Capitalizing on crisis
As the crisis deepens in the economies of Latin America, multilateral lenders have returned centre stage. The IDB sees itself at the heart of regional rescue, but questions remain about whether the bank can meet the needs of the region
“Who would have imagined a year ago in Miami that we’d see things the way they are today?” reflects IDB president Luis Alberto Moreno. “Two or three years ago people were questioning whether development banks were relevant any longer, whether we still really mattered. It will be interesting to see what positions those people take now.”
While the critical voices grew louder, the IDB continued to be a solid presence in the region, even as Latin America distanced itself from other Washington-based multilaterals. The IMF had been all but banished by the start of 2008 – with just 1% of its lending in the region. But IDB lending remained steady, with totals of $6 billion and over through 2003–06. In fact, ahead of the storm, the Bank’s lending was already on the increase – it approved over $9 billion in 2007.
Last year the Bank’s lending approvals climbed to $11.2 billion as it entered crisis mode. Anticipated funding for 2009 is $18 billion.
“In the face of the crisis, the role of the IDB, like that of our counterparts such as the IMF, is to be as counter-cyclical as possible,” says Moreno. “We are doing unprecedented things. In our case, where our normal lending level is around $7.5–8 billion, we will do $12 billion in ordinary funding this year, plus an extra $6 billion through the Liquidity Programme for Growth Sustainability.”
No doubting the mood of action at the IDB. The pains of restructuring under the first years of Moreno’s leadership are past, says the Bank’s chief – no more realignment... now it’s all hands to the pump.
But there are a few big questions hanging over the Bank’s plans. Even with doubled lending, will it be able to make a difference as the crisis potentially deepens into major recession? Will it get the capital it wants to step up that lending? And, in fact, is the Bank up to the job?
According to Andres Velasco, Chilean minister of finance, in an interview with Emerging Markets, its capacity is constrained as the crisis gathers pace: “The IDB does a good job, but it is not clear that it can scale up to the potential needs of many Latin American countries.”
So goes the continuing slide of IMF global growth forecasts over recent months: 3% in last October’s world economic outlook report, revised down to 2.2% in a November update, to 0.5% in January, with a further revision in March to a global contraction of 0.6%. Forecasts for Latin America and the Caribbean stayed just slightly above the global average at 1% in January, but at press time looked likely to be revised down further.
“I think the consensus forecast now is that every time a new forecast comes out the true figure is likely to be even lower,” notes Moreno.
The IDB has not published its own projections of the depth or length of the crisis – but, says Moreno, with governments and others, it has to be prepared for a downturn extending through 2010.
“A lot depends on the effects of stimulus packages now and how well they are synchronized,” he says, “whether they will help stabilize and bring some recovery in the major economies of the world. And there is an increasing challenge for all emerging markets, about whether the focus on stimulus in US, Europe will crowd out emerging market finance.”
In other statistics, increased urgency comes with estimates from the Latin American Shadow Financial Regulatory Committee that the region could need funding to the tune of some $250 billion in 2009. With most global and local capital markets all but closed for emerging market credit, even Federal Reserve swap lines and doubling of multilateral funds will leave a serious gap. Moreno says he has seen estimates that perhaps 50% of the region’s funding needs will go unrealized.
“I’ve seen lots of different estimates from our own analysts and from other very well respected researchers,” says Moreno. “I don’t have an opinion on particular figures. Without getting into amount X or amount Y, I agree there will definitely be a financing gap. We can see that just from the demands now coming in for our lending – we could easily double our lending levels.”
Getting its way
The IDB’s last recapitalization was in 1995 – an addition of $40 billion in new shareholder capital brought its total ordinary capital up to $101 billion. The plan now, if the Bank’s 48 shareholders (with the addition now of China) agree, is for a substantial injection of new funds.
“For the first time since 1994 the Bank is constrained by its capital,” says Ricardo Haussman, professor of economic development at Harvard University and former IDB chief economist between 1994 and 2000. “It has the structure and relationships to be doing much more – the replenishment will be fundamental.”
No figures are forthcoming as yet. A special commission chaired by former Peruvian prime minister Pedro Pablo Kuczinski (currently partner and senior adviser at the Rohatyn group) will publish its recommendation to the shareholders at the start of the Bank’s annual meeting in Medellin. In Haussman’s opinion, the Bank should be asking for something like a tripling of its current capitalization.
Will the Bank get the money? The largest shareholder – 30% – is the United States, currently running up a historic deficit to try and save its own financial system and economy. While the US and other G20 nations talk of potentially tripling funding to the IMF, will there be anything to spare for the Latin bank?
Says Claudio Loser, former Lat Am chief at the IMF: “The IDB might get a little increase in capital, but I don’t think they’ll be able to increase to the level they want. And in this case the reluctance won’t just come from the US but from regional shareholders themselves, given the uncertainties they’re all facing right now.”
Bank-watcher Vince McElhinny of the Bank Information Center says it may at least have to wait. “For the US, the order of priority, after its domestic needs, is the IMF and then the Asian Development Bank,” he says. “And if it is successful, it would likely be a two or three year programme to get replenishment. The US Treasury is not going to post an authorization bill this year – at the earliest things could move ahead in 2010, if it can show the need is still there.”
Haussman is hopeful for the Bank. He points out that the request is for governments to subscribe callable capital which is not subject to budget constraints – and that in the Bank’s history so far this capital has never been called.
“The flight to quality caused by the crisis enhances governments’ capacity to borrow,” he says. “The US and others can pass on that capacity to institutions like the IDB without increasing their own net debt, helping to reflate the world economy, while showing support for the region.”
Speaking to Emerging Markets, Brazilian finance minister Guido Mantega said that Brazil and Argentina will contribute to a recapitalization. “We are discussing with the IDB whether we will put more money into its capital,” he says. “Maybe this will be done soon because it is important to finance infrastructure especially in Brazil and other countries.”
Up to the job?
But there’s a thundercloud over the Bank’s upscaling plans, and it keeps on rumbling. In September 2008 the IDB announced unrealized losses of around $1 billion in the first eight months of the year on securitization instruments. The news drew little attention in the midst of major commercial banks collapsing on all sides under their toxic weight, but criticism surfaced in February in a letter to Moreno from senator Richard Lugar, Republican ranking member on the Senate foreign relations committee.
“The reported scale of the IDB’s investment portfolio losses of $1.9 billion – 10 to 100 times higher than the losses of the other development banks – is of grave concern,” wrote the senator on February 5, 2009. Moreno’s reply was followed by another Lugar letter on February 20 with further hard questions – including the claim that IDB management ignored a 2005 finding from its Office of the Auditor General (OAG) which “registered
concern regarding the significant concentration of ABS [asset backed securities] and MBS [mortgage backed securities] investments in the portfolio.”
Moreno denies any failure of responsibility by Bank staff in managing securitization assets, stating in his March reply to Lugar’s second letter that “the problem has not been ‘asset selection’ by the investments team, but market-to-market price performance of the entire ABS and MBS asset class in the financial markets in the worst financial crisis in 75 years.”
Speaking to Emerging Markets, Moreno said that the Bank does not have the comparative data to assess the size of its securities losses relative to other development banks. Asked about Lugar’s question on the audit finding, he says, “At the moment our exposure to ABS and MBS is around 25% of our total portfolio.”
Do the losses affect the IDB’s working ability? Most analysts agree with the Bank that these unrealized losses (or, it says, no more than $71 million in realized losses last year) have no substantial effect on lending capacity.
In a research update on February 25, Standard & Poor’s affirmed the Bank’s triple-A rating and stable outlook. The agency noted the first operating loss reported in the IDB’s history, but said that its liquidity remained adequate.
But the question remains whether this affects the Bank’s credibility as it reaches out to its shareholders.
The crisis in the region is passing through the shadowy sphere of finance into the real economy. But development lending in Latin America is far more than just a financial or economic issue: it is profoundly political.
“As the crisis unfolds in Latin America, as the tsunami, as someone put it, hits deeper, it will undoubtedly produce political effects,” says Moreno. “And yes, we have five presidential elections this year, five more next year, not to mention congressional elections. The main point: I think we will see an increased debate on the effects of globalization.”
The IDB has a place at the centre of this debate.
“Right now the region is polarized between two radically different visions,” says Haussman. “The IDB is an institution aligned with hemispheric collaboration and a market-oriented approach.”
From this side of the fence, now is the time for the IDB to step up and prove itself as an integral part of regional crisis management. From the other side, as Vince McElhinny puts it, “The last few years have seen governments distance themselves from the Washington-based institutions. Now the challenge is whether those governments will follow through and find new ways of dealing with crisis.”
“From my point of view, Latin America needs to focus on what comes after,” says Moreno. “What kind of economy will be in place when we come out of the crisis?”