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From issue: China's Global Rise: Implications for the Americas (Winter 2012)

Policy Update

A snapshot of policy trends and successes in the region.

In this issue:

Finance: The Importance of Foreign Exchange Reserves

Luis Oganes

An important lesson of the 2008–2009 financial crisis was that the emerging market economies with high levels of international reserves were better able to withstand the ripple effects of the global meltdown. In Latin America, the cases of Brazil and Mexico provide a clear illustration.

When Lehman Brothers went under in September 2008, Brazil had foreign exchange (FX) reserves of $205.5 billion—equivalent to 12.9 percent of GDP—while Mexico had $83.6 billion, or 7 percent of GDP. While the FX reserve levels easily covered a year of short-term debt maturities, Mexico’s were below the other precautionary threshold of six months of import coverage.

Brazil’s much higher level allowed its central bank (BCB) to more effectively respond. It intervened in the FX market to help stabilize the Brazilian real, provide FX swap lines to Brazilian corporations that faced difficulties rolling over U.S. dollar-
denominated maturities and assist exporters hit by the global dry-out of trade financing lines.

In contrast, Mexico’s central bank (Banxico) did not have the flexibility to support the Mexican peso and meet the surge in U.S. dollar demand from Mexican corporations. Overall, the strong FX reserves position was a key factor that allowed Brazil to adopt more aggressive countercyclical measures and emerge from a short-lived recession by the second quarter of 2009. Mexico had to endure a deeper downturn that lasted several quarters.

The explanation for the divergent tales of Brazil and Mexico is in their different balance-of-payment structures. On the current account front, 55 percent of Brazil’s exports are composed of commodities, which had surged in the years prior to the Lehman collapse and helped sustain a current account surplus. On the capital account front, Brazil’s high interest rates and booming economy had attracted hefty portfolio and foreign direct investment (FDI) inflows. All this allowed the BCB to more than triple its FX reserves between 2004 and 2008 amid heavy U.S. dollar buying to prevent excessive Brazilian real appreciation.

Commodities account for less than 20 percent of Mexican exports. In the years that preceded Lehman, Mexico—following China’s entry into the World Trade Organization—faced stiffer competition from China in selling manufactured goods to the United States. As a result, the nation’s current account always stayed in deficit and its FX reserves increased only 40 percent between 2004 and 2008.

The rest of Latin America fell somewhere between Brazil and Mexico. However, the region registered a current account surplus from 2004–2007 and FX reserves had more than doubled to around $437 billion when Lehman hit.

Since the end of 2008, Latin American central banks have accumulated FX reserves of more than $225 billion, of which over $100 billion alone correspond to 2011. This leaves the region in a very solid position to withstand the external shocks that may come from the sovereign debt and banking crises in Europe, a slowdown in the U.S. and China, lower commodity prices, and a moderation in capital flows.

Interestingly, the cases of Brazil and Mexico no longer bracket the extremes. Brazil’s FX reserves remain the highest in the region at $352.9 billion, or 14.9 percent of GDP. But Mexico has managed to build a stronger reserves position—of $144 billion—since the crisis. Taking into account the additional $72 billion available in the Flexible Credit Line granted by the International Monetary Fund to Mexico, for all practical purposes, its reserve position is now equivalent to 18 percent of GDP—more than double the ratio seen in September 2008.

That said, the pace of accumulation of FX reserves in Latin America will moderate substantially in 2012, following the current trend of deterioration in current account balances [see table]. The region’s aggregate current account deficit is expected to widen from $38 billion in 2011 to $90 billion in 2012 amid lower commodity prices, while the relative resilience of domestic consumption and investment should prevent a comparable decline in imports. As a result, the region’s FX reserves are expected to increase by only $20 billion this year, with Argentina, Ecuador and Venezuela seeing reserve losses as they deal with conflicting policy objectives.

In terms of financing, FDI inflows are still projected to fully cover current account gaps in Chile, Mexico and Peru. Visibly slower growth will curb the gap in Argentina, which otherwise will need to be covered by FX reserve losses or by a policy change that prioritizes accessing capital markets instead of paying down debt on a net basis. In turn, portfolio and debt flows should provide the financing for Brazil and Colombia. These balance-of-payments dynamics suggest that Latin currencies will not face the same pressures on appreciation seen over the past two years.

In general, though, while higher FX reserves will not insulate Latin America from the global economy this year, at least they will give policymakers room to maneuver and help contain the pressure on external accounts and currencies.

Education: Chile's Students Demand Reform

Gregory Elacqua

Chile’s educational success over the past two decades would seem to be a model for the region. Ironically, it was precisely those advances—and the problems they created—that led Chilean students into the streets in May last year to call for an overhaul of the country’s higher education system.

Chile´s high school graduation rates have increased (almost 90 percent of 25- to 34-year-olds hold high school degrees, versus less than 40 percent of 55- to 64-year-olds), and access to higher education has greatly expanded over the past 20 years. More than 1 million students are enrolled today in postsecondary institutions, compared to less than 250,000 in 1990. At the same time, national and international tests point to significant improvements in the quality of Chile’s primary and secondary schools. The socioeconomic achievement gap also has narrowed. Today, 7 of 10 Chileans attending university are the first generation in their families to do so.

But student advances have also ushered in new demands.

Higher education is expensive, and families and students have to cover most of the costs. Middle-class families spend nearly 40 percent of their income per child on higher education expenses—a much higher rate than in other OECD countries. And this trend is escalating. Tuition at public and private universities has increased by more than 60 percent (in current dollars) over the past decade. One result is a high postgraduation debt burden on many students. Chilean college graduates pay three to five times more of their income in student loans than their peers in OECD countries.

The rising costs and high interest rates have led many students to default on their loans. The high costs are complicated by the fact that university degree programs are also quite long—usually six to eight years—and completion rates are low; fewer than 50 percent graduate. As a result, many students end up stuck with burdensome debts and no college degree.

The problem—and public anger—have been aggravated by Chile’s unregulated higher education market. The government pours a large share of its education funds into public and private universities, demanding little accountability. Many nonprofit private universities that receive indirect public funding through subsidized student grants and loans are actually for-profit companies in disguise. In the case of these for-profit education ventures, shareholders set up companies and provide services and then lease the facilities to the university.

Not long after the student protests began, statements of sympathy and strong endorsements started pouring in from across the political spectrum. Seeking to capitalize on the movement’s popularity, senators and deputies, ministers, and influential domestic unions such as the Teachers Union, the National Confederation of Workers and the State Employee Union jumped on the student bandwagon. Even President Sebastián Piñera expressed support for the movement.

Adept at shaping public opinion, the students have been much less successful at influencing policy. The students’ web and media presence, their capacity to mobilize tens of thousands of students and sympathizers for large-scale marches, and their ability to occupy hundreds of state university buildings—locking out administrators and professors—have been impressive. And despite the waning patience among parents and residents who live in the city center where most of the marches are staged, polls suggest that most Chileans agree with the student movement’s essential message.

Congress has undertaken a number of initiatives to try to translate the movement´s demands into legislative actions. For example, a bipartisan group of senators introduced a bill in October to address one of the student’s most controversial demands: halting the funding of for-profit educational institutions. For-profits serve one-third of primary and secondary students and one-fourth of postsecondary students.

The government has also introduced bills that would expand student grants and reduce interest rates on loans. These legislative initiatives are currently under congressional review.

The challenge for the students is to convert their specific demands into policy. While the students have changed the national conversation on education, the route to reform has to run through the politics of Chile’s heavily criticized and non-representative two-bloc binomial electoral system.

The students have rejected the congressional proposals and have been unwilling to participate in any formal negotiations or dialogue with congress or the executive. Translating the visionary goals of a social movement into the murky give-and-take of Chilean politics of electoral calculation and legislative maneuvering has not been easy. Students consider the politicians outdated and unrepresentative of the society they serve, and have distanced themselves from the two major political coalitions, Concertación and Alianza.

In contrast, the most conventional higher education interest group in Chile—public and traditional private university presidents—is much better adapted to the environment of Chilean politics. From the beginning of the protests and at least through the end of last year, they have maintained a constant dialogue with the executive and congress. Most of their demands, such as increased direct funding for public and traditional private universities with few strings attached, have been incorporated in the 2012 budget.

Conversely, many of the students’ demands—tuition caps, stricter regulation and greater accountability for public funds allocated—were not included in the budget. While the students feel more comfortable spreading their message on social networks and on the streets than in the halls of congress, the university presidents have leveraged their governmental contacts and political organization to achieve their goals.

Currently, the student movement is divided on the best way to move forward. Some leaders—most
from universities in Santiago—recognize that despite the protests, students have had limited success at influencing the legislative agenda. They are more open to establishing a dialogue with the executive and congress.

Other, more extreme groups—many from state universities outside of Santiago—maintain that exerting pressure through protests is the best path to reform.

Their agendas must be reconciled. If students do not channel their demands through government and politics, the outcome may not only be inadequate reforms for future generations of students, but more marches and occupations in 2012—a result that is unlikely to please anyone.

Trade: Brazil's New Protectionist Agenda

Ricardo Camargo Mendes

Brazilian policymakers seem to be making import substitution industrialization (ISI) fashionable again. The dominant economic model between 1950 and 1970 in Brazil and much of the region is often credited with the development of Brazil’s industrial sector—that is, until it fell victim to inefficiencies and to isolation from the more dynamic global market.

Those same risks exist today as Brazil rushes to protect and support domestic industries in certain economic sectors (the so-called strategic development plans) through import barriers and generous public support—at the expense of international competition.

The administration of President Luiz Inácio Lula da Silva first reintroduced the concept of strategic development plans with the launch of the Política Industrial, Tecnológica e de Comércio Exterior (Industrial, Technological and Foreign Trade Policy—PITCE) in November 2003. After 25 years without an official industrial policy, the PITCE was recreated to stimulate innovation in Brazilian companies.

Unlike the development plans of the 1950s and 1970s, the PITCE was based on the concept of “competitive international insertion” of Brazilian industry. It created mechanisms to foster the competitiveness of certain industries and services so that they could then enter the global market. With a focus on innovation and export policies, it preserved the “relative liberalism” and multilateralism in trade policy introduced in the 1990s.

Shortly afterward, the Lula administration expanded the initiative in a policy to stimulate technology and basic industries. In May 2008, it launched the Política de Desenvolvimento Produtivo (PDP, or Production Development Policy). Administered by the Brazilian Development Bank (BNDES in its Portuguese acronym), the PDP seeks to position Brazilian companies, particularly in the mining, steel, aviation, and biofuels sectors, to become global leaders.

This state-led policy was in large part a response to the appreciation of the real. Combined with tax, logistical, bureaucratic, and educational challenges (the so-called “Brazil cost”), the real’s rise relative to international currencies undercut the competitiveness of Brazil’s industrial and service sectors, especially relative to China. The international crisis that hit the markets in 2008 deepened this change.

In her first year in office, President Dilma Rousseff quickened the pace of inward-looking industrial policy. In the wake of the economic crisis, as a number of countries threw up protectionist barriers to trade and Brazil’s currency continued to climb, fear began to mount of Brazilian deindustrialization.

The most pronounced step came in September 2011 when the Brazilian government imposed a 30 percent increase in the IPI (imposto sobre produtos industrializados, or industrialized products tax) for vehicles with less than 65 percent of their value added originating in Brazil, MERCOSUR countries or Mexico. The policy, which is in effect through the end of 2012, disregards World Trade Organization rules and demonstrated a shift in Brazil’s rhetoric away from multilateralism toward its own development agenda. The goal of the temporary IPI increase is to boost the internal market for manufactured goods and promote investment in technology and innovation.

The IPI was the first and most visible shot across the bow of the larger Brasil Maior (Bigger Brazil) policy launched in August 2011, shortly after the largest drop in industrial output since 2008. In the plan, Rousseff announced the government’s intention to apply a series of defensive trade mechanisms (antidumping, safeguards and countervailing measures) to curb the flood of cheap imported goods that came mostly from Asia.

Beyond a more protectionist trade policy, the Rousseff government is also increasing the role of the Brazilian state in the economy, another tool of an industrial development plan. The best indication of the state’s increased activity in picking and promoting winners is the recent activity of the BNDES. Since 2000, its loan disbursements have increased from 23.4 billion reais per year to 168.4 billion reais in 2010. Not coincidentally, the biggest one-year jump in BNDES disbursements (45.1 billion reais) came between 2008 and 2009—the year following the onset of the global economic crisis.

These disbursements have allowed the BNDES to support and prop up national companies. At the same time, state-owned enterprises have recently played a greater role in the Brazilian economy. Their investments have jumped from 1 percent of GDP in 2004 to 2.2 percent in 2010. By 2015, estimates forecast that investments by the government and state enterprises will account for 4 percent of Brazil’s GDP.

With a growing state presence, government procurement becomes extremely important for local industries. To favor Brazilian bidders, the government approved Law 12.349 in 2010, which establishes preference margins of up to 25 percent for domestic suppliers in government procurement, in effect limiting outside competitition.

But the return to ISI is not limited to trade. Similar to decades ago, the Brazilian government, through BNDES and Research and Projects Financing (FINEP in its Portuguese acronym), is actively seeking to appropriate (nationalize) international technology for its own development. The idea is, rather than invest in local efforts at innovation in key industries, to buy technology on the international markets as a way to make the leap into the technology product cycle.

In Brazil, the apparent move toward thinly veiled protectionist policies in trade, industry and technology is occurring at an exceptional time in the world economy. The extent to which some of the more heavy-handed policies—like the IPI—will be continued or are only the first step in a more aggressive ISI-like policy remains to be seen. In the meantime, there is little doubt that the economic crisis and the overvaluation of the currency have triggered greater protectionist tendencies.

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