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LatinMacroWatch Special Analysis LMW: the Big Picture on a Small Screen A new RES feature 8-7-02 LAC-7 Outlook: The Specter of Capital Flight August 7, 2002 Prepared for Presentation at IADB Board of Directors, Washington, DC KEY QUESTIONS What’s behind the current sharp growth slowdown in the region? Is there evidence of Contagion? What kind? Are the G-7 shooting in the right direction? Should Moral Hazard be their main concern? How likely is it for the region to enter a new “lost decade”? What is likely to happen in Brazil? What should IDB do? 3 OUTLINE I. Capital Flight and Macroeconomic Performance II. The Specter of Capital Flight III. Vulnerabilities to Capital Flight: Recent Experiences of Argentina, Uruguay and Brazil IV. Summary and the Role of the IADB LAC-7 Business Cycle: 1997-2002 (s.a. GDP, mean annualized quarterly growth rate) 9% Deceleration 7% Recession Recovery Stalling 5% 3% 1% -1% -3% Includes: Argentina Brazil, Chile, Colombia, Mexico, Peru and Venezuela 2002.I 2001.III 2001. I 2000.III 2000.I 1999.III 1999.I 1998.III 1998.I 1997.I -7% 1997.III -5% LAC-7 Components of Demand (1998.II = 100) Recession 130 Stalling Recovery Exports 120 Consumption 110 100 Investment 90 80 Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru 2002.I 2001.IV 2001.III 2001.II 2001. I 2000.IV 2000.III 2000.II 2000.I 1999.IV 1999.III 1999.II 1999.I 1998.IV 1998.III 1998.II 70 LAC-7 Capital Flows (4 quarters, millions of US dollars and % of GDP ) 120000 6% 100000 5% % of GDP 80000 4% Millions of US dollars 60000 3% Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela 2002-I 2001-III 2001-I 2000-III 2000-I 1999-III 0% 1999-I 0 1998-III 1% 1998-I 20000 1997-III 2% 1997-I 40000 LAC-7 Non-FDI Capital Flows (4 quarters, millions of US dollars and % of GDP ) 60000 2% % of GDP 40000 1% 20000 0% Millions of US dollars Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela 2002-I 2001-III 2001-I 2000-III -4% 2000-I -60000 1999-III -3% 1999-I -40000 1998-III -2% 1998-I -20000 1997-III -1% 1997-I 0 LAC-7 Business Cycle and Capital Flows 2% 1% Non FDI Capital Flows 0% -1% GDP -2% -3% Mar-02 Sep-01 Mar-01 Sep-00 Mar-00 Sep-99 Mar-99 Sep-98 Mar-98 Sep-97 Mar-97 Sep-96 -4% Non FDI Capital Flows (% GDP) 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% Mar-96 GDP (yoy % change) (GDP and Non FDI Capital Flows, last four quarters) OUTLINE I. Capital Flight and Macroeconomic Performance II. The Specter of Capital Flight III. Vulnerabilities to Capital Flight: Recent Experiences of Argentina, Uruguay and Brazil IV. Summary and the Role of the IADB Net Private Capital Flows to LAC (Billions of real US dollars of May 2002, deflated by US CPI) 100 80 60 40 20 0 Source: WEO, IMF 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 -20 Net Direct Investment to LAC (Billions of real US dollars of May 2002, deflated by US CPI) 70 60 50 40 30 20 10 Source: WEO, IMF 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 0 Financial Flows to LAC (Billions of real US dollars of May 2002, deflated by US CPI) 100 80 60 40 20 0 -20 -40 Financial Flows= Net Portfolio Investment + Othe Ner Investment Source: WEO, IMF 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 -60 Cumulative Total Private Capital Flows to LAC (Billions of real US dollars of May 2002, deflated by US CPI) 1974-1981 1982-1989 80 500 450 60 400 40 350 300 20 250 0 200 150 -20 100 -40 50 0 -60 Financial Flows Source: WEO, IMF FDI Total Private Flows Financial Flows FDI Total Private Flows Cumulative Total Private Capital Flows to LAC (Billions of real US dollars of May 2002, deflated by US CPI) 1990-1998 600 1999-2001 250 200 500 150 400 100 300 50 200 0 100 -50 0 -100 Financial Flows Source: WEO, IMF FDI Total Private Flows Financial Flows FDI Total Private Flows Cumulative Total Private Capital Flows to LAC: 1990-2001 (Billions of real US dollars of May 2002, deflated by US CPI) 700 600 500 400 300 200 100 0 Financial Flows Source: WEO, IMF FDI Total Private Flows Cumulative Total Private Capital Flows to Asia (Billions of real US dollars of May 2002, deflated by US CPI) 1989-1997 600 1998-1999 150 100 500 50 400 0 300 -50 200 -100 100 -150 0 -200 Financial Flows Source: WEO, IMF FDI Total Private Flows Financial Flows FDI Total Private Flows OUTLINE I. Capital Flight and Macroeconomic Performance II. The Specter of Capital Flight III. Vulnerabilities to Capital Flight: Recent Experiences of Argentina, Uruguay and Brazil IV. Summary and the Role of the IADB Exposure of the Public Sector to Capital Flight (Public Debt in % of GDP) 65% In US$ 55% In domestic currency 45% 35% 25% 15% 5% Uruguay Argentina Pre- Capital Flight levels Brazil Chile Current levels Exposure of the Private Sector to Capital Flight (Share of foreign currency loans to the non financial private sector) 80% 70% 60% 50% 40% 30% 20% 10% 0% Argentina Uruguay Pre- Capital Flight levels Brazil Chile Current levels Exposure of the Financial System to the Public Sector Credit to the public sector in % of total assets 30% 25% 20% 15% 10% 5% 0% Brazil Current level Argentina Uruguay Pre- Capital Flight level Chile Current level Vulnerability to Capital Flight: A Summary Argentina Brazil Uruguay Chile Public Debt to GDP Financial mismatches of the Public Sector Financial Mismatches of the Private Sector Banking System Exposure to the Public Sector = High vulnerability = Medium vulnerability = Low vulnerability BRAZIL Exchange Rate and Country Risk 2400 3.1 2.9 2.7 2.5 1400 1200 2.3 1000 800 2.1 EMBI+ spread 7/2/02 5/2/02 3/2/02 1/2/02 11/2/01 9/2/01 7/2/01 5/2/01 1.9 3/2/01 600 R$ per dollar nominal exchange rate 1800 1600 1/2/01 basis points 2200 2000 May-02 Mar-02 Ene-02 Nov-01 Sep-01 Jul-01 May-01 Mar-01 Ene-01 Nov-00 Sep-00 Jul-00 May-00 Mar-00 Ene-00 Public Debt (% of GDP) 61 Level: US$ 263.8 billion (58.6% of GDP) 59 57 55 53 51 49 47 45 Public Debt Structure June 2002 Fixed Rate 7% External or FX indexed Public Debt Others 9% Indexed to the Interest Rate 44% 40% Banks’ Exposure to the Public Sector Public Bond Holdings 350% 300% 250% 200% 150% 100% 50% 0% In % of Banks’ Assets In % of Banks’ Net Worth Fiscal Sustainability April 2002 Public Debt (% of GDP) 54.5% Primary Balance Interest Rate 10.9% Growth Rate 3.5% Required 3.9% Observed 3.4% Adjustment = 0.5% Public Debt Dynamics Public Debt (% of GDP) April 2002 Interest Rate Growth Rate 54.5% 10.9% 3.5% 3.9% 57.2% 10.9% 3.5% +0.2% Primary Balance that stabilizes Debt Fiscal Impact of: 10% real depreciation Public Debt Dynamics Public Debt (% of GDP) Interest Rate Growth Rate 54.5% 10.9% 3.5% 3.9% 10% real depreciation 57.2% 10.9% 3.5% +0.2% 1% increase in the domestic interest rate 54.5% 11.4% 3.5% +0.3% April 2002 Primary Balance that stabilizes Debt Fiscal Impact of: Public Debt Dynamics Public Debt (% of GDP) Interest Rate Growth Rate 54.5% 10.9% 3.5% 3.9% 10% real depreciation 57.2% 10.9% 3.5% +0.2% 1% increase in the domestic interest rate 54.5% 11.4% 3.5% +0.3% 1% reduction in the growth rate 54.5% 10.9% 2.5% +0.6% April 2002 Primary Balance that stabilizes Debt Fiscal Impact of: Liquidity Requirements of the Public Sector (Millions of US dollars) July 02 - Dec 02 July 02 - June 03 I. FISCAL DEFICIT (est.) 11,535 20,787 II. PUBLIC DEBT AMORTIZATIONS 46,768 88,861 41,005 5,763 75,282 13,580 III. (I) + (II) 58,303 109,649 IV. MONETARY BASE 19,000 19,000 77,303 128,649 Domestic Debt External Debt V. POTENTIAL LIQUIDITY REQUIREMENTS: (III) + (IV) Liquid International Resources of the Public Sector (Millions of US dollars) I. International Reserves (end June without IMF loan) 32,000 II. IMF Credit Line 10,000 III. Total Available Liquid Funds ( I+II) 42,000 In % of July02-Dec02 Liquidity Req. 54% In % of July02-May03 Liquidity Req. 33% Note: Under the IMF agreement there is an agreed floor for reserves of US$ 15 billion. 50000 2001-IV 2001-III 2001-II 2001-I 2000-IV 2000-III 2000-II 2000-I 1999-IV 1999-III 1999-II 1999-I 1998-IV 1998-III 1998-II 1998-I 1997-IV Total Gross Private External Debt In millions of US$ 170000 150000 130000 110000 90000 70000 Liquidity Requirements of the Private Sector (Millions of US dollars) July 02 - Dec 02 July 02 - June 03 EXTERNAL DEBT AMORTIZATIONS 16,370 28,309 Medium and Long Term 9,694 14,957 Short Term 6,676 13,352 Capital flight and financial collapse can generate: severe productive disruptions political instability social unrest … and these conditions may validate the initial flight. Furthermore the disruptive effects of the flight of financial capital can frighten FDI and thereby multiply its effects. OUTLINE I. Capital Flight and Macroeconomic Performance II. The Specter of Capital Flight III. Vulnerabilities to Capital Flight: Recent Experiences of Argentina, Uruguay and Brazil IV. Summary and the Role of the IADB SUMMARY There are clear signs of Capital Flight since the 1998 Russian Crisis. Economic Contagion is not obvious, although the whole region is suffering from higher spreads. The depth and spread of crises in region may be rooted in G-7 Pontious Pilate approach to financial crisis in EMs, caused by fear of a Moral Hazard epidemic. Political cycle and backward-looking politicians who fail to see the enormous rebound potential of the region. Financial vulnerabilities 38 ROLE OF THE IADB Help to convey the regional view about the cause of, and remedies for, the current crises-partly to counteract the Moral Hazard obsession: it is time for the IADB to move forward from the end of the line, and make its voice heard and heeded at the planning stage! Design social programs that help prevent social unrest, a serious deterrent for FDI (the main source of international finance in the region). Design social programs to ameliorate the impact of crises on poverty. Enhance competitiveness programs and support of FTAA negotiations. 39 LAC-7 Outlook: The Specter of Capital Flight August 7, 2002 Prepared for Presentation at IADB Board of Directors, Washington, DC LatinMacroWatch Special Analysis LMW: the Big Picture on a Small Screen A new RES feature 8-7-02