If China Sneezes, Will Latin America Catch Pneumonia? - Liliana Rojas-Suarez

Summary

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Podcast Summary

The CGD Podcast: If China Sneezes, Will Latin America Catch Pneumonia?

Guest: Liliana Rojas-Suarez (Senior Fellow, Center for Global Development & Head of Latin America Shadow Financial Regulatory Committee, CLAFF)

Host: Lawrence MacDonald

Date: June 16, 2014

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Overview

In this episode, Lawrence MacDonald speaks with Liliana Rojas-Suarez about Latin America's growing economic ties to China and the risks these ties create. Using the provocative question, “If China sneezes, will Latin America catch pneumonia?”, they discuss the structural changes in trade relationships, potential risks from a slowdown in China’s economy, and the policy recommendations from the Latin America Shadow Financial Regulatory Committee (CLAFF) to mitigate such risks.

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Key Discussion Points and Insights

1. The Role and Purpose of CLAFF

[02:37–04:06]

• CLAFF consists of former finance ministers, central bank heads, and top academics who collaboratively create influential regional policy statements.
• Unlike other regions, this group is unique in its broad representation and high profile.
• The mission: “our audience really is trying to recommend policies or raise awareness of certain fragilities that could be affecting the countries.” (Liliana Rojas-Suarez, [03:14])

2. China’s Increasing Importance to Latin America

[04:08–06:08]

• Over the last two decades, China rapidly grew from a minor to a major trade partner, especially for economies reliant on commodities (minerals, soy, meat).
• “The dependence on Brazil is quite large, but it's the most diversified in terms of the number of commodities. But the commodities that you have mentioned are precisely those that China buys.” (Liliana Rojas-Suarez, [05:31])

3. Systemic Risk: Could a Slowdown in China Infect Latin America?

[06:08–07:18]

• Traditional dependence was on the US; now, the risk is that China’s slowdown would hurt Latin American economies.
• Concerns stem from China's “growth of investment has not always been led by the most profitable investments… the level of non-performing loans in the banking system has been increasing significantly.” (Liliana Rojas-Suarez, [06:08])

4. Dangers in China’s Economic Model

[07:18–09:05]

• China's stimulus post-2007/08 led to rapid investment, including many unproductive projects (e.g., “ghost towns”).
• Emergence of “shadow banking” due to regulated deposit interest rates fueling higher returns in less regulated financial entities.
• Real estate bubbles and mounting non-performing loans pose systemic risk, but China’s control over its financial system may prevent a typical bank run, even if problems manifest differently.

5. Transmission Mechanisms: How China’s Problems Could Spill Over

[09:45–14:37]
Liliana breaks down four primary channels:

1. Commodity Price Shock:
   A Chinese slowdown would lower demand and prices for Latin American exports—especially mineral and agricultural products.
   “They will suffer a double dummy in the sense that both the prices and the quantities of their commodities will decrease significantly...” (Liliana Rojas-Suarez, [10:38])
2. Reassessment of Risk in Emerging Markets:
   Investors may withdraw from Latin American markets upon sensing China’s instability, seeking safer assets.
   “So the class of emerging market could suffer significantly…” ([11:31])
3. Reduced Foreign Direct Investment from China:
   While FDI is not huge yet, Chinese banking and mining investments are growing. If Chinese banks suffer, they may retract overseas investments—especially dangerous given recent Chinese bank acquisitions in Brazil and Argentina.
4. Emerging Financial Links:
   Includes credit lines and swaps with Latin American banks, potentially cut in crisis, restricting trade finance and liquidity.

6. Differential Vulnerability Among Latin American Countries

[15:10–16:48]

• Chile and Peru—most exposed but well prepared, thanks to “so much accumulation of reserves… with more flexible exchange rate… agile central bank… well managed fiscal management…” (Liliana Rojas-Suarez, [15:16])
• Brazil & Argentina—more vulnerable due to inflation and less policy flexibility.
• Venezuela—politically reliant on Chinese funding, could face acute problems if Chinese support is withdrawn.

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Policy Recommendations from CLAFF

1. Recapitalize the IMF to Be the True Lender of Last Resort

[16:49–20:51]

• Countries alone cannot respond to shocks of this nature—“The IMF needs to take the role as a land of last resort.” ([17:11])
• Recommended capital increase: over $1 trillion globally, based on Latin America needing $200 billion during the last crisis.
• The logic: “It's callable capital, of course… the fact that it's there means it doesn't need to be called.” ([20:05])

2. Pooling Latin America’s Monetary Reserves

[21:02–23:15]

• Greater regional coordination via a strengthened Latin American Reserve Fund (FLAR).
• While FLAR includes some countries (Colombia, Ecuador, Venezuela, Peru), major economies like Brazil and Mexico have not joined.
• The rationale: “if Ecuador goes bad, we go bad too… it's in their own geopolitical interest to actually protect the neighborhood.” ([21:55])
• Encourages more countries to join and grow the fund’s size/effectiveness. Recent negotiations for Chile to join offer hope.

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Notable Quotes & Memorable Moments

• “If China catches cold, Latin America is going to get pneumonia.”
  — Liliana Rojas-Suarez ([15:12])
• “We are not going to stop making this recommendation because it's the right recommendation to make.”
  — Liliana Rojas-Suarez on IMF recapitalization ([17:11])
• “The availability of renminbis is not going to stop a crisis.”
  — Liliana Rojas-Suarez ([20:51])
• “If Ecuador goes bad, we go bad too.”
  — Colombian policymaker, paraphrased by Liliana Rojas-Suarez ([21:55])

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Important Timestamps

• 02:37 – Introduction to CLAFF and its unique role
• 04:08 – Growing China-Latin America trade ties
• 06:08 – Main risks from potential China slowdown
• 09:45 – Four risk transmission mechanisms explained
• 15:16 – Differential resilience among Latin American economies
• 16:49 – The call for IMF recapitalization
• 21:55 – Case for pooled regional reserves (FLAR)

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Closing Thoughts

• The episode ends on a balanced note: while China’s engagement is largely positive, mounting risks mean Latin America must be better prepared.
• Rojas-Suarez’s take: “There's some risks that you focused on, but overall this is good news.” ([23:47])

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This summary focuses on the essential debate and recommendations, omitting the introductory music contest and outro segments.

Transcript

[A]

Welcome to the Global Prosperity wonkcast. I'm Lawrence MacDonald. Some of our listeners wrote in to say that the music that we used in the show did not delight them. So I asked Aaron King, my producer, to select three alternatives. There's a huge amount of free and wonderful music on the web. We had three selections and we asked listeners to vote. Those selections were SEO Chow by Bonnie Freight and Rio de Janeiro and. And Bonnie Freight, as I learned from a Google translation today, arose from an alchemical experiment involving a mirror and some plants. Sorry, Bonifreit, you didn't win. Our second contestant was Hold Me Back and Make It Monstrous by Xple. Xpley is Matt Legro and he is based in Montreal. Matt, thanks for playing. You also were not selected. Our winner was number three, Chaari Kenyambe, out by Noise Problems, a group from Amsterdam. Noise Problems are not the musicians. Noise Problems, it says, is a net based label dedicated to electronic and amplified music of all sorts. It's also a collection of live shows. So the musicians of this lovely piece will remain unknown unless you hear it and it's yours and you write to us, in which case we will be keen to acknowledge you. We received about 75 responses to our survey and we promised a randomly selected voter that she or he would get a free CGD coffee mug and a long sleeve T shirt. I'm happy to say that the winner. Drum roll. Is Ray Langston, professor of Sociology at the American University of Cairo. As it happens, Ray was among the listeners who wrote to me to say, can't you please give us some different music? Music. So congratulations, Ray. You helped to inspire the contest and you're the winning voter. The CGD coffee mug and long sleeve T shirt are winging their way to you. And now stay tuned for the next center for Global development, Global Prosperity Wonkast welcome to the Global Prosperity Wonkcast. I'm Lawrence MacDonald. I'm pleased to welcome to the studio today Liliana Rojas Suarez. She's a senior fellow here at the center for Global Development and the head of the Latin America Shadow Financial Regulatory Committee, known to some of our listeners as claf. Liliana, welcome to the show.

[B]

Thank you, Laurence.

[A]

We had the pleasure of hosting claf, the Latin America Shadow Financial Regulatory Committee this week. Some of our listeners know that it's comprised of former senior officials. That's why they are a Shadow Financial Committee. Ministers of finance, head of central banks, yourself, other prominent academics. You work in an unusual way. You get together for two days, you've chosen a topic beforehand. You Work day and night and then you issue a statement. The statement I have in front of me is statement number 31. It's two or three pages. And those statements are often pretty influential in the region. Talk to me about that.

[B]

Yes. What happened is that we predetermined the nature of the statement long time in advance and we have a conversation between the members long before we actually meet. But also based on the recognition, the name recognition of the members in Latin America. That's what caught the attention of members, many of the audience, especially policymakers, because our audience really is trying to recommend policies or raise awareness of certain fragilities that could be affecting the countries. And that having this group from many different countries with high level profile of exposure is quite unusual. A group like us doesn't exist in the world.

[A]

So many of these people have been in the hot seat themselves. They've had to make these tough decisions and now they're offering their wisdom to those who are currently in the hot seat.

[B]

Absolutely.

[A]

So this time you chose, I think, a fresh topic. We had a very nice turnout. Enter the Dragon Risks from China to Latin America why should Latin American financial policymakers be worried about China?

[B]

Yeah, because over the last two decades, the participation of China in the export sector of Latin America has been tremendous. I mean, China was just a small partner, trade partner for Latin America in the 80s and early 90s. People wouldn't even talk about that. It was mostly centered towards the United States and Europe. Countries like Brazil and Argentina export were directed towards Europe. But in the last two decades it has moved significantly toward China. Because the growth of China implied was led by a growth in investment. An investment implied an increase in the commodities produced, especially mineral commodities produced by Latin America like copper, steel, iron. And that has driven or increased the importance of China for the activity, economic activity for Latin America.

[A]

Latin America of course, is still quite commodity dependent. Do they also buy a lot from Brazil? Soy, meat, increasingly agricultural commodities, Commodities as well.

[B]

Exactly, exactly. The dependence on Brazil is quite large, but it's the most diversified in terms of the number of commodities. But the commodities that you have mentioned are precisely those that China buys.

[A]

Okay, so the Latin American economies have become more dependent on Chinese demand. There used to be a phrase, you don't hear it anymore. People used to say the United States catches cold, Latin America catches pneumonia. Lately we've seen a decoupling. We had a terrible financial crisis here, launched a global financial crisis. Latin America skated along pretty well. Have we now reached a point where China catches a cold and Latin America.

[B]

Catches Pneumonia, it's quite possible. And that's the reason why we have produced this statement. Because we are very concerned that the Chinese growth path is actually going to decline significantly over the coming years. We don't know the exact timing of it. It's very hard to say because it's a more controlled economy. They have more space of action by the policymakers than a fully market oriented economy would have. But the truth of the matter is that the growth of investment has not always been led by the most profitable investments, by the most highly productive investment. Actually some of them have proven to be non productive and the level of non performing loans in the banking system has been increasing significantly.

[A]

So with the 0708 crisis, I think people who follow these things know that China was very effective at injecting a lot of liquidity. It helped the globe to keep demand at a decent level through the crisis. But when you push that much money into an economy, it's not all going to go to highly productive investments.

[B]

No, no. Especially if you go that fast. And they went that fast to keep the growth momentum. And so we have so many stories of really unproductive investment that have taken place. Ghost towns, a bridge that are in place without a river under it or things like that. And also what also happened is that at the same time in the world the interest rates were very low, as you know. But also the Chinese put regulations in the banking system, controlling interest rates. But in an economy that is booming and with so many people wanting to actually make more money, they actually these kind of regulations putting controls on the deposit rates actually led to the creation of what is called shadow banking in China, which was that new trust emerged that were not regulated as the banks and so they were able to offer higher amount of interest rates on deposit.

[A]

So these are non bank financial institutions, not very carefully regulated, possibly. Do we hear the word bubble here? People talk about a real estate bubble in China, for example.

[B]

That's right. And most likely there is one. And the capacity and the reason why we think that there is time is because the authorities have the capacity to put controls and therefore you know that there's not going to be. If there is a crisis in the banking system, it's not going to be a typical crisis. There is not going to be a banking run like in Latin America. Why? Because every contract is in renminbi and the central bank will be able to issue as much renminbi as they want. Also because the control about the activities of the population is much more strict. So they can actually control and say, no, nobody's taking the money off the banks. But that doesn't mean that the problems are not mounting.

[A]

So you wouldn't see a Latin America style crisis with runs on the bank, but you might see a sudden reduction in growth going from the current 7, 8% year after year to what it.

[B]

Could be 4 or 3%. Yes. And you see, what happened is that even though there's not a run in deposits, still the banks themselves could feel that to clear up their banking, their balance sheets, they have to start lending less. And so the less amount of credit that will come will actually be fueling less growth, which is the normal way of operation of any bank banking system in the world.

[A]

Okay, so let's assume that there, we don't know, it might or might not happen. If it happens, we don't know when, but let's assume that there's a significant slowdown in China. You and the Latin America Shadow Financial Regulatory Committee presented several transmission mechanisms. I want to run through them quickly because I want to save time for your recommendations. Commodity prices.

[B]

Yes.

[A]

What would happen if there was less demand in China?

[B]

That's the most important channel because there will be an effect that go through prices and through quantities. A lower growth will imply less demand from China to the rest of the world, which will depress the price of the commodities that they buy as well as the quantity that they purchase.

[A]

So copper, iron, steel, soy, chicken, pork.

[B]

All of the above. Exactly.

[A]

Lower prices for Latin American exports.

[B]

Exactly, exactly. With the exception of Mexico, interestingly enough, which is so linked, and Central America, this is more South American phenomenon. The linkage of Mexico is directly with the US, not with China as much. And so, yes, they will suffer a double dummy in the sense that both the prices and the quantities of their commodities will decrease significantly, which implies that you could have a number of pressures in the fiscal stance because now governments whose revenues are based on the taxes that they charge for this export of commodities will decline significantly.

[A]

Okay, your second transmission belt. Reassessment of risk in emerging markets. People look around, they say, oh, China's in trouble. I guess the world's not as safe as I thought. U.S. treasuries. Yes, I'm headed back to U.S. treasuries again, huh?

[B]

Absolutely, absolutely. You need to think about this as a world where China was perceived at the time of the crisis in the US and the crisis in Europe. China was perceived as the locomotive of the motor that was actually pulling the world. And so what you have now is that the US recovery very slowly still Europe is quite flat. The most is 1% growth, if that. And China is also coming down. So well, let's reassess now. I mean the advanced economies are recovering but China is coming down. So why should we continue investing as financial investment into emerging markets? So the class of emerging market could suffer significantly. In addition to that you said, okay, where are the most countries most affected? Well, the story that I just told you about trade relationships with China gets an immediate connection.

[A]

So I look around and say China slowed down, it's not demanding as much. Who's going to be hurt? Latin America's hurt. I guess I better pull my money out.

[B]

Exactly.

[A]

Your third one, FDI Foreign direct investment. Is Chinese investment in the region important enough that a pullback would be significant?

[B]

They are not as important right now, but increasing, especially in sectors such as mining for example, or automotive industries. And in particular countries like Brazil for example. So what we are most concerned is that they have started making large investments into the banking system, especially in Brazil and Argentina. Large banks from China are buying medium sized banks in those countries. And the risk there is that they can pull off resources if there's problems in their home country in China. Right.

[A]

Your fourth item is emerging financial links with Chinese banks. That's basically. It's related to the FDI question. Because they have these links, because they bought these banks, the Chinese themselves could pull back.

[B]

Exactly. And they have established credit lines too in renminbi with some countries. Now this if things looking on a long term trend, this could actually be good news because it actually helped trade finance in the short term. However, if this line of craze get cut, you also are cutting a transmission through which this export could actually take place from Latin America to China.

[A]

So are Latin American firms borrowing renminbi from these?

[B]

No, no. The lines of craze are there to. They're like swaps, like the swaps that during the crisis were established between the Federal Reserve and countries and the Central bank of Brazil for example, that in case of trouble you could actually access those lines. This is more or less in line with the new facility created by the BRICS that is going to be ineffective in 2015. Well, in addition to that overall facility, there are bilateral facilities with some of the countries.

[A]

So we've gone through them. Let's see if I can remember. We've got the commodity shock, potentially less demand for the things that Latin America is good at producing. We've got the reassessment of risk and sort of a fall on effect. If Latin America is not going to be Selling commodities to China, maybe it's not such a good place to invest. We've got the reduction in FDI and then these new linkages through Chinese banks. So overall, if China catches pneumonia, Latin America might catch a cold or the other way around.

[B]

No, I think you are absolutely right. I mean, it's.

[A]

Well, if China catches cold, Latin America.

[B]

Cold, Latin America is going to get pneumonia.

[A]

Is that dependent?

[B]

It's that dependent. But of course, we are talking about the charge decrease in growth from China right now. The good news, and we actually say that in the statement, is that the countries that are the most exposed are the ones that are the best prepared. And we have two examples, and those are Chile and Peru. Those are the most exposed countries to all these channels that we've been talking about. But they are the one that have so much accumulation of reserves in addition, combined with more flexible exchange rate to face the shock. A very agile central bank to actually give liquidity to whatever is needed. Countries whose economies are so well managed right now that have no problems with their fiscal management at this moment that those countries will be the strongest. However, there is many other countries in the regions, and in that line I would mention particularly Brazil, that are facing inflation right now. They are raising interest rates to fight inflation at the time when everybody else is actually lowering interest rates. I mean, Argentina, who has its own problems and is dependent. Venezuela, who is dependent of Chinese for political reasons, recipients of funds from China that would definitely be extremely severely affected from a slowdown from China. China might decide to cut all the kind of support that it was given to.

[A]

So those countries that are a little tiny bit wobbly to start with might have a harder time.

[B]

Exactly.

[A]

So what's to be done? You've got two recommendations. The first one seems like it's the solution for everything and it's just never going to happen. Which is to recapitalize the imf, that the IMF should be the lender of last resort. It needs to be bigger. I attended your press conference and I said, how much bigger? But it's not going to happen, I gather, because the United States is standing in the way.

[B]

Yes. You know, as a committee, this is not the first time that we make this recommendation. We are not going to stop making this recommendation because it's the right recommendation to make. The IMF needs to take the role as a lend of last resort. There is no way that countries by themselves are going to be able to face shocks as large as them, regardless how many more reserves do they have to accumulate as you know, there's an opportunity cost of holding reserves. It's expensive to be holding so much treasuries. So there has to be an institution that comes there and give liquidity. And we know that that is a long term solution, we know that it will take a long time, but I don't think that it's never going to happen.

[A]

You know, right now this is really not part of the work of claf, but my understanding is that it's tied up because of the package concerning votes and voice and quota and all of that is basically a package negotiated by the United States is now blocked by the US Congress. If that's not approved, then the other countries who might have put in more money won't put in more money because the Americans aren't putting in more money.

[B]

Yes, that's correct.

[A]

It's stuck because of people here in Washington.

[B]

Because of the U.S. however, we got very close to actually doing something more about it at the time of the global crisis here. That's when the flexible credit line was implemented. The thing is that for emerging markets there was a quick recovery and there was not too much need of using the resources. But the IMF started to move into that direction during the global crisis and the US had no alternative but to approve the support of that credit line. Because you see, if the countries around the world stop really get a severe contraction, that's also going to affect adversely the US the world functions as it is not because the US is a large exporter. It works because there is a trade negotiation between the world. And if the world slows down significantly, if emerging markets slow down, the US is going to suffer.

[A]

How much more money would the IMF need to have in order to be truly a lender of last resort to be able to respond to a global crisis sufficiently to keep it from becoming a global depression?

[B]

We made an estimation for Latin America during the time of the global crisis and it was only for Latin America and it was 200 billion. If you just make a simple calculation, I would say it's about, it's over $1 trillion that you would need just to make. It's a complete back of the envelope calculation. But that would be the amount that would actually kind of stop the problem because investors will feel that, okay, this is a stable world and this is.

[A]

Not money that countries need to contribute. They need to make the pledge that it'll be there as callable capital.

[B]

It's callable capital, of course.

[A]

So you make the pledge in hopes that it'll never actually be called but the fact that it's there means it doesn't need to be called.

[B]

Exactly. Because the truth of the matter is that in the case of emerging markets, because their currencies are not convertible really, they are not tradable internationally, the moment there is a problem, the run is toward hard currencies. And the hard currencies are few countries. Right. And the few countries are, well, the Eurozone as a zone, the US dollar, the yen, there's like five currencies, really. So if you make these currencies that are believed to be hard currencies in the world available and people know that there is, that's all you need, it will stop. The availability of renminbis is not going to stop a crisis.

[A]

So let's assume that the recapitalization of the imf, if not never, certainly not soon, you have a fallback position. What is that second recommendation?

[B]

Well, what happened is that countries are right now accumulating reserves on their own. But you could have. And the reserves are in US dollars. So if you cannot print dollars, at least you can accumulate them. Right. And so it's equivalent, but each one is doing the work individually. You can pool those reserves into a fund and if you do that well, the amount that you have is much larger. And there is a fund that actually exists in the region right now that is called the Fondo Latin Americano dos Reservas, the Latin American Reserve Fund. But it's small, small, not in size relative to the countries that participate, but it's small in the number of countries that it has. It has a number of countries like Colombia, Ecuador, Venezuela, Peru, but the large countries don't belong, like Brazil and Mexico don't belong today.

[A]

So would your committee recommend more countries join?

[B]

Absolutely. That more countries join, that they pool reserves and that they take in mind. One of the best examples was given to me by a Colombian policymaker. I was asking the Colombians why is Colombia interested, a strong country right now in the region? Why is it interested in participating near to a weak country like Ecuador? And the answer was very strong. Because if Ecuador goes bad, we go bad too. So it's in their own geopolitical interest to actually protect the neighborhood. So it's in the interest of Brazil to be sure that there are no problems in terms of this asset class contagion that I just mentioned to you that Latin America is going in trouble. Even though just a couple of countries are. Well, that could be stopped if somebody just shows the money and the money.

[A]

What are the prospects for more countries joining this Latin Fund, it's moving.

[B]

It's actually moving. Our committee actually wrote a recommendation about that about a year ago.

[A]

We discussed it.

[B]

I remember we discussed that. And now they are in negotiations for the addition of Chile. And that could be if. Chile is not a big country. It's a small country, but it is a first rated country in the region. It would provide a great signal if Chile joins. So I think it's moving in the direction we would like it to.

[A]

Liliana, thanks so much. It's always a pleasure talking to you. I know very little about finance, but I always learn something when I chat with you.

[B]

Thank you, Lawrence. It's easy and great talking to you.

[A]

This has been the Global Prosperity wonkcast from the center for Global Development. My guest today, Liliana Rojas Suarez. She is the head of the Latin America Shadow Financial Regulatory Committee. Say that five times fast or claf. And we've been discussing enter the the risks to Latin America from the increasing closeness to China, which is not a bad thing, Liliana.

[B]

Right.

[A]

There's some risks that you focused on, but overall this is good news.

[B]

That's right, it is.

[A]

You can find the Wonkast online on itunes and on stitcher. Just search for wonkcast or cgd. Sign up to hear a new interview every week. Until next time. I'm Lawrence MacDonald. Thanks for listening.