Journal Issue

LATAM Outlook: Latin America: Still Resilient, but Risks Ahead

International Monetary Fund. External Relations Dept.
Published Date:
May 2008
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Deteriorating global economic conditions will present the first major test of the improved macroeconomic policy frameworks that most Latin American and Caribbean (LAC) countries have put in place during the past decade, the IMF said in its Regional Economic Outlook for the Western Hemisphere.

Much of Latin America enjoyed strong growth between 2002 and 2007—the best sustained performance since the 1970s—because of the strong policy frameworks and favorable global economic conditions. With the exception of a handful of countries, that growth was accompanied by relatively modest inflation.

But in response to a tightening of financial markets and a slowdown in growth in the advanced economies, the IMF projects that economic growth in the region will fall from about 5.6 percent last year to 4.4 percent in 2008 and 3.6 percent in 2009 (see table). At the same time, inflationary pressures that began in 2007 as a result of strong domestic demand and rising world food and energy prices will persist.

Risks to the growth outlook are skewed largely to the downside. Among them are a fall in exports if global growth slows more than expected or persistent inflation pressures, which could lead to difficult policy choices.

“Navigating this period of financial turbulence and heightened uncertainty is the key near-term policy challenge,” said Anoop Singh, Director of the IMF’s Western Hemisphere Department.

Region better placed

“The region is better placed than in the past to absorb the sharp slowdown foreseen in global growth,” the IMF noted in its report. The high level of reserves coupled with strong banking systems, lower public debt levels, reduced public sector financing requirements, and generally flexible exchange rates provide Latin America with more room to deal with adverse global developments than in the past.

One major plus, so far at least, has been the stability of money and bond markets in Latin America despite the turmoil in financial markets in the advanced economies. Still, the region has not totally escaped the problems roiling global credit markets, in which that had their roots in the subprime mortgage market in the United States.

Possibly weakening external surpluses

The slowdown in global growth, which could be worse than expected, could hurt Latin America by reducing demand for its exports and bringing down the prices of many of the commodities that Latin American countries sell abroad. International prices for the LAC region’s main commodity exports “have in aggregate risen by 150 percent since 2003.”

Strong current account surpluses (which measure trade in goods and services and profits and interest payments), a major source of strength in recent years, also began to weaken in 2007, because high import growth outpaced export growth in many major countries such as Argentina, Brazil, Colombia, and Venezuela. The external current account surplus, about 1½; percent of GDP in 2006, registered a small surplus in 2007, but is expected to slip into a small deficit in 2008. Moreover, strong capital flows are expected to moderate this year As a result, LAC countries will accumulate international reserves at a slower pace than last year. Although projected to be $500 billion (12½; percent of GDP) at year’s end, they are quite high by historical standards and provide a strong buffer against adverse international developments.

Growth decelerates

Real GDP is projected to continue to grow in Latin America, although it will slow in 2008 and further in 2009.

(real GDP growth; annual rate, percent)1

Latin America and the Caribbean2.
South America2.
Central America3.
The Caribbean4.
Source: IMF, World Economic Outlook; and staff estimates.

Inflation pressures remain

Inflation in the region rose from about 5 percent in 2006 to 6 percent last year and is expected to remain at that level in 2008, with some countries exhibiting inflation much higher than that.

The run-up in international prices of fuel and, especially, food prices has been particularly troubling because of the strong “impact on the poor, especially in the low-income countries,” the IMF said. One of the important effects of the good growth and inflation performance in the LAC since 2002 has been a marked reduction in poverty and some reversal of income inequality.

External food and fuel inflation explains about 30 percent of domestic inflation, according to the IMF analysis. Much of the rest is explained by “excess demand pressures,” the IMF said.

In some countries, those demand pressures have been exacerbated by strong procyclical government spending, which began to outpace revenue growth in 2007, reducing structural balances. “Primary fiscal balances in the region are expected to fall to about 2.4 percent of GDP in 2008—down from the historical peaks of about 3.5 percent of GDP in 2005–06—with public debt falling slightly to 48 percent of GDP,” the IMF said.

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