Latin America, out of IMF’s control
World Economy and Latin America
20 December, 2011
Contents
Introduction
Past relationship between Latin America and IMF
How LAC could get out of IMF’s control
Conclusion

Introduction
Latin America was a volatile region with a history of exceptionally high inflation rates, substantial macroeconomic instability, and a record of unsuccessful monetary and fiscal stabilizations. However, during the past decade, Latin America’s economy has strengthened their body and benefited from high exports, strong economic growth in its trading partners and good global financial conditions and domestic policies. All of this is related with international financial institutions and one of IFIs, International Monetary Fund had affected in currency perspective in the region. In this paper, I will search the changing relationship between Latin America and one of IFIs, IMF whose role is so involved with Latin America’s economy. The first session will explain the relevance between the region and IMF and in the following part, there will be the reasons that Latin America could escape from IMF’s control.

Past relationship between Latin America and IMF
The IMF was set up to assist countries that had temporary current account deficits and lacked a sufficient quantity of official reserve assets to support a fixed exchange rate. However, the slow motion collapse of the fixed exchange rate system in the 1970s created an odd situation for the IMF. At about the same time as the attempts to reconstruct the global system of fixed exchange rates was becoming futile, oil prices soared.
While the IMF was created to finance temporary current account deficits in a fixed exchange rate system, it increasingly was lending large amounts of money to countries in the region that were already heavily indebted. It was also attempting to get other creditors to reschedule the existing debt to make the situation more manageable for the countries involved. By the late 1980s, it was clear the institution could not continually support current account deficits on this scale. At this time, it was also clear that the region could not support the transfer of real economic resources necessary to fully pay off all accumulated debts. A series of negotiations among the most indebted countries of the region, the creditors, the IMF, and the US government resulted in a reduction of the total amount of debt to a level consistent with a resumption of economic growth. By the late 1990s, many of the countries had been able to repay the reduced level of debt. The role of the IMF in this period is controversial. Its lending to countries of the region was a necessary cushion but it came at the price of painful austerity programs. Its participation in the negotiations with commercial banks and the US government led to charges that it was overly concerned about the financial health of private sector banks in high-income countries. Perhaps this is a reflection of the more general problem of the role of the IMF in a world of floating exchange rates.
By the late 1980s, it was becoming increasingly clear that many of the countries of the region would not be able to repay the accumulated debt in total. While the IMF had provided needed foreign exchange in the early and mid-1980s, growth in the region had stagnated. Servicing this debt was still taking nearly half of export earnings. More importantly, servicing debt was requiring 5 to 6 percent of GDP in a region of middle-income countries. Further IMF lending was not economically feasible. There had been little growth in the region for ten years and GDP per capita was falling. In the end, a solution was brokered by the US government. The debt of most of the countries of the region was replaced by 30-year bonds. These new bonds had a face value that was 65 percent of the value of the original bonds. In the end there were no winners. The governments of the region borrowed far too much in the late 1970s and early 1980s. The commercial banks providing the loans were insufficiently attentive to the ability of the borrowers to repay their debts. Given the size of the debt, whether or not IMF austerity programs would work was questionable. The history of the Lost Decade provides the answer to that question. In Latin America as elsewhere, a mix of imprudent governments and financial institutions is detrimental to the economic health of both the citizens of the borrowing countries and owners of the financial institutions.

How LAC could get out of IMF’s control 1. High commodity price
The periodic booms and busts in commodities and the perpetual price instability are more than a nuisance to producers and consumers. Especially in Latin America commodities are sufficiently important that changes in commodity prices can affect the entire economy. To view the concept of real GDP I need to consider the components of GDP.
Y= C + I + G + (X - M)
From the equation the effect of exporting a new commodity or changes in the price of exported commodities becomes clear. If commodity prices can a high percentage of total exports, then changes in commodity prices can significantly affect the total value of exports. In turn, this would change the trade balance (X-M). Now, if exports are a high percentage of GDP then the chain of logic would lead one to the conclusion that changes in commodity prices can affect the entire economy. A boom in commodity prices could either lead to a trade surplus or reduce the size of the trade deficit. Everything else equal, this would tend to increase real GDP. The link from commodity prices to the entire economy is relatively simple. A boom in commodity prices may constitute a drag on the entire economy. 2. Monetary Fund A. Banco del Sur (Bank of South)
Banco del Sur is a monetary fund and lending organization established on 26 September 2009 by Argentina, Brazil, Paraguay, Uruguay, Ecuador, Bolivia and Venezuela with an initial capital of US$20 billion. The Bank is intended as an alternative to borrowing from the IMF and the World Bank. Hugo Chávez has promised to withdraw from the IMF and encourages other member states to do so as well. Latin America's dependence on the IMF fell dramatically between 2005 and 2008, with outstanding loans falling from 80% of the IMF's $81bn loan portfolio, to 1% of the IMF's $17bn of outstanding loans. Brazil and Argentina are also refusing to borrow from the IMF again. In 2005, Latin America made up 80% of the IMF's lending portfolio. With Latin American countries refusing to continue dealing with it, that percentage dropped to 1% by 2007.
Analysts believe the Bank of the South initiative reflects the increased unpopularity of the IMF and the World Bank among many South American countries. Mark Weisbrot, co-director of the Center for Economic and Policy Research in Washington, also sees it as one of many signs of a new independence from institutions such as the IMF and its unwanted austerity measure. "At the beginning of this decade, scepticism in Latin America was sealed when Argentina disregarded IMF advice by defaulting on its debt and then experienced robust economic recovery," Luis Maldonado, a presidential representative to the government body that helps regulate Ecuador's banking sector, argues that "Latin America has been impoverished and harassed long enough that we have no other choice [but to] start the Bank of the South." B. FLAR (LARF: Latin American Reserve Fund)
The FLAR (Fondo de Latino Americano de Reservas) is a financial institution whose purpose is to provide balance of payments assistance to the Member Countries by granting credits or guaranteeing loans to third parties. It also helps harmonize the countries' exchange, monetary and financial policies, and improves the terms of investments of international reserves made by the Andean countries. The FLAR was born as an extension of the Andean Reserve Fund (FAR), a financial institution that subsequently modified its Charter to permit the accession of third countries. The new agreement was signed in Lima, Peru on June 10, 1988 and entered force on March 12, 1991.
The idea that Latin American reserves might be pooled through a regional entity like FLAR and used for coinsurance against sudden stops has some appeal. To the extent that sudden stops are imperfectly correlated across countries, pooling can be used to reduce the real resource cost of reserve accumulation. To the extent that countries suffering purely from problems of illiquidity can be identified, the substantial costs of the financial instability induced by interruptions to private capital flows can be avoided. The idea that the absence of suitable instruments renders emerging markets vulnerable to capital-flow volatility has been developed in the literatures on balance-sheet effects, de-facto dollarization, and original sin. The literature on balance-sheet effects emphasizes that sudden stops precipitating depreciation of the currency have strongly negative effects in emerging markets. Negative effects arise because emerging markets are net foreign debtors and because their external liabilities are disproportionately denominated in foreign currency. When the United States sees its currency depreciate, the main effect is to crowd in exports and stabilize output, rather than causing financial stringency. In emerging markets with foreign-currency-denominated liabilities, in contrast, the main effect is to raise the costs of debt service and heighten financial distress.
FLAR could contribute to financial stability in its member countries by using some portion of its reserve pool to invest in their issuance of state-contingent debt securities with desirable risk-sharing properties. But such an initiative will be effective only if it is complemented by efforts to develop a regional index of such securities and by other steps to further develop the market 3. Regional Integration A. MERCOSUR
The MERCOSUR (Mercado Común del Sur) was formed by Argentina, Brazil, Paraguay and Uruguay by the Treaty of Asunción, signed in March 1991. Associate members are Bolivia, Chile, Colombia, Ecuador and Peru. Venezuela signed a membership agreement in June 2006, but before becoming a full member its entry has to be ratified by the national parliaments of the four original members.
Its objectives are to create a common market with free movement of goods, services and productive factors; adopt a common external policy; coordinate common positions in international forums; and coordinate sector and macroeconomic policies.
As from December 2008 Brazil has announced its decision to eliminate the double charging of trade tariffs, in order to reduce costs (even at a loss of tariff revenue for some members, such as Paraguay, which depends on this item for almost 20% of its fiscal revenue). Brazil has also announced its intention to reduce the nationalized component of imports from Paraguay and Uruguay, a political decision still to be translated into technical procedures.
MERCOSUR has opted for remaining an inter-governmental exercise, instead of creating a supranational structure, as in the European Union and in other integration exercises in the region. This has, of course, costs and benefits. Among the former, the low degree of implementation of the common rules in MERCOSUR is often related to the lack of supranational entities that might impose higher degree of discipline. The benefits of the inter-governmental model, on the other hand, stem from its relative flexibility: in several critical situations this lack of institutional rigidity has allowed for changes in the negotiating process.
MERCOSUR has signed some 17 agreements, most of them in the period 2004-06. Not all of these agreements comprise trade preferences. Some are only ‘base-agreements’ with generic objectives and common purposes. But the total number of agreements mirrors the ‘global trader’ perspective adopted by MERCOSUR since its early days.
The main institutional traits of Mercosur are the strong inter-governmental bias of its organs, the key role of consensus in decision-making and the non-existence of an “autonomous” legal order (including a jurisdictional body to settle disputes). These features have been consistent with an institutional model that emphasizes continuous bargaining, flexibility and adaptability. This institutional approach was very effective to increase interdependence in a context where functional demands for integration were weak. As
Khaler (1995) argues, “state-like” institutions may not be the most efficient institutional form in all environments. Decentralized and informal institutions can be more effective when scarce and expensive information requires substantial information gathering before additional institution building can occur or, alternatively, when plentiful and cheap information about the preferences and reputation of partners make reputation-based systems sufficient to ensure compliance.
In the initial years of MERCOSUR institutions with the ability to adapt rapidly and easily to changes in the environment proved to be both effective and durable, helping to increase interdependence and develop a “learning process” that may eventually lead to more formal, centralized and substantive institutional forms as demand and supply conditions develop. Moreover, this institutional design did not prevent taking “hard” policy decisions. B. UNASUR (The South-American Union of Nations)
The UNASUR (Unión de Naciones Suramericanas) is an intergovernmental union integrating two existing customs unions: Mercosur and the Andean Community of Nations (CAN), as part of a continuing process of South American integration. It is modeled on the European Union. The UNASUR Constitutive Treaty was signed on May 23, 2008, at the Third Summit of Heads of State, held in Brasília, Brazil. According to the Constitutive Treaty, the Union's headquarters will be located in Quito, Ecuador. The South American Parliament will be located in Cochabamba, Bolivia, while the headquarters of its bank, the Bank of the South are located in Caracas, Venezuela. The goal is to gradually form a free trade area in South America, as well as to provide economic complementarities among countries in the region. UNASUR represents a new model of regionalism, not focused predominantly on trade issues. Its agenda comprises other issues, such as energy integration and infrastructure, as well as social and cultural themes. Together with ALADI (Asociación Latinoamericana de Integración), these are the two integration schemes that comprise all South American countries. C. CAN (Andean Community)
The CAN (Comunidad Andina) was formed in May 1969 by Bolivia, Colombia, Ecuador and Peru. Until 1996, it was known as the Andean Pact. Originally both Chile and Venezuela were member countries. The former left the Community in 1974 opting for a more open multilateral approach and the latter in 2006 based on the argument that the negotiations of Colombia and Peru with the United States would affect the essence of the Community. Associate members are Argentina, Brazil, Chile, Paraguay and Uruguay. Observer members are Mexico and Panama.
CAN’s objectives are to promote the harmonic development of the member-countries in equal conditions, through integration and economic and social cooperation; to gradually form a Latin American common market; to foster sub-regional solidarity; and to reduce external vulnerability.
The Andean Community differs from MERCOSUR in that there are no exceptions among the products affected by preferences, it has common norms with regard to trade mechanisms such as anti-dumping and safeguards policies, and it adopts common norms also for trade in services, investment, intellectual property and competition. It has also a rather complex institutional structure.
The Andean Community has negotiated trade agreements with the European Union and – in the case of Colombia and Peru – with the US, but this remains to be approved by the US Congress. Negotiations between MERCOSUR and the Andean Community were completed in 2004; they are essentially bilateral trade concessions. D. CARICOM
The CARICOM (Caribbean Community) was formed in July 1973 by Antigua & Barbuda, Bahamas, Barbados, Belize, Dominica, Granada, Guyana, Haiti, Jamaica, Montserrat, St Lucia, St Kitts & Nevis, St Vincent & Grenadines, Suriname and Trinidad & Tobago. Associate members are: Anguila, Bermuda, British Virgin Islands, Cayman Islands and Turks&Caicos Islands
CARICOM’s objective is to promote economic integration of member-countries by means of a common market, coordination of a common external policy and functional cooperation in terms of health, education, culture, communication and industrial relations.
In 2002 a common legislation was adopted for commercial defence mechanisms and technical and sanitary rules, as well as norms regulating trade in services, intellectual property and competition policy.
CARICOM has perhaps the most complex institutional structure of all American integration experiments. Intra-regional trade has been dynamic in recent years, surpassing 20% of total exports.
Relations among the English-speaking Caribbean countries – with the recent adhesion of Dutch-speaking Suriname and French-speaking Haiti – have always gone well beyond trade relations. Most member countries are former European colonies and until recently their products had benefited from differentiate treatment in the European market on the basis of specific trade agreements.
In 2006 a CARICOM Single Market (CSM) has been created to provide free movement of goods and services, as well as of labor and capital. All 12 countries participate in the initiative, which comprise harmonization in economic policies, leading to a common currency as of 2009. Between 2010 and 2015 a full monetary union is to be implemented, with policy coordination in several sectors. Central issues for Caribbean countries are energy and labor movement. Countries systematically demand special and differentiated treatment in the WTO and manifest increasing concern with the progressive elimination of preferences under the Cotonou Agreement.

Conclusion
Financial and monetary cooperation has been an issue in regional integration for quite some time. Policy choices are limited to attaching the national monetary system to one of the strong currencies, to join forces in regional groupings by monetary and financial cooperation or pursuing active interventions in exchange markets and accumulating international reserves.
One recent initiative with the multiple objectives of dealing with the mismatching of bilateral parities with regard to the dollar, at the same time reducing transaction costs and hence foster regional trade was adopted by Brazil and Argentina. Recent initiatives are more related to improving long-term financing. Development financing in Latin America has been predominantly provided by the World Bank, the Inter-American Development Bank (IDB), by CAF-Andean Development Corporation, the Central American Economic Integration Bank (CABEI) and the Caribbean Development Bank (CDB).
The Banco del Sur project is originally conceived as a development bank, to provide financing to large projects. But it is also often referred to as an alternative fund to the IMF, with less strict criteria imposed on member countries to have access to its resources.
Monetary cooperation and joint initiatives in financial matters in Latin America are less developed than in other regions.
The low intra-regional trade also raises doubts about the probability of success in adopting a common currency, in most groups of countries. National monetary policies are defined on an individual basis by each country and there is nothing similar, even though the Latin American Fund (FLAR) has been in operation for three decades now and is recognized as having contributed significantly in helping Andean countries meet foreign exchange shortages, Initiatives have been concerned with the availability or resources to finance (mostly infrastructure) projects and – except for the specific experience of FLAR only recently have encompassed the pooling of reserves to deal with payment constraints.
In a changing international environment with globalised financial markets, those institutions, monetary and financial cooperation and regional integration, could make Latin America less dependent on IMF. Now, IMF is visiting Latin America asking to give some lessons to advanced countries. I don’t know how their relationship will go further, but at least it will give some pleasure to examine their cooperation or disharmony.

References
Barry Eichengreen. 2006. “Insurance underwriter or financial development fund: what role for reserve pooling in Latin America?”, CEPAL

Javier Reyes and Charles Sawyer. 2011. “Latin American Economic Development”, Routledge

Klein, N. 2007. “The Shock Doctrine”, Penguin books.

Latin American Shadow Financial Regulatory Committee. 2007. “Does Latin America Need the International Monetary Fund?”

Lourdes Heredia. “Why South America wants a new bank”, BBC News. 10 December 2007.
McElhinny, and Vince. "Bank of the South", Global Exchange. www.globalexchange.org/countries/americas/venezuela/BankoftheSouth.pdf. 25 February 2011.

Renato Baumann. 2008. “Integration in Latin America – Trends and Challenge”, CEPAL

Roberto Bouzas and Hernán Soltz. “Institutions and regional integration: the case of MERCOSUR”, University of London/ILAS-The Brookings Institution

UNCTAD. 2007. “ Trade and Development Report-2007”, United Nations Conference on Trade and Development: Geneva

--------------------------------------------
[ 1 ]. Y Real GDP, C Consumption by the public, I Residential and Nonresidential Investment, G Government spending on goods and services, X Exports of Goods and Services, M Imports of Goods and Services
[ 2 ]. M. Khaler (1995), International Institutions and the Political Economy of Integration,
Washington DC: The Brookings Institution.
[ 3 ]. South America nations found union". BBC News. 23 May 2008.