB
10
BB-
9
B+
8
B
7
B-
6
CCC+
5
CCC
4
CCC-
3
CC
2
SD
1
Investment
Grade
MAIN POINTS OF THE PRESENTATION

In every major episode of global financial turmoil Latin America suffered
a severe blow.

If recent episodes of capital market turbulence are any indication, the
unfolding of a full blown global financial turmoil episode, would be a
‘lethal combo’. Given past experience, it will send once again Latin
America diving.

The analysis based on past experience is faulty, since the external
environment is less risky and Latin America’s fundamentals are much
stronger today. Thus, the region is less vulnerable to global financial
turmoil episodes than in previous expansions.

At closer look, the world is still a risky place and Latin America’s
underlying vulnerabilities to a global financial turmoil episode are still
large, but the current bonanza is disguising a host of fundamental
fragilities.
‘Plus Ça Change, Plus Ça Reste La Même Chose’
(The more things change, the more they remain the same)
 The World is still a risky place
Great Moderation?
The Calm Before the Storm…
450
Debt Crisis
LTCM / Russian Crisis
400
Moody’s Baa
Corporate
Spread
(basis points)
375
350
379
300
250
1978-2007 Avg.
200
150
165
169
100
116
50
0
80
66
70
60
Moody’s Baa
Corporate Spread 50
Volatility
40
1978-2007 Avg.
30
15
20
24
10
11
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
0
1978
(3 year moving
standard deviation,
in basis points)
48
The Global Financial Turmoil Histogram
(Moody’s Baa Spread Histogram, 1978 – 2007)
12.6%
Global Financial Turmoil
Probability: 4.5%
11.2%
9.8%
8.4%
7.0%
Mean+1s
5.6%
4.2%
Mean+2s
2.8%
1.4%
390
370
350
330
310
290
270
250
230
210
190
170
150
130
110
90
0%
‘Plus Ça Change, Plus Ça Reste La Même Chose’
(The more things change, the more they remain the same)
 The World is still a risky place
 Latin America’s fundamentals are weaker
than meets the eye
Assessing Performance in Latin America:
A Counterfactual Exercise*
Forecast for GDP: 2003 – 2006
Forecast for GDP: 1998 – 2001
(LAC-7, Values in logs)
(LAC-7, Values in logs)
4.72
4.83
90% confidence interval
4.70
90% confidence interval
4.68
Steady
State GDP
4.78
4.66
4.64
Predicted GDP
w. Observed
External Factors
4.62
4.68
4.60
Steady
State GDP
4.58
4.56
*Simulations based on the model by A. Izquierdo, Romero, R., and Talvi, E. (2007), “Booms and Busts in Latin America:
The Role of External Factors”.
Nov-01
Jul-01
Mar-01
Nov-00
Jul-00
Mar-00
Nov-99
Jul-99
Mar-99
Nov-98
Jul-98
Jul-97
Mar-97
Jul-06
Mar-06
Nov-05
Jul-05
Mar-05
Nov-04
Jul-04
Mar-04
Nov-03
Jul-03
Mar-03
Nov-02
Jul-02
4.54
Mar-02
4.58
Observed
GDP
Mar-98
Observed
GDP
4.63
Nov-97
4.73
Predicted GDP
w. Observed
External Factors
Latin America External Balance:
A Different Perspective*
(LAC-7, current account, in millions of USD and % of GDP)
55,000
5%
LTCM /
Russian
Crisis
35,000
3%
% of GDP
Millions of USD
1%
-5,000
-1%
-25,000
% of GDP
Millions of USD
15,000
-3%
-45,000
Terms of Trade
Adjusted at I.2002
prices
-4.5%
-65,000
-5%
-4.9%
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-7%
1990
-85,000
* G. Calvo and Talvi, E. (2007): “Current Account Surplus in Latin America: Recipe Against Capital Market Crises?”; www.rgemonitor.com (forthcoming)
Latin America: International Reserves
(billions of US dollars and % of M2)
260
60%
LTCM / Russian Crisis
Reserves
240
220
55%
Reserves / M2
180
Average 2002.IV –
2006.III: 48.3%
160
50%
Average 1991.I-1998.II: 45.6%
140
45%
120
Average 1998.II2002.IV: 40.3%
100
40%
80
60
35%
M2 = Currency outside banks + demand deposits + time, savings and foreign currency deposits of resident sectors
Source: IFS and own calculations
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
20
1991
40
30%
% of M2
Billions of US dollars
200
Latin America: Structural Fiscal Balance*
Chile
LAC-7
(% of GDP)
(% of GDP)
LTCM /
Russian
Crisis
2.0%
Beginning of
Current Boom
9,0%
1.0%
Observed
Balance
1.0%
LTCM/
Russian
Crisis
Beginning of
Current Boom
7,0%
Observed
Balance
5,0%
0.0%
Structural
Balance**
-1.0%
3,0%
-2.0%
1,0%
-3.1%
-3.0%
-2.4%
-2.7%
Structural
Balance
-1,0%
Structural
Balance
-4.0%
-3,0%
Dic-06
Dic-05
Dic-04
Dic-03
Dic-02
Dic-01
Dic-00
Dic-99
Dic-98
Dic-97
Dic-96
Dic-95
Dic-94
Dic-93
Dic-91
Dec-06
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
Dec-93
Dec-92
Dec-91
-5,0%
Dic-92
-4.5%
-5.0%
**Excluding Venezuela
*A. Izquierdo, Ottonello, P., Talvi, E. (forthcoming), “ If Latin America Were Chile: A Comment on Structural Fiscal Balances and Public Debt” .
Latin America: Fiscal Revenues and
Expenditures*
LAC-7
Chile
(Mar-91 = 100)
(Mar-91 = 100)
LTCM /
Russian
Crisis
280
Beginning of
Current Boom
Fiscal
Revenues
260
LTCM/
Russian
Crisis
Beginning of
Current Boom
280
240
Fiscal
Revenues
220
230
200
Fiscal
Expenditures
180
Adjusted
Revenues
180
160
Fiscal
Expenditures
140
130
120
Mar-05
Mar-03
Mar-01
Mar-99
Mar-97
Mar-95
Mar-05
Mar-06
Mar-03
Mar-04
Mar-01
Mar-02
Mar-00
Mar-98
Mar-99
Mar-96
Mar-97
Mar-94
Mar-95
Mar-92
Mar-93
Mar-91
Mar-93
80
80
Mar-91
Adjusted
Revenues
100
*A. Izquierdo, Ottonello, P., Talvi, E. (forthcoming), “ If Latin America Were Chile: A Comment on Structural Fiscal Balances and Public Debt” .
Prociclicality in Public Expenditures
Increase in Public Expenditures for LAC-7
Increase in Public Expenditures per Country
(in % of increase in fiscal revenues, 2002-2006)
100%
Increase in Total
Revenues
(in % of increase in fiscal revenues, 2002-2006)
92%
Venezuela
87%
Brasil
80%
Interest
Payments
2%
85%
Mexico
60%
Argentina
40%
Primary
Expenditures
68%
76%
Colombia
73%
Peru
57%
20%
Chile
0%
0%
25%
20%
40%
60%
80%
100%
Latin America: Structural Debt
(LAC-7, in % of GDP)
LTCM / Russian Crisis
90s Boom
55%
Current Boom
52%
50%
49%
48%
Observed Debt
45%
Structural Debt
42%
40%
39%
35%
32%
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
30%
*A. Izquierdo, Ottonello, P., Talvi, E. (forthcoming), “ If Latin America Were Chile: A Comment on Structural Fiscal Balances and Public Debt” .
Debt Mutation: Two Compelling Examples*
Brazil
Mexico
(Federal Domestic Securities, exchange rate
linked + Selic linked, % of total debt)
Pre-Asian
Crisis
Pre-Tequila
Crisis
Pre-Devaluation
100%
88.1%
90%
(Federal Government Domestic Securities, exchange rate
linked Tesobonos, % of total debt)
Pre-Devaluation
80%
66.9%
70%
80%
60%
70%
60%
50%
50%
40%
40%
30%
30%
28.3%
20%
20%
10%
10%
0%
0%
August 1997
November 1998
4.9%
December 1993
November 1994
* E. Cavallo, Izquierdo, A., and Talvi, E. (in progress), “External Financial Conditions and Debt Composition: the Mutation Factor”.
MAIN POINTS OF THE PRESENTATION

In every major episode of global financial turmoil Latin America suffered
a severe blow.

If recent episodes of capital market turbulence are any indication, the
unfolding of a full blown global financial turmoil episode, would be a
‘lethal combo’. Given past experience, it will send once again Latin
America diving.

The analysis based on past experience is faulty, since the external
environment is less risky and Latin America’s fundamentals are much
stronger today. Thus, the region is less vulnerable to global financial
turmoil episodes than in previous expansions.

At closer look, the world is still a risky place and Latin America’s
underlying vulnerabilities to a global financial turmoil episode are still
large, but the current bonanza is disguising a host of fundamental
fragilities.

The evidence from credit ratings and the behavior of asset prices is
consistent with the view that Latin America is still vulnerable to global
turmoil, but financial shocks so far have been “too small to hurt”.
Credit Ratings Agencies Verdict
(LAC-9 excluding Ecuador, Standard & Poor´s Credit Ratings)
Numerical Transformation
of Credit Ratings*
Russian
Crisis
11,0
Investment Grade
BB+
Chile
Colombia
Mexico
BB+
10,5
Investment Grade
Chile
Colombia
Uruguay
10,0
9,5
9,0
8,5
Investment Grade
8,0
BB
Chile
Mexico
*A. Powell and J.F. Martinez, (2007), “On Emerging Economy Spreads and Ratings” (forthcoming)
Dic-06
Dic-05
Dic-04
Dic-03
Dic-02
Dic-01
Dic-00
Dic-99
Dic-98
Dic-97
Dic-96
7,5
AAA
21
AA+
20
AA
19
AA-
18
A+
17
A
16
A-
15
BBB+
14
BBB
13
BBB-
12
BB+
11
BB
10
BB-
9
B+
8
B
7
B-
6
CCC+
5
CCC
4
CCC-
3
CC
2
SD
1
Investment
Grade
Let Prices Talk: EMBI Spreads Reaction to
Spikes in US High Yield Spreads
Systemic Turmoil
Period
Relatively Tranquil
Recent Period
(US High Yield and Latin EMBI spreads, basis points)
1600
Latin EMBI
1200
(1)
(2)
(3)
Dating
Δ US HY
Spread
Δ LA EMBI
Spread
(4)
Naïve Beta
(3) / (2)
3-Aug to
19-Oct-98
299
444
1.5
12-Sep to
15-Dec-00
139
109
0.8
7-Feb to
9-Apr-01
97
96
1.0
21-May to
4-Oct-01
218
430
2.0
10-May to
14-Oct-02
409
539
1.3
Systemic Turmoil Period Average
800
400
2006
2005
2004
2003
2002
2001
2000
1999
1998
0
1997
US High Yield
1.3
19-Apr to
17-May-04
55
77
1.4
10-Mar to
18-May-05
158
80
0.5
10-May to
27-Jun-06
43
47
1.1
26-Feb to
7-Mar-07
30
20
0.7
23-Jul to
16-Aug-07
90
49
0.5
Recent Period Average
0.8
Measuring Contagion:
The Forbes-Rigobon Adjustment*
Beta Coefficient
b = r sx
sy
where r is the correlation coefficient between x and y,
and s x and s y are the variance of x and y, respectively
Variance Adjustment
Coefficient
sh
dt = - 1
sl
xx
h
where sx x is the variance of x during a period of market
l
turmoil and sx x is the variance of x during a period of
relative market stability
xx
Correlation Adjustment
r=
t
rt u
1 + dt [1 - (rtu ) 2]
u
where r t is the actual correlation coefficient and r t
is the unadjusted correlation coefficient
*K. Forbes and Rigobon E. (1999), “No Contagion, Only Interdependence: Measuring Stock Market Co-Movements”
Let Prices Talk: EMBI Spreads Reaction to
Spikes in US High Yield Spreads
Beta Coefficient
Systemic Turmoil
Period
Relatively Tranquil
Recent Period
(average beta per period,
US high yield vs. Latin EMBI)
(US High Yield and Latin EMBI spreads, basis points)
1600
1.4
1.27
Latin EMBI
1.2
1200
1.0
0.86
800
0.8
0.76*
0.6
400
2006
2005
2004
2003
2002
0.4
2001
2000
1999
1998
0
1997
US High Yield
0.2
Systemic
Turmoil Period
Relatively Tranquil
Recent Period
*Adjusted using Forbes, Rigobon (1999) methodology
IN SUMMARY
 When scratching the surface, Latin America is
still highly vulnerable to a global financial turmoil
episode
 Although we should enjoy the good times, policy
makers in the region should be on guard and fire
departments (i.e. multilaterals) in full alert mode
 This analysis should not be construed as a gloomy
forecast, but rather as a warning against “irrational
exuberance”.
Global Financial Turmoil:
Is Latin America Sheltered?
Ernesto Talvi
CERES
October 16th, 2007
Prepared for Presentation at the XXVI Meeting of the Latin American
Network of Central Banks and Finance Ministries, IADB, Washington DC