Latin America Expects Recovery to Continue

Latin America’s nascent economic recovery is overly dependent on foreign direct investment, leaving it vulnerable to a sudden change in investor sentiment, some economist fear, as the region braces for another avalanche of overseas funds that are expected this year to equal or surpass last year’s record pace.

Latin America’s economy is expected to grow by 3.5% or better this year after a stagnant 1999. And that growth will be fueled by as much as $70 billion from foreign companies looking to establish new operations or to buy formerly state-owned enterprises now going private.

But once all the state-owned concerns have been sold off and the pace of foreign investment levels off, Latin America could find itself short of the capital it needs to grow, said Guillermo Calvo, an economist at the University of Maryland and Latin specialist, because foreign credit, such as bonds and bank loans, is currently unavailable and because domestic capital sources aren’t enough.

Direct foreign investment has helped mitigate the regionwide economic shock waves after Brazil devalued its currency in early 1999, as multinationals such as Ford Motor Co. of the U.S., Repsol and Telefonica of Spain and others poured money in as they expanded their operations or bought into state-owned properties. Last year, the region surpassed Asia as the prime destination for foreign investment and this year is expected to see the same or greater amount of outside investment.

But the concerns, raised at a seminar on the eve of the Inter-American Development Bank’s annual meeting here, have set off an intense debate because it goes against the conventional wisdom that direct foreign investment is beneficial.

The region’s reliance on foreign investment has increased because other sources of foreign capital, bond issues, bank loans and stock market investment are still inaccessible to emerging market countries, almost three years after the Asian crisis began a chain of economic crises capped by Brazil’s devaluation in January 1999, said IDB chief economist Ricardo Hausmann.

The words of caution also struck a discordant note a meeting where many Latin American government officials and experts are in a congratulatory mood for this year’s positive growth forecast and for having averted disaster in the aftermath of last year’s Brazilian devaluation, an event that many though would wreak much more severe consequences.

Other economists attending the New Orleans meeting rebutted the dangers of too much foreign investment, saying that the flood of capital is a sign of confidence in the region and that it will bring improvement in advances in technology and human capital.

“Foreign direct investment is not an unmitigated blessing, but a blessing it is,” said Marcilio Marques Moreira, a Merrill Lynch director and a former Brazilian economics minister.

The flood of foreign investment capital last year helped governments stabilize their currency and finance growing trade imbalances in the face of shock waves caused by the Brazilian devaluation.

A reversion to economic stagnation such as the region witnessed last year could exacerbate already simmering tensions in Latin economies where middle and lower classes complain they have yet to see the benefits of the market-based economic reforms there, Calvo said.

Shahid Javed Burki, a Washington-based investment consultant formerly with the World Bank, also noted that the reliance on foreign direct investment is breeding intense competition among countries and regions within countries. They are outbidding one another by offering incentives that distort the economy and give resources meant for citizens to the foreign companies, Burki said.

He cited the competition between Bahia and other Brazilian states for a $1-billion Ford factory. Although Bahia won the factory, it spent a minimum of $335 million in taxes and other sweeteners to attract the plant.

The annual seminar is closely watched by Latin America experts because it deals with pressing macroeconomic themes. Inter-American Development Bank is a multilateral bank funded by 46 nations that provides loans for a variety of social and infrastructure projects in Latin America and the Caribbean.

Pedro Pou, president of Argentina’s central bank, said chances of a solid economic recovery in Latin America are good because of rising prices of commodities on which many Latin economics depend and because the outlook is bright in other parts of the world including Asia and the United States.

Risks include rising interest rates in the United States, which could make credit even tougher to come by in Latin America, and a possible hard landing by the United States economy.

Foreign direct investment has grown from $6 billion in 1990 to $70 billion last year, a tenfold increase, said Jose Antonio Ocampo, executive director of Economic Commission for Latin America and the Caribbean.

The dimension of foreign businesses’ present role in the regional economy was shown by ECLAC figures saying sales of foreign owned businesses grew 90% from 1990 to 1998 and now make up 38% of total domestic sales in Latin America.

Spain was the leading investor nation in 1999, as its companies including Repsol and Banco Santander Centro Hispano expanded their presences. But BSCH general director Francisco Luzon told the seminar that Latin economies must continue to reform and liberalize if the flow is to continue .

“The problem is not too much foreign investment, but too little,” said ECLAC’s Ocampo.

J.P. Morgan managing director Ernest Stern, also a former World Bank official, predicted that the foreign investment flood would indeed dissipate incoming years but that it will be replaced by more plentiful credit markets, an improvement that is already underway.

Hausmann made a pitch for dollarization of the region’s currencies, a proposal he advanced at last year’s IDB meeting. Such a move would enhance countries’ ability to raise debt capital because they could sell bonds denominated in dollars, which are far more appealing to foreign investors than local currencies.