Latin American Debt Crisis of 1980s

Latin American debt crisis of 1980, also referred as ‘lost decade’ resulted many Latin American countries not able to service their foreign debt. The origin of the crisis dates back to 1970s when two large oil price shocks created current account deficits in many countries of Latin America. At the same time they also created current account surpluses with the countries exporting oil. Many US money-centre banks were willing intermediaries between the two groups due to encouragement given by the US government. The banks provided safe and liquid place for their funds and then lending those funds to Latin America.

The borrowings of Latin America from commercial bank of US and other creditors drastically increased in the 1970s. The outstanding debt in the year 1970 from all sources amounted to $29 billion. By the end of 1978, the debt skyrocketed to $159 billion and by 1982 the debt level raised to $327 billion. By the year 1982, the largest UD money-centre banks held Latin American debt amounting to 176% of their capital.

By the end of 1970s, the priority of industrialized world was lowering the inflation, which led to tightening of the monetary policies in Europe and the US. Nominal interest rates rose globally and in the year 1981 the world economy entered recession. The commercial banks started to charge higher rate of interest and shorten the repayment period. The Latin America soon found their debt burden unsustainable.

The spark for the crisis occurred in August 1982, when Mexican Finance Minister Jesús Silva Herzog informed the Federal Reserve, the US Treasury, and the International Monetary Fund (IMF) that Mexico would be unable to service its $80 billion debt. Other countries quickly followed suit. Ultimately, 16 Latin American countries and 11 less developed countries (LDCs) in other parts of the world rescheduled their debts. The sudden and unexpected cut-off in bank financing plunged Latin America into recession.

The Federal Reserve and other international institutions responded to the crisis with a number of actions that ultimately helped Latin America to alleviate the situation, though with some unintended consequences. In August 1982, the Federal Open Market Committee (FOMC) called for an emergency meeting of central bankers all over the world to provide bridge loan to Mexico. The federal also encourages the US government to participate in a program to reschedule Mexico’s loans. As the crisis spread across Mexico, the US government took the led to organise a cooperative rescue effort among the IMR, commercial banks and the central banks. Under the program, the commercial banks agreed to restructure the countries’ debt and the official agencies including IMF lent the LCDs funds to pay the interest. In return, the LCDs agreed to eliminate budget deficits and undertake structural reforms of their economies. The logic behind these reforms was to increase the LDCs exports and generate trade surpluses and dollars to pay their external debts. The reforms solved the immediate crisis but allowed the problem to fester as many LDCs cut spending on the infrastructure, education and health, leading to high unemployment and steep in per capita income and stagnant/negative growth.