Financial Crisis Will Have Strong and Negative Effect on Latin America
Current situation reveals the need to improve risk management and market regulation.
(27 March 2009) Today's global financial crisis will have a strong and negative effect on Latin American economies, and is the most severe since the Great Depression in the 1930s. It also reveals the urgent need to improve risk management and market regulation.
Two documents recently published by the Economic Commission for Latin America and the Caribbean (ECLAC) analyze the background, causes and lessons to be learned from this crisis as well as past episodes.
The impact of financial crises on the region is closely related to the degree to which external finance becomes scarce and costly, and to the magnitude of disruption of international trade, assert the authors. Moreover, financial crises have had deep and protracted effects in the region, independently of their idiosyncratic features and initial conditions.
The document concludes that the current situation in Latin America, as in past crises, will have generalized, deep and negative effects on the economies in the region, regardless of their connection to international financial markets, the degree of openness to international trade or their initial conditions.
As an example of this, the authors point out that the regional average of GDP per capita fell between 1.2% during the Argentinean crisis to 12.6% during the foreign debt crisis. Investment dropped between 13.7% during the Mexican and Argentinean crises, to 46.6% during the debt crisis. External finance also decreased significantly during these critical episodes.
As for the current turbulence, private capital flows to the region have diminished since the second semester of 2008; in some countries, they have even been reversed. Private capital flows are expected to be 50% lower in 2009 than in 2008, and world trade may decline by nearly 9%.
"The empirical evidence suggests that in the case of Latin America, the current episode and its manifestations are not an exception to previous crises patterns.... Notwithstanding the efforts of countries to mitigate the effects of the crisis, these may be insufficient to avoid the stagnation or even the expected contraction of economic activity in the region," state the authors.
One of its causes is the lack of regulation and inadequate supervision of some areas of the market that contributed to an excessive expansion of credit and reckless risk-taking. Additionally, in Latin America operate intermediaries that are insufficiently regulated and supervised, and become potential factors of instability.
Correia, Manuelito and Jiménez classify the lessons Latin America may learn from the crisis in terms of domestic regulations in four broad areas:
The need for a prudent macro approach to complement the current regulatory approach. The authors suggest a global perspective on financial regulation that may oversee the performance of the financial system as a whole and not just the individual actions of certain institutions.
Reduction of the procyclicality of financial systems. In other words, private financial institutions should refrain from compounding the economic cycle, be it in times of economic boom or recession.
Extending the traditional scope of regulation and supervision to all financial institutions that may potentially affect the economy as a whole.
Certain aspects of the relationship between risk rating agencies, external auditing firms and financial institutions derive in deficient risk management.
According to the authors, the current regulatory framework should be complemented by a broader approach that recognizes the accumulation of macroeconomic imbalances, increasing indebtedness and credit concentration as potential detonators of financial crisis.
They also urge the adoption of mechanisms and policies to counteract the procyclical behavior of financial systems, which exacerbates economic fluctuations and does not mitigate the effects of economic boom and depression.