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IDB: Latin America needs new instruments to prevent financial crises

BELO HORIZONTE, Brazil – Latin America must devise new methods to avoid financial crises, taking advantage of current favorable conditions in international markets, according to a study presented today at an Inter-American Development Bank seminar.

The study, Debt Instruments and Policies in the New Millennium: New Markets and Opportunities, fed the discussion at the seminar held ahead of the Annual Meeting of the IDB’s Board of Governors, which will take place here April 3-5.

From a financial standpoint, Latin America is going through an unprecedented auspicious period. Spreads on sovereign bonds are at all-time lows. Booming exports, lower inflation and dwindling fiscal deficits are giving governments opportunities to improve their debt profiles.

Nevertheless, as IDB President Luis Alberto Moreno pointed out at the opening of the seminar, Latin America should not forget the lessons of its recent past, when access to international markets closed abruptly, leading to financial crises.

Moreno pointed out that the accumulation of international reserves and emergency lines of credit provided by multilateral agencies were not enough to prevent the “sudden stops” of capital inflows.

“An efficient response will require new methods to better manage the risks to which emerging economies are exposed,” he said. “The challenge for the region’s countries – in which the IDB expects to assist them – is to develop new alternatives now, in good times, which will be useful when we have to cross troubled waters.”

The study prepared for the seminar by economists Eduardo Borensztein and Ugo Panizza of the IDB’s Research Department and Barry Eichengreen of the University of California-Berkeley, says the international community should revive its discussions on improving the global financial architecture as well as revisit several possible mechanisms with a greater sense of urgency.

Among other ideas, the study highlights financial instruments capable of automatically compensating for economic setbacks, such as bonds linked to commodity prices, national growth rates or the occurrence of natural disasters.

“Country insurance” facilities could be created to meet liquidity needs of emerging economies, financing them with the backing of the abundant international reserves accumulated by those same countries in different regions of the world.

A third possibility would be to set up a stabilization fund that would purchase developing countries’ bonds when their prices drop due to panics in markets. The fund would sell the bonds gradually as investors recover their nerve.

The IDB is supporting the development of local currency-denominated debt markets in Latin America through its own bond issuance program. Since 2004 the Bank has issued 19 bonds in Brazilian reais, Chilean pesos, Colombian pesos and Mexican pesos.

Resources raised through these issues can be used to finance local currency loans, which can be an attractive option to eliminate foreign exchange risks in projects where income will be denominated in local currencies.

The IDB bonds in local currencies can also help expand the range of available credit risks as well as attract new investors to Latin American debt markets.

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