How did Latin America survive the global credit crunch?

Back in 2008, after the Lehman collapse, bank lending to emerging markets contracted sharply. But while bank lending was retreating in Eastern Europe and emerging markets in Asia, it shrank comparatively little in Latin America. Why?

A partial answer can be found below, courtesy of a new working paper from the IMF.

[Share of foreign banks' lending through their local affiliates, 2008 (in percent of total)]

When talking about foreign bank lending it's important to distinguish between cross-border flows (when a foreign bank lends to another country from its headquarters abroad) and lending by foreign banks' local affiliates. The graph above shows that unlike other emerging market regions, foreign bank lending in Latin America is mostly conducted through their local branches.

This type of lending is much more stable than cross-border flows, in large part because loans by foreign banks' local affiliates are mostly financed by local deposits. These types of loans are also more likely to be denominated in domestic currency, which as can be seen below, turns out to be the case in Latin America.

[Share of foreign banks' lending denominated in domestic currency, 2008 (in percent of total)]

But there's another piece of the puzzle. The largest foreign banks in Latin America, Santander, Scotiabank and BBVA, to name a few, did not have large exposures to Eastern European markets, which made it less likely for tough conditions over there to affect lending in Latin America.

So in sum, it does indeed seem like Latin America is atoning for its original sin, and if foreign bank flows are to be taken advantage of, countries should promote the type that takes place through their local affiliates.

Original Sin no more

It seems that Latin American countries are starting to atone for their original sins, or at least according to a new policy brief by the Inter-American Development Bank.

Original sin, the tendency among developing countries to borrow excessively in foreign currency (yes, academic economists like to come up with dramatic names for seemingly boring subjects), was a common culprit in economic crises during the 1990s. Long story short, countries found themselves with a lot of cheap foreign capital at their disposal and tended to borrow heavily in foreign currency and usually at very short maturities. The problem is that global capital flows can be rather fickle and often come to a sudden stop, unpredictably, leaving countries strapped for cash. Throw in a domestic currency crash and all of a sudden the value of your foreign debt explodes (a so-called "balance sheet effect"), leaving countries bankrupt.

So, the IDB now reports that Latin American policymakers have taken a "step in the directions of "safer" debt composition." Between 1997 and 2009 foreign currency debt as a share of total public debt has plummeted from 64% to 37%.

What is more, this "safer" level of foreign currency debt has not reversed since the onset of the global financial crisis, when the U.S. Fed started to flood the market with cheap funds. In other words Latin American debt managers have resisted the temptation to revert to old patterns and take advantage of all 'em cheap dollars. Now this is the part where someone else would tell you that this shows how the region is "maturing." But don't worry, I find that kinda talk far too patronizing and rather anthropomorphic since these are COUNTRIES we're talking about, not children for fucks sake. Anyway, RANT OVER.