Latin American governments are the biggest emerging market borrowers, a tradition that goes back nearly two centuries. They are also repeat delinquents, defaulting on loans repeatedly down the years. So why do governments still borrow so much money? Why are the region’s economies still so dependent on imported capital? And why on earth do lenders in the developed world continue to buy bonds from deadbeat borrowers?
Argentina is only an extreme case of Latin America’s addiction to debt – no other country has squandered its wealth and sunk into debt as recklessly as Argentina.
Many other governments run up budget deficits not because they necessarily spend a lot of money, but because people don’t pay taxes. Enforcement is weak, tax collectors are often corrupt. As a result, public services are terrible so people feel even less compelled to pay their taxes. And of course, incomes in all Latin American countries are low, so taxes levied on people and companies raise relatively small amounts of money. Controlling public spending is practically impossible. In many countries, budget deficits continue to swell even as government privatize loss-making state-owned companies. People are poor, so they cannot save large amounts of money to lend to the government. In any case, local capital markets are moribund in most Latin American countries.
The only source of relatively cheap, long term financing is in the global financial system. But borrowing from foreigners in dollars, euros and yen is expensive and risky: dollar and euro interest rates are well over 10% a year for many governments. So debt crises and defaults are common, particularly because the region is still dependent on low-value added commodities with no pricing power. Although investors know this – or could find out easily enough – they keep lending. Why? Because they are seduced by promises of reform and by attractive the coupons on emerging market debt. Although the maxim of where there is reward there is also risk is one of the most basic concepts in finance, investors seem to expect the yield on “reforming” country bonds to keep rising. Only a few true reformers – Chile and Mexico – are seeing their yields decline steadily over time.