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Regional Focus: Risk Scenarios Latin America: Better able to Cope with Adversity

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
May 2007
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Latin America has been growing at its fastest sustained pace in more than three decades. Part of that success is attributable to solid economic policies, but part is due to benign external factors: strong global growth, high commodity prices, and favorable financial conditions.

The IMF’s World Economic Outlook (WEO) predicts a continued favorable external environment that would result in at least another two years of solid growth in Latin America, with real GDP increasing a little less than 5 percent in 2007 and 4¼ percent in 2008. But because Latin America has traditionally been sensitive to global conditions—the IMF estimates that about half the medium-term variance in Latin American growth since the mid-1990s can be attributed to external factors—the Fund’s Western Hemisphere Department sought in its regional economic outlook to quantify that sensitivity. It developed a model that encompasses six of the region’s biggest economies—Argentina, Brazil, Chile, Colombia, Mexico, and Peru—which together account for 90 percent of Latin American output, a group it called the “LA6.”

The model projected that Latin American growth would not suffer too much from changes in the external environment that might happen with reasonable probability over the medium term. But real GDP growth would be more seriously damaged were there to be a sharp deterioration in credit conditions, a big decline in commodity prices, or if world economic growth were dramatically lower than projected—events the IMF deemed very unlikely.

Assessing sensitivity to external shocks

Using the WEO as a base, the IMF identified four types of risks from outside the region:

  • A moderate deviation from the world growth forecast, either up or down.

  • A sharp decline in world growth, a scenario given a low probability that would probably occur were there a “disruptive unwinding” of global imbalances.

  • Declines in the prices of nonfuel commodities greater than envisioned in the WEO forecast.

  • A big tightening of world credit conditions—probably triggered by a global retreat from risk, an emerging market crisis, or some other shock that would cause rates on emerging market debt to rise substantially.

Of the three growth scenarios, “only the sharp world slowdown would have a significant impact on Latin American growth,” the IMF concluded. Even a bigger-than-expected slowdown in the United States “would have a muted impact on LA6 growth” (see Chart 1). But a “disruptive adjustment of global imbalances,” although considered highly improbable, “would not only have stronger effects through trade links, but would also be expected to lead to sharply higher risk and maturity” premiums in the United States. In that case, the model forecasts a severe slowdown in Latin growth to about 2¾ percent this year and 1½ percent next (see Chart 2).

Chart 1A moderate slowdown

Real GDP growth in LA61 countries would not be affected significantly if global growth were slightly below forecast.

Citation: 36, 8; 10.5089/9781451938388.023.A004

(percent)

Sources: IMF, World Economic Outlook 2007, and staff calculations.

1 The LA6 countries are Argentina, Brazil, Chile, Colombia, Mexico, and Peru.

Chart 2If the global economy plummets

Real GDP growth in LA61 countries would be severely affected if world growth were substantially below forecast.

Citation: 36, 8; 10.5089/9781451938388.023.A004

(percent)

Sources: IMF, World Economic Outlook 2007, and staff calculations.

1 The LA6 countries are Argentina, Brazil, Chile, Colombia, Mexico, and Peru.

The IMF model paints a similar scenario for commodity prices, a major source of Latin American growth for the past three years that the WEO already forecasts will moderate slightly. Latin America could weather even a 20 percent decline. Growth would slow, but would still be robust at about 3½ percent to 3¾ percent this year and next (see Chart 3). A 50 percent decline, however, “would lead to a severe slowdown, of almost the same magnitude as a disruptive unwinding in global imbalances.” LA6 growth would fall to an average of 3 percent this year (worse in the last half) and 1¼ percent in 2008.

Chart 3Commodity price impact

Sources: IMF, World Economic Outlook 2007, and staff calculations.

1The LA6 countries are Argentina, Brazil, Chile, Colombia, Mexico, and Peru.

A financing shock in the form of a 400-basis-point rise in emerging market bond spreads and a 200-basis-point increase in the U.S. high-yield bond spread would also seriously damage LA6 growth, “but by less than either a global crisis or a 50 percent drop in commodity prices” (see Chart 4). Growth would fall to just under 3 percent this year and 2¾ percent next.

Chart 4Financing shock

If credit conditions deteriorate, real GDP growth in LA61 countries would suffer, but not as badly as during a sharp global growth decline or a 50 percent falloff in commodities’ prices.

Citation: 36, 8; 10.5089/9781451938388.023.A004

(percent)

Sources: IMF, World Economic Outlook 2007, and staff calculations.

1The LA6 countries are Argentina, Brazil, Chile, Colombia, Mexico, and Peru.

Because the external environment has been so benign for so long, the IMF economists concluded that, overall, the risk that growth will deviate from projections is “moderately tilted to the down side.” Some, although improbable, risks could lead to much lower-than-projected growth, while there is “no offsetting scenario…that involves much higher growth in the short run.”

The report concluded that reducing Latin America’s vulnerability to shocks “requires additional efforts to lower public debt, make budgets and exchange rates more flexible, strengthen financial systems, and diversify its export structure.”

Copies of Regional Outlook: Western Hemisphere, April 2007, are available for $31.00 each from IMF Publication Services. Please see page 128 for ordering details. The full text is also available on the IMF’s website (www.imf.org).

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