Payback time for Latin America

Brazil and Argentina have repaid in full the debt owed to the IMF. But while Brazil seemed grateful for the loan, Argentina's president made a bridge-burning speech attacking the Fund's policies. Josh Goodman looks at the two nations' economic outlook

It was a move without precedent. Within two days in mid-December, Brazil and then Argentina - two of the biggest emerging market debtors - decided to pay down in one fell swoop more than $25 billion in combined debt owed to the International Monetary Fund (IMF).

Cutting the apron strings with the much-despised IMF was bound to be a popular move in both countries, hobbled as they are by widespread poverty and a huge gap between the rich and poor. But there was a gulf in the way each country's government went about announcing the repayments.

For a combative Argentine president Nestor Kirchner, it was his chance to score some political points at the IMF's expense. Cheered on by his Peronist party faithful, the president, in announcing his decision on December 15, blamed the IMF for "acting towards our country as a promoter and a vehicle of policies that caused poverty and pain among the Argentine people".

By contrast, Brazil's president Luis Inacio 'Lula' da Silva looked to appease the IMF when he unveiled the decision, taken two days earlier on December 13. IMF managing director Rodrigo Rato was greeted with a trademark Brazilian bear hug by Lula when he flew down in early January to preside over the repayment of $15.57 billion in debt nearly two years ahead of schedule. In Argentina, Rato wasn't even invited.

Investors reacted accordingly, heralding Brazil's decision as a savvy financial move while simultaneously deriding Argentina for what they considered reckless policy-making. Astonishingly, however, the economical rationale behind the two decisions couldn't have been more similar. Both countries, albeit for divergent reasons and to different degrees, have rarely been on such solid ground fiscally.

The international reserves of both countries' central banks, from which they drew the funds to repay the IMF, have been soaring over the past year. Buoyed by a robust $15.2 billion in foreign direct investment and an inflow of $10.7 billion in portfolio investment last year, Brazil's reserves were near an all-time high of $68.2 billion on December 19, 2005. Following repayment a week later, they dipped to $53.2 billion, but have since climbed back to $57 billion. "At this rate, reserves will be back at their pre-IMF repayment levels within a few months," says Christian Stracke, emerging market strategist at CreditSights.

Economic recovery

Kirchner's autocratic style of rule has kept Argentina largely off the radar screens of foreign investors, portfolio or otherwise. Nonetheless, the country's economy, which has grown over 9% each of the past three years, continues to coast along thanks to pent-up demand and central bank intervention to keep the peso artificially low and spur exports.

For all of Kirchner's populist rhetoric, the president has largely behaved like the sort of fiscal orthodox the IMF bureaucrats could only dream of, say analysts. The country, whose 2001 crisis was precipitated by ballooning fiscal deficits during the booming 1990s, has been running a fiscal surplus since 2002. This year it's expected to be the equivalent of 1.5% of GDP. Although inferior to Brazil's 4.25% target, the additional savings combined with strong growth and the country's successful $100 billion debt restructuring last year has been enough to bring debt-to-GDP levels down from a whopping 120% in 2004 to a current 73%. "Paradoxically Kirchner, who's been the IMF's most vocal critic, is the same person responsible for implementing this savings plan," says Claudio Loser, former head of the western hemisphere department of the IMF.

For investors, the loss of an economic watchdog in the form of the IMF is cause for little concern. In the wake of Argentina's default, and the failure of the IMF to stand by bondholders even as it continued demanding payments itself, the Fund's reputation was already severely tarnished in many people's eyes. "Investors should rejoice," says Walter Molano, strategist for BCP Securities. "The IMF was a senior creditor who was always paid at par. Furthermore, it proved to be a disloyal ally who advocated that investors should be bailed in rather than bailed out. Without the IMF, markets will be able to function more rationally and efficiently. It will take out the arbitrariness that results when there is a lender of last resort."

But not everyone is convinced that the repayment made good financial sense. The interest on multilateral debt is capped at artificially low levels nearly half of what emerging market sovereigns pay on international capital markets. As such, the savings would have been greater had Brazil or Argentina bought back internationally held foreign debt.

A further concern in Argentina's case is the impact on the country's reserves, which some say dipped to a dangerously low level of $18.58 billion following repayment. Reserves are almost half of what they were throughout much of the 1990s. "This decision reduces its international reserves to levels that might be too low if any serious external shock happens any time soon," says Ricardo Amorim, head of Latin America research for WestLB.

Of course if investor sentiment changes, both countries could find themselves in the Fund's care again, and it could be Brazil that makes the first move. "With so much exposure to portfolio investment, and foreign direct investment slowing, if sentiment changes Brazil could burn through reserves very quickly," says Stracke at CreditSights. "Argentina, for better or worse, has chosen a more insular economic model."

However, the possibility of either country finding itself in trouble is remote. Thanks to excess global liquidity, capital inflows to the region have never been hotter. Investors poured more than $10 billion into dedicated emerging market bond funds last year, more than three times the amount in 2004. At the start of 2006, investment levels were flourishing, setting an all-time monthly inflow record of $1.3 billion in January, according to data compiled by Emerging Portfolio Fund Research. For now, at least, it's good riddance to the Fund.