Americas Quarterly - Spring 2009

From Decoupling to Deleveraging and Divergence Benjamin D. Wolf

exceeding sovereign issuance for the first time in 2006 and the long-standing preference for foreign-currency-denominated bonds waning in 2006 and 2007. Institutional investors in the United States, Europe and Asia, aggressively seeking growth, began to view Latin American holdings as a “core asset class,” greatly increasing capital flows to the region’s financial markets.

This historic expansion can be attributed to a confluence of several factors, including a staggering global liquidity boom, increased political stability throughout much of the region, record commodity prices, and increased trade liberalization. The most significant reason for the unprecedented growth, however, was also the most basic: greatly improved macroeconomic fundamentals led to an unprecedented period of sustained growth across the region. Despite varied economic performance in different countries, aggregate Latin American growth averaged nearly 6 percent for the period from 2002 to 2007. In the period from 2003 to 2005 alone, the economies of Latin America expanded by 53 percent. By almost any meaningful measure, the period from 2003 to 2007 represented the broadest and most significant economic expansion in Latin America in 40 years.

Decoupling: Just
Wishful Thinking?

This period of sustained economic growth, combined with more diversified trade with the rest of the world and, in some cases, more prudent fiscal policy, led to the so-called “decoupling” of Latin America’s economies from that of the United States. Having watched foreign capital flee in prior financial crises, many Latin American policymakers worked hard to reduce their dependence on foreign credit and successfully accumulated vast international reserves. Moreover, Latin American banks had virtually no exposure to the subprime crisis through mortgage-backed securities or other complex financial instruments. Though there is great disparity within the region, Latin Amer-

ica as a whole is less dependent on the U.S. economy and better positioned to endure a global downturn than at any time in its history. At the onset of the credit crisis in 2007, this apparent insulation from American and European market turmoil made Latin America an attractive destination for investment in long-term assets.

In September 2008, when asked about the financial crisis, Brazilian President Luiz Inácio Lula da Silva responded, “What crisis? Go ask Bush about

that.” Until recently, Lula’s comment was largely representative of attitudes in the region. As the depth and severity of the global financial crisis has set in, however, decoupling has become an increasingly quaint notion.

By the middle of October, the Bovespa was down nearly 50 percent from its 2008 highs. Stock exchanges elsewhere in Latin America have undergone comparably precipitous declines. Across the region, there has been a sharp increase in exchange rate volatility. Commodities prices are sharply declining, tighter credit terms are constraining exporters, and inflation is becoming increasingly difficult to control, even among the strongest economies. In short, Latin American markets have not proven immune to the contagion of the financial crisis.

The impact on the region’s capital markets has been abrupt and severe. Though share prices and bond spreads have recovered somewhat from the lows reached during the trough of the crisis last fall, new issuance of both equity and corporate debt securities has ground virtually to a halt in all Latin American markets. The IPO market, which now seems like a pre-crisis relic, has ceased to exist.