Regional Economic Outlook, April 2012 : Western Hemisphere
2. Outlook and Policy Challenges for Latin America and the Caribbean
- International Monetary Fund. Western Hemisphere Dept.
- Published Date:
- April 2012
Growth in much of Latin America remains solid, although it slowed during the second half of 2011 under the combined effects of policy tightening and global uncertainties. However, many countries are still operating near or above potential, and global financial conditions and commodity prices remain stimulative. In this context, countries should continue to rebuild buffers, to regain fiscal space, preserve hard-won fiscal credibility, and increase monetary policy flexibility. Monetary policy, meanwhile, should shift into neutral and serve as a first line of defense in a downside scenario, complemented by macroprudential policies to address financial excesses.
Output in Latin America and the Caribbean (LAC) expanded by about 4½ percent in 2011, down from a post-crisis rebound of 6¼ percent the previous year. Growth moderated in the second half of last year, amid increased global uncertainties and the lagged effects of earlier steps to normalize fiscal and monetary policies (Figure 2.1). Growth continues to be led by commodity exporters, for which overheating pressures remain relevant as favorable external conditions continue to push domestic demand growth above output growth. Meanwhile, growth has held up reasonably well in Mexico and Central America, in part as a result of the slow but steady recovery in the United States. The Caribbean region finally turned the corner in 2011 after a long recession, although high debt levels and tourism dependence continue to constrain the outlook. Overall, output growth was more evenly distributed across the region in 2011 than the year prior.
Figure 2.1.Growth in Latin America slowed in the second half of 2011, but remains robust. Downside risks dominate the outlook.
Financial markets lost ground in the second half of 2011 but have recovered. Fears of a full-blown financial crisis in Europe and an impasse on the 2012 budget in the United States increased sovereign spreads and sent regional currencies and equities sharply lower in mid-2011. Markets recovered fairly quickly on positive news on the strength of the U.S. recovery and strong policy action in Europe, although conditions remain volatile (Figure 2.2).
Figure 2.2.Following a period of global distress in mid-to late 2011 (less severe than Lehman), financial markets rebounded, although conditions remain volatile.
Sources: Bloomberg LP; Emerging Portfolio Fund Research, Inc.; Haver Analytics; and IMF staff calculations.
1 Weighted average of oil and non-oil commodities.
2 Average of Brazil, Chile, Colombia, Mexico, and Peru.
Under our baseline, growth in the region is projected to slow to near 3¾ percent in 2012 and strengthen to about 4 percent the following year. This slowdown is consistent with the projected moderation in global growth (to 3½ percent in 2012) as well as further policy tightening to counteract a still-stimulative external environment. Commodity prices are expected to remain high, although food and metal prices will soften relative to the levels observed in 2010—11. External financing will remain cheap and abundant (notwithstanding some increase in funding costs more recently) because monetary policy in advanced economies continues to support their fragile recoveries. Small downward revisions to the LAC outlook (½ percent for 2012—13, compared with six months ago) mainly reflect lower projected global growth.
Short-term risks still tilt to the downside. The baseline for LAC hinges on further strong policy action in advanced economies and the containment of geopolitical tensions. However, more adverse scenarios (Figure 2.1) entail risks to growth and instability in capital flows:
Renewed tensions in Europe—Slippages in carrying out fiscal consolidation plans in euro area countries could trigger a spike in sovereign and bank spreads along with more disruptive deleveraging. IMF staff simulations suggest that global spillovers under this downside scenario could reduce LAC’s GDP by about ½ percent through end 2013 (Figure 2.1). The subsidiary model of European banks operating in the LAC region is likely to mitigate the impact of deleveraging (Box 2.1). But a disorderly process could lead to a fire sale of bank assets and a credit crunch and cause liquidity pressures to re-emerge in Latin America’s foreign exchange and interbank markets.
Oil-price shock—The baseline scenario assumes that geopolitical tensions ease and that oil prices fall gradually after peaking this year. However, escalating tensions in the Middle East could trigger a spike in oil prices, adversely affecting global growth and reducing non-oil commodity prices, especially for metals. Countries highly dependent on oil imports (Central America and the Caribbean) and non-oil exports (e.g. Chile, Paraguay, Peru) would be particularly affected. Although the impact of an oil shock on the region as a whole will be more muted (the region is, on average, a small net oil exporter), a shock of this type could well be accompanied by increased financial stress, engendering wider spillovers.
Frontloaded U.S. fiscal adjustment—The baseline scenario assumes that U.S. fiscal policy strikes a reasonable balance between supporting the recovery and medium term consolidation. However, political gridlock may prevent extending income tax cuts (the “Bush tax cuts”) and unemployment insurance for 2013. Failure to extend the tax cuts would add the equivalent of 1½ percentage points of GDP to the fiscal withdrawal that year, with possible spillovers to economies strongly linked to the United States (Mexico and Central America).
Downside risks will linger in the medium term. The lack of an agreed-upon framework for reducing public debt in the United States could, over time, push up interest rates and crimp capital flows to the LAC region. Also, difficulties in reorienting growth in China away from investment and exports and toward consumption could harm China’s trend growth, and consequently, reduce global growth and commodity prices. A scenario of a sharp slowdown in Asia would have a severe impact on LAC (see Figure 2.1 and Box 2.2).
Upside risks cannot be dismissed. A weak, yet stable, recovery in Europe and other advanced economies would reduce global uncertainty and prompt surges in capital flows that would boost credit and domestic demand in Latin America. The U.S. recovery could also prove stronger than expected, particularly if the housing sector begins to recover. Finally, domestic demand and output growth in LAC could be higher than under the baseline if the assumed policy normalization does not materialize or turns out to be insufficient.
External conditions are expected to remain favorable, notwithstanding downside risks. In this environment, the challenge for many countries is to take advantage of favorable conditions to rebuild fiscal space and strengthen fiscal policy frameworks. This challenge is especially crucial for South America: countries there stand to benefit the most from continued favorable terms of trade and low global interest rates, but with output near or above potential, they also need to guard against overheating (Figure 2.3). Mexico and Central America, which are more dependent on the U.S. economy than their southern neighbors, also need to continue rebuilding fiscal buffers, especially Central America, where output is near potential and public debt in some cases is approaching uncomfortable levels. Weak balance sheets and strong tourism dependence will continue to restrain growth in the Caribbean, where fiscal consolidation needs to continue despite the sluggish growth environment.
Figure 2.3.Growth is projected to slow during 2012-13, led by South America, which continues to enjoy strong terms of trade. Output gaps have closed in most countries.
South America’s Financially Integrated Economies—Balancing policies in a stimulative yet volatile environment
Real GDP growth in South America’s financially integrated commodity-exporting countries slowed to about 5½ percent on average in 2011 from close to 7 percent in 2010 (Figure 2.4). Earlier policy tightening (particularly in Brazil) and weaker global demand in the second half of 2011 dampened economic activity and domestic demand. Output is projected to expand by about 4½ percent during 2012—13, roughly in line with potential. With output gaps largely closed, policies are expected to hold steady or tighten in some cases, to balance the still-stimulative external conditions of easy financing and high commodity prices. Growth will continue to be driven by domestic demand, supported by strong credit and labor market conditions (unemployment is at or near historic lows in many countries).
Figure 2.4.In financially integrated (FI) South America, output growth, inflation, and domestic demand are moderating, but current account deficits are widening.
Annual inflation reached 5½ percent in 2011, up from 4¼ percent, brought about, in part, by higher food and fuel prices. For most of 2011, headline inflation trended near or above the upper bound of the official inflation target range, and core inflation rose. More recently, however, inflation appears to have peaked, and inflation expectations have stabilized within target ranges in most countries (except for Uruguay).
The current account deficits of these countries continued to widen, despite very favorable terms of trade, as domestic demand growth persisted in outstripping activity. During 2011, these deficits rose to an average of about 2 percent of GDP (from 1¼ percent in 2010) and are projected to widen by an additional ¾ percent in 2012. Although still manageable, the external accounts of these countries (and others in South America) are increasingly vulnerable to sharp declines in commodity prices. (A reversal of commodity prices to 2005 levels, for example, would widen current account deficits, on average, by about 3¼ percentage points of GDP, all else equal).
Capital inflows to these countries remain buoyant but volatile (Figure 2.5). After peaking in 2011:Q1, inflows came down slightly in the second half of the year amid heightened global risk aversion; flows of foreign direct investment remained strong, however, and offset lower portfolio flows. For the year as a whole, capital inflows continued to be larger than current account deficits, and international reserves coverage ratios rose to well above precrisis levels. Preliminary data suggest that capital flows have been on the rise since early 2012 on improved global sentiment.
Figure 2.5.In FI South America, buoyant capital flows continue fueling bank credit and exchange rates.
Exchange rates rebounded with the resumption of capital flows. During the global financial stress of late 2011, most central banks stopped intervening and let currencies depreciate to buffer the shock; some also provided U.S. dollar funding and took other steps to counter liquidity pressures in domestic foreign exchange and interbank markets. In 2012, as global uncertainties receded, real exchange rates have appreciated (to near historic highs in some cases), leading some countries to again accumulate reserves (Brazil, Colombia, Peru) and tighten capital flow management measures (Brazil). 1
Bank credit, in real terms, continues to expand rapidly in many countries of the region. This dynamism is generalized across market segments, although the fast growth in mortgage credit stands out in a few cases (Brazil, Colombia and Peru), albeit from a low base. 2
Banks by and large remain well capitalized, profitable, liquid, and funded primarily by domestic deposits. Although credit quality has deteriorated in some sectors, and banks rely increasingly on external borrowing to finance credit expansion, overall credit quality remains healthy and bank leverage levels is still relatively low. Household and corporate indebtedness in some countries has also been on an upward trend but remains at comfortable levels. That said, data gaps limit proper assessment, particularly of the extent of household leverage across much of the region (see also Chapter 5). Overall, although financial and external vulnerabilities continue to build up in many of the financially integrated economies of the region, they remain generally manageable.
With these financially integrated economies operating near or above potential, monetary policy should remain nimble and strike a balance between anchoring inflation expectations and mitigating the impact of shocks on activity. The monetary policy responses during the 2011 episode of global financial stress was varied. Some countries (Brazil, Chile, Peru) reduced or kept nominal policy rates unchanged in response to slowing growth (Figure 2.6). Others (Colombia and Uruguay) continued tightening as demand pressures persisted and inflation expectations stayed above targets (Uruguay).
Figure 2.6.Monetary tightening has been put on hold in some FI countries, but fiscal consolidation continues.
Now that global conditions have settled somewhat, some countries in this group may need to resume tightening to neutral levels to keep inflation expectations well anchored. Thus, keeping inflation closer to the midpoint of the official range will be important, to offset earlier slippages. In the meantime, central banks should remain watchful of liquidity conditions in foreign exchange and interbank markets, which could be disrupted by further bouts of financial stress emanating from Europe. Under such conditions, central banks should stand ready to respond to ensure smooth market functioning and prevent negative spillovers to domestic financial conditions.
Fiscal consolidation should continue. Most financially integrated countries strengthened fiscal primary balances and reduced public debt levels during 2011, processes aided by strong growth and commodity-related revenues. However, fiscal deficits and public debt remain above precrisis levels in most countries, and the situation in Europe underscores that hard-won fiscal credibility can be fragile. With output gaps closed or positive, fiscal consolidation is necessary to allow needed flexibility for monetary policy, particularly as high real interest rates can attract potentially disruptive short-term flows. Finally, countries should strengthen their fiscal positions today because the current favorable external environment will wane and could even reverse in the medium term (Box 2.2).
However, fiscal consolidation must be designed to avoid compromising social and infrastructure spending, and revenue mobilization should be considered where the tax burden is low. In addition, countries should contemplate moving toward structural fiscal targets (i.e., isolating expenditures and revenue developments driven by the economic cycle). An important guiding principle should be to set the annual growth of primary government expenditures broadly in line with growth in structural revenues, which in most cases roughly corresponds to potential output growth. 3
Exchange rates should remain flexible to provide buffers against external shocks. To deal with high and volatile capital inflows, exchange rates should be allowed to fluctuate to avoid creating one-sided bets. Foreign exchange intervention could be considered, particularly after a substantial degree of appreciation has been allowed, while staying mindful of sterilization costs. 4 Administrative measures to discourage inflows could also be part of the toolkit, but they should not substitute for an appropriate policy stance. Trade restrictions should also be avoided.
Macroprudential policies may be needed to avoid financial excesses, particularly in the face of volatile capital inflows. The financially integrated countries, Brazil in particular, continue to be active on this front (see Table 2.1). The impact of these policies has been difficult to gauge since they have been targeted to specific markets or sectors and generally complement action on the monetary front. Although more research is required to appropriately calibrate macroprudential policies, these tools tend to work best when they complement macroeconomic policies, although they need not always move in the same direction. Moreover, because the effect of macroprudential policies tends to be short-lived, some regular fine-tuning may be needed to sustain their impact (see Chapter 2, October 2011 Regional Economic Outlook: Western Hemisphere [IMF, 2011c]).
Figure 2.7.In FI countries, vulnerabilities remain low, but they are growing in some areas. Meanwhile, cheap financing continues to fuel corporate borrowing.
|Capital requirements and loan-to-value ratios||✓||Slow down credit growth.||Brazil (long-term consumer loan market, 2010↑-2011↓), 3 Peru (countercyclical and concentration-based capital requirements, 2010↑)|
|Dynamic provisioning 1||✓||Build up cushion against expected losses in good times to be used in bad times.||Bolivia (2008), Colombia (2007), Peru (2008), Uruguay (2001)|
|Liquidity requirements 2||✓||Measures to identify, monitor, and control liquidity risk under conditions of stress.||Colombia (2008)|
|Reserve requirements on bank deposits||✓||Limit credit growth, manage liquidity, and complement monetary policy.||Peru (2010↑, 2011↑), Brazil (2010↑, 2011↓), 3 Uruguay (2009, 2010, 2011↑)|
|Reserve requirements on short term external liabilities of banks||✓||Make short term borrowing less attractive to banks.||Peru (2010↑,2011↓)|
|Limits to manage foreign exchange credit risk||✓||✓||Internalize credit risks from lending to unhedged borrowers.||Peru (2010↑), Uruguay (2010↑)|
|Limits on foreign exchange positions||✓||✓||Manage foreign exchange risk in on- and off-balance sheet assets and liabilities of banks.||Brazil (reserve requirement on short spot dollar positions, 2011↑), Peru (2010, on net FX derivative position, 2011↑)|
|Reserve requirements on non-resident financial institutions||✓||✓||Reduce incentives for short-term capital inflows and tilt the composition of bank liabilities toward a more stable base.||Peru (2010↑)|
|Tax on foreign borrowing||✓||Lower short-term capital inflows and tilt the maturity structure toward the long-term.||Brazil (IOF tax, 2010↑,2011↑ and ↓,2012↑)|
|Limits to foreign investment by domestic pension funds||✓||Manage capital outflows to offset pressures on currency.||Peru (2010↓)|
Chile’s 2011 system of forward-looking provisioning is not classified as dynamic provisioning as it does not involve accumulating generic provisions in a reserve fund as is the case in the other countries cited, but rather bases a specific provision on forward-looking estimates of loan default.
In many countries liquidity requirements exist, but they do not necessarily involve stress testing conditions.
In recent months, Brazil has eased macroprudential policies by (i) lowering the capital requirements on auto-loans and personal credit with maturities less than 36 months and payroll deduction loans with maturities less than 60 months—while raising the capital requirements on longer term loans (Nov-2011); and (ii) authorizing large banks to acquire credit portfolios and securities of small banks through the use of resources locked in reserve requirements on time deposits (Dec-2011). To encourage the acquisition of these, the remuneration on time deposits was decreased.
Figure 2.8.In other commodity-exporting countries of South America, policies remain highly procyclical, resulting in capital outflows in some cases.
Last, close monitoring of the financial and corporate sectors remains a priority. More efforts are required to close information gaps to allow a proper assessment of vulnerabilities and to improve oversight, particularly by strengthening capacity to assess banks’ risk-management practices. Moreover, it remains important to continue monitoring corporate off-balance-sheet operations, particularly those that could give rise to currency and maturity mismatches.
South America’s Less Financially Integrated Commodity Exporters—Another Boom-Bust Cycle in the Making?
Growth in South America’s less financially integrated commodity exporters 5 remained strong in 2011, averaging about 6 percent, supported by continued high prices for their main commodity exports and highly expansionary policies in most countries. Most of these economies have been operating above potential for some time. Inflation generally remains high, reflecting procyclical policies and supply constraints, notwithstanding price controls in a few countries (Argentina and Venezuela). In Bolivia and Paraguay, inflation peaked in mid-2011 and declined significantly thereafter, mainly as a result of lower food prices and (in Paraguay) the lagged effects of monetary policy tightening.
Real interest rates remain negative (except in Paraguay), and monetary aggregates and private credit continue to expand rapidly. Fiscal policy continues to fuel demand pressures, with government expenditures growing well above potential output growth in all of these countries. In some countries (Argentina and Venezuela) the deterioration of external accounts, despite strong export prices, prompted the imposition of exchange controls and import restrictions.
For 2012, real GDP growth in these economies is projected to slow, especially in Argentina and Ecuador. Increasingly binding supply constraints, weaker external demand, and weather-related shocks in some cases will weigh on growth. Given still favorable terms of trade, stronger policy efforts will be necessary to rein in demand growth and contain overheating pressures. 6
Downside risks in the event of a sharp drop in commodity prices are more significant than for the financially integrated exporters because these countries did not build adequate buffers during the boom years (with the exception of Bolivia and Paraguay). Accordingly, a priority is to strengthen policy frameworks (particularly fiscal) to avoid procyclicality and limit macroeconomic volatility, including through the adoption of rules that limit expenditure growth during export price booms (Box 2.3). Also, improving the business and investment climate remains crucial for addressing supply bottlenecks and increasing potential output.
Mexico and Central America—Enduring a slow U.S. recovery
Mexico’s real GDP grew by 4 percent in 2011 (5½ percent in 2010), supported by strong manufacturing exports and domestic demand—which benefited from the recovery of U.S. manufacturing as well as from improved employment and credit conditions. 7 The output gap continued to narrow, with a modest gap remaining. Inflation expectations are well anchored, although headline inflation has increased in recent months owing to food price shocks. Output growth is projected to settle near 3¾ percent during 2012—13, allowing the remainder of the output gap to close. Risks to Mexico’s economic outlook are tilted to the downside, linked to those for the United States and sensitive to renewed tensions in Europe.
Figure 2.9.Although Mexico’s recovery remains linked to that of the United States, domestic demand has strengthened.
Mexico’s policy stance has continued to strike a prudent balance between supporting economic activity and rebuilding buffers, and exchange rate flexibility continues to play a critical role in buffering the impact of external shocks. 8 Monetary policy remains accommodative, and the pace of fiscal consolidation has been calibrated to avoid undermining the recovery. In addition, the government has continued taking advantage of the favorable financing conditions to improve its debts structure.
Looking forward, the policy challenge is how to unleash Mexico’s growth potential and employment generation while tackling the long-term fiscal issues arising from a projected decline in the ratio of oil revenues to GDP and age-related pressures. To boost growth, Mexico needs to press ahead with structural reforms to increase productivity and promote investment. Addressing the longer-term fiscal challenges requires a combination of non-oil revenue mobilization efforts and expenditure rationalization.
Output growth in Central America, Panama, and the Dominican Republic (CAPDR) held up relatively well in 2011. Excluding El Salvador and Panama, real GDP grew by about 4 percent on average. In Panama, the canal expansion and a large public investment program boosted GDP growth to 10 percent; at the other extreme, growth in El Salvador remained subdued. Inflationary pressures in Central America abated in mid-2011, showing the effects of moderate food inflation and tighter monetary policy in a few cases, but average inflation stayed above 6 percent.
Although exports and remittances continued to grow at robust but slowing rates, imports grew more quickly due in part to higher oil prices. As a result, the current account deficit widened markedly (to 8 percent of GDP on average). Rising foreign direct investment and official flows helped cover the widening deficits, leaving international reserve positions largely unchanged. Nonetheless, external vulnerabilities in most CAPDR countries are, again, a concern.
Figure 2.10.Central America: Growth has held up well, supported by exports and remittances.
Growth is projected to moderate to 3½ percent in 2012, driven by slower external demand and a weaker fiscal impulse. Downside risks are strongly linked to those for the United States, which is CAPDR’s main export market and source of remittances and where growth will remain subdued in the medium term. In addition, a spike in oil prices would compromise the external positions of most countries in the region and put pressure on their energy subsidy schemes (especially in the Dominican Republic, El Salvador, and Nicaragua).
Countries in the CAPDR region have been slow to normalize their policy stances, especially fiscal. The fiscal space used by most of the countries in the aftermath of the global crisis has not been recovered; public debt remains well above pre-crisis levels, although revenue mobilization efforts are under way in some countries. 9 With output near potential in most countries, debt reduction should remain steady but can be gradually paced to avoid compromising growth.
In most cases, redoubled efforts are needed to rein in current public expenditures, especially wages (which are abnormally large as a share of GDP). 10 Further revenue mobilization is also required to meet large infrastructure and social needs. Increasing direct taxes (by aligning corporate tax rates with international standards) and reducing generous tax concessions and incentives are two promising areas.
Other than El Salvador and Panama, which are fully dollarized, countries in the region also need to step up efforts to reform their monetary policy frameworks. 11 Progress toward greater exchange rate flexibility has been unduly slow in many cases, leaving the authorities with one less tool to buffer external shocks and undermining the transmission of monetary policy (see Medina Cas, and others, 2011a, 2011b).
In contrast to the financially integrated commodity exporters, Central America is benefiting little from accommodative conditions in global financial and commodity markets. Lower potential growth in the United States will be a headwind for these economies in the medium term. Accordingly, structural reforms to boost potential growth remain a key priority, particularly reforms that enhance the business climate and competitiveness (see Swiston and Barrot, 2011).
Figure 2.11.Central America: Monetary and fiscal policies have been slow to adjust. Public debt remains above pre-crisis levels.
The Caribbean—Repairing balance sheets amid continued headwinds
Real GDP growth in the tourism-intensive countries of the Caribbean is slowly picking up after a deep and protracted recession. Constrained by a still-difficult external environment and fiscal consolidation, output is expected to expand by about 1½ percent in 2012 (compared with ½ percent last year). Tourist arrivals continue to recover but at different speeds determined in part by variations in the weak employment conditions in their main tourism markets.
Figure 2.12.Activity in the Caribbean is picking up slowly and fiscal consolidation remains modest.
Vast challenges from high public debt levels and from adverse terms of trade, attributable to high oil prices continue to weigh on growth. Prospects are somewhat more favorable for the commodity exporters (Guyana, Suriname, and Trinidad and Tobago), where output is projected to grow by 3½ percent on average this year (2½ percent in 2011) supported by high commodity prices, particularly for gold and oil. Meanwhile, Haiti is projected to expand by close to 8 percent in 2012, reflecting increased earthquake reconstruction efforts.
In the tourism-intensive Caribbean countries, external current account deficits are widening again, reflecting higher oil imports and stagnant competitiveness. These external imbalances are being financed by foreign direct investment, which is slowly picking up, as well as by official flows, including from the IMF. 12 Financing through concessional loans from Venezuela’s Petrocaribe is also helping to buffer the impact of high oil prices for some countries.
Fiscal consolidation is progressing, although slippages occurred in a few countries in 2011 (Barbados and Jamaica). The fiscal primary balance improved by an average of 1 percentage point in 2011, but public debt persists at dauntingly high levels. Stronger consolidation efforts are necessary to put debt on a steady downward trend. In some cases, the consolidation may have to be complemented with market-friendly debt restructuring, as was recently done in St. Kitts and Nevis. 13
Financial sector weaknesses in the region remain elevated. Bank credit quality, particularly for indigenous banks, continues to deteriorate. Efforts are under way to assess the balance sheets of weak banks and develop strategies to strengthen them. High exposure to sovereigns (including to those that have recently restructured debt), along with the lack of public resources, makes the task of strengthening bank balance sheets particularly challenging.
On the nonbank side, the resolution of the problems in the insurance subsidiaries of a financial group based in Trinidad and Tobago (Colonial Life Insurance Company, or CLICO; and British American Insurance Company, or BAICO) three years after the collapse of the holding company has been uneven. Trinidad and Tobago has settled claims against CLICO, but in Barbados the resolution is still pending. In the Eastern Caribbean Currency Union (ECCU), part of the insurance subsidiary is being sold, and a fraction of the claims are pending a regional resolution.
Risks to the region’s outlook are tilted to the downside. On the external front, renewed tensions in Europe do not bode well for tourism and foreign direct investment flows, and an oil price spike would put further pressure on the external accounts (oil accounts for more than half of all imports in the tourism-dependent economies). On the domestic front, fiscal fatigue could undermine market confidence, and financial sector vulnerabilities could weigh on already-high public debt levels.
Looking to the future, greater efforts are needed to tackle structural weaknesses to boost competitiveness and growth (input costs are high compared with small islands in other regions: see Box 2.4.) Policies to reduce labor and energy costs would enhance competitiveness and invigorate growth. Diversifying tourism toward emerging markets would also help.
Figure 2.13.Tourism in the Caribbean is recovering at different speeds, and financial strains and fiscal drags remain a constraint.
Box 2.1.Foreign Banks’ Exposure and Deleveraging Risks in Latin America and the Caribbean (LAC)
Foreign banks’ claims in the LAC region have increased considerably during the past decade. The increase in foreign claims on the region parallels that of other emerging regions, although it has been somewhat faster in emerging Asia. Contrary to the experience in emerging Europe, foreign bank claims on the region continued to grow following the global financial crisis, after a short-lived blip.
Foreign Bank Claims by Region, 2003-11
LAC: Foreign Bank Claims and Liabilities in Local Currency, 2003-11
Sources: Bank for International Settlements; and IMF staff calculations.
Simple averages. BIS data on an immediate borrower basis as reported by the consolidated banking statistics. International claims includes cross-border claims and local claims in foreign currency. LA6 includes Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. Offshore centers (Aruba, The Bahamas, Barbados, Panama) are excluded.
Foreign banks’ exposure (size and composition) varies substantially across the region.
In the larger, financially integrated economies (LA6: Brazil, Chile, Colombia, Mexico, Peru, and Uruguay), foreign bank claims average about 30 percent of GDP, roughly half of which are local claims in local currency (credit to residents by foreign bank subsidiaries), with the other half being international claims (a combination of direct cross-border lending and credit by bank subsidiaries in foreign currency). European claims on the region are largest in the LA6 (more than 60 percent of all claims) because of the large presence of Spanish banks (Chile and Mexico have the largest exposure).
Outside the LA6, foreign claims are much smaller, with the notable exception of the Caribbean. European claims in Central America and the Caribbean are small (less than 30 percent of total).
The latest data suggest a small decline in foreign claims during 2011:Q3. Although this partly reflects a depreciation of currencies in the region (given the significance of claims in local currency), evidence also indicates that short-term funding in foreign currency came under pressure in late 2011, prompting authorities in some countries to inject foreign exchange liquidity and supply trade credit, although in the case of trade financing, banks from other regions also covered the void left by European banks. Moreover, credit standards and funding conditions tightened somewhat during the second half of 2011.
Vulnerabilities to a large deleveraging by European banks seem manageable, although not negligible. The bulk of the region’s exposure to Europe takes place through well-capitalized and highly profitable Spanish subsidiaries that fund themselves mainly through domestic deposits; this positions the region well to withstand deleveraging shocks. IMF staff simulations show that under a large European deleveraging scenario (in which banks in Europe reduce credit by €500 billion more than under the baseline), credit in Latin America would contract and lead to a ½ percentage-point decline in real GDP levels over a two year period (WEO Special Report: Cross-Border Spillovers from Euro Area Bank Deleveraging). However, the impact on credit and output would be greater under a large and disorderly deleveraging process, that is, a tail event, in which uncertainties weigh on foreign bank equity prices and hinder their ability to dispose of their assets. The decision in November 2011 by a Spanish bank to sell an 8 percent stake of its operations in Brazil and Chile, had a non-negligible impact on bank equity prices (stocks fell by about 15 percent); yet this effect was temporary and did not affect overall bank credit.
The region must continue to watch closely for any signs of deleveraging. Authorities should also develop contingency plans against a large and unanticipated fire sale of foreign bank assets in the region, in particular, to ensure an orderly sale and transfer of bank balance sheets. The increased reliance of foreign bank subsidiaries on non-deposit (less stable) forms of financing also deserves attention.Note: Prepared by Luis Cubeddu and Camilo E. Tovar.
Box 2.2.The Importance of Fiscal Buffers: Public Debt Under Downside Scenarios in Financially Integrated Economies
The steady reduction in public debt levels since the early 2000s created space for many Latin American economies to implement countercyclical fiscal policies during the 2008-09 financial crisis. Supported by strong growth, currency appreciation, and primary fiscal surpluses, gross public debt as a share of GDP in the financially integrated economies of Latin America (LA6: Brazil, Chile, Colombia, Mexico, Peru, and Uruguay) fell by an average of 13½ percentage points of GDP during 2002-07, and reliance on foreign-currency-denominated debt declined markedly. Fiscal stimulus programs during 2008-09 led to a 4 percentage-point increase in public debt levels by end-2012, although the strong economic recovery since has allowed some reversal.
Despite current trends, public debt levels remain vulnerable to global conditions, particularly declines in global growth and commodity prices. To quantify this vulnerability, we estimate the impact on public debt of the two downside scenarios considered in the April 2012 World Economic Outlook and a scenario based on the region’s post-crisis experience. The estimates are based on a multi-country public-debt stress test that includes shocks to GDP, commodity revenues, and real exchange rate (10 percent real depreciation), and that assumes no discretionary fiscal policy.
LA6: Public Debt
Sources: National authorities; and IMF staff calculations.
LA6: Public Debt under Risk Scenarios
Sources: IMF staff calculations.
Europe downside scenario assumes that an intensification of the adverse feedback between bank asset quality and sovereign risk in the euro area triggers an even larger bank deleveraging in Europe and fiscal consolidation in several euro area countries. Under this scenario, Latin America’s GDP levels would fall by ½–1 percent during the next five years relative to the baseline, with commodity prices falling by 10 percent through end-2013 (gradually converging to the baseline thereafter).
Asia downside scenario assumes a downward revision to potential output and a deceleration of bank credit in Emerging Asia. This would send GDP levels 3—5 percent below the levels in the baseline during the next five years and reduce commodity prices by 20—30 percent by end-2013 (with partial convergence to the baseline thereafter).
Lehman-Eke scenario assumes a contraction in GDP and a temporary decline in commodity prices similar to that observed following the 2008-09 global crisis. GDP levels would remain 4½ percent below the baseline, whereas commodity prices would drop by 30 percent during the first year and return to the baseline shortly thereafter (2014).
Consistent with limited trade and financial linkages, the Europe downside scenario would result in a 3 percentage-points increase in public debt levels in LA6, with roughly half of the increase explained by the presence of revenue-side automatic stabilizers (or the impact of growth on noncommodity revenues). However, a shock centered in emerging Asia would result in a quick debt build up (more than 10 percentage points of GDP by 2016), reflecting not only the growth impact on revenues, but also the combined effect of lower commodity revenues and higher valuation of foreign-currency-denominated debt. Similar effects on public debt levels are found under the Lehman-like scenario.
Strong government balance sheets allowed many Latin American economies to adopt strong countercyclical policies during the 2008-09 global crisis. In the future, rebuilding the fiscal space used during the crisis remains a priority given the region’s exposure to global conditions, especially to growth prospects in Asia.Note: Prepared by Jose Daniel Rodriguez-Delgado.
Box 2.3.Can Macro Policies Mitigate the Effects of Commodity Boom-Bust Cycles?
Commodity price swings have often generated pronounced economic cycles in Latin America, with adverse effects on output, unemployment, and fiscal and external sustainability. To what extent can prudent macroeconomic policies help smooth these cycles and mitigate their consequences? To answer this question, we study macroeconomic outcomes under alternative monetary and fiscal policy regimes during a commodity price boom-bust cycle—similar to that observed during 2007-09 (Panel A)—using a dynamic stochastic general equilibrium model calibrated to an average Latin America commodity-exporting country. 1
Policy options. We consider two fiscal policy rules: (1) balanced budget, and (2) structural balanced budget. The first rule ensures that spending matches current revenues at all times, whereas under the second rule the windfall from a temporary surge in commodity prices (and tax revenues) is saved, and the proceeds are spent in bad times. We also consider two possible monetary policy rules: (1) Inflation targeting, and (2) exchange rate stabilization. Under the first, monetary policy focuses only on complying with an inflation target; in the second rule the central bank has a dual objective of stabilizing prices and the real exchange rate.
Impact on output. The combination of a structural balanced budget rule and inflation targeting is the most successful policy mix in isolating output from commodity price swings. In contrast, a balanced budget rule tends to amplify the cycle, generating sizable output gains during the boom, but also large losses after the bust (Panel B). The output boom-bust induced by a balanced budget rule is exacerbated when monetary policy prevents a real exchange rate adjustment. It is worth noting that the estimated output losses are likely to be a lower bound, because macroeconomic volatility tends to lead to lower long-term growth (see Berg and others 2012), an effect not captured by the model.
Simulation Assumptions and Key Results
Sources: IMF staff calculations.
1 Commodity prices during the period 2007:0.1-2009:04.
2 The policies analyzed are: Balanced Budget (BB), Structural Balanced Budget (SB), Inflation Targeting (IT), and Exchange Rate Stabilization (ERS).
External and public debt outcomes. Commodity-producing economies following a balanced budget rule also will tend to exacerbate external vulnerabilities (Panel C). More important, and contrary to a common perception, attempting to stabilize the real exchange rate does not necessarily translate into lower external imbalances because lower interest rates (necessary to prevent appreciation) tend to stimulate aggregate demand and imports (see Lama and Medina, 2010). The combination of a structural balance rule and inflation targeting is the most successful for limiting external imbalances. Moreover, the structural balance fiscal rule also allows sizable fiscal buffers (Panel D), enabling countries to adopt better countercyclical policies during the commodity price downturn.
Caveats. This model-based analysis abstracts from the process of implementing fiscal and monetary rules, which usually require transparent and efficient institutional arrangements. Also, the model is fairly stylized and omits other relevant features of Latin American economies, such as dollarization, procyclical capital flows, and domestic credit, which could exacerbate the output effects of commodity price cycles.Note: Prepared by Ruy Lama and Juan Pablo Medina. 1 The ratio of total exports to GDP is assumed to be 33 percent, commodity production 10 percent of GDP, and fiscal commodity revenues at 4 percent of GDP. Details of the model used in the simulations are presented in Medina and Soto (2007). IMF (2012a) presents similar simulations but focuses on a different set of countries.
Box 2.4.Competitiveness in the Tourism-Intensive Caribbean
In tourism-dependent Caribbean countries, which by in large have fixed exchange rate systems, two-decades worth of growing current account deficits, and shrinking shares of global tourism have given rise to competitiveness concerns. Tackling these problems will require action on several fronts, including reducing the costs of labor, energy, and trade.
Rising current account deficits and net external liabilities. External current account deficits have widened from close to balance in the early 1990s to a peak of 17½ percent of GDP in 2008. In tandem, the net foreign assets positions of these countries have deteriorated significantly, with net foreign liabilities currently averaging 90 percent of GDP. The bulk of these claims are in foreign direct investment in the tourism sector. Meanwhile, real exchange rates have been broadly stable, although they have weakened some since the early 2000s.
Declining global share of tourism and goods exports. The Caribbean’s loss of tourism market share has been pronounced. The region has also lost market share in exports in tandem with the erosion of preferential access to European banana and sugar markets and the attendant pressure from more efficient competitors.
Rising business costs, including energy and labor. Despite a relatively healthy business climate, the cost of key inputs is higher than in competitors. For example, the cost of electricity in the Caribbean is about 16 percent higher than in the Pacific Islands and more than two times that of islands in the Indian Ocean (Mauritius and Seychelles). Meanwhile, the cost of labor redundancy is double that of the Pacific Islands, and the cost of starting a business is twice that of Indian Ocean Islands. That said, the Caribbean region ranks above those competitors on important dimensions of governance, such as government effectiveness, regulatory quality, the rule of law and control of corruption.
Policy options. Policies to address competitiveness need to focus on key structural weaknesses, such as: (1) lowering the cost of energy, including by exploring renewable sources; (2) reducing the cost of labor, through productivity enhancements and reduction of redundancy costs; (3) lowering the cost of trading across borders; and (4) diversifying tourism markets. These actions need to be accompanied by renewed efforts to reduce high public debt levels to bring down external imbalances and address any real exchange rate misalignments.
Doing Business Indicators: The Caribbean versus Other Small Islands
Sources: Caribbean Electric Utility Service Corporation; Caribbean Tourism Organization; Central Electricity Board Annual Reports; Doing Business Reports and World Development Indicators; External Wealth of Nations Database; Fiji Commerce Commission Energy Information Administration; IMF Direction of Trade Statistics; Seychelles Abstract of Statistics; World Bank; World Travel and Tourism Council; and IMF staff calculations.
1 Caribbean includes The Bahamas, Barbados, Belize, Jamaica, and the ECCU member states.
2 Pacific Islands includes Palau, Fiji, Solomon Islands, Samoa, Vanuatu, Kiribati, and Singapore.
|2011||2001–11 average||2011||Latest available|
|GDP 2 ($US bil.)||Population (mil.)||GDP per capita ($PPP)||Nominal output share of LAC region 2||Real GDP growth (Percent)||CPI inflation 3 (Percent)||Current account (Percent of GDP)||Domestic saving (Percent of GDP)||Trade openess 4 (Percent of GDP)||Gross reserves (Percent of GDP)||Unemployment rate (Percent)||Poverty rate 5||Gini coefficient 5||Sovereign credit rating 6|
|Trinidad and Tobago||22.7||1.3||20,053||0.4||5.2||6.8||17.6||36.9||100.4||45.6||5.8||—||—||A-|
|Eastern Caribbean Currency Union||5.1||0.6||14,429||0.1||1.8||2.8||−19.2||13.7||100.0||16.9||—||—||—||—|
|Antigua and Barbuda||1.2||0.1||17,981||0.0||1.5||2.3||−17.2||21.1||113.9||11.0||—||—||—||—|
|St. Kitts and St. Nevis||0.7||0.1||15,573||0.0||1.7||3.6||−21.0||24.3||84.2||29.3||—||—||—||—|
|St. Vincent and the Grenadines||0.7||0.1||11,491||0.0||2.4||3.2||−22.0||2.8||87.2||14.4||—||2.9||40.2||B+|
|Latin America and the Caribbean||5,613.5||567.7||11,863||100.0||3.5||6.8||−0.2||20.7||44.0||13.7||—||—||—||—|
Estimates may vary from those reported by national authorities on account of differences in methodology and source.
At market exchange rates, except for Venezuela for which official exchange rates are used.
End-of-period, 12-month percent change.
Exports plus imports in percent of GDP.
Data from Socio-Economic Database for Latin America and the Caribbean (SEDLAC). Poverty is share of population earning less than US$2.50 per day. Data for the U.S. are from the U.S. Census Bureau and for Canada is from Statistics Canada.
Median of ratings published by Moody’s, Standard & Poor’s, and Fitch.
Figures on real GDP growth and CPI inflation for Argentina are based on official data. The IMF has called on Argentina to adopt remedial measures to address the quality of the official GDP and the consumer price index (CPI-GBA) data. The IMF staff is also using alternative measures of GDP growth and inflation for macroeconomic surveillance, including data produced by private analysts, which have shown significantly lower real GDP growth than the official data since 2008, and data produced by provincial statistical offices and private analysts, which have shown considerably higher inflation figures than the official data since 2007.
(End of period, percent)
|External Current Account Balance
(Percent of GDP)
|Antigua and Barbuda||−10.3||−8.9||−0.5||1.0||2.5||2.4||2.9||3.9||3.4||3.0||−19.2||−12.9||−10.8||−13.7||−15.5|
|St. Kitts and Nevis||−5.6||−2.7||−2.0||1.0||1.8||1.2||5.0||1.2||2.1||2.5||−25.7||−20.6||−14.0||−18.7||−17.9|
|St. Vincent and the Grenadines||−2.3||−1.8||−0.4||2.0||2.0||−2.2||0.9||4.7||0.7||2.6||−29.4||−31.6||−28.8||−25.1||−22.9|
|Trinidad and Tobago||−3.3||0.0||−1.3||1.7||2.4||1.3||13.4||5.3||4.0||4.0||8.2||19.9||20.7||20.0||18.2|
|Latin America and the Caribbean||−1.6||6.2||4.5||3.7||4.1||4.8||6.6||6.7||6.3||5.9||−0.6||−1.1||−1.2||−1.8||−2.0|
|Eastern Caribbean Currency Union 6||−5.7||−2.4||−0.2||1.5||2.2||−0.3||3.2||4.1||2.5||2.5||−20.2||−20.0||−19.9||−21.4||−20.5|
Regional aggregates calculated as PPP-GDP-weighted averages, unless otherwise noted.
End-of-period (December) rates. These will generally differ from period average inflation rates reported in the IMF’s, World Economic Outlook, although both are based on identical underlying projections.
Figures are based on Argentina’s official GDP and consumer price index (CPI-GBA) data. The IMF has called on Argentina to adopt remedial measures to address the quality of the official GDP and CPI-GBA data. The IMF staff is also using alternative measures of GDP growth and inflation for macroeconomic surveillance, including data produced by private analysts, which have shown significantly lower real GDP growth than the official data since 2008, and data produced by provincial statistical offices and private analysts, which have shown considerably higher inflation figures than the official data since 2007.
Fiscal year data.
Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela (the seven largest economies in Latin America and the Caribbean).
Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, as well as Anguilla and Montserrat, which are not IMF members.
|Public Sector Revenue
(Percent of GDP)
|Public Sector Primary Expenditure
(Percent of GDP)
|Public Sector Primary Balance
(Percent of GDP)
|Public Sector Gross Debt
(Percent of GDP)
|Costa Rica 5||14.0||13.7||13.8||14.7||15.6||15.3||16.8||15.8||16.4||16.7||−1.3||−3.0||−1.9||−1.7||−1.0||24.8||27.2||29.2||30.8||32.4||33.2|
|El Salvador 7||15.9||17.3||17.9||18.5||18.9||18.9||19.4||19.8||18.8||18.4||−3.0||−2.1||−1.9||−0.4||0.5||39.3||48.2||50.1||50.8||50.0||49.3|
|Antigua and Barbuda 10||18.5||22.0||20.1||21.6||21.4||29.4||20.2||19.7||23.8||17.9||−10.9||1.8||0.3||−2.2||3.5||63.2||83.7||75.2||74.6||82.4||79.3|
|The Bahamas 8||16.5||16.8||17.8||17.5||17.8||19.1||18.9||19.9||20.1||19.8||−2.6||−2.1||−2.2||−2.6||−2.0||32.6||37.9||45.4||48.6||49.9||51.8|
|St. Kitts and Nevis 10||32.6||31.0||37.2||30.3||29.4||28.9||31.9||28.8||26.9||24.8||3.7||−0.8||8.4||3.4||4.6||131.0||148.5||163.6||153.4||151.2||147.3|
|St. Lucia 10||27.1||27.1||27.3||26.7||25.9||27.5||28.7||31.7||30.6||27.4||−0.4||−1.6||−4.4||−3.9||−1.4||58.8||63.2||65.3||71.9||76.4||78.5|
|St. Vincent and Grenadines 10||29.6||27.3||25.9||27.1||27.6||30.1||30.2||27.4||26.7||26.7||−0.4||−3.0||−1.4||0.4||0.9||57.0||64.9||67.8||71.4||70.4||70.4|
|Trinidad and Tobago||30.3||34.0||36.6||36.1||35.4||36.6||35.3||34.4||36.8||36.3||−6.3||−1.3||2.2||−0.7||−0.8||24.9||30.8||35.9||32.4||37.3||38.6|
|Latin America and the Caribbean|
Definitions of public sector accounts vary by country, depending on country-specific institutional differences, including on what constitutes the appropriate coverage from a fiscal policy perspective, as defined by the IMF staff. All indicators reported on fiscal year basis. Regional aggregates are PPP-GDP-weighted averages, unless otherwise noted.
Primary balance defined as total revenues less primary expenditures (thus interest received is included in total revenues).
Federal government and provinces; includes interest payments on an accrued basis.
Nonfinancial public sector reported for revenue, expenditures, and balances (excluding statistical discrepancies); combined public sector including Ecopetrol and excluding Banco de la Republica’s outstanding external debt reported for gross public debt.
Includes central government and social security agency. Gross debt is for the central government only.
Primary expenditures for Suriname exclude net lending.
General government only; data for El Salvador include operations of pension trust funds. Revenues include grants received.
Central government only. Gross debt for Belize includes both public and publicly guaranteed debt.
Revenues and Primary Balance exclude interest received.
Central government for revenue, expenditure, and balance accounts; public sector for gross debt.
Fiscal data cover the nonfinancial public sector excluding the Panama Canal Authority.
Overall and primary balances include off-budget and public-private partnership activities for Barbados and the nonfinancial public sector. Revenue and expenditure components of these items are not available and not included in the revenue and primary expenditure estimates.
Eastern Caribbean Currency Union members are Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. Central government for revenue, expenditure, and balance accounts; public sector for gross debt.
Note: Prepared by Luis Cubeddu and Sebastian Sosa, with contributions from Alexandra Peter, Camilo E. Tovar and Evridiki Tsounta. Andresa Lagerborg and Anayochukwu Osueke provided excellent assistance.
In March 2012, Brazil extended the 6 percent tax on foreign loans to cover loans with maturities of up to three years (maturities of up to two years were already taxed), and two weeks later, extended the IOF to loans with maturities of up to five years.
In the case of Brazil, public banks hold much of the mortgage credit.
With output near or above potential, some countries (Chile, Peru, Uruguay) unwound earlier policy stimulus in 2011 by reducing the growth in real primary spending to less than potential output growth.
Adler and Tovar (2011) find that interventions are more effective when there are signs of currency overvaluation.
The group comprises Argentina, Bolivia, Ecuador, Paraguay, and Venezuela.
In Paraguay, a severe drought has helped to reduce domestic demand growth and ease overheating pressures.
Mexico’s share in the U.S. market has been on an upward path since the 2008–09 global crisis.
In response to global uncertainties, the Bank of Mexico announced in November 2011 that it would sell US$400 million whenever its currency depreciated by more than 2 percent on any given day. The mechanism has not yet been triggered.
Tax reforms were approved in El Salvador (December 2011, worth ½ percent of GDP) and Guatemala (February 2012, 1½ percent of GDP cumulatively by 2015). The reform approved in Costa Rica (March 2012, 1¼ percent of GDP) was recently deemed unconstitutional.
Honduras recently approved legislation establishing new rules for setting wages for teachers and reforming their pensions.
The Dominican Republic officially adopted an inflation targeting framework (January 2012), and Honduras introduced a crawling exchange rate band (July 2011).
Antigua and Barbuda, Grenada, and St. Kitts and Nevis are receiving financial assistance from the IMF in the context of a program. In addition, Dominica received IMF financing in early 2012 under the Rapid Credit Facility.
In February 2012, St. Kitts and Nevis made a formal exchange offer to its bondholders and external commercial creditors. The offer was accepted with a participation rate of more than 95 percent. Discussions with domestic creditors are ongoing.