The Latin America and Caribbean region is recovering from the crisis somewhat faster than previously anticipated. However, the speed of recovery and the associated policy challenges differ markedly across countries. For some of the larger commodity exporters, a favorable external environment and a strong rebound in domestic demand are boosting growth. Challenges ahead include managing the upswing of the economic cycle and adjusting to easy external financial conditions. In contrast, for some of the smaller commodity importers, challenges will likely be shaped by continued sluggish activity, particularly in countries more reliant on tourism and constrained by high debt levels.
Growth Is Gaining Momentum
The economic recovery in the Latin America and Caribbean (LAC) region as a whole is advancing faster than previously anticipated. Following a steep decline at the end of 2008 and early 2009, regional growth, in purchasing-power-parity-weighted terms, resumed in the second half of 2009. The recovery is being driven by a strong rebound in private consumption. Investment collapsed at the peak of the crisis, but is expected to accelerate in the coming periods (Figure 2.1).
For 2010, regional GDP is expected to grow by 4 percent—good performance by historical standards.1 This represents an upward revision of about 1 percentage point compared with our forecast in the October 2009 Regional Economic Outlook: Western Hemisphere. Better prospects for commodity exports help to explain about 30 percent of the growth forecast revision, cheaper external financial conditions about 30 percent, and changes in historical data and the base effect from higher growth in the second half of 2009 explain the remaining 40 percent (Figure 2.2).2
A rebound in consumption and better external conditions are supporting the recovery.
Source: IMF staff calculations.Better external conditions explain about 60 percent of the forecast revision in 2010 growth.
LAC: GDP Growth Forecast Revision for 2010
(Annual percent change; PPP-GDP-weighted average)
Source: IMF staff calculations.There are risks to the outlook on both sides. As discussed in Chapter 1, our baseline scenario assumes that external financial conditions remain relatively easy for some time. Improvements in financial market sentiment would entail upside risks to growth in those emerging markets in the region with brighter growth prospects and stronger ties to international capital markets. Commodity prices could also rally further if Asia’s rebound proves faster than currently anticipated. This would bring good news to the region’s major commodity exporters. Careful macroeconomic management will be critical to mitigate risks of a potential boom/bust cycle fueled by favorable external conditions.
Downside risks are still present, being more pronounced in 2011 and beyond. Growth in advanced economies remains highly dependent on public support, with uncertainty mounting as stimulus winds down after 2010. Slow progress in repairing financial sector balance sheets, or concerns over fiscal sustainability, could undermine confidence in the world recovery and heighten global risk aversion. The spike in government bond spreads in Greece in January 2010, and the spillovers to Portugal, Spain, and other advanced economies with important fiscal challenges, have underscored continuing fragilities. Real linkages with the LAC region are limited, but the region could be affected if tail risks materialize (Box 2.1). A weaker recovery in advanced economies would also bring with it weaker employment and consumption, posing downside risks for those economies in the LAC region more dependent on income from tourism and workers’ remittances.
Different Speed of Recovery—Different Policy Challenges
Stronger growth prospects for the LAC region as a whole mask some important differences across countries. The multispeed global recovery is exposing the region to a heterogeneous external environment, leading to a multispeed recovery also within the LAC region. As in past editions of the Regional Economic Outlook: Western Hemisphere, we divide the region into four analytical country groupings, aiming to capture differences in their exposure to external shocks (Box 2.2 and Panel 2.1).3
The rebound in growth is expected to be strongest for the financially integrated commodity exporting countries (Figure 2.3). Their outlook is being supported by favorable external conditions. Commodity prices have risen strongly from the troughs in late 2008, and in the cases of metals and energy, are expected to trend slightly upward in 2010–11 (see Chapter 1). Demand for these countries’ exports is also growing faster than previously forecasted, and access to foreign capital is resuming on relatively easy terms. Finally, substantial policy stimulus implemented during 2009 is still bearing fruit.
Panel 2.1. LAC: Monthly “Nowcast” of Real Economic Activity1
While both groups of commodity exporters are showing signs of a rebound, the financially integrated exporters have recovered to precrisis levels, owing in part to a favorable external environment and a strong rebound in domestic demand. For some of the smaller commodity importers, activity continues to be sluggish, particularly for those reliant on tourism and constrained by high debt levels.
Sources: Country authorities; CMC; CTO; Haver Analytics; IFS; WDI; and IMF staff estimates.1 The monthly “nowcast” of real economic activity is constructed on the basis of monthly indicators of real activity, such as real currency in circulation, capital imports, sales of retail and industrial/intermediate goods, electricity/energy consumption, industrial production, aggregate activity indicators, and others. The monthly GDP “nowcast” index is normalized to each country’s August 2008 level. The PPP-weighted regional average is shown in the left column (solid) against averages for the four country LAC analytical groupings. Each group average is then shown in the middle and right columns (solid) against the individual country indices. Shaded area corresponds to periods of “nowcasting.”Potential Spillovers from GIPS to Latin America
The global slowdown has heightened underlying fiscal vulnerabilities in advanced economies, triggering a confidence crisis in Southern Europe in early 2010. Greece has been at the epicenter. Spreads for Greek government bonds started to diverge markedly from other European countries in October 2009. Sovereign spreads in Portugal, Spain, and Italy have been the most affected. Indeed, since late last year, Greece, Italy, Portugal, and Spain (GIPS) have been the largest contributors to intersovereign contagion in the Euro zone (Global Financial Stability Report, 2010).
CDS Spreads in FCE and GIPS
Source: Bloomberg, L.P.Real linkages with the LAC region are limited, but there could be financial spillovers should tail risks materialize. Exports to GIPS account for less than 5 percent of total exports of the LAC region, limiting contagion through real channels. However, in an extreme scenario, a sovereign debt crisis in Southern Europe could have spillovers through market confidence effects. Our analysis suggests that sovereign CDS spreads in the LAC region do not react much to movements in Greek CDS spreads, but are relatively more sensitive to global risk aversion, proxied by the implied volatility in the S&P 500 (VIX). The VIX suddenly jumping in January 2010 and again in April, along with Greek spreads. But it has remained relatively low by historical standards.
Spanish banks operating in the LAC region represent a direct transmission channel, although there are sources of resilience. Sovereign funding pressures could crowd out private lending and prompt global banks to withdraw from crossborder activities. However, global banks in the LAC region, including Spanish banks, have relied primarily on subsidiaries funded by local deposits rather than crossborder flows. This has proven to be a source of resilience during the global crisis (see Chapter 4 in the May 2009 Regional Economic Outlook). Moreover, Spanish banks operating in the region remain well capitalized and have sizable provisions, thanks to regulations that take into account the economic cycle. Some authorities are considering tightening limits to related party lending to mitigate any potential risks.
Share of Banking Assets Held in Subsidiaries or Branches of Global Foreign Banks 1/
(Percent of total banking system assets, end-2009)
Sources: National authorities; Bankscope; and IMF staff calculations.1/ Included in the calculations are the five main foreign banks with global presence. In some countries, the actual share of foreign bank ownership of assets could be higher owing to the presence of other international or regional banks.LAC Country Analytical Groupings
In analyzing the outlook, we split LAC countries into four groups designed to capture their different exposures to key external shocks. To reflect the greatly varying impact of external terms-of-trade shocks, a first distinction is made between net commodity exporters and net commodity importers. Among the net commodity exporters, we further distinguish between countries that have full access to international financial markets and those that are relatively less financially integrated. Among the net commodity importers, we further distinguish countries with predominant tourism sectors from the rest.
Current Account Revenue Structure
Sources: IMF, Balance of Payments Statistics; Comrade; and IMF staff calculations.-
Net commodity exporting countries with full access to international financial markets. For brevity, these are called commodity exporting, financially integrated countries. This group comprises five countries that account for two-thirds of the region’s GDP (Brazil, Chile, Colombia, Mexico, and Peru). They are the most linked to global financial markets and have access to those markets on relatively favorable terms, with investment grade credit ratings (except Colombia). They also tend to have more developed domestic capital markets. These countries share other characteristics. They are inflation targeters, with the highest degree of exchange rate flexibility, and more generally follow rules-based macroeconomic policies. Terms of trade for these countries have usually moved with world commodity prices.
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Other net commodity exporting countries. This group comprises Argentina, Bolivia, Ecuador, Paraguay, Suriname, Trinidad and Tobago, and Venezuela. In general, these countries are currently less integrated with global financial markets. On average, they have experienced the most significant terms-of-trade gains.
Terms of Trade
(Index, 2000 = 100; simple average within groups)
Source: IMF staff calculations.Net commodity importing countries with large tourism sectors. For simplicity, these will be referred to as commodity importing, tourism intensive countries. This group comprises Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. These countries depend primarily on tourism for their current account revenues. In general, they have high external debt burdens but otherwise are not closely integrated with external financial markets. They experienced sizable terms-of-trade losses during 2000–08, given their limited goods exports base and their reliance on imported fuels.
Other commodity importing countries. This group comprises Costa Rica, Dominican Republic, El Salvador, Guatemala, Guyana, Haiti, Honduras, Nicaragua, Panama, and Uruguay. Many of these countries rely heavily on remittances. Some of these countries have sizable commodity exports but still experienced terms-of-trade losses in 2000–08 given their large fuel imports.
Note: This box was prepared by Jorge Iván Canales-Kriljenko and Ana Corbacho.At the other end of the spectrum, growth in the commodity importing tourism intensive countries has been marked down and is expected to perform worse in the current cycle than in previous episodes of global stress. The relevant external conditions are less benign for these countries. Reflecting strong links to weak employment in advanced economies, shocks to tourism have not fully reversed, and elevated commodity import prices are weighing on activity. Moreover, in some of these countries, high levels of debt constrain the room for policy maneuver. Although some countries managed to implement countercyclical fiscal policy in 2009, the payoff in growth was limited, probably reflecting small multipliers. And fiscal stimulus efforts may be short-lived, given financing constraints in forthcoming periods.
Policy challenges in the coming years will correspondingly vary across countries. For many of the financially integrated commodity exporters, the challenge will be managing the upswing of the business cycle. A main theme will be the timing and sequence of exit from the macroeconomic stimulus implemented in 2009, and the adjustment to a more benign external environment. In turn, for many of the tourism intensive commodity importers, the sluggish recovery, coupled with high external and fiscal imbalances, will require difficult policy choices.
The recovery in other countries in the region is traveling a middle ground, but with striking differences. Other commodity exporting countries are starting to ride another commodity cycle, especially the energy exporters. Policy challenges will include avoiding the perils of procyclicality that have been common in the past, anchoring macroeconomic policies, and regaining credibility and access to financial markets. In contrast to many countries around the world that are battling with weak demand, some of the other commodity exporters are struggling with supply constraints. In these countries, improving the business climate will be critical to attract private sector investment and support potential growth.
Other commodity importing countries are gradually recovering. Higher exports are supporting growth, but inflows from remittances, closely linked to the still weak labor market in the United States, continue to contract. Possible downside risks in global growth down the road may require more fiscal austerity than warranted by the current stage of the economic cycle to replenish fiscal buffers depleted during the crisis. Within the other commodity importers, Haiti faces an especially challenging outlook, as the devastating earthquake will require major efforts to improve social conditions and rebuild the economic infrastructure (Box 2.3).
Financially Integrated Commodity Exporters (FCE)
Bouncing Back
Economic activity regained strength in the second half of 2009 in the financially integrated commodity exporters (Figure 2.4). Quarter on quarter growth turned positive in all countries by September 2009, and gained momentum in the most recent months. Strong domestic consumption and the inventory cycle have been the main drivers. In Colombia, growth resumed as early as the first quarter of 2009, but lost some steam later in the year on account of lower exports to Venezuela. In Chile, the recent earthquake may slow down the strong ongoing recovery. In 2010, real GDP in the financially integrated exporters is expected to grow by about 4.5 percent, following a decline of about 1.5 percent in 2009. Upside risks to the growth outlook prevail in the near term.
Social indicators have no doubt been affected by the global financial crisis. But in contrast to past experience, the significant gains made over the last decade will not be undone (Box 2.4). In the financially integrated exporters, employment losses were more subdued in comparison with previous crises (and also with recent employment dynamics in the United States). This is noteworthy given the much more severe external shocks at play this time around. This is testament to active countercyclical policy responses and the avoidance of domestic financial crises that would have amplified the impact of global shocks.
Growth turned positive in the second half of 2009, with a decline in external balances amid rising imports.
1/ Includes reinvested earnings as well as repatriated amounts.Sources: Haver Analytics; EMED; and IMF staff calculations.Impact of the Earthquake on Haiti and the Role of the IMF
A powerful earthquake of magnitude 7.0 struck Haiti on January 12, 2010. The Port-au-Prince area (80 percent of GDP) suffered extensive damage to transportation, communication infrastructure, and housing. Most public buildings were damaged or destroyed, including the tax and customs office and the central bank. The payments system was impaired and the banking system temporarily shut down. The Post Disaster Needs Assessment (PDNA) conducted by the United Nations and the World Bank estimated damages and losses at about US$8 billion dollars, equivalent to about 120 percent of 2009 GDP. More than 225,000 people died, and one million still require shelter.
The macroeconomic outlook for 2010 is challenging. The earthquake represents a major setback for Haiti, after several years of significant progress in maintaining macroeconomic stability. GDP is projected to fall by 8.5 percent in FY2010, despite a projected recovery in the second half of the year. This recovery is expected to be led by reconstruction activity, a good agricultural harvest, and manufacturing growth. Inflation is expected to remain at single digit levels, despite some increases in construction materials and housing prices.
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A collapse in fiscal revenue is causing a fiscal gap of US$250-350 million. Tax collections are estimated to fall by about half during this fiscal year, as businesses have suffered damages from the hurricane and the tax administration agency has been weakened by the destruction of part of its infrastructure.
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The authorities are seeking to secure budget support disbursements from donors to close this gap. Securing such support will be critical in helping to avoid the inflationary risks that would be associated with a significant increase in central bank financing of the budget.
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To help restart bank credit to the economy, the Central Bank is working toward the establishment of a Partial Credit Guarantee fund. Uncertainty as to the value of collateral and financial status of banks’ clients has led to a credit crunch. This fund would support viable enterprises and thus employment and economic activity. It would also help to address the impaired assets of the banking system, which is well capitalized and generally sound.
Over the medium term, large expected inflows of foreign aid and higher remittances will need to be managed carefully. A challenge will be to avoid the emergence of Dutch disease effects and to ensure that appropriate conditions are in place to spur exports and private sector economic growth. The government’s reconstruction plan represents a unique opportunity to implement a new development model for Haiti based on the creation of viable poles of economic activity outside the capital, boost infrastructure, and improve social conditions. To that effect, the reconstruction plan will need to include an ambitious program of structural reforms as well as sustained donor support and technical assistance in the coming years.
The IMF has moved quickly to provide emergency support to Haiti and stands ready to support the authorities’ medium-term reconstruction plans. Within two weeks of the earthquake, the IMF approved the sixth review under the Extended Credit Facility (ECF) and an augmentation of access of 80 percent of quota. A disbursement of US$114 million was made at end-January. The authorities used these additional resources to ensure that there was no shortage of cash in circulation, boost reserves, and finance critical imports for reconstruction. The IMF is also providing technical assistance in the financial and fiscal sectors to support the authorities’ post-earthquake needs and revised medium-term priorities. The IMF will continue to support the authorities’ reconstruction and growth strategy and, in that context, discussions for a new ECF program are expected to start in May 2010.
Note: This box was prepared by Aurelie Martin and Stephanie Medina Cas.The Global Crisis and Social Outcomes
Economic crises in the LAC region have set back poverty reduction efforts in a significant manner in the past. During the three previous crises, poverty in the region fluctuated significantly, reaching its peak at 48.3 percent in 1990. It took the region twenty-four years to undo the increase in poverty since the 1980s debt crisis, when the income gap relative to the Organisation for Economic Co-operation and Development (OECD) widened sharply. Significant strides have been made in the most recent years. From 2003 to 2008, poverty declined steadily to a historical low of 33.2 percent.
LAC: Poverty and GDP per Capita
Sources: ECLAC; and IMF staff calculations.The poverty impact of the current global financial crisis may be smaller than what could have been expected given the severity of external shocks. Despite the large drop in output, the current crisis is expected to have a relatively small impact on the poverty rate of about 1.1 percentage point in 2009 (ECLAC, 2009), thanks to the progressive commitment of countries to allocate public funds to social policies since 1990. Social public spending, per person, almost doubled during the 2006–07 period, compared with 1990–91, and increased by 18 percent, compared with 2004–05. However, there are significant disparities between countries. Namely, the least developed countries cannot implement countercyclical measures during economic downturns given their budget constraints. Hence, poverty remains a major problem in the least developed countries.
LAC: Change in Real Per Capita GDP and Poverty Rate in Crisis Periods
(Percent, simple averages)
Sources: ECLAC; and IMF staff calculations.Employment losses in the financially integrated commodity exporters have been more subdued. This is in contrast to the United States and other advanced economies (Spring 2010 World Economic Outlook, Ch. 3). The sound banking system in the LAC region is complementing the strong domestic demand, which promises a relatively speedy economic recovery.
Active social safety nets to cushion the most vulnerable have been at play. Cash transfers to households have increased the income of 40 percent of the poorest households (ECLAC, 2009). Among the different types of transfers, retirement benefits and pensions stand out with their contribution to poverty reduction in the region. Welfare transfers have played an important role in raising the living standards of the poorest segments of society, raising per capita income for the poorest by 15 percent.
FCE: Employment Before and After Crisis Episodes
Sources: Haver Analytics; EMED Emerging Americas; and IMF staff calculations.Sluggish bank credit in some countries contrasts with the improvement in nonbank external financing.
Sources: Bank for International Settlements; Haver Analytics; EMED; and IMF staff calculations.The gradual improvement in external current accounts came to a halt in the third quarter of 2009, driven by shrinking trade balances as imports firmed. Still, external current account deficits are expected to widen only moderately in 2010, as high commodity prices and the recovery in external demand are expected to sustain exports.
Domestic credit to the private sector is turning around, following the sharp deceleration in late 2008 and early 2009 (Figure 2.5). Credit growth has been strongest in Brazil, supported by buoyant lending from public institutions.4 In Mexico, public banks have also stepped up activities, but from a much lower base.5 In general, credit from private institutions is restarting, but only timidly. Nevertheless, with domestic financial conditions normalizing, support from extraordinary liquidity facilities is being phased out.6
Overall, the crisis had a limited impact on the stability of the financial sectors. Stronger policy frameworks, including financial and regulatory reforms implemented over the last decade, and the buildup of buffers were critical in this respect.7
The sharp deceleration in foreign banks’ lending appears to be bottoming out. In the third quarter of 2009, total foreign bank lending to the LAC region grew by 3 percent with respect to the second quarter, with Brazil at the lead. Notably, cross-border lending to the region stopped declining, in contrast with continued withdrawal by foreign banks in other emerging market regions.
Access to nonbank external financing has improved markedly. As anticipated in our last edition, the financially integrated commodity exporters have become an attractive destination for foreign investors. Capital inflows have gone back to precrisis levels, with record volumes in portfolio investments at the end of 2009. More recent data on external issuances suggest these trends have continued in early 2010. Even high yield firms, which were rationed out during the peak of the crisis, have been able to tap international markets. Still, anecdotal evidence suggests that small and medium-size firms continue to face constraints in access to finance.
With inflows resuming, and global risk aversion declining, asset prices have recovered the losses experienced during the crisis (Figure 2.6). Equity markets have bounced back, notably ahead of the U.S. market. In most countries in the region, price earnings ratios remain within historical averages. In Brazil and Colombia, however, stock market valuations appear now stronger than historical averages. (See also the Spring 2010 Global Financial Stability Report).
Since March 2009, exchange rates have strengthened across the board to precrisis levels in most countries, in both nominal and real effective terms. Currency appreciation has helped to stem pressures from foreign inflows. In addition, authorities have accumulated foreign exchange reserves, strengthened macroprudential regulations, raised reserve requirements, and in the case of Brazil, reintroduced capital controls (Box 2.5).
Asset prices have generally recovered to precrisis levels.
Sources: Haver Analytics; and IMF staff calculations.Capital Inflows—An Aspect of “Good Times”
The recovery in global capital markets has been faster than anticipated, contributing to a positive short-term growth surprise in advanced economies, and easing external financing conditions for emerging markets. External bond issuance by emerging market sovereigns and corporations picked up in the second half of 2009, suggesting that access to international capital markets has normalized, and on several metrics (for example, EMBI spreads, market volatility), market conditions for emerging markets are close to or as easy as before the crisis. Amid very low U.S. Treasury base rates, on the one hand, the cost of external bond financing (as measured by yields) has dropped to near-record lows for stronger-rated emerging markets. On the other hand, the recovery of crossborder bank lending remains slow, as global banks continue to repair balance sheets.
LAC: External Bond Issuance
(Billions of U.S. dollars)
Sources: Dealogic; and IMF staff calculations.At the current juncture, both “push” and “pull” factors spur capital flows toward emerging economies with attractive risk profiles.
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“Push” factors arise from financial market developments—returning appetite for risk, ample global liquidity, and low interest rates in major economies.
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Besides structural factors, the multispeed global recovery also generates “pull” incentives for this capital flow pattern; emerging markets with good structural growth prospects and more advanced and broader-based cyclical recoveries are benefiting.
Indeed, portfolio and equity flows to several regions have recovered. Flows have picked up particularly to countries with good structural growth prospects in Asia and Latin America and to commodity exporters; Brazil has been particularly attractive, with net inflows of US$70 billion in 2009. At the same time, capital flows to Emerging Europe remain anemic.
The low cost of external financing and the possibility of accelerated capital inflows may pose some challenges, particularly in countries that are cyclically advanced. These include smoothing the foreign exchange and financial market volatility associated with inflows, avoiding an excessive appreciation of the exchange rate, reducing the probability of asset bubbles and credit booms, and avoiding potential overheating associated with “easy money” conditions. The latter two considerations are especially important for economies already close to operating at full potential (such as Brazil and Peru), but give less immediate reason to be concerned for countries with large economic slack (such as Mexico).
International Reserves
(January 4, 2007 = 100)
Sources: ECLAC; and Haver Analytics.Emerging market countries around the world have resorted to a variety of instruments to reduce risks associated with capital inflows.
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Exchange rates and reserves. Most emerging markets—including major Latin American economies—responded with a combination of exchange rate appreciation (which reduces incentives for capital inflows) and reserve accumulation (which strengthens buffers and can reduce volatility). Among the FCE, Brazil experienced the strongest increase in reserves—US$35 billion since capital flows picked up in mid-2009, against an increase of US$60 billion in the first half of 2007, even as the exchange rate in both episodes appreciated by about 10 percent. In Peru, reserves increased by US$4 billion since mid-2009—similar to the amount in the first half of 2007. However, the currency has appreciated about 5 percent in recent months, although it remained broadly stable in early 2007. In Colombia, the exchange rate appreciated about 10 percent with broadly unchanged reserves in recent months. The currencies of several major Asian economies (for example, India, Indonesia, and Korea) also appreciated since mid-2009 in real effective terms, even as these countries accumulated similar or smaller amounts of reserves than in the 2007 capital inflow episode.
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Prudential regulations. These instruments target slowing asset price or credit booms; and strengthening the financial sector’s resilience. For example, Hong Kong, Korea, and Singapore have recently taken steps to cool down the housing market, and China has raised reserve requirements and introduced measures to strengthen risk management in the banking sector. Among the financially integrated exporters, Peru has increased reserve requirements on short-term (less than 2 years) external loans, and Brazil announced it will raise reserve requirements on deposits after having lowered them during the crisis. In Mexico, pension fund regulations have been revised to increase flexibility in episodes of high volatility.
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Capital controls. Restricting inflows or reducing restrictions on outflows may help manage the situation (for example, Chile relaxed limits on foreign investments and foreign exchange hedging requirements for pension funds), although the effectiveness of some control measures may be lower in countries with substantially open capital accounts. Brazil has recently introduced a 2 percent tax on fixed income and equity inflows. On the other hand, Colombia has not reverted to its precrisis capital control measures that included unremunerated reserve requirements and minimum stay rules for FDI.
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Macroeconomic policy mix. So far, countries are still in recession-averting mode. But the speed of exit from supportive policies should vary significantly. Countries that are more cyclically advanced may need to withdraw fiscal stimulus faster than anticipated, and ahead of monetary stimulus, to manage possible risks from capital inflows.
Policy Challenges: Managing Good Times
With favorable external conditions and the economic recovery advancing faster than anticipated, the main policy challenge for the financially integrated commodity exporters will be managing the upswing of the economic cycle. The resumption of capital inflows and easy external financial conditions more broadly add further complexity to policy challenges in the years ahead.
Varying starting conditions will shape the needed pace of stimulus withdrawal. Output gaps are expected to nearly close in Brazil and Peru in 2010, but remain sizable in Mexico. In turn, economic slack may increase somewhat in Colombia, given idiosyncratic shocks (Figure 2.7).
Inflation gaps—the difference between expected and target inflation—are also projected to close in 2010. Inflation started to increase in recent months, partly reflecting a slow rise in food and fuel prices in line with higher world commodity prices. Headline inflation is expected to reach the midpoint of the inflation targeting bands by the end of 2010. In Mexico, one off effects from changes in taxes and administered prices will lead to a temporary increase in inflation above the midpoint of the band in 2010, before converging by 2011. In Colombia, disruptions arising from El Niño could bring inflation to the upper part of the target range.
Inflation gaps are expected to close in 2010.
FCE: Cycle in 2010
(Percent)
Source: IMF staff calculations.1/ Projected inflation at end-2010 minus inflation target for end-2010. In Mexico and Colombia, idiosy ncratics hocks account for temporary higher inflation in 2010. See main text for details.2/ GDP in 2010 minus potential GDP, in percent of potential GDP.Monetary policy remains highly stimulative. Following significant cuts in monetary policy rates during the crisis, central banks have kept rates unchanged, remaining below neutral levels in all financially integrated exporters. Markets are already pricing in rate increases in 2010.
The fiscal impulse implemented during the crisis is not expected to be fully withdrawn in 2010.8 As described in our last edition, the financially integrated commodity exporters were able to run countercyclical fiscal policies during this crisis, in marked contrast with previous episodes of global stress. In 2010, fiscal stimulus will be only partially reversed, except in Brazil and Mexico.9 In Chile, spending related to reconstruction would have an expansionary effect on fiscal policy. With fiscal revenues growing again, overall fiscal balances in the financially integrated commodity exporters are expected to improve, allowing a moderate reduction in debt (Figure 2.8).10
As economic activity recovers, and inflation and output gaps close, the stance of macroeconomic policies will need to return to neutral. As discussed in our earlier edition, given that the recovery in the region does not depend exclusively on public support, risks from withdrawing stimulus too early are not as severe as in the advanced economies. The faster recovery currently being forecasted reinforces this notion. Countries where output gaps are closing more rapidly will need to move to a tightening mode ahead of others. In general, fiscal stimulus should be withdrawn ahead of monetary stimulus.11
Easy external financial conditions pose additional challenges. As analyzed in more detail in Chapter 3, sustained periods of easy external financial conditions can lead to currency appreciation and loss of competitiveness, but that is only part of a broader picture. Perhaps more important risks of such conditions are that they can also lead to overheating, triggering and then fueling booms in domestic demand and credit, along with widening current account deficits. If not well managed, these trends could in time lead to the accumulation of significant vulnerabilities and risks.
Given the still sluggish recovery in bank credit in most countries, the risk of a credit boom may not be imminent, but growth of domestic demand is already robust in some countries. Policymakers need to plan ahead, as the current episode of easy external financial conditions may persist for some time, with effects that do not play out immediately, but can be very significant for the financially integrated exporting countries.
Although concerns over currency appreciation tend to be the most visible and politically charged, policymakers will need to focus beyond that one issue. Policies should be framed to address the broader risks from a demand boom, given the potentially damaging consequences. A macroeconomic policy mix favoring a tighter fiscal stance would be appropriate, helping also to stem appreciation pressures. In the context of bold stimulus policies during the crisis in 2009, policy mixes can be adjusted by reversing temporary fiscal impulse, creating room for monetary policy to be tightened somewhat more slowly than otherwise. Macroprudential policies should play an important complementary role in moderating the cycle and influencing risk-taking behavior in firms and households (see Chapter 3). Controls on capital inflows and foreign exchange intervention to resist currency appreciation can be part of the toolkit, but policymakers need to be mindful of their limitations—including that some approaches may backfire and attract more capital inflows.12
Monetary policy remains stimulative, whereas fiscal impulse will be partially withdrawn.
Source: IMF staff calculations.Easy external financial conditions also bring some opportunities. Access to cheap foreign money can help fill investment gaps and alleviate infrastructure bottlenecks. Easy external financial conditions also provide attractive options for deft public debt management. For example, Colombia recently issued an 11-year global treasury bond denominated in domestic currency—the first such sovereign issue since the onset of the global crisis.
Further Strengthening Policy Frameworks
The forthcoming good times provide an opportunity to solidify credibility and further strengthen policy frameworks.
On the fiscal front, rising fiscal revenues on account of the favorable commodity and economic cycle will test authorities’ resolve to implement countercyclical fiscal policy in good times. A fundamental goal should be to save revenue windfalls and rebuild buffers. This would ease fiscal constraints in future bad times. Second, fiscal frameworks could be refined to explicitly consider countercyclical provisions. Targeting cyclically adjusted fiscal balances is one option. Simpler expenditure rules may also work. Finally, there is a need to strengthen automatic stabilizers on the expenditure side. Improving the targeting, efficiency, and speed of additional spending during recessions is critical in this respect.
Flexible exchange rates proved an invaluable instrument to absorb the impact of recent external shocks. Further improvements in balance sheets would allow additional space for exchange rate swings without destabilizing effects, particularly in the more dollarized economies.
Gains in credibility allowed monetary policy easing during the crisis without undue risks to inflation expectations. But there are still open questions posed by the inflation performance of the financially integrated exporters in the run up to the global crisis, with fairly high inertia in some countries and a strong pass through from supply shocks in others. Higher world commodity prices and closing output gaps will likely start pressuring inflation. Ensuring that inflation expectations remain anchored would lower sacrifice ratios and reduce the need for significant tightening.
On macroprudential frameworks, important progress has been made. Challenges ahead remain concentrated in five areas in line with undergoing global initiatives (see Box 1.3): (i) broadening the perimeter of regulation to cover all systemically important institutions; (ii) strengthening the mandate for financial stability; (iii) improving consolidated supervision; (iv) reducing procyclicality; and (v) disclosing information and systemic risks with high transparency standards. 13
Tourism Intensive Commodity Importers (TIC)
Global Shocks Persisting
The severity of the crisis impact and the outlook for the tourism intensive, commodity importing countries diverges markedly from the pace of recovery projected for the rest of the region (Figure 2.9). While output in the rest of the LAC region declined by about 0.2 percent in 2009, it fell by more than 4 percent in these countries.14
With the economy still contracting, average inflation moderated to below 2 percent by end-2009, helped in part by collapsing food and energy import prices. The average current account deficit narrowed to roughly 20 percent of GDP (from around 25 percent in 2008), notwithstanding the acute shock to tourism revenues and indirect appreciation from exchange rates pegged to a strengthening U.S. dollar.
The global financial downturn spread to the tourism intensive economies through their tight links with advanced economies, and in particular, through Organisation for Economic Co-operation and Development (OECD) unemployment increases not seen in nearly three decades. Unemployment increased both in the United States and Europe. In contrast, Canada provided a welcome boost to regional tourist arrivals owing to its stronger economic performance during the crisis (see Chapter 1). The forecast in the October 2009 Regional Economic Outlook for year over year declines in tourism arrivals materialized at the lower end of the 10–15 percent range, albeit with significant heterogeneity. Tourist arrivals declined by double-digit rates in most countries, and as much as by 25 percent in St. Kitts and Nevis, but increased in Jamaica.15
Estimates of tourist arrivals to the tourism intensive commodity importers suggest that the impact of a 1 percent increase in OECD unemployment implies a contemporaneous decline of 4 percent in arrivals, on average (Box 2.6). For the current downturn, the approximate 3 percentage point increase in U.S. unemployment squares with the average 10 percent decline in Caribbean tourism.
Longer-term investments in the form of vacation real estate and other forms of tourism fell concomitantly with short-term vacation arrivals, as household wealth declined in the aftermath of the financial crisis. This is particularly costly for the tourism intensive importing countries, as median FDI (in percent of GDP) had tripled, from below 4 percent in 1996 to more than 16 percent of GDP by 2008. The importance can be observed in the concurrent declines in median unemployment in the region, from more than 16 percent in 1996 to single digits in the most recent years. With the onset of the crisis, FDI fell sharply to 10 percent of GDP in 2009.
Growth and inflation decelerated sharply.
TIC: GDP Growth
(Annual percent change)
Inflation Deceleration in the Tourism Intensive Commodity Importers
(Annual percent change, end of period)
Inflation Deceleration in the Tourism Intensive Commodity Importers
(Annual percent change, end of period)
| 2008 | 2009 | Difference | |
|---|---|---|---|
| Antigua and Barbuda | 0.7 | 2.4 | 1.7 |
| Bahamas | 4.5 | 1.3 | -3.2 |
| Barbados | 7.2 | 3.2 | -4.0 |
| Dominica | 2.1 | 3.2 | 1.0 |
| Grenada | 5.2 | -2.4 | -7.5 |
| Belize | 4.4 | -0.4 | -4.8 |
| Jamaica | 16.8 | 10.2 | -6.6 |
| St. Kitts and St. Nevis | 7.6 | 1.0 | -6.6 |
| St. Lucia | 3.8 | 1.0 | -2.7 |
| St. Vincent and Grenadines | 8.7 | -1.5 | -10.3 |
| Average | 6.1 | 1.8 | -4.3 |
Inflation Deceleration in the Tourism Intensive Commodity Importers
(Annual percent change, end of period)
| 2008 | 2009 | Difference | |
|---|---|---|---|
| Antigua and Barbuda | 0.7 | 2.4 | 1.7 |
| Bahamas | 4.5 | 1.3 | -3.2 |
| Barbados | 7.2 | 3.2 | -4.0 |
| Dominica | 2.1 | 3.2 | 1.0 |
| Grenada | 5.2 | -2.4 | -7.5 |
| Belize | 4.4 | -0.4 | -4.8 |
| Jamaica | 16.8 | 10.2 | -6.6 |
| St. Kitts and St. Nevis | 7.6 | 1.0 | -6.6 |
| St. Lucia | 3.8 | 1.0 | -2.7 |
| St. Vincent and Grenadines | 8.7 | -1.5 | -10.3 |
| Average | 6.1 | 1.8 | -4.3 |
Employment in advanced economies is expected to improve only gradually, with weak prospects for tourism in the coming years.16 This Regional Economic Outlook projects a modest increase in arrivals of approximately 5 percent in 2010. This, alongside weak FDI, implies a sluggish recovery for 2010 to virtually no output growth in the tourism intensive importers in the region, with unemployment hovering around present levels of 13 percent. Arrivals to more European dependent destinations will take longer to increase, given the expected delayed recovery relative to the United States. Should downside risks to the OECD materialize, the recovery in the tourism intensive importers could be delayed further (Figure 2.10).
The Impact of Employment Conditions on Tourism, and Tourism on Output
The crisis in OECD economies is transmitted to tourism intensive commodity importing countries in part through higher unemployment rates that reduce tourist arrivals. In principle, tourist arrivals are the result of individual decisions by OECD consumers that depend on factors such as employment conditions, savings rates, consumer confidence, and wage growth. Bilateral regressions of tourist arrivals and OECD unemployment suggest a heterogeneous impact within the tourism intensive importers. The weighted average elasticity for the tourism intensive importers is -4.5, which implies that an increase in the home country unemployment rate of 1 percent leads to a decline of approximately 4 percent in arrivals (see Romeu, IMF Working Paper, forthcoming). For example, the unemployment rate for the United States (the dominant OECD economy for the Caribbean) increased by 3.4 points from 5.8 percent in 2008 to 9.2 percent in 2009, implying a regional tourist decline of 13 percent, which is broadly in line with the observed decline.
The impact of declines in tourist arrivals on output growth varies within the region. Bilateral estimates are shown for the region (with the weighted average of these indicated by the horizontal line—see figures). After controlling for storms, output growth in OECD economies, and other factors such as the price of oil or changes in the value of the U.S. dollar, the elasticity of output with respect to arrivals is (in weighted average) 0.2. This implies that a decline in arrivals of 10 percent in a given year leads to a fall in GDP growth of -2 percent, all other things equal. These estimates suggest that falling tourist arrivals from the OECD contributed 2–2½ percentage points of the roughly 4 percent regional output decline observed in 2009. Panel estimation, which pools data across tourism intensive importing countries to find a joint estimate of the impact of deteriorating OECD employment, broadly confirms these results. The panel estimation suggests that arrivals drop by approximately 3 percent per unit increase in the OECD unemployment rate, whereas GDP contracts by approximately 1 percent for each 10 percent decline in arrivals. Jointly, these estimates suggest that roughly half of the decline in GDP in 2009 stemmed from increasing unemployment rates in the OECD.1
TIC: Growth in Tourist Arrivals and Output, 2009
TIC: Growth in Tourist Arrivals and Output, 2009
| Arrivals | GDP | |
|---|---|---|
| Antigua and Barbuda | -11.8 | -7.0 |
| Bahamas, The | -9.3 | -5.0 |
| Barbados | -8.6 | -5.3 |
| Belize | -5.2 | -1.1 |
| Jamaica | 3.6 | -2.8 |
| St. Lucia | -5.8 | -5.2 |
| St. Vincent and the Grenadines | -11.2 | -1.9 |
| St. Kitts and Nevis | -25.6 | -5.5 |
| Grenada | -10.4 | -7.7 |
| Dominica | -9.7 | -0.3 |
| Simple Average | -9.4 | -4.2 |
| Simple Average Excl. Jamaica | -10.9 | -4.3 |
TIC: Growth in Tourist Arrivals and Output, 2009
| Arrivals | GDP | |
|---|---|---|
| Antigua and Barbuda | -11.8 | -7.0 |
| Bahamas, The | -9.3 | -5.0 |
| Barbados | -8.6 | -5.3 |
| Belize | -5.2 | -1.1 |
| Jamaica | 3.6 | -2.8 |
| St. Lucia | -5.8 | -5.2 |
| St. Vincent and the Grenadines | -11.2 | -1.9 |
| St. Kitts and Nevis | -25.6 | -5.5 |
| Grenada | -10.4 | -7.7 |
| Dominica | -9.7 | -0.3 |
| Simple Average | -9.4 | -4.2 |
| Simple Average Excl. Jamaica | -10.9 | -4.3 |
Impact of Tourist Arrivals on GDP
Sources: Caribbean Tourism Organization; and IMF staff calculations.Impact of Unemployment on Tourist Arrivals
Sources: Caribbean Tourism Organization; and IMF staff calculations.Differences in economic conditions in the originating countries can help to further explain developments in tourism in the region. The four groups of OECD visitors to the tourism intensive importers used here are Canada, the United States, Europe, and the rest (labeled “other”), which in many of the tourism intensive importers largely reflects visiting expatriates living in the OECD. Canada’s relatively strong performance (see Chapter 1) during the crisis, and in particular, the strength of its labor market, led to positive growth in tourism in 2009. This was an important countercyclical flow for some of the tourism intensive economies; and countries among the tourism intensive importers (as well as within the broader Caribbean) that were positioned to receive Canadian tourism fared much better in terms of arrivals during this crisis. For example, in Jamaica, Canada was the major driver of growth for arrivals in 2009.
Tourism from European economies declined across the board during the crisis, owing in part to slightly larger increases in unemployment compared with Canada. In the future, this could represent a vulnerability for the region, as tourism from Europe during this crisis declined by more than 1 percent on average for individual economies—more than twice the rate of U.S. declines to the region (see lower figure) despite a larger observed increase in U.S. unemployment—and Europe as a region did not increase its arrivals to any tourism intensive economy in 2009. U.S. arrivals to the region declined as a whole, but increased to some destinations, including Jamaica. Finally, regarding visits from the residual category of “other” OECD countries, more detailed arrival statistics (where available) and anecdotal evidence suggest that a significant part of these visits are conducted by expatriates of the tourism intensive countries. One unemployment proxy for this subgroup is the U.S. unemployment rate for Hispanics. Despite showing the largest increases in unemployment of the four subgroups (and double that of Canada and Europe), “other” arrivals to the tourism intensive countries recorded the lowest declines in arrivals in 2009, owing in part to the strong links to these economies.
Note: This box was prepared by Rafael Romeu. 1 System estimation, which controls for the endogeneity of shocks across arrivals and GDP from exogenous factors—such as natural disasters that would both lower arrivals and lower output growth but are unrelated to OECD unemployment—confirms further the robustness of these results.Tourism and FDI remain depressed.
Sources: Caribbean Tourism Organization; Haver Analytics; and IMF staff calculations.Financial sectors in these countries have felt substantial pressure from both internal and external shocks. Externally, regional offshore financial sectors have come under greater international scrutiny as the fallout from the global financial crisis combined with greater pressure to close regulatory loopholes and, in some cases, outright fraud. Offshore Financial Centers (OFCs) have been required to comply with increasingly tighter international standards (spearheaded by the G20) in the fiscal/tax and financial/regulatory areas. In the future, country regulators and financial market participants will need to adapt to remain classified as countries meeting the minimum international standards. While costly, these initiatives will strengthen the existing OFCs in the long term, hence maintaining their beneficial impacts on the domestic tourism intensive economies, including (moderate) fiscal revenues and associated tourism.
In addition to this external pressure, the tourism intensive countries have faced financial shocks emanating from within the region:
-
The January 2009 collapse of the Trinidad and Tobago-based CL Financial Group sent shock waves throughout the Caribbean that are continuing to reverberate. Low debt and high reserves permitted Trinidad and Tobago to bail out three domestic subsidiaries at a cost of US$850 million (about 3.8 percent of GDP). However, higher exposure combined with high debt levels in several countries in the rest of the Caribbean pose significant challenges in dealing with the problems created by the group’s insurance subsidiaries, the Colonial Life Insurance Company (CLICO) and the British American Insurance Company (BAICO). Estimates of exposure to the two companies range as high as 17 percent of the Eastern Caribbean’s combined GDP. The extent of the subsidiaries’ financial distress varies across the region, with ECCU countries particularly vulnerable as funding gaps in that area account for larger shares of GDP.
-
The Caribbean has also experienced an episode of Ponzi schemes. In February of 2009, the U.S. Securities and Exchange Commission charged Robert Allen Stanford and three of his companies for orchestrating a fraudulent, multibillion dollar investment scheme. This scheme is at the center of the collapse of the Stanford Financial Group in Antigua and Barbuda and the intervention of the Bank of Antigua.
Both experiences point to the need to improve financial regulation and crossborder cooperation.
Policy Challenges: Ensuring Fiscal Sustainability amid Low Growth
The slow expected recovery in the tourism intensive commodity importers will test the resolve of policymakers, as existing vulnerabilities—combined with particularly elevated debt levels and limited financing—will impose strong constraints on policies despite prolonged recessionary conditions (Figure 2.11).
The foremost challenge for authorities will be to manage fiscal policy in 2010, including in some cases a further withdrawing of fiscal stimulus, despite the difficult economic environment. Cuts in average primary expenditure are expected to be in the order of 0.5 percent of GDP in 2010, with a withdrawal of fiscal impulse of about 1.5 percent of GDP on average for tourism intensive importers. Hence, although some limited fiscal relief was available in 2009, binding resource constraints will likely force a withdrawal of this stimulus in the future.
Given limited borrowing opportunities constraining fiscal policy, and fixed exchange rates limiting monetary policy, it is imperative to continue with structural reforms that unlock potential growth through higher productivity, as well as strengthen social safety nets that protect the most vulnerable and explore options for diversifying sources of growth.
The balance of risks faced by the tourism intensive commodity importers include a potential rebound in commodity prices, the dependence on bilateral concessional assistance from Venezuela’s PetroCaribe, and further real shocks in 2011.17 A high dependence on energy imports would put added pressures on external accounts, as higher oil and other commodity prices outweigh benefits from regional exports (such as sugar, bauxite, and bananas). PetroCaribe has helped finance part of the oil imports, and hence, any potential altering of the program’s terms could open a new regional vulnerability.
The global crisis has further inflated debt levels.
Sources: IMF, World Economic Outlook; and IMF staff calculations.Finally, the risk of further real shocks in 2010 is low, but could increase in 2011 as the stimulus is wound down in advanced economies. Knock-on increases in sovereign yields from the near doubling of OECD national debts in the coming years could generate renewed financial pressure on the tourism intensive importers. International investors are increasingly focusing on long-term debt sustainability (see Box 2.1), and high debt levels in the tourism intensive commodity importers, where some of the world’s historically most indebted countries reside, pose important challenges.18 Furthermore, with weakening access to international sources of financing, recourse to domestic banks has accentuated existing vulnerabilities and hampered the prospects for a swift debt resolution process in some of the tourism intensive countries.
In this difficult environment, countries have engaged the IMF in new programs. The recent program in Jamaica is illustrative of the substantial support provided by the IMF in response to the global financial crisis.19 Dominica, St. Lucia, and St. Vincent and the Grenadines also received IMF financial support through the IMF’s exogenous shock facility, in response to the deteriorating external environment and its impact on tourism and GDP. In Grenada, the IMF recently approved a successor Extended Credit Facility program; and in St. Kitts and Nevis, the IMF has provided support through its Emergency Assistance for Natural Disasters facility. IMF staff also reached agreement on a program with the Antiguan authorities through a Stand-By Arrangement. Finally, the IMF’s Caribbean Regional Technical Assistance Centre (CARTAC) launched a Financial Literacy Public Education program in response to the worldwide economic crisis. The ECCU has also stepped up crisis efforts, including the recently announced eight point transition program to stabilize the region, while efforts by the Caribbean Community (CARICOM) are ongoing to establish a College of Regulators to enhance regional financial surveillance.
Other Commodity Exporters (OCE)
Riding the Commodity Cycle
Higher commodity prices and the rebound in global trade are supporting the recovery in many of the other commodity exporting countries. Alongside these direct effects, indirect spillovers from the strong economic performance in one of the major regional economies—Brazil—are further helping growth among neighboring countries, including in Argentina, Bolivia, and Paraguay.20 Hence, in considering the role of policies during the recent downturn, it is also important to recognize auspicious exogenous factors in the future.
As noted in the October 2009 Regional Economic Outlook, some of the countries in this group weathered the global crisis relatively well, while others suffered significant declines in activity and trend growth. For 2010, average growth for the group is expected to recover to 2.7 percent, after a decline of 0.6 percent in 2009. Nevertheless, a fast recovery in Bolivia and Paraguay contrasts markedly with still-contracting economic activity expected in Venezuela.
For 2010, average inflation for the group is expected to increase to 9.5 percent (from about 6.5 percent in 2009). In Bolivia, Paraguay, and to some extent Suriname, inflation could become a concern as demand picks up and growth gains momentum. The potential for resurging inflation is also underscored by double digit real increases in measures of domestic liquidity over the last twelve months, particularly in Bolivia and Paraguay. Moreover, although output gaps in these three countries remain negative, they are small on average. Importantly, while trend growth declined by about 1.2 percent since 2007 on average for the whole group—or double the decline in the rest of the LAC region—it remained broadly stable and robust in Bolivia, Paraguay, and Suriname, where positive prospects are likely to fuel FDI in key sectors (Figure 2.12).21
In some countries in the other commodity exporters group, a deteriorating private sector investment climate has further aggravated supply constraints, while accelerating inflation. Should recent declines in trend output growth continue ahead, as supply expands slowly, some of these countries will face either stagflation or high inflation under even moderate output growth. In addition, some of these countries recently conceded investment opportunities to foreign firms while at the same time nationalizing foreign production assets. The higher premiums required to do business in volatile investment environments are likely to continue constraining growth and pushing up prices. Hence, for those affected countries, the need to enact structural reforms aimed at fostering and diversifying economic growth is increasing.
Policy Challenges: Avoiding the Perils of Procyclicality
Fiscal policy responses differed markedly during the crisis. On average, the group of other commodity exporters had a procyclical fiscal stance, with a negative fiscal impulse of about 1 percent of GDP. Some countries managed to implement countercyclical policies to help cushion the impact of the crisis.22 But some of the other commodity exporters resorted to procyclical budget cuts to weather declines in public sector revenue exceeding 10 percent of GDP in 2009. In some countries, significant expenditure increases during commodity booms exhausted the possibility of smoothing the external shocks during the crisis (Box 2.7). In the future, effective demand management and long-term fiscal consolidation will be essential to avoid the procyclicality that has marred economic performance in the past.
Losses in trend output and inflation pressures differ markedly across other exporters.
Sources: Haver Analytics; and IMF staff calculations.Without conventional stabilizing policy options, some economies resorted to unorthodox measures, such as reserves transfers from central banks, nationalizations (of banks, pension funds, and private sector companies), and devaluation combined with multiple exchange rates to adjust to declining commodity revenues. Crisis management continued to reflect long-standing and predictable issues owing to the absence of a macroeconomic anchor or a cycle dampening policy framework.
Fiscal Performance and Commodity Cycles: Not a Standard Amusement Ride
Commodity prices are firming up, and countries with sizable commodity exports could receive significant windfalls. These windfalls can be temporary. Some countries in the region, however, have had a pervasive behavior of fiscal spending reacting strongly to commodity shocks.
In this box, we assess the dynamic response of fiscal indicators to commodity price swings in the major commodity exporters of the LAC region and in some advanced commodity exporters. We estimated VARs based on quarterly data for the period 1994–2008.1 We find that total revenues do not respond very differently across countries to commodity price shocks. However, estimates of primary expenditure responses suggest that, although some Latin American countries behave in a similar fashion to those high-income countries that have cemented fiscal prudence, others react strongly to commodity price shocks. At one end of the spectrum is Chile, which behaves similarly to the high-income commodity exporting countries, such as Australia, Canada, and Norway. At the other end of the spectrum is Venezuela, where expenditures rise even more than proportionally to revenues when faced with a commodity price shock.
The current crisis has shown that countries that had secured enough political consensus for the application of more prudent fiscal frameworks entered the crisis better prepared, in particular owing to the accumulation of large fiscal buffers during good times. This is particularly important for countries with a large proportion of commodity-related revenues in total revenues, as fiscal revenues in such countries tend to be more unpredictable, with commodity price gaps not necessarily coinciding with domestic output gaps.
Commodity Prices Boom, Bust, and Recovery 1/
(U.S. dollar; index 2005 = 100)
Source: IMF staff calculations.1/ Soy: Chicago soybean futures contract; Copper: LME spot price; and Oil: crude oil simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh.2/ A standard deviation price shock goes from 8 percent for Brazil to 16 percent for Venezuela. Lines stand for 1 standard deviation confidence intervals.Going Back to Financial Markets?
The need to manage foreign exchange will be important in some of the other commodity exporters that currently have lesser access to external financial markets (Figure 2.13). The average current account balance for the whole group is expected to recover from 2.9 percent of GDP in 2009 to about 4.5 percent in 2010—an important source of external financing. Nevertheless, large amortization payments are coming due, in particular for Ecuador (more than 25 percent of existing reserves in 2010 and again in 2011).23 In Venezuela, although amortization needs are smaller, foreign exchange pressures could arise from the continuing sizable capital outflows, which in 2009 exceeded US$20 billion, and is equivalent to two-thirds of central bank reserves or 40 percent of oil exports.
So far, foreign exchange management in some countries has included import restrictions, export taxes, financing from the Corporación Andina de Fomento (CAF), the Inter-American Development Bank (IADB) and other multilateral funds, and bilateral over-the-counter East Asian loans largely tied to natural resource exploitation. Nevertheless, some of the other commodity exporting economies will need traditional capital market inflows in the medium term. In some of these countries, tapping external markets may prove costly and difficult, as average sovereign spreads exceeded 600 basis points in 2009. Furthermore, potential sources of credit are limited because of outstanding disputes over past debt defaults. 24 In some countries, completion of the regular Article IV policy consultation with the IMF could facilitate access to international financial markets.25
Procyclicality and external financing pressures pose important challenges.
Sources: Bloomberg, L.P.; national authorities; and IMF staff calculations.Other Commodity Importers (OCI)
Traveling the Middle Ground
Not without some heterogeneity, a gradual recovery is under way in the other commodity importers. Economic activity seems to have bottomed out by the end of 2009, with growth picking up most strongly in the Dominican Republic, Panama, and Uruguay. In El Salvador and Honduras, economic activity finally stopped contracting (Figure 2.14). In Haiti, the powerful earthquake had devastating effects, with sizable human and economic losses (see Box 2.3). In 2010, average growth in the whole group is expected to rise to about 2 percent, from 0.8 percent in 2009.26
The external environment for other commodity importing countries remains mixed. Faster than previously forecasted U.S. growth is providing some impetus to exports. However, workers’ remittances continue to post significant declines on an annual basis, reflecting weak employment in the U.S., particularly for Hispanics and in the construction sector. The pickup in commodity prices is also a negative shock for these countries, with energy import bills starting to rise. All these factors combined are projected to widen the average external current account deficit to 7 percent of GDP in 2010, from about 4 percent of GDP in 2009.
Credit growth has been sluggish. Bank deposits keep growing, and lending rates have declined, signaling continued normalization in domestic financial markets. Credit, however, is picking up modestly and only in a few countries (for example, Dominican Republic and Uruguay). Moreover, cross-border bank lending continued to contract through the third quarter of 2009.
Notwithstanding the sharp deceleration in growth, financial systems in other importing countries weathered the global crisis relatively well overall. Financial soundness indicators point to some deterioration in credit quality, but banks’ capital adequacy ratios remain at comfortable levels.
A gradual recovery is under way amid a mixed external environment.
1/ Excludes Guyana, Haiti, and Uruguay.Sources: National authorities; and IMF staff calculations.Policy Challenges: Replenishing Buffers
Downside risks in the global recovery in 2011 and beyond call for prudent macroeconomic policies in the other commodity importing countries, even if growth does not recover at the same pace as in some other countries in the region.
In many countries, fiscal policy provided needed support to economic activity during the peak of the crisis (Figure 2.15). On average, other commodity importers implemented a fiscal impulse of about 1 percent of GDP in 2009.27 But buffers have been mostly depleted. In most countries, public debt levels are not alarmingly high, but limited financing possibilities constrain options for substantial further stimulus in 2010. Any remaining fiscal space would be more appropriately saved in case downside risks to global growth materialize down the road. Countries where growth is already on strong footing (for example, Uruguay) would benefit from a tighter fiscal stance.
Substantial economic slack and low commodity prices contained inflationary pressures during 2009. However, inflation has started to pick up in recent months. In many cases, the pickup in inflation is being driven by high food and fuel prices, whereas core inflation has been stable. In Uruguay, however, inflation expectations and core inflation are edging above the inflation target range.
For 2010, inflation is projected to increase to about 5 percent on average. However, the pass-through from commodity prices was significant in the past. With commodity prices recovering, there could be upside risks to inflation, particularly in those countries where domestic demand is growing relatively fast.
Policy buffers need to be replenished given global downside risks in 2011 and beyond.
1/ Increase denotes appreciation.Sources: National authorities; and IMF staff calculations.Moving toward more flexible exchange rates, where possible, would serve as a cushion against potential future external shocks. In some countries, limited exchange rate flexibility constrained the room for more aggressive cuts in monetary policy rates during the crisis.
The IMF continues to engage fully in the region. In Costa Rica, El Salvador, and Guatemala, high access Stand-By Arrangements have bolstered international confidence during the global crisis. The Dominican Republic also signed a high access Stand-By Arrangement to support reserves, countercyclical fiscal stimulus, and social safety nets. In Honduras, the IMF has reengaged in discussions after the international community recognized the newly elected president, and is also continuing work with Nicaragua on its Extended Credit Facility. The IMF also made substantial efforts in working with Haitian authorities after the devastating earthquake in January (Box 2.3).
Concluding Remarks
The LAC region is recovering from the global financial crisis somewhat faster than anticipated. Still, there is considerable heterogeneity across countries. While growth in many of the region’s commodity exporters is gaining momentum, it is proceeding at a weak pace for other countries in the region, especially those more reliant on tourism from advanced economies.
For many of the financially integrated commodity exporters, the challenge in coming years will be managing the upswing of the business cycle. Countries where output gaps are closing more rapidly will need to move to a tightening mode ahead of others. Easy external financial conditions and the resumption of capital inflows pose additional challenges. Careful macroeconomic management will be critical to mitigate risks of boom/bust cycles. In this context, a policy mix favoring a tighter fiscal stance would be appropriate, helping to mitigate risks from overheating while also stemming currency appreciation pressures.
The weak recovery in the tourism intensive commodity importing countries will test the resolve of policymakers, as elevated debt levels and limited access to financing will impose difficult policy tradeoffs. Efforts to protect vulnerable groups and unlock growth potential through structural reforms should be priorities in the policy agenda.
For some of the other commodity exporting countries, policy challenges will include avoiding the perils of procyclicality, anchoring macroeconomic policies, and regaining access to financial markets. Other commodity importing countries are gradually recovering, boosted by higher exports, but inflows from remittances continue to contract. In many of these countries, the room for macroeconomic stimulus has been almost depleted and should be prudently saved for downside risk scenarios.
The LAC region has continued to benefit from the IMF’s lending facilities. By April 2010, the IMF had committed 42 billion SDRs to countries in the region, an increase of 2 billion since the last edition of the Regional Economic Outlook: Western Hemisphere. This represents more than 35 percent of IMF total commitments to its members around the world, in large part reflecting access under the IMF’s new Flexible Credit Line (FCL) received by Colombia and Mexico.28 Owing to strong external positions, most countries in the LAC region have not drawn on their IMF loans, but treated them as precautionary to boost international confidence throughout the global crisis and the ongoing recovery.
Note: This chapter was prepared by Ana Corbacho and Rafael Romeu, with inputs from Jorge Iván Canales-Kriljenko, Gabriel Di Bella, Herman Kamil, Kornelia Krajnyak, Leandro Medina, Ben Sutton, and Secil Topak.
Regional growth has averaged 2.5 percent since the 1980s, before accelerating to more than 5 percent during the boom period 2004–07.
These estimates are derived from the IMF’s BVAR regional model for Latin America, comparing the forecast under different scenarios: (i) the one prevailing in the October 2009 Regional Economic Outlook; (ii) a scenario that incorporates historical data revisions; (iii) a scenario that incorporates actual outcomes in the second half of 2009; and (iv) the current scenario that incorporates the latest forecasts for the external environment.
The analytical groupings aim to capture structural differences across the economies and do not imply country rankings.
Quasi-fiscal stimulus from public banks in Brazil is estimated at more than 3 percent of GDP in 2009, higher than fiscal stimulus channeled through the budget.
While credit to the private sector from public sector institutions accounts for about 40 percent of total credit in Brazil, it represents less than 10 percent of total credit in Mexico.
For example, Brazil has now unwound almost all of the emergency foreign exchange liquidity facilities implemented during the crisis. These included direct U.S. dollar loans against collateral, U.S. dollar swap lines to exporters, and the sale of U.S. dollar futures.
The fiscal impulse is defined as the change in the domestic cyclically adjusted fiscal balance (that is, excluding commodity-related fiscal revenues and foreign grants), and measures the impact of discretionary fiscal policy on domestic demand. See the October 2009 Regional Economic Outlook: Western Hemisphere, Chapter 4, for further details.
In Mexico, the withdrawal of fiscal stimulus in 2010 reflects the authorities’ goal to ensure medium-term sustainability given an expected structural decline in oil revenues.
In Colombia, revenues as a percent of GDP are expected to fall in 2010, owing to lower oil-related revenues linked to low international fuel prices in 2009.
The general recommendation is that fiscal policy should return to a neutral or passive role in the management of the demand cycle, also facilitating the conduct of monetary policy.
Heavy intervention in the foreign exchange market to stem nominal appreciation may have the unintended consequence of attracting more capital inflows, by stirring expectations for further appreciation and reducing the volatility of the exchange rate as authorities lean against the wind. This can exacerbate the ensuing credit and domestic demand boom, resulting in overheating and an increase vulnerabilities in the financial sector. Notwithstanding initial efforts to mitigate appreciation and protect the export sector, domestic inflation will pressure the real exchange rate.
For a detailed assessment of the current state and challenges in financial regulation, see Rennhack and others (2009).
Simple average across countries.
The recovery from recessions led by financial crises tends to be slow (see Chapter 3 of the April 2010 World Economic Outlook). Unemployment in the United States—by far the largest client country in the Caribbean—is projected to remain above 9 percent for the current year.
For details on PetroCaribe, see Box 2.8 in the October 2008 Regional Economic Outlook: Western Hemisphere.
See IMF (2005) on debt in the Caribbean.
Jamaica’s 27-month Stand-By Arrangement (SBA) is for US$1.3 billion, half of which was disbursed upfront and earmarked for the Financial Sector Fund. This fund was established to provide liquidity support to financial institutions in the event of problems directly related to Jamaica’s debt exchange. The debt exchange achieved a 99.2 percent participation rate, and led to interest savings of 3.5 percent of GDP and a 65 percent reduction in maturing debt payments over the next three years. The SBA paved the way for US$1.1 billion in financing from other multilaterals over the next two years.
The spillovers are also visible in Uruguay, which is discussed in the next section.
Estimates of trend output were obtained by setting the smoothing parameter of a Hodrick-Prescott (HP) filter at different values (6, 10, 100, and 250). To avoid the end-of-period bias, the filter was applied to series that include forecasts through 2011. See Chapter 4 of the October 2009 Regional Economic Outlook: Western Hemisphere.
For instance, the fiscal impulse in Paraguay and Suriname exceeded 2 percent of GDP, and in Bolivia, sustained growth justified maintaining their prudent fiscal stance.
Close to one-half of Ecuador’s 2009 amortization consisted of buybacks of defaulted external debt.
The Congress of Argentina reopened the debt restructuring process, and an offer has been made for bond holdouts.
Policy consultations between the IMF and each member are set forth in Article IV of the IMF Articles of Agreement. Currently, there are only four nonprogram member countries that have not had an Article IV consultation with the IMF within the regular period: Argentina, Ecuador, Somalia, and Venezuela.
Economic indicators for Haiti are not averaged with the rest of the other commodity importers, given the sizable impact of the earthquake.
There were significant differences, with a fiscal impulse of more than 3 percent of GDP in Costa Rica and a negligible one in Nicaragua.
