World Economic and Financial Surveys

Regional Economic Outlook

Western Hemisphere

Tale of Two Adjustments

APR 17

©2017 International Monetary Fund

Cataloging-in-Publication Data

Names: International Monetary Fund.

Title: Regional economic outlook. Western Hemisphere : tale of two adjustments.

Other titles: Western Hemisphere : tale of two adjustments | Tale of two adjustments | World economic and financial surveys

Description: [Washington, DC] : International Monetary Fund, 2017. | World economic and financial surveys, 0258-7440 | Apr. 2017. | Includes bibliographical references.

Identifiers: ISBN 978-1-47557-522-4 (paper)

Subjects: LCSH: Economic forecasting—Western Hemisphere. | Economic development—Western Hemisphere. | Western Hemisphere—Economic conditions.

Classification: LCC HC95.A1 R445 2017

The Regional Economic Outlook: Western Hemisphere is published annually in the spring to review developments in the Western Hemisphere. Both projections and policy considerations are those of the IMF staff and do not necessarily represent the views of the IMF, its Executive Board, or IMF Management.

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Contents

• Preface

• Executive Summary

• 1. A Shifting Global Landscape and the Outlook for the United States and Canada

  • Shifts in the Global Landscape

  • U.S. Outlook: More Growth, Higher Risks

  • Canada: Promising Prospects, Higher Uncertainty

  • References

• 2. Latin America and the Caribbean: Setting the Course for Higher Growth

  • Recent Developments and Outlook: Shifts in the Global Landscape

  • Wider Range of Risks

  • Policy Priorities: Setting the Course for Higher Growth

  • South America

  • Mexico, Central America, Panama, and the Dominican Republic

  • The Caribbean

  • Annex 2.1. Data Disclaimer

  • References

• 3. External Adjustment to Terms-of-Trade Shifts

  • The Ongoing External Adjustment to Terms-of-Trade Shifts: A Historical Perspective

  • Adjustment of the Current Account to Terms-of-Trade Shifts: Income Effect, Expenditure Switching, or Both?

  • Do Depreciations Boost Short-Term Export Performance? Going Granular

  • Policy Implications

  • Annex 3.1. The Panel Vector Autoregression Model: Data and Methodology

  • Annex 3.2. Export Shares Model

  • References

• 4. Drivers of Capital Flows and the Role of the Investor Base in Latin America

  • Setting the Stage

  • Drivers of Capital Flows

  • Role of the Investor Base and Market Characteristics

  • Conclusions and Policy Implications

  • Annex 4.1. Technical Details

  • References

• 5. Migration and Remittances in Latin America and the Caribbean: Macroeconomic Stabilizers and Engines of Growth?

  • Migration and Remittances at a Glance

  • Estimating the Impact of Migration and Remittances on Growth

  • The Stabilizing Role of Remittances

  • The Perils of Dependence on Remittances

  • Policy Priorities

  • Annex 5.1. Characteristics of Latin American and Caribbean Migrants

  • Annex 5.2. Empirical Results

  • References

• Country Groups and Country and Region Abbreviations

• New Publications from the Western Hemisphere Department

• Boxes

  • 1.1 The Destination-Based Cash Flow Tax

  • 2.1 Exposures to the United States

  • 2.2 Long-Term Fiscal Gaps

  • 2.3 Correspondent Banking Relationships

  • 3.1 Expenditure-Switching versus Income Effects

  • 3.2 A Comparative Analysis of External Adjustment in South America

  • 3.3 The Exchange Rate and External Competitiveness

  • 3.4 The Impact of Depreciations on Sectoral Growth

  • 4.1 Commodity Prices and Underlying Global Forces

  • 4.2 Commodity Prices and Investment in Commodity and Noncommodity Sectors

  • 5.1 “Brain Drain” in Jamaica

  • 5.2 Sending Remittances Is Costly

  • 5.3 How Do Migration and Remittances Affect Inequality? A Case Study of Mexico

Preface

The April 2017 Regional Economic Outlook: Western Hemisphere was prepared by a team led by Hamid Faruqee and S. Pelin Berkmen under the overall direction and guidance of Alejandro Werner and Krishna Srinivasan. The team included Steve Brito, Carlos Caceres, Yan Carrière-Swallow, Roberto García-Saltos, Carlos Gonçalves, Kotaro Ishi, Anna Ivanova, Carlos Janada, Emanuel Kopp, Genevieve Lindow, Nicolas E. Magud, Udi Rosenhand, Galen Sher, Bert van Selm, and Juan Yépez. In addition, Chapter 1 included guidance and review from Nigel Chalk, Stephan Danninger, and Cheng Hoon Lim; Michal Andrle, Valentina Flamini, Benjamin Hunt, and Jaume Puig contributed to Chapter 2, and Yixi Deng and Victoria Valente provided research assistance for the Central America section; Sergi Lanau contributed analysis to Chapter 3; Carolina Osorio Buitrón provided data used in Chapter 4; and Chapter 5 was produced by a team led by Jan Kees Martijn and comprised of Kimberly Beaton, Svetlana Cerovic, Misael Galdamez, Metodij Hadzi-Vaskov, Zsoka Koczan, Franz Loyola, Bogdan Lissovolik, Yulia Ustyugova, and Joyce Wong. Production assistance in the Western Hemisphere Department was led by Misael Galdamez, with assistance from Adrean Howes in the Special Office Support division of the Human Resources Department. Linda Long of the Communications Department coordinated editing and production, with editing help from Lucy Morales and Sherrie Brown. The Grauel Group provided layout services. From the Corporate Services and Facilities Department, Carlos Viel and Virginia Masoller, with the administrative support of María Fraile de Manterola, led the translation and editing team in the production of the Spanish edition. This report reflects developments and staff projections through early March 2017.

Executive Summary

Shifts in the global landscape are taking place following disappointing growth in 2016. Momentum picked up in the second half of 2016, and the outlook for advanced economies has improved for 2017–18. Better growth prospects in the United States, Europe, and Japan reflect some rebound in manufacturing and trade, as well as prospects of likely U.S. fiscal stimulus in the wake of the November elections. As it seeks a new policy course, the United States should see solid economic growth in the near term with job creation and rising inflation. With a shift in the direction of U.S. policies, market sentiment has strengthened alongside advancing equity markets, a stronger U.S. dollar, and higher U.S. interest rates. Meanwhile, growth prospects marginally worsened for emerging market and developing economies compared to last fall. However, financial conditions have improved here too, though financial risks and market volatility remain elevated. Stronger growth this year and next is projected for these economies, including China, given its stronger-than-expected policy support. On balance, global growth is envisaged to rise modestly in 2017 and 2018 but with widely dispersed risks. Global vulnerabilities include a rising tide of economic nationalism in major advanced economies marked by greater antipathy toward trade, immigration, and globalization.

In this global setting, economies of Latin America and the Caribbean are recovering from a recession at the regional level in 2016. In a tale of two adjustments, growth has been held back by weak domestic demand. This reflects both the ongoing external adjustment to earlier terms-of-trade shocks and, in some cases, fiscal adjustment, in addition to other country-specific domestic factors. The regional recession, however, masks divergent outcomes across countries, with relatively robust growth in Central America; deep contractions in a handful of countries such as Argentina, Brazil, Ecuador, and Venezuela; and generally modest growth elsewhere.

Regional activity overall is expected to pick up gradually this year and next, but the outlook is weaker than projected last fall. The projection for medium-term growth remains modest at about 2.6 percent. The outlook is shaped by key shifts in the global economic and policy landscape, including a modest rebound in commodity prices and in partner demand and higher policy uncertainty at the global level. Domestic fundamentals and developments, however, will continue to play a significant role in determining growth in many economies. At the same time, risks to regional growth have widened in a setting of higher global policy uncertainty.

In this challenging external context, countries should aim for completing fiscal and external adjustments to preserve or rebuild policy buffers. Charting a course toward higher, sustainable, and more equitable growth will also require strengthening structural reforms aimed at closing infrastructure gaps; improving the business environment, governance, and education outcomes; and encouraging female labor participation to boost medium-term growth and foster income convergence.

In South America, weaker domestic fundamentals combined with a large terms-of-trade shock took a toll on economic performance and led to sharp recessions in some major economies. Despite the improved external outlook, extending external and fiscal adjustment domestically to structurally lower commodity revenues should continue. Continued efforts are also needed to reduce domestic distortions, resolve policy uncertainties, improve governance, and further structural reforms.

The outlook and risks for Central America and Mexico are influenced by their exposure to the United States through trade, migration, and foreign direct investment linkages. In this context, maintaining macroeconomic stability and market confidence in an environment of heightened uncertainty is crucial. Prospects for the Caribbean are improving, but public sector debt remains a major vulnerability.

This issue of the Regional Economic Outlook features three analytical chapters that assess the progress in external adjustment to terms-of-trade shifts, analyze drivers of capital flows, and examine migration and remittances in Latin America and the Caribbean. Key findings are:

• Past external adjustment to negative terms-of-trade shocks in Latin America has worked through a compression of domestic demand and imports rather than growth of supply and exports. In the ongoing adjustment, real depreciations have boosted noncommodity exports and lowered imports more than in the past, and demand has shifted toward locally produced goods unlike in past adjustments. This has alleviated the domestic demand compression needed to achieve external adjustment—that is, a lower sacrifice ratio—for countries with flexible currencies. At the same time, the cost of external adjustment has increased for countries with more rigid exchange rate regimes, given increasing use of flexible regimes in trading partners and competitors. Finally, the overall sluggish response of exports to real depreciations masks differences across industries, including a stronger export performance response for manufacturing goods than for commodities.

• Following a decade of strong capital inflows, Latin America and other emerging markets are now facing the prospects of weaker economic growth and financial flows. Overall, capital inflows are strongly influenced by global cyclical factors as well as country-specific structural factors. In particular, good governance and solid institutional and regulatory frameworks play a key role in attracting inflows over periods longer than the usual business cycle. At the same time, having deeper domestic financial markets with a large and stable domestic investor base, as well as allowing for more exchange rate flexibility, are effective ways to reduce the vulnerability of capital flows to external shocks.

• Migration from and remittance flows to Latin America and the Caribbean have major economic and social ramifications for the migrants’ home countries. Outward migration in isolation may lower growth in home countries by reducing the labor supply and productivity, but the remittances sent home by migrant workers serve as a mitigating factor. Remittances serve as a large and relatively stable source of external financing, notably in Central America and the Caribbean, and help cushion the impact of economic shocks. However, the region’s dependence on remittances primarily from the United States can pose risks, due to both cyclical reasons and to possible changes to immigration-related policies in host countries. Targeted reforms aimed at leveraging the pool of high-skilled and highly educated workers at home can help reduce outward migration and the attendant adverse consequences. Similarly, given the key financing and stabilizing roles played by remittances, policies to reduce transaction costs and promote the use of formal channels of intermediation merit support.