Latin American Lessons from the 2008 Financial Crisis – Liliana Rojas-Suarez

May 01, 2012

Conventional wisdom has it that when the United States catches a cold, Latin America gets pneumonia. But when the United States caught financial pneumonia in 2008, Latin America escaped with little more than a cold. What’s changed?In this week’s Wonkcast, CGD senior fellow Liliana Rojas-Suarez explains why Latin America was mostly successful in coping with the fallout from the 2008 global financial crisis and she introduces a new methodology for predicting how countries will fare in the next global financial crisis. Our conversation draws on her new working paper, Credit at Times of Stress: Latin American Lessons from the Global Financial Crisis, written jointly with Carlos Montoro of the Bank for International Settlements (BIS).The link between financial sector health and development can often seem abstract compared to issues such as trade, jobs, or childhood vaccinations. Regardless, finance is essential for development, explains Liliana.“The truth of the matter is, there is not a single transaction that we undertake that does not involve finance,” she says. “Without finance, there is simply no development. Taking aside wars and major diseases, financial crises kill more people than anything else in the world.”Liliana and Carlos Montoro undertook a study at BIS which examines how countries stood financially in 2007, to see if key indicators would predict how they fared in the 2008 crisis. The study weighed several macroeconomic indicators such as the amount of debt a country owes to the rest of the world and the amount of its national reserves. A third variable, the level of a country’s currency mismatch, has a large impact on a country’s ability to deal with a financial crisis, explains Liliana.“For example, the if a Latin American government borrows U.S. dollars to build a road, and the government then collects taxes in the local currency” to repay the loan, says Liliana. “But, say the crisis hits and the local currency loses value. How is the government going to pay back the loan if the government doesn’t have enough U.S. dollars accumulated as foreign exchange reserves? So if you have a big currency mismatch, you’re going to be more vulnerable.” Most Latin American countries learned this lesson from previous crises and, as a result, have significantly reduced currency mismatches as well as accumulated large amounts of foreign currency reserves.The indicators predicted that Asian countries would fare the best – and they did. China, Taiwan, Korea, and the Philippines came out on top. Latin America followed closely behind, and emerging Europe fared the worst. Liliana explains that countries such as Latvia and Estonia were in a bad position relative to their currency mismatch. These countries borrowed large amounts of Euros prior to the crisis, and then saw their currency depreciate after the crisis – causing them to suffer the most.I ask Liliana to what extent culture comes into play in these results. For example, it seems to me that there’s a quality in Asian economic management that anticipates hardship and places strong emphasis on being prudent.Liliana says there’s something to my theory, but you can only protect yourself against what you see coming. For example, currency mismatches played a large role during the East Asian crisis of 1997. Asian and Latin American countries learned from this period, but Eastern Europe did not.At the end of the Wonkcast, I ask Liliana if her indicators could predict what will happen if the situation in Greece worsens and the world suffers another global financial shock. Liliana says yes, and predicts how countries will fare, based on her new index.“We looked at where countries were at the end of 2011 and did the same experiment,” says Liliana. “Some Latin American countries such as Brazil are a little weaker now because they have used up some of their buffers, but Chile remains strong, and China remains strong.”The weakened countries are working to build up their foreign reserves and pay down debts to restore fiscal strength but only time will tell if they’ve done enough, Liliana says.I’d like to thank Alexandra Gordon for serving as producer and recording engineer, and for helping to draft this post.


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.