On May 22nd, members of the Latin American Shadow Financial Regulatory Committee (CLAAF), convened at CGD to discuss some of the most pressing fiscal and monetary issues affecting Latin American economies. The result of the committee’s two-and-a-half-day-long discussion was a four page statement and several clear recommendations for rethinking financial policies in the midst of a global crisis.
My guest on this week’s Wonkcast, CLAAF chair and CGD senior fellow Liliana Rojas-Suarez, tells me that CLAAF is in a unique position to influence Latin American financial policies. The committee is comprised of several former Latin American Ministers of Finance and Presidents of Central Banks who are able to return to their countries and place the committee’s recommendations directly in the hands of key policy makers.
Liliana explains that there are reasons to be concerned about the potential damaging effects on Latin America’s financial systems stability and sustained economic growth arising from current events in the North. While Latin America weathered the 2008 global financial crisis relatively well compared to other emerging markets, the region is now weaker in terms of the fiscal numbers. “If another crisis were to hit, the fiscal capacity to reactivate Latin American economies would be lower than during 2008-09,” Liliana tells me. “In 2007 before the eruption of the global crisis, a large number of Latin American countries were running fiscal surpluses, so they had a lot of space to do countercyclical fiscal policies. That’s not the case now”.
But even if a new full-blown crisis does not materialize, the long period of very low interest rates in advanced economies is exacerbating risks to the global economy, and Latin America is not immune to these risks, Liliana adds. To clarify Liliana provides an example: “At the current very low policy rates in advanced economies, government debts of these countries might appear sustainable even if the markets’ signal of risk, the yield spread of sovereign bonds, is very high. But if interest rates were to increase, even modestly, unsustainable debt positions may emerge, leading to a liquidity squeeze”. The CLAAF report states that the “general policy of promoting low interest rates for a sustained period may end up planting the seeds of future problems.”
Under these conditions, the CLAAF report recommends that central banks built up their defenses by ensuring that the financial system maintains high levels of external liquidity. Liliana specifies that this liquidity “should be kept in the form of assets denominated in hard currencies, namely, currencies that are internationally tradable, because only this type of assets can be considered safe in periods of financial turbulence”. In addition, CLAAF recommends that governments in Latin America take advantage of the Flexible Line of Credit offered by the IMF, which allows countries in good economic standing to pre-qualify and have immediate access to this source of funding at times of severe stress in the international capital markets. To date, only Colombia and Mexico have access to this credit line.
CLAAF also recommends that the inflation target regimes followed by central banks in the region be complemented explicitly by foreign exchange intervention. Liliana tells me if central banks are more transparent in terms of their policies for foreign exchange intervention, exchange rates will be less volatile.
We conclude the Wonkcast by discussing recommendations from the Basel Committee on Banking and Supervision (BCBS). I ask Liliana what the problem is with BCSC’s recommendations on liquidity ratios as they relate to developing countries, and why we should care.
Liliana says we should “deeply care” about Basel’s recommendations. In a recent blog post, she states, “some of the Basel Committee’s recommendations for banks’ capital and liquidity requirements would actually increase the danger that sovereign debt problems lead to banking crises.” Lliana and CLAAF have both asserted that, contrary to BCBS recommendations, government paper issued by developing countries should not be included as part of high-quality liquid assets held by banks since this type of instruments quickly loose liquidity at the first sight of problems. Liliana adds: “maintaining credible access to true liquid assets is extremely important in avoiding future crises”.
Click here to read CLAAF’s full statement and recommendations.