As Latin American nations settle debts and shake off their reliance on multilaterals, the IMF and other Washington institutions must redefine themselves to stay in the game.
| Inter-American Development Bank DC headquarters. |
Last December, Argentina and Brazil – the International Monetary Fund’s (IMF) first and third-largest borrowers and its two biggest clients in Latin America – announced within days of each other that they would repay their debt before schedule. Brazil wiped out its entire $15.5 billion IMF tab, and Argentina knocked out its remaining $9.6 billion in obligations to the lender of last resort. In a remarkable shift of circumstances, these countries that once had to beg for help from multilateral agencies like the IMF were able to erase vast debts with the stroke of a pen. However, this has underlined yet again the identity crisis facing the IMF and the other Washington institutions – the Inter-American Development Bank (IDB) and the World Bank. Put simply, as Latin America’s financial health strengthens and the structure of its economies changes, there is less interest in the main product available from these agencies: big dollar loans for the public sector. Governments dicing with bankruptcy once coveted those loans, but now demand is slipping by the year.
As a result of early repayments, over the next two years the IMF stands to lose $1.9 billion in interest revenue. In fact, the Fund has already revised down its earnings forecasts by around 40% for the fiscal year ending April 2006, and expects to see a budget shortfall of over $116 million this year.
The move by Argentina and Brazil demonstrates a wider trend in Latin America of moving toward greater financial self-sufficiency. Like much of Asia, the region is cutting debt, building up reserves and allowing currencies to float. By reinvesting windfall profits from the boom in commodity prices, countries should be able to handle economic shocks and financial crises lurking over the horizon. On the flip side, a healthier Latin America presents a serious challenge to the multilaterals, which must find a new way to support economic development, or risk becoming obsolete.
Mohammed El-Erian, who in February left Pimco, the largest emerging market debt fund, to manage Harvard University’s $25.9 billion endowment, has thought a lot about this question. He was even a candidate to become the Fund’s managing director, and he will spend part of his time at Harvard teaching classes on governing the international financial system. He believes the Fund’s ability to generate revenue is declining. With a $1.1 billion standby arrangement with the IMF, Uruguay is now the Fund’s largest debtor in Latin America, El-Erian notes. In 2005, Uruguay was Latin America’s 13th largest economy in terms of GDP according to the IMF World Economic Outlook Report. “The IMF has to come to an agreement on other sources of long-term sustainable capital raising,” El-Erian concludes.
Redefining Relevance
The notion of relevance is clearly on the bosses’ minds at all the Washington institutions. It’s a word they use constantly when discussing their mission. These agencies grew in size and importance by lending to Latin American governments and state companies. Privatization, public debt reduction and the growing importance of the private sector as the region’s engine of growth signal a decline in demand for these loans. Adam Lerrick, a professor of economics at Carnegie Mellon University in Pittsburgh, says only two things can save the agencies from irrelevance: a collapse in the financial markets that would restore their competitive advantage over private banks; or a new business plan that focuses on countries without access to private sector capital. At the same time, Non-governmental organization (NGO) pressure to impose “social agendas” reduces the economic yield to borrowers of bank loans. “The [multilateral] banks are caught in a terrible wedge,” he contends.
Some even question whether there is a need for these institutions at all. Kevin Danaher, co-founder of Global Exchange, a San Francisco-based non-profit organization, opposes lending hard currency to poor countries because he believes it creates a culture of dependency that perpetuates poverty. “The relationship between the lenders and the third world elite creates a stronger allegiance to first world lenders than to their people,” argues Danaher, who is also the author of Ten Reasons to Abolish the IMF and the World Bank, a book published by Seven Stories Press in 2001.
Danaher championed a grass roots campaign in 2000 to boycott World Bank bonds and has drummed up support from more than 100 city councils, socially responsible investors, churches and foundations who refuse to buy World Bank bonds for their investment portfolios.
Even mainstream investors in the capital markets are questioning the role of multilateral institutions in the region. James Barrineau, senior vice president of global economic and risk research at fund manager Alliance Capital, says what needs to be rethought is the role of the IMF and the World Bank going forward. “In my view, the best service they could perform is to focus on micro reforms that are less politically controversial, rather than trying to tell [countries] what level [their] fiscal surplus should be.”
Barrineau thinks Latin American countries are doing just fine on their own. “Latin American countries are becoming less risky as they take more steps to improve their debt profiles,” he asserts. “With the exception of Venezuela, these countries are doing a great job in taking advantage of a favorable external environment to manage their own affairs.”
Plus, investors appear more comfortable taking on risk. Private capital flows to Latin America increased to $44 billion last year from $29 billion in 2004, according to the Institute of International Finance. Even Ecuador, permanently on the brink of disaster, issued a $650 million 9.375% 2015 bond in December led by JP Morgan and Deutsche Bank that attracted a staggering $1.3 billion in orders. George Estes, who manages $4.3 billion in emerging-market debt at Boston- based Grantham, Mayo, Van Otterloo & Co, explains that this sort of appetite has been driven by a low premium being paid out for risk across asset classes. “You can’t say Latin debt stands out in the financial markets around the world as being mis-priced.”
Perhaps these capital inflows explain why, apart from a spike in 2003, disbursements from the World Bank and the IDB have been shrinking since 2000 (see charts, right). Still, this renewed investor hunger for higher yielding, riskier assets like Latin American debt can’t last forever.
Multilateral development banks describe their role as ‘catalysts’ – they step in during economic crises to mitigate political risks and make up for shortfalls in private investment. Even amid positive economic growth – Latin American economies expanded 4.3% last year, on average – it’s evident that the multilaterals still have a role to play in the region as these gains aren’t trickling down to the man in the street. Poverty levels in Latin America and the Caribbean last year were 6% below 1999 levels – per capita income of $3600 compared with $3840 – according to World Bank data, although they had started to climb from a low of $3260 in 2003. The World Bank reported in February that a quarter of Latin Americans live on less than $2 a day.
Latin America is the least competitive region in the world after Africa, according to the World Economic Forum’s 2004-2005 Global Competitiveness Report. Reduced public-sector borrowing means development institutions must find ways to serve a rich vein of new clients: the private sector. This migration could spark dilemmas of its own.
Manish Bapna, executive director of the Bank Information Center, an independent non-profit that advocates for transparency and accountability in the Washington institutions, worries that multilaterals might cluster around a group of hard-driving private investors and neglect less profitable but vitally important development projects. “Development banks have historically suffered from schizophrenia,” Bapna says. “Are they development agencies or banks? The rhetoric suggests the former but the incentive structure points to the latter.”
Seeking Remedies
Enrique García, president of Andean development bank Corporación Andina de Fomento (CAF), which set aside 60% of its $4.7 billion in loan approvals last year for the public sector, dismisses the idea that multilateral development banks will ditch the public sector in favor of private sector clients. “The role of multilaterals becomes very important for mitigating risks to the private sector with private guarantees,” García explains. In fact, he sees demand from the public sector for CAF support rising since Latin American governments need to double the 2.5% of GDP they invest in infrastructure if they want to compete on the world stage. “Many of these projects and programs cannot be done exclusively by the private sector; they depend a lot on public sector elements.”
Carlos Guimarães, private sector coordinator at the IDB, says his development bank is gearing up to mobilize private investment in infrastructure projects. “The private sector is now responsible for 90% of economic activity in the region,” he notes, “and we need to be more responsive to them. If we want to work with the private sector, we need to work like the private sector.” That requires a revamping of these organizations’ very philosophy, staffing and internal organization, as well as the creation of a new generation of financial products. Unlike the IDB’s old clients – governments and state-owned enterprises – private sector companies prefer to borrow whenever possible in local currencies, not dollars. They also require faster response times, and IDB clients frequently complain that the bank is bureaucratic, unimaginative and slow to make decisions.
The IDB acknowledges that it needs to modernize. Guimarães, a former head of Latin American investment banking at Citigroup, joined the IDB last year to integrate its three, fragmented private sector arms. The IDB currently caps private sector lending at 10% of total assets, which stood at $9.66 billion as of end of 2004. In January, the IDB raised the ceiling on financing private sector projects to $200 million from $75 million per project, and to $400 million for projects that the bank considers critical for the region. By raising the ceiling, the IDB hopes to attract private capital to bigger projects.
The International Finance Corporation (IFC), the private arm of the World Bank, has worked for decades to back private sector companies in the developing world. The IFC, under the guidance of treasurer Nina Shapiro, has brought a succession of innovative bond deals to market both in local currencies and dollars. These deals have helped develop local capital markets, which triggered a boom for asset-backed bonds that, in turn, spawned new markets for housing finance products.
New Financial Tools
These local currency debt issues helped broaden the number of assets available to domestic investors, but did less to assist locals who crave to borrow in their own currencies. It was the Inter-American Investment Corporation (IIC), a division of the IDB that invests in and lends to small- and medium-sized enterprises that issued a groundbreaking $66 million-equivalent Colombian peso bond – the first true local currency bond in Latin America from a multilateral financial institution – last year. The Colombian peso bond was structured so that the IIC could loan to five leasing companies in the country on the condition that they then extend their own credit to a thousand small- and medium-sized enterprises in Colombia.
Jacques Rogozinski, the IIC’s general manager, hopes to replicate the Colombian issue in other markets since he sees such leasing deals as enormously useful for enterprises that don’t have much collateral or credit. Already, in Brazil, the IIC lent $30 million in US dollars to financial group Banco Itaú to fund leasing deals.
Guimarães says the IDB also wants to build on the success of the IIC’s Colombian peso bond. “Lending in local currency should be central to our mission to develop Latin America’s domestic capital markets into deeper and more liquid markets,” he asserts.
CAF’s García, though, is cautious about a radical shift into local currency funding. “The markets are very positive, but there is not an infinite capacity to issue in local currency,” he contends. “Remember that Latin America’s average savings rate is relatively low at about 18%. You cannot issue entirely in local currency when there are not enough local savings. It is something that has to be built up step by step. Foreign currency is crucial in terms of closing the gap.”
García also thinks development banks should partner with each other to mitigate risks and fund meaningful projects in areas like infrastructure.
Identity Crisis
The IMF should try to take on more of an advisory role as part of its evolution, recommends Harvard’s El-Erian, and deepen its understanding of global financial markets in the process. “We are now in the situation where the IMF can bring to bear its policy discussions with other countries that have faced the challenges that many Latin American countries now face. There is no other mechanism to do this. Direct collaboration between policy makers in emerging market economies is low,” he says.
The Fund could, for example, apply its macroeconomic expertise to help countries deal with appreciating local currencies, which is an issue that most Latin American nations have never had to face before since they were always focused on protecting currencies from depreciation.
Atul Mehta, director for Latin America and the Caribbean at the IFC, says development banks have already proven they can be effective advisors by nurturing relationships with companies in which they have invested. The IFC put several million dollars into a range of companies last year, including Mexican microfinance lender Financiera Compartamos and Brazilian plastics firm Dixie Toga.
“Our value added doesn’t stop at the initial investment,” Mehta explains. “Our advice is more credible because we have a financial relationship with our clients. That creates greater accountability.”
Ted Truman, a senior fellow at the Institute for International Economics who has written exhaustively on strategies for IMF reform, proposes that the Fund – together with the World Bank – provide emerging market countries with facilities for sustainable growth that also offer some protection from external shocks. “It would allow countries that experience, for example, a sharp drop in exports because of a global economic slowdown to run counter-cyclical fiscal policies,” notes Truman.
Although many in the financial markets snort at the idea of the IMF reinventing itself as a consultant on managing growth, especially after its failure as umpire during the Argentine crisis, few doubt that one day the IMF will be called upon in another financial crisis in Latin America. As the debate for IMF reform rages on and multilateral development banks strive to redefine their relevance, the global financial markets grow more complex and the seeds of the next financial crisis are being sown. That event will put these evolving institutions to the test.
Making A Difference
The Multilateral Investment Fund (MIF), which is part of the Inter-American Development Bank (IDB), broke new ground when it pushed to improve statistical reporting of remittance flows in 2000. Under the leadership of Donald Terry, it spearheaded an effort to lower money transfer costs and encourage financial institutions to bring these consumers into mainstream banking. Terry calls it promoting “financial democracy,” adding that, “poor people save money if you give them a chance.” Similarly, the International Finance Corporation is working to set up credit bureaus in Latin America to help small business owners and low-end consumers get loans. The IFC also established a project to help fledgling enterprises cut through red tape; that endeavor has yielded results mostly by naming and shaming the most bureaucratic countries. In Peru, for example, two years ago it took 11 visits to a municipality in Lima over on average of 60 days to obtain a business license. Now it takes two days and two visits.