Towards an external debt crisis in Latin America?

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February 11th, 2016

Historically Latin America has always been highly sensitive to increases in the benchmark interest rate in the US. In the 1980s the Federal Reserve's interest rate hike pushed the previous decade's growth trend in public debt to unsustainable levels and 27 countries had to restructure their public debt. Could a similar crisis be repeated in the current context of tighter monetary policy in the US?

After falling to minimum levels in the last few decades, Latin America's total external debt picked up appreciably, going from representing 20% of GDP to 30%, almost the same as the average for the period 1980-2015. Although this level is lower than what is conventionally considered to be high risk (from 60%-70% of GDP in the case of emerging countries), the recent trend and speed of debt growth are certainly cause for concern.

Such concern increases when this external debt is compared with international reserves (a measure of a country's capacity to respond in a crisis).1 As happened with the region's external debt, the trend in reserves was positive until 2011 but since then any gains made have been reversed and, in 2014, it stood at the equivalent of 50% of external debt. This is precisely the threshold that is normally used as a reference for the minimum level of reserves, so in just a short period of time the region has gone from being in a comfortable, safe zone to the limit of what is prudent.

An analysis by country backs up these conclusions. In 2015 four of the region's countries exceeded the threshold of 40% of GDP in external debt (Chile, Mexico, Uruguay and Colombia). However, of these only Uruguay has a safe level of reserves (76% of its external debt). Fortunately Mexico and Colombia have a flexible line of credit from the IMF, granted precisely to help countries with solid macroeconomic fundamentals, which increases their capacity to react if necessary. And Chile benefits from an element that cannot be quantified but is nonetheless relevant, namely its improved international credibility and a reasonably healthy macroeconomic situation.

Nonetheless this does not rule out all the sources of risk. What would happen, for example, if a subsidiary located in Spain of a Brazilian firm issued bonds in dollars in London and these were bought by a Brazilian resident? This liability is not included in Brazil's external debt as it is issued by a non-resident entity and bought by a resident. But there is foreign exchange risk and, depending on how the parent-subsidiary relationship of the Brazilian firm is structured, it could end up affecting the parent company's solvency. This kind of risk is precisely what the BIS has warned about on repeated occasions, and to quantify such risks it has complied information on the bonds issued by national entities outside their country of origin and bought both by resident and non-resident entities.2 Although these cases might appear anecdotal, the figures prove otherwise as they were in excess of 12% of Latin America's GDP in 2014. Moreover their trend is growing (in 2008 this was only 8% of GDP) and this instrument is being increasingly used by banks and companies. Such use by the private sector is particularly prevalent in Chile (the international debt of banks and enterprises in 2014 totalled 15.6% of GDP), Mexico (10.6%) and Brazil (10.5%).

Although an episode of defaults similar to the 1980s is unlikely, it is true that the region's debt has grown, much of it is sensitive to changes in international financing and there is less room to manoeuvre than just a few years ago.

1. In a more detailed analysis, international reserves are evaluated in relation only to short-term debt.

2. According to the BIS, issuances by a Brazilian parent company and its foreign subsidiaries are considered in this statistic as «Brazilian domestic».