Whither the Credit and Asset Price Cycle in Latin America?

The charts show three variables of the cycle in credit and asset prices in Latin America: the credit to GDP ratio (an approximation to leverage), the real exchange rate, and the EMBI spread. The sample can be divided into three periods: the upturn of 1990-1997 with high growth of leverage and real exchange rate appreciation, the downturn of 1998- 2002 with low growth of leverage, increasing EMBI spreads and exchange rate depreciation, and the upturn of 2003-2008 with high growth of leverage, decreasing EMBI spreads and exchange rate appreciation. A new downturn started with the global crisis of 2009.

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The second and third charts also show other variables relevant to the cycle of credit and asset prices. The first one is the US high yield. The correlation between the US high yield and the EMBI spreads shows that in a globalized environment investors’ risk aversion drives bond prices in advanced and emerging economies alike. The second one is the price of housing; the chart shows the figures I have available for the case of Colombia. It is evident that the price of housing is synchronized with other variables in the cycle of credit and asset prices.

As shown in the right side panels, the case of Mexico is different. Following the Tequila crisis in 1995 a slow process of deleveraged followed. This lengthy process ended in 2003 with the start of the new regional upward phase of the cycle in credit and asset prices.

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The beginning of the 1998-2002 downturn was characterized by banking crisis, IMF programs and banking sector reform. In contrast, the beginning of the 2009 downturn cycle in Latin America is characterized by resilience in the banking sector. And this means that this time the banking sector may not act as a propagator of the shocks, it does not mean that the external shocks are not a constraint to growth.

The cycle in credit and asset prices is closely related to the cycle in the external shocks to the region and to the cycle of output. This is evident from a comparison of the charts in this post with those of my previous one “On the links to a recovery in Latin America” in this same blog.

How will these external factors unfold? What is the future of the credit and asset price cycle in Latin America? The global crisis averted the upward phase of the cycle of credit and asset prices. Asset prices did not reach exuberance levels. Looking forward, capital flows would point upwards from the very low levels seen during the crisis, and world output will remain below potential. The likely path of the price of exports, in turn, is surrounded by considerable uncertainty. So the central scenario is a balance of these forces, with an upward risk consisting of an even larger increase of capital inflows and export prices and a downward risk consisting of the so called double-dip recession.

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