Preventing Crisis and Contagion: Fiscal and Financial Dimensions

Recent economic developments highlight Latin America's vulnerability to economic and financial turmoil that is triggered by events in distant corners of the globe. The Asian financial crisis that began in 1997 and the more recent Russian crisis have left the region profoundly shaken, and living in fear of a full-scale collapse. This "contagion" has occurred through a number of channels. The collapse of Asian demand has contributed to the recent slide in world commodity prices, cutting into the commodity-dependent region's export income and undermining the public finances in a number of countries. The Russian devaluation has raised the spectre of sovereign default, making investors around the globe more wary of increasing their cross-border exposure. The financial crises in Asia and Russia have also severely undermined balance sheets of emerging-market investors, reducing their capacity to invest in the region, and forcing them into fire sales of their Latin American investments. In this paper we lay out the fiscal and financial policies that can help protect economies from the kind of global financial turbulence the world is now experiencing. Exchange rate policies are discussed in a separate paper.