LATIN AMERICA: Region's faith in Rato may be misplaced

Analysis

In the past two decades Latin America has been the IMF's largest borrower as a region; Brazil and Argentina alone are its first and third largest debtors, owing some 26 billion and 15 billion dollars, respectively. For this reason, the region strongly supported the candidacy of former Spanish economy minister, Rodrigo Rato, to succeed Horst Koehler as managing director of the IMF, arguing the need for a figure with strong regional expertise and credibility. Rato's appointment on May 4 was therefore widely welcomed in Latin America -- above all in Argentina and Brazil, in the light of the supportive attitude of the former Spanish government, in particular with regard to Argentina's debt restructuring process. (Paradoxically, there have been suggestions in both countries that the election of Socialist Jose Luis Rodriguez Zapatero would imply better relations with Spain than under his predecessor, Jose Maria Aznar, owing to supposedly greater ideological sympathies.)

Certainly Rato's initial statements following his appointment pointed to the intention to maintain close relations with both countries:

• In the case of Argentina, he stressed that, while the Fund is following the progress of negotiations with creditors, these should be bilateral, without intervention by the IMF.
• With respect to Brazil, Rato noted that the fact that the government does not plan to renew its existing stand-by agreement with the Fund "makes clear that Brazil has attained a healthy position in the international financial community".
• In more general terms, Rato stressed his long-standing relations with a number of the region's finance ministers, and that he intended to use his familiarity with the region to work "with total dedication" with regional governments "to the benefit of their citizens".

Rato also specifically stressed his good relationship with Argentine Economy Minister Roberto Lavagna - possibly a gesture of support given Lavagna's somewhat tense relations with President Nestor Kirchner.

Personalist perceptions.However, despite the fact that Rato is a Spanish speaker with experience of Latin America, the expectation that he could prove more flexible in the conditions imposed on lending to countries in the region appears ill-founded. Rato himself has noted that this type of favouritism has not been employed in the past and will not be the case in future -- and indeed, that his nationality cannot be taken to presuppose any preferential treatment. In any case, personal preference -- if it existed -- would by necessity take a back seat to the position adopted by the IMF's executive board, and by the G7 members in particular. That position is unlikely to soften, in particular with respect to Argentina.

Changed agenda. Even were Rato's personal views to inform Fund policy in Latin America, this would not imply automatically that his stance would remain the same as when he was serving as Spain's economy minister:

• If the Spanish government has taken a far more supportive line vis-a-vis Argentina since the default than its other European counterparts, this relates in large part to the fact that most Spanish investment in Argentina is concentrated in foreign direct investment (FDI), and in particular in the energy, telecommunications and banking sectors, rather than in bonds. As such, Spanish companies have a vested interest in seeing strong economic recovery. By contrast, the governments of the United Kingdom, Italy and Germany in particular have come under pressure from bondholders in their countries to demand a rapid (and favourable) restructuring of defaulted debt, regardless of whether the fiscal pressure involved might inhibit growth.
• Rato is personally well-connected to the Spanish business community, and is close to Alfonso Cortina, the president of oil company Repsol YPF. Increasing tensions between Repsol YPF and the Argentine government, relating in particular to investment levels, petrol prices and the recent increase in export taxes on fuel, might if anything generate a less positive attitude toward Argentine economic policies.

One area which will test the IMF's appetite for radical change is the calculation of primary fiscal surpluses. Argentina and Brazil had jointly requested that state infrastructure investments be excluded from this calculation (see ARGENTINA/BRAZIL: IMF stance plays to public opinion - March 23, 2004). On April 26, Brazilian Finance Minister Antonio Palocci announced that the Fund had agreed to this modification in the case of Brazil, although not in the case of Argentina (see BRAZIL: FDI rise will not affect short-term growth - April 28, 2004). Shortly thereafter, IMF economist Philip Gerson denied that this was the case, saying that the question remains under consideration and no rapid decision is expected. (It would in any case be unlikely that the IMF would decide to apply the change only in the case of Brazil, rather than determining a more general rule of practice; and Argentina's recent strong fiscal performance makes it implausible that it would be explicitly excluded from any such change.)

Looming challenges. Brazil and Argentina will represent immediate challenges for Rato:

1. Brazil. Despite strong export performance and signs of a recovery in industrial output, Brazil remains highly vulnerable with respect to growth and debt prospects. Country risk has risen to over 800 basis points on concerns that the US Federal Reserve will soon raise rates, reducing the attractiveness of Brazilian securities and increasing its interest burden. The government must refinance 34.8 billion reais (11.1 billion dollars) in domestic debt this month, the highest monthly figure for a decade. Continuing debt pressures could force the Central Bank to reverse its recent practice of gradually lowering the benchmark Selic rate, reducing prospects for much-needed growth. Maintaining a primary surplus of 4.25% of GDP is having a similarly negative effect on growth, and in any case is insufficient to guarantee service of a foreign debt of over 210 billion dollars if the international climate becomes increasingly adverse.
2. Argentina. The third review of the stand-by accord is scheduled to take place in June. Although growth and fiscal performance have exceeded expectations to date, serious questions remain over the failure to advance in either banking reform or the passage of a new revenue-sharing agreement with the provinces. Neither of these goals will be met within the time frame agreed. At the same time, creditors will increase pressure on the IMF to push for progress in debt restructuring talks - pressure which Rato is unlikely to be able to resist. Although a formal proposal is expected next month, creditors complain that the government has not significantly altered its original offer of a 75% writedown, and that the limited talks which have occurred to date do not constitute a negotiating process. At the same time, recovery is likely to slow later in the year owing to lack of credit, energy shortages and the sharp fall in the real, which reduces Argentine competitiveness and exports to Brazil.