From Decoupling to Deleveraging and Divergence

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The global financial crisis has caused a dramatic disruption in Latin American capital markets. While asset values in mature markets had been diminishing for well over a year prior to the fall 2008 meltdown, the crisis hit Latin American markets abruptly. In a matter of months, major regional stock indices lost nearly half their value, the issuance of corporate securities came to an abrupt and seem- ingly definitive end, and foreign investors fled the region en masse.

Capital markets in Latin America had been in a period of rejuvenation during the preceding five years. Capital, lured by increased political stability and growth prospects better than those of any advanced economy, flowed to the region’s financial markets in unprecedented volume. This period of protracted growth did more to address the principal constraints confronting the region’s financial markets than the decade of market reform that preceded it. Yet it also masked an emerging divergence between countries that made prudent policy choices to foster dynamic capital markets and those that merely reaped the rewards of the commodities windfall and global liquidity boom.

The financial crisis has crystallized this divergence. The strength of capital markets not only serves as a rough proxy for overall economic health, it is one of the key determinants of growth. In Latin America’s strongest economies, well developed capital markets act as a catalyst. In less dynamic economies, capital market activity is merely an offshoot of growth, rarely one of its principal drivers. This distinction will play a significant role in determining the effects of the financial crisis across the region.

Prior to the 1990s, Latin American capital markets were grossly underdeveloped and consisted primarily of sovereign bank lending—in contrast to the prolonged expansion of financial markets in developed economies that began with the demise of the Bretton Woods system in the early 1970s. Local equity and bond markets remained negligible and did not attract the attention of international investors. Latin American governments’ disproportionate reliance on commercial bank debt led to the debt crisis that stunted economic growth across much of the region in the late 1970s and early 1980s and limited the development of domestic capital markets for nearly a decade…