Latin America Debt CrisisCase Study 1

Overview Financial crisis that originated in the early 1980s

Also known as Lost Decade

Countries reached a point where their foreign debt exceeded their earning power and they were not able to repay it

Origins In the 1960s and 1970s many Latin American

countries, notably Brazil, Argentina, and Mexico, borrowed huge sums of money from international creditors for industrialization; especially infrastructure programs

These countries had soaring economies at the time so the creditors were happy to continue to provide loans

Origins contd… Initially, developing countries typically

garnered loans through public routes like the World Bank

Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent

Origins contd… This heightened borrowing led Latin America to

quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region‘s GDP

Debt service (interest payments and the repayment of principal) grew even faster, reaching $66 billion in 1982, up from $12 billion in 1975

Causes As interest rates increased in the United States of

America and in Europe in 1979, debt payments also increased, making it harder for borrowing countries to pay back their debts

Deterioration in the exchange rate with the US dollar meant that Latin American governments ended up owing tremendous quantities of their national currencies, as well as losing purchasing power

Awareness of Crisis While the dangerous accumulation of

foreign debt occurred over a number of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans

Declaration Mexico's Finance Minister, Jesus Silva-Herzog

declared in 1982 that Mexico would no longer be able to serve its debt

Mexico declared that it couldn't meet its payment due-dates, and announced unilaterally, a moratorium of 90 days; it also requested a renegotiation of payment periods and new loans in order to fulfill its prior obligations

Effects of Declaration In the wake of Mexico's default, most commercial

banks reduced significantly or halted new lending to Latin America

As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due immediately.

Repercussions Incomes dropped

Economic Growth Stagnated

Because of the need to reduce importations, unemployment rose to high levels

Inflation reduced the buying power of the middle classes

Counter Measures There were several stages of strategies to slow and

end the crisis. The IMF moved to restructure the payments and reduce consumption in debtor countries. Later it and the World Bank encouraged opened markets

Finally, the US and the IMF pushed for debt relief, recognizing that countries would not be able to pay back in full the large sums they owed

Solutions Latin America, unable to pay their debts, turned to the IMF

(International Monetary Fund) who provided money for loans and unpaid debts

In return, the IMF forced Latin America to make reforms that would favor free-market capitalism

The IMF also helped Latin America utilize austerity plans and programs that will lower total spending in an effort to recover from the debt crisis.

Results The efforts of the IMF brought Latin America's economy to become a

capitalist free-trade type of economy which is a type of economy preferred by wealthy and fully developed countries

The efforts of the IMF helped Latin America regain some balance after the debt crisis but was not able to resolve all of its issues

Between 1982 and 1985, Latin America paid back 108 billion dollars

The application of structural adjustment program, entailed high social cost in terms of rising unemployment and underemployment, falling real wages and incomes, and increased poverty

Greek Government Debt CrisisCase Study 2

Overview The Greek depression is the sovereign debt crisis

faced by Greece in the aftermath of the financial crisis

The Greek crisis started in late 2009, triggered by the turmoil of the Great Recession, structural weaknesses in the Greek economy, and revelations that previous data on government debt levels and deficits had been undercounted by the Greek government of 2007–08

Origins The economy of Greece was one of the rapidest growing economies in

Europe between the years 2000 and 2007. During those 8 years, it maintained an annual growth rate of 4.2%, which was mainly possible because of the enormous amount of foreign capital that the country received. The resulting strong economy and dropping bond yields permitted the Greek government to run huge structural deficits

Numerous Greek governments, one after another, ran huge deficits to pensions, public sector jobs and other such social benefits. Because of this, since the year 1993, the debt to GDP proportion has always remained more than 100%.

Origins contd… During the initial years, borrowing was possible because of

the currency devaluation in Greece. After the introduction of the Euro, the country was still able to borrow a lot because their government could command low interest rates on bonds

The global economic recession in the year, which began in the year 2008, had a substantially huge effect on Greece. The country’s 2 chief industries, shipping and tourism fell dramatically, recording 15% lower revenues in the year 2009

Origins contd… In the year 2009, when the global economy was still dealing

with the fallout of the global economic slowdown of 2008, Greece announced it had been understating the actual extent of its deficit burden

This set off alarm bells; many questioned the soundness of Greece's finances and doubted its ability to pay back its debt

Standard & Poor’s estimated that investors will lose close to 50% of their money if a default took place

Effects Both the Greek trade deficit and budget deficit rose from

below 5% of GDP in 1999 to peak around 15% of GDP in the 2008–2009 periods

Another driver of its investment inflow was Greece's membership in the EU, which helped lower the yields on its government bonds following the Eurozone's creation

Greece was perceived as a higher credit risk alone than it was as a member of the EU, which implied that investors felt the EU would bring discipline to its finances and support Greece in the event of problems

Effects contd… Reports in 2009 of Greek fiscal

mismanagement and deception increased borrowing costs; the combination meant Greece could no longer borrow to finance its trade and budget deficits at an affordable cost

Effects contd… A typical country facing a “sudden stop” in private investment

and a high (local currency) debt load typically allows its currency to depreciate to encourage investment and to pay back the debt in cheaper currency

This was not possible while Greece remained on the Euro. Instead, to become more competitive, Greek wages fell nearly 20% from mid-2010 to 2014, a form of deflation.

This significantly reduced income and GDP, resulting in a severe recession, decline in tax receipts and a significant rise in the debt-to-GDP ratio. Unemployment reached nearly 25%, from below 10% in 2003

Solution Significant government spending cuts helped the Greek government

return to a primary budget surplus by 2014 (collecting more revenue than it paid out, excluding interest)

A second bailout package was finalized in February 2012, following the passage of a fifth batch of austerity legislation. It brought the total the European Central Bank, EU countries and the IMF – disparagingly called the “troika”– had diverted to Greece to €246 billion. The terms required Greece to reduce its debt from 160% of GDP to 120% by 2020. As part of the deal, banks holding Greek bonds would take a 53.5% loss on the face value of their holdings, for an actual loss of perhaps 75%

Assessment In January 2010, the Greek Ministry of Finance

published Stability and Growth Program 2010

The report listed five main causes, poor GDP growth, government debt and deficits, budget compliance and data compatibility. Causes found by others included excess government spending, current account deficits and tax avoidance.

References https://en.wikipedia.org/wiki/Latin_Ameri

can_debt_crisis

http://www.businesstoday-eg.com/case-studies/case-studies/greece-bankruptcy.html