Brad Setser co-authored the piece.
Differences BWII countries and Latin America
Here we highlight seven differences between Latin America and BWII countries.
First, international reserves to GDP ratio reached 11% in 2005 in Latin America as compared to 30% in China. One country, in turn, has almost three times more reserves than all the Latin America countries.
Second, China’s current account surplus reached 7% of GDP in 2005 but never exceeded 2% in Latin America. While China display both features - high current account to GDP, high net international reserves to GDP – other Asian countries and oil producing countries have at least one of these features. In turn, the high international reserves are being used by the ‘periphery’ to buy US securities. In other words, a significant share of the increase in international reserves in these countries is being used to finance the US deficit. The role of Latin America in financing the US is marginal because of the lower current account and net international reserve as a share of GDP as compared to the BWII countries. In turn, the absence of Latin America would not affect the ‘periphery’ and its relationship with the ‘center’.
Third, it seems that the amount of international reserves posted by BWII countries exceeded the precautionary reasons. In fact, according to Dooley (2006), the development of Asian countries that are part of BWII system is sustained by an undervalued exchange rate as a tool to attract foreign direct investment and thus lead to export led growth. Sterilized intervention was one of the tools used for this purpose. The increase in international reserves is a by product of such strategy and not a goal by itself. In contrast, the ongoing strategy in Latin America seems to lean more towards the accumulation of foreign exchange currency that can be served as cushion against ‘sudden stops’ in international markets. Likewise, some Latin America countries are using a share of their reserves to implement debt management policies to decrease their external debt and eventually issue debt in their own currency.
Fourth, the excess reserves beyond short-term debt is six times greater in Asia than in Latin America, since 2001. The greater amount suggests that Asia’s reserve accumulation exceeded the precautionary reasons that are still guiding Latam international reserves.
Fifth, the low current account to GDP in Latin America is not due to an investment boom but to the fact that savings in 2005 is still higher (19% of GDP) than investment (18% of GDP). Latin American countries would have to decrease interest rates as a way to increase domestic investment and foreign investment.
Finally, the seventh distinction is that interest rates in Latin America are higher than the ones in BWII countries. In turn, the cost of reserve accumulation is higher in Latin America than in China, Korea or oil producing countries.
While BWII countries (periphery) are financing the United States (center) through their purchase of US securities, Latam is not. The amount of reserves to GDP is 30% in China and 10% in Latin America.
The fact that Latin America reserve accumulation in 2005 resembles the one displayed by Korea in 1999 does not imply that Latam is currently following a similar pattern as the Asian countries. Even assuming that Latin America is accumulating reserves for precautionary reasons as well as for debt management purposes, the resemblance with the BWII countries ends here. This is so because BWII countries are essentially export led growth economies whereas Latin America is not. BWII countries are financing the US because they need to preserve an undervalued exchange rate to foster their exports. Dooley (2006) also argues that Asia as whole has more capital control than Latin America, which in turn, makes it harder for Latam policy makers to preserve an undervalued exchange rate through sterilization policies.
In brief, the increase in international reserves in Latin America does not imply that the region is following the same path as the BWII countries. Latam has more of a ‘domestic’ bias to accumulate reserves: public debt management and prevent ‘sudden stops’. BWII countries have an ‘external’ reason to be in the BWII system. In other words, by having a more controls on the capital flows, BWII countries can promote sterilization policies to preserve undervalued exchange rates and in turn preserve the ‘export led growth’ strategy. On one hand, such mechanism end up financing the U.S. deficit and on the other hand, it tends to increase even more the BWII exports to the US.
In turn, the accumulation of international reserves in Latin America is neither a necessary nor sufficient condition to be part of the BWII system. Asian countries and oil exporters preserve an undervalued currency - formally or not pegged to the dollar - mostly because of their growth-cum strategy. Capital controls in these countries increase the efficacy of sterilization policies that in turn preserve an undervalued currency. The fact that these countries are pursuing an ‘export led growth’ strategy is crucial for the whole BWII story. The fact that China, Japan and oil exporter countries – the core of BWII – are among the top five largest buyers of US securities is a more of a consequence of the overall export-led growth strategy than an isolated goal.
In turn, reserve accumulation in the China, Korea and the oil producing countries has been triggered by concerns on export competitiveness. Latin America is not part of the BWII and is currently accumulating reserves for insurance purposes against sudden stops.
While we do not consider that BWII is something that should be spread out around the ‘periphery’, we tried to pose a few arguments as to why Latin American countries are not part of the current system and it is not the mere passage of time that will turn the Latam countries part of the ‘periphery’.