Brookings Institution
June 2, 2011
Last week, at a panel on emerging markets at the Luxembourg Financial Forum, I was asked what lessons for the European debt crisis could be drawn from the rich and diverse experiences of emerging markets. It was not the obvious comparison with the Argentine economic crisis that came to mind, but rather the Latin American debt crisis of the early 1980s.
The Latin American debt crisis originated from excess liquidity caused by a surge in oil prices in the 1970s and abundant savings by oil exporters, which were channeled to developing economies. Seduced by the easy money, the economies of Argentina, Brazil, Mexico and Peru, among others built up important stocks of hard currency debt that proved to be lethal once interest rates normalized, capital flows retreated, and inflated developing country currencies faced depreciation pressures that pushed debt ratios to unsustainable levels.
The first approach to the Latin American debt problem was denial. Supposedly, all that was needed was time to implement a drastic fiscal adjustment, for which the International Monetary Fund, sponsored by the United States, would provide the needed refinancing. In 1985, the Baker Plan elaborated on this approach by introducing private sector involvement through the voluntary rescheduling of bank loans, so as to lengthen the fiscal adjustment period. The result was a massive debt overhang that discouraged investment and triggered frequent spells of capital flight and disappointing growth that was reflected in growing debt ratios. This became known as the lost decade for Latin America.
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