IDB's capital increase: The long and winding road

Tuesday, April 12, 2011

Calgary's chilly weather during IDB's annual meeting in late March provided a stark contrast to Latin America's sunny overall prospects for the coming years.

The meeting mainly revolved around the region's macroeconomic responses to capital inflows and currency appreciation and infrastructure needs, and it ended with broad recognition of Latin America and the Caribbean's promising economic outlook from bankers, government officials and CEOs.

"For several months now I have been repeating in many forums a phrase in which I firmly believe: This should be the decade of Latin America and the Caribbean," IDB president Luis Alberto Moreno said in his opening speech. "We are on a path of rapid growth that should allow us to cement the progress we have made in fighting poverty and building more just and inclusive societies."

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In turn, IDB governors renewed calls for quick implementation of the bank’s ongoing US$70bn capital increase, approved last year in Cancún, Mexico.

But it was not all wine and roses at the five-day event in Calgary, as the potential fallout from the current domestic budget showdown in the US raised concerns that IDB's single largest shareholder, with a 30% stake in the bank, would not meet its 2011 commitment.

Questions also arose in Calgary regarding the sustainability of Latin America's long-term growth, and attendees were surprised by a not-so-subtle warning of a new impending banking crisis by regulators.


The board of governors, IDB's top decision-making body, last year reached an agreement to raise the bank's authorized capital up to a total of US$170bn over a five-year period. This aims to expand IDB's lending capacity to some US$12bn annually, against an average US$7.8bn for the period between 1994 and 2008.

To implement the capital increase, the legislature of each member country must approve the funding proposal before October 31, although IDB's board of executive directors may extend the deadline. Failure to get approval would likely cut the IDB's lending capacity by 50%. The capital increase needs the approval of 75% of the bank's members.

And while on Friday (Apr 8) the US government shut-down was avoided by a late stop-gap spending deal, that doesn't mark the end of future clashes between Republican members of congress and the White House.

"As Republicans and Democrats square off over the budget, multilateral dues are easy victims. But the costs of this short-sightedness will be significant," said Shannon O'Neil, Douglas Dillon Fellow for Latin America Studies at the Council on Foreign Relations.

Skipping out on IDB dues directly undercuts US efforts to reach out to Latin America and its economic markets in its goal of doubling exports by 2015, "and for those that fear 'losing' Latin America to China - an IDB member that will pay its dues - this is not the way to show that the US cares," she said.

"In the end, I do think [US President Barack Obama's] administration will push hard for the US$102mn first installment from the US toward IDB's capital increase, but it may be a long and hard political battle with the legislature," she said.

During her address in Calgary, US Treasury assistant secretary Marisa Lago praised IDB's results in moving forward on core governance reforms, which include a more rigorous process for approving IDB loans.

"And we, the United States, are taking the requisite steps to meet our commitment to fulfill the IDB general capital increase," she said.

Obama's recent visit to Brazil, Chile and El Salvador reinforced his commitment to promoting regional integration with Latin America, according to Lago.

"The current dimensions of the IDB have become too small for our region's demands," said Brazilian planning minister Miriam Belchior. "That is why the approved capital increase must not be delayed, lest we involuntarily compromise the institution's relevance."

Latin America still faces many challenges, with 180mn individuals living below the poverty line, according to Moreno. That is why the multilateral must have the capacity to assist borrowing member countries in boosting their productivity, improving the quality of education, modernizing their infrastructure, deepening their economic integration and dealing with climate change and natural disasters, he said.


The new economic order that has emerged after the global financial crisis will likely generate an unprecedented favorable international environment for Latin America and the Caribbean in coming years, according to a study presented in Calgary called, "One Region, Two Speeds? Challenges of the New Global Economic Order for Latin America and the Caribbean."

Leaders in the region should seize the opportunity to adopt policies that reduce external vulnerabilities and ensure sustainable economic growth, according to the study, coordinated by IDB chief economist Alejandro Izquierdo and Ernesto Talvi, director of the Center of Economic and Social Studies (CERES).

The report highlights how key structural characteristics of Latin American and Caribbean countries are defining two quite different regional clusters in terms of opportunities and challenges ahead.

Brazil-type countries are the clear winners, being net commodity exporters, with low exposure to industrial countries in terms of exports of goods and services - and much to gain from larger investment demand in response to low world interest rates. On the other hand, Mexico-type countries, mainly net commodity importers and highly exposed to trade in goods and services with industrial countries, are likely to face substantial challenges, despite that they too stand to gain from lower world interest rates, the report reads.

The current economic situation is causing several commodity exporting countries to battle overheating, currency appreciation and an inflow of short-term capital, which can have destabilizing effects on the economy.

"If capital inflows are large and economic growth is strong, this is the time to review regulations to allow banks in the region to build up capital and liquidity," said Talvi, noting that Latin America survived the recent crisis reasonably well in part because it had prudent macroeconomic policies in place. "This will allow them to build a strong cushion during the good times and use it when the international environment becomes less favorable."


If there was one presentation that hardly went unnoticed, it was that delivered by Ted Price, assistant superintendent of Canada's Office of the Superintendent of Financial Institutions.

In a speech delivered at a panel organized by the Institute of International Finance (IIF), Price warned that the next global banking crisis could be on its way and that regulators should bear down on the financial industry before it hits.

The world's banks are now entering a "dangerous" phase from a regulator's point of view, where profits are strong and they are increasingly willing to invest in risky assets that offer high returns, he said.

"I believe we have passed the easy part of the cycle, and it is time for regulators to get tough," Price said. "Increased competition, diminishing returns and increased risk appetite: I think we have seen this movie before, but the amazing thing is we continue to expect a different ending."

Price's warning came as the IIF is seeking to avert the efforts by G20 policymakers to impose stricter capital and liquidity standards on banks in hopes of preventing bank failures and bailouts like those seen in the last crisis.