LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATIONJosé Antonio OcampoColumbia University

Medium-term cycles of capital flows to emerging markets:

1975-81 -- Recycling of petrodollars, via bank loans, to oil-importing EMs1982, Aug.-- Mexico unable to service its debt on schedule, defaults

=> Start of the Latin American debt crisis, 1982-89

1990-97 -- New capital flows to EMEs following 1989 Brady Plan1994, Dec. -- Mexican peso crisis1997, July -- Thailand forced to devalue and seek IMF assistance => Start of East Asia crisis1998, Aug. -- Russia defaults on much of its debt => Contagion to Brazil.2001-02 -- Turkey and Argentina currency & debt crises

2003-07 -- New capital flows into developing countries2008, Sep. – Lehman Brothers collapse => Beginning of North Atlantic Financial Crisis

2009-13 -- Post-crisis surge in capital flows to emerging markets,

2013, May -- May 2013 U.S. Fed tapering began the contraction phase

But, so far, financing conditions have continued to be good

1.

2.

3.

4.

3

Net resource transfers to Latin America

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Figure 1: Net resource transfer, 1950-2012 (% of GDP at current prices)

via financial flows via FDI Total

Source: Authors’ estimates based on ECLAC data

4

Major phases of liberalization and regulation

1950-75 -- Extensive FX and capital account regulations in all LA▫ Exceptions: Mexico and Venezuela

1975-81 -- Capital account liberalization in Argentina, Chile and Peru, but Brazil and Colombia remain relatively closed; Domestic liberalization in Argentina and Chile

▫ 1982-89 -- Closing of the capital account during LA debt crisis

1990-98 -- Broad-based capital account liberalization in LA, including Brazil and Colombia, but with new instruments to regulate capital flows:

▫ Taxes on capital flows in Brazil, and URRs in Chile and Colombia.▫ Regulations on FX transactions, e.g. restrictions on domestic

financial deposits in FX. -- Semi-dollarized systems in Argentina and Peru, hyperinflations of 1989 and 1990; but not in Brazil despite its hyperinflation in early 1990s

2000-06 -- Further liberalization in Brazil, Colombia, Chile (FTA with U.S.), but reversal of liberalization in Venezuela and Argentina

▫ 2004-13 -- Peru used differential RRs on deposits in dollars and short-term external borrowing by domestic banks vs. deposits in the domestic currency

▫ 2007-08 -- Colombia used URRs before FTA with U.S.▫ 2009-11 -- Brazil used taxes on capital inflows after the North-

Atlantic crisis

1.

2.

3.

5

Comparison of capital account restrictiveness of Latin America vs Emerging Market Economies

Figure 2: Capital Account Restrictiveness in Latin America and EMEs

Source: Negative of Chinn-Ito index of capital account openness.

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1970 1975 1980 1985 1990 1995 2000 2005 2010

LA7 EMEs

6

Capital flow regulations in Latin AmericaFigure 3: Capital Flow Regulations in Latin America and EMEs

Source: Updated by Erten and Ocampo (2013) with data from Schindler (2009) and Ostry et al. (2012).

.1

.2

.3

.4

.5

.6

.7

.8

.9

1996 1998 2000 2002 2004 2006 2008 2010

LA7 EMEs

A. Capital Inflow Regulations

.1

.2

.3

.4

.5

.6

.7

.8

.9

1996 1998 2000 2002 2004 2006 2008 2010

LA7 EMEs

B. Capital Outflow Regulations

.1

.2

.3

.4

.5

.6

.7

.8

.9

1996 1998 2000 2002 2004 2006 2008 2010

LA7 EMEs

C. FX-related Regulations

.1

.2

.3

.4

.5

.6

.7

.8

.9

1996 1998 2000 2002 2004 2006 2008 2010

LA7 EMEs

D. Financial Sector Specific Restrictions

7

Lessons from capital account liberalization and regulation

• Surges in international capital flows generate pressure to adopt pro-cyclical macroeconomic management and to liberalize capital account and financial regulations, with large destabilizing effects:▫ Both the liberalization of the 1970s/early-1980s and that of the

1992-97 ended up in major crises.

• However, not all booms end up in crises: The critical issues are current account deficits and associated currency appreciation.▫ Reduction of external debts and accumulation of reserves serve as

additional buffers against capital flow volatility.▫ The domestic counterpart of the current account deficit is important:

the experience of the Southern Cone during the first boom and of a broader group of countries during the second was problematic, since external financing was essentially consumed.

• Maintaining some capital account regulations to directly manage capital flow volatility is important.▫ Brazil, Chile, Colombia and Peru used some of these tools effectively.▫ But these regulations should be used as a complement, not as a substitute

for domestic financial regulations – in some cases, their use as a substitute has made crises unavoidable and more severe.

8

Current conditions in Latin America: what can we expect?

The recent boom in external financing generated a strong recovery of investment, for the first time since the boom of the 1970s.

An additional strength was the reduction in external debt ratios, both gross and net of foreign exchange reserves:• More macroeconomic policy autonomy.• Better access to external financing

But Latin America spent –in fact, overspent— the terms of trade boom Significant vulnerability to the deterioration of the terms of

trade… … and therefore to the Chinese slowdown.

However, so far, access to financing has continued to be good: Almost unaffected by successive euro crises Marginally so by FED tapering Somewhat more by the fall in commodity prices.

9

Investment as a share of GDP

15%

16%

17%

18%

19%

20%

21%

22%

23%

24%

25%

26%

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

Figure 4: Latin America Investment ratio, 1965-2013 (2000 prices)

Source: ECLAC

10

External debt as a share of GDP

Source: Authors’ estimates based on ECLAC data

0%

5%

10%

15%

20%

25%

30%

35%

40%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

External Debt (gross and net) as % of GDP

Debt Net of foreign exchange reserves

11

Current account balance has deteriorated since 2002 when adjusted by terms of trade

Source: Authors’ estimates based on ECLAC data

-9.0%

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Current account balance, adjusted by the terms of trade (% of GDP)

Current account balance Adjusted by the terms of trade

12

But, so far, access to external financing looks good (1)

Source: ECLAC

0.0

5.0

10.0

15.0

20.0

25.0

Latin American bond emissions, 2003-Jun 2015(billion dollars)

Monthly Five-months moving average

13

But, so far, access to external financing looks good (2)

Source: JPMorgan

0

2

4

6

8

10

12

14

16

18

20

4/1/

1997

7/1/

1997

10/1

/199

71/

1/19

984/

1/19

987/

1/19

9810

/1/1

998

1/1/

1999

4/1/

1999

7/1/

1999

10/1

/199

91/

1/20

004/

1/20

007/

1/20

0010

/1/2

000

1/1/

2001

4/1/

2001

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2001

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2003

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1/20

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/1/2

006

1/1/

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4/1/

2007

7/1/

2007

10/1

/200

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1/20

084/

1/20

087/

1/20

0810

/1/2

008

1/1/

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4/1/

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7/1/

2009

10/1

/200

91/

1/20

104/

1/20

107/

1/20

1010

/1/2

010

1/1/

2011

4/1/

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7/1/

2011

10/1

/201

11/

1/20

124/

1/20

127/

1/20

1210

/1/2

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1/1/

2013

4/1/

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7/1/

2013

10/1

/201

31/

1/20

144/

1/20

147/

1/20

1410

/1/2

014

1/1/

2015

4/1/

2015

7/1/

2015

Latin America: Spreads and Yields of Soverign Bonds, 1997-2015

LATAM Spreads

LATAM Yields

LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATIONJosé Antonio OcampoColumbia University