Growth and External Financing in Latin America

This paper discusses the economic performance of Latin America in the last decade, paying special attention to growth and the financial sector. In particular, it shows that external factors, such as like U.S. interest rates and the business cycle, play a key role in capital inflows, investment, and growth.2 As a result, economic growth in the region tends to be fragile and exhibits a high degree of co-movement, i.e., high cross-country output correlation. This last feature exacerbates fragility, because there is little room for mutual insurance within Latin America in case a country suffers a bad shock, and finance during downturns has to come primarily from outside the region. The “Lost Decade” of the 1980s and the recovery of the early 1990s are clear illustrations of these tendencies. During the 1980s the slow resolution of the debt crisis kept Latin American countries outside the international private capital market. In contrast, the 1990s brought a dramatic increase in capital inflows that exceeded expectations. In addition, whenever crises struck, their negative effect on growth was dramatic. This paper will provide some clues regarding the big swings in capital inflows. It will argue that although these swings are oftentimes triggered by external factors, domestic financial vulnerabilities could seriously contribute to magnifying them. Thus, crisis depth is positively correlated with phenomena like a weak banking sector and large debt amortizations. However, it will also be argued that the central capital market has represented an additional source of disturbance for all Emerging Market Economies (EMs) and not just Latin America.