2. Latin America and the Caribbean: Developments and Outlook
- International Monetary Fund. Western Hemisphere Dept.
- Published Date:
- October 2009
The LAC region is doing considerably better than in past crises, but there is growing heterogeneity within the region. External shocks to remittances and tourism are still playing out and will continue to affect countries in Central America and the Caribbean. In contrast, some of the larger economies have already bottomed out. These varying output dynamics, coupled with differing room for policy maneuver, are shaping policy challenges in the near term. In addition, long-lasting legacies from the global crisis will have significant implications for the region.
External Shocks Fading at Different Speeds
As documented in the May 2009 Regional Economic Outlook, starting in the last quarter of 2008 the LAC region was hit by severe and wide-ranging external shocks.1 The cost of external borrowing spiked and capital flows turned negative. Exports collapsed owing to a combination of lower commodity prices and plunging volumes on other exports. Remittances and tourism receipts fell. Remittances and tourism receipts fell. Uncertainty mounted.
In the past six months, as fears of a 1930s-style scenario subsided, conditions have generally improved (Chapter 1). Financial markets stabilized, and asset and commodity prices recovered sharply in the second quarter of 2009. More recently, demand for noncommodity exports seems to be picking up, albeit slowly. But tourism and remittances, more dependent on consumption and employment conditions in advanced countries, are lagging (Figure 2.1).
Figure 2.1.External demand for goods is likely to recover sooner than that for tourism and remittances, given weak employment and private consumption in advanced economies.
Source: IMF staff calculations.
1/ Remittances and tourism are four quarter moving averages.
This mixed external environment will have different implications for countries across the LAC region. To illustrate these differences, we divide the region into four country groups (Box 2.1). These groups aim to capture the countries' varying exposures to external shocks.
With low volatility in financial indicators, the region’s financial heat map has returned to mostly green by now (Figure 2.2). But there are differences across countries. The hike in corporate and sovereign spreads and yields has been completely reversed for the better-rated countries. But for a number of countries with lower credit ratings, sovereign and corporate interest rates are still significantly higher than before the spike in September 2008.
Figure 2.2.Sovereign yields declined, and market access recovered considerably. This has reduced financial volatility, turning the financial heat map mostly green. Box 2.1.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.
Net commodity exporting countries with full access to international financial markets. For brevity, these are called commodity exporting, financially integrated countries. This group includes 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. 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.
Other net commodity exporting countries. This group includes Argentina, Bolivia, Ecuador, Paraguay, Suriname, Trinidad and Tobago, and Venezuela. In general, these countries are less integrated with global financial markets. On average, they have experienced the most significant terms of trade gains.
Net commodity importing countries with large tourism sectors. For simplicity, these will be referred to as commodity importing, tourism intensive countries. This group includes 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 includes 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.
Current Account Revenue Structure
Sources: IMF, Balance of Payments Statistics; Comtrade; and IMF staff calculations.
Terms of Trade
Source: IMF staff calculations.
Similarly, access to debt markets has been improving. By the second quarter of 2009, bond and loan issuances had returned to close to precrisis levels and were well above levels prevailing during 2003–06, just before the surge in capital inflows to emerging markets. Still, although access for sovereigns and quasi-sovereign entities seems to have fully recovered, corporate issuance remains below precrisis levels, particularly for high yield firms. This could reflect a market that has become more discriminating but also firms' lower financing requirements given the slowdown in investment.
Within the context of reduced market access, the IMF has supported the LAC region with renewed intensity. It has provided support in policy discussions through surveillance and timely technical assistance. Together with other multilateral organizations, the IMF also has provided external liquidity support to bolster the authorities' efforts to stabilize the economy, in some cases using newly established mechanisms.2 Most countries have treated the IMF arrangements as precautionary (Box 2.2).
The lower external demand was felt by all LAC countries but differed fundamentally in its effects on commodity and manufactured exports (Figure 2.3). The decline in external demand for manufactures materialized primarily through lower volumes, affecting especially Mexico and the Central American countries that are members of the Dominican Republic–Central America Free Trade Agreement with the United States. The decline in external demand for commodity exports, which dominate the export structure of the other commodity exporting, financially integrated countries, was reflected mostly in lower commodity prices.3 The decline in export volumes was much lower for the other exporting countries, particularly the energy exporters. With commodity prices having recovered substantially, external shocks to commodity exporters are easing, while noncommodity exports are recovering more slowly.
Figure 2.3.While exports are recovering for all country groups, remittances and tourism continue to lag. Box 2.2.The IMF’s Support to the Region during the Crisis
As part of its response to the global economic crisis, the IMF beefed up its lending capacity and undertook a major reform of its lending instruments. Through bilateral borrowing arrangements with some members with strong reserve positions, in the first half of 2009, the IMF secured SDR 67 billion (US$99 billion) in additional resources, increasing its lending capacity to SDR 213 billion (US$316 billion). At the same time, the IMF approved a major overhaul of its lending toolkit, adding flexibility to the terms and size of its loans and further streamlining conditionality. Two key innovations were the creation of a Flexible Credit Line (FCL), to provide large and up-front financing without ex post conditions to members with very strong fundamentals and policies, and the enhancement of Stand-By Arrangements (SBAs), by increasing their “normal” size and allowing up-front disbursements of a large fraction of the funds under the arrangement.
Latin America was the region that first benefited from these changes in the IMF’s lending toolkit. On January 16, 2009, before the instruments had been completely overhauled, the IMF approved an SDR 514 million (US$763 million) SBA to El Salvador under which two-thirds of the total resources became available on approval. Three months later, on April 17, Mexico became the first country to receive an FCL (for the equivalent of 10 times Mexico’s quota in the IMF—SDR 31.5 billion, US$46.7 billion). So far this year, the IMF Board has approved arrangements with 11 LAC countries, most of these in Central America and the Caribbean. By end-June 2009, the IMF’s total loan commitments to the Western Hemisphere countries had reached SDR 40.2 billion (US$59.6 billion), up from SDR 333 million (US$494 million) one year earlier. This represented more than 50 percent of IMF loan commitments to all its members (see table). Notably, however, more than 99 percent of all IMF loan commitments to the region during 2009 have been of a precautionary nature (i.e., countries have obtained access to IMF resources but have chosen not to draw on them). In contrast, in regions more severely affected by the global crisis (e.g., central and eastern Europe), countries with IMF arrangements have chosen to draw on their IMF loans to alleviate their balance of payments difficulties.
|End-June 2008||End-June 2009|
|Western Hemisphere||World||Western Hemisphere||World|
|Flexible Credit Line||…||…||38,494||52,184|
The distribution of SDR 160 billion (US$237 billion) in newly created SDRs was another significant IMF initiative to help mitigate the effects of the global crisis. The new SDRs were distributed on August 28 among all members in proportion to their IMF quotas and had the immediate effect of strengthening members' reserve positions. Over time, the SDR allocation will facilitate access to “hard currencies” for members that may encounter difficulties securing foreign exchange in global markets. Altogether, Western Hemisphere countries, excluding Canada and the United States, have received SDR 13.5 billion (US$20 billion) in new SDRs. Owing to their relatively strong external positions, however, most LAC countries seem to have opted to keep the SDR allocation as reserves rather than for making international payments.Note: This box was prepared by Miguel Savastano.
The fall in tourism receipts has not yet been as large as that in exports but should be more persistent, weighing down on prospects for the tourism intensive economies. A sharp reduction in tourist arrivals led to price discounts in many Caribbean countries. Even after the eventual recovery of employment in the United States and other tourism-source countries, tourism receipts will continue to be affected by higher private saving rates envisaged in the United States and other advanced economies (Box 2.3).
The outlook for remittances is not favorable either because they also depend on employment conditions in advanced economies. Remittances have continued falling, affecting especially commodity importing countries, notably in Central America. Sluggish construction activity and a continued increase in the unemployment of Hispanics in the United States have been the key drivers of this decline.
Severe Economic Impact, but Green Shoots Visible …
How did the global recession and financial stress get transmitted to lower activity in the LAC region? Export volumes did contract in many cases, but a fast and sizable drop in domestic demand played a dominant role (Figure 2.4).
Figure 2.4.Domestic demand decelerated amid a sudden stop in credit, lower imports, and narrower external balances.
The general story is that the private sector reacted quickly to the external shocks and extreme real and financial uncertainty of late 2008, consuming fewer durable goods, postponing investment plans, and running down inventories. The reduction in domestic demand reflected primarily lower investment (including inventory adjustments), although in some countries it also entailed lower consumption.
Box 2.3.A Less-Crowded Caribbean Next Year? Tourism Trends
The global financial crisis has affected tourism-dependent economies profoundly, with large declines in arrivals leading to sharp discounts. As the crisis unfolded in the United States, destinations closer to the epicenter (Mexico and the Caribbean) felt its impact sooner. As the downturn spread to continental Europe, arrivals declined in destinations less dependent on U.S. travel, such as Barbados, Cuba, the Dominican Republic, and some countries in South America. In response, many tourist destinations have attempted to slow collapsing arrivals by cutting prices. Although the hotel price data are limited, by the end of 2008 hotel rates had declined by 7 percent in both the Caribbean and Latin America, with even greater cuts observed in 2009. These price cuts underscore the potential for steep revenue declines and consequent reductions in foreign exchange earnings in the coming months.
The effects of the financial crisis on the Caribbean will likely persist into 2010 because tourism depends on employment conditions in advanced economies, which typically lag output recoveries.1 In the 2001 recession, for example, declines in tourist arrivals to Mexico and the Caribbean followed increases in unemployment rates, which did not improve until 2003 despite an output recovery in 2002. Econometric estimates of tourist arrivals to the region factoring in increasing unemployment rates suggest a regional decline of between 10 percent and 15 percent because of this crisis. U.S. unemployment rates are currently projected to enter double digits—for the first time in more than 60 years—and remain there until the last quarter of 2010.
The outlook for tourism in 2010 could be further affected by spillovers from increasing U.S. openness toward Cuba and a potentially sharp recovery in Mexico. In April 2009, the United States lifted travel restrictions on its residents with family members in Cuba, boosting their arrivals to Cuba by 11 percent and overall arrivals by 6 percent. Although the impact on the Caribbean of this change is likely to be small, further near-term opening of U.S. travel to Cuba would increase regional competition significantly.2 In addition, since 2003, increases (and declines) in U.S. travel to Mexico have been offset by U.S. arrivals to the Caribbean. The sharp reductions in arrivals to Mexico this year resulting from the H1N1 virus and other shocks have slowed the rate of decline in the Caribbean. Should Mexico recover quickly in 2010, this would put further pressure on the Caribbean.
|April-June Percent Change||Cumulative Percent Change (to month)|
|Antigua & Barbuda||-13.8||-12.8||Jul|
|St. Vincent & Gren.||-24.1||-17.4||Jun|
|St. Kitts and Nevis||-25.5||-27.0||Jun|
Change in U.S. Unemployment Rate and Tourist Arrivals
Sources: Haver Analytics; and IMF staff calculations.
The reduction in domestic demand led to a sharp deceleration in economic activity, but the pace of deceleration has not been uniform. Indeed, the evidence shows that the external shocks were felt more rapidly by countries that are most financially integrated and linked internationally through exports of goods, rather than through income from tourism and remittances.
As noted in the May 2009 Regional Economic Outlook, exchange rates played a crucial role in absorbing the external shocks in the most financially integrated economies (Figure 2.5). Following the Lehman collapse, the real exchange rates of these countries depreciated considerably but bounced back in 2009, mainly reflecting their currencies' movements against the U.S. dollar. In other countries, real effective (trade-weighted) exchange rates moved in the opposite direction: this pattern was primarily explained by changes in nominal effective exchange rates, in particular the appreciation of the U.S. dollar relative to other major currencies, rather than differences in inflation rates. Indeed, with activity declining and output gaps widening in all countries, inflation fell across the board.
Figure 2.5.Real exchange rates are returning to pre-Lehman levels, reflecting mainly action from nominal effective rates.
Financial systems have been resilient to these shocks, but credit growth has decelerated. Across the region, credit expansion virtually stopped because firms and households tended to reduce their credit exposure, and banks became more cautious. During 2009, nonperforming loans have increased from low levels and profitability has generally declined, but risk-weighted capital adequacy ratios have improved. Procyclical provisioning may have played a role. This suggests that banks acted to increase their risk-adjusted capital cushions by taking relatively less credit risk (Figure 2.6).
Figure 2.6.Nonperforming loans have increased and profitability has declined, but risk-weighted capital adequacy ratios have improved.
Many factors have helped keep the LAC domestic financial systems afloat: larger and better capital and liquidity cushions, systematic upgrading of the legal, regulatory, and supervisory framework over more than a decade, and better risk management by financial institutions.
As discussed in the May 2009 Regional Economic Outlook, financial stress was felt in the Caribbean with the Clico and Stanford debacles, which have had significant regional repercussions that are still unfolding. Despite significant improvements in prudential regulation throughout the LAC region, these events illustrate some of the pending regulatory challenges that still need to be addressed.
With receding external shocks and uncertainty reduced (because tail risks have become smaller), a rebound of economic activity is starting. Indeed, recent indicators suggest a turnaround, especially among the financially integrated commodity exporters. For instance, Colombia had started to grow already in Q1 and Q2, while Brazil rebounded strongly in Q2. Other commodity exporting countries should post positive growth in the second half of the year. In contrast, commodity importers are lagging behind, affected still by headwinds from the external environment, although there are some green shoots in these countries as well (e.g., Costa Rica).
Across country groups the median current account balances declined in absolute terms. The sharp reduction in domestic demand led to lower imports across the board, which fell more than exports in real terms. In effect, net exports made a positive contribution to GDP.
In the financial account of the balance of payments, large nonresident portfolio outflows turned out to be short lived, with foreign inflows returning to the larger countries already in the first part of 2009 (Figure 2.7). In some countries, the private sector and the government drew down their foreign assets to smooth the reversal in capital inflows. The bulk of the financial account reversal occurred through portfolio flows, as foreign investors scrambling for liquidity sold their domestic financial holdings. As in past episodes of capital account reversals, foreign direct investment flows remained much more stable than other flows (Box 2.4). The financial adjustment made by the private sector, including the drawdown of foreign assets, mitigated the shock to the balance of payments and sharply reduced the need for official action. In fact, official international reserves declined only moderately, and generally remained above their end#–2007 levels.
The initial pullback of global banks, in the months following the Lehman event, was essentially reversed by March of this year. Total claims of BIS-reporting banks on the LAC region, measured at constant exchange rates, did contract in the last quarter of 2008, but much less than in other parts of the world. This greater stability relates to the fact that most loans and other claims by global banks on the LAC region had been disbursed by their local affiliates and financed with local deposits (see also Chapter 4 of the May 2009 Regional Economic Outlook).
Figure 2.7.Portfolio inflows have returned. Foreign direct investment has remained relatively stable.
The impact on labor markets in LAC countries has not been as severe as in the United States. Unemployment rates have tended to increase, though in many cases this has reflected rising labor force participation rates rather than declining employment. In some countries (e.g., Brazil), unemployment has already started to decline.
Box 2.4.FDI during the Recent Crisis: Resistant but Not Immune
In line with what occurred in previous episodes of turbulence, foreign direct investment (FDI) has been more stable than other external financing inflows in the past year. However, FDI has not been totally immune to the effects of the global crisis and will likely remain below peak levels for some time, especially in Caribbean countries where it increased rapidly during the boom years.
FDI to Latin America and the Caribbean was quite buoyant in recent years, but not to the extent seen in other regions.1 From 2003 through 2008, FDI to the LAC region as a whole more than doubled in real-dollar terms. Other regions, however, saw even more rapid growth of FDI: flows to emerging Asia and to the Middle East and Africa more than tripled, and flows to central and eastern Europe increased by a factor of five. Thus, the share of Latin America and the Caribbean in global FDI flows to emerging and developing economies fell to 25 percent in 2003 from more than 40 percent during the late 1990s and to less than 20 percent in 2008.
Viewed in relation to the recipient country's economic size, FDI has increased significantly in many Central American and Caribbean countries but by much less in other countries of the LAC region. For the largest economies, the LA7, the FDI-to-GDP ratio has generally been stable at about 3 percent of GDP.2 For other countries of South America, FDI on average has increased only moderately as a share of GDP in the past five years.3 In contrast, FDI to Central America—which had already been increasing in the early part of the decade owing to increased global integration—has grown at a much higher rate in recent years.4 FDI to the Caribbean has also risen during the past few years, reaching an average of more than 15 percent of GDP during 2006–08, owing to large real estate and tourism investments.5
Net Inward FDI Flows
Source: IMF staff calculations.
Composition of Net Inward FDI Flows
Sources: IMF, Balance of Payments Statistics; and IMF staff calculations.
Over the years, FDI has not displayed the boom-and-bust behavior typical of other capital flows. The various types of flows have behaved very differently during previous crisis episodes: FDI remained remarkably stable, while portfolio flows, bank loans, and trade credit experienced sudden reversals and severe drops. Indeed, FDI flows to the LAC region have tended to remain positive even during periods when portfolio investment and other investment have registered substantial net redemptions.6 Underlying this fact are the notions that FDI is driven by positive evaluations of longer-term business conditions in the recipient country or implies an investment that is more difficult to reverse than other capital flows.7
Previous Crisis Episodes: Net Inward Capital Inflows 1/
Sources: Haver Analytics; and IMF staff calculations.
1 Two-quarter moving average of annualized gross foreign direct investment, portfolio, and other inflows in percent of GDP six quarters before financing peak. Each line is a simple average of the capital inflows–to–GDP ratio for all LAC countries for which quarterly data are available.
Although it is still early to judge the present episode, data available for some countries suggest that even though FDI has not been completely immune to the global financial turmoil, it has once again been the most stable source of financing. Compared with what might be expected from the intensity of the global crisis, FDI flows to many LAC economies have been remarkably resilient in the most recent period. Data through the first quarter of 2009, where available, show that, on the one hand, FDI flows as a share of preturmoil GDP remained steady in the LA7 and other South American countries and dipped moderately in Central America.8 Portfolio and other capital inflows, on the other hand, dropped in the second half of 2008, turning negative in the fourth quarter in all regions, before rebounding partially in the first quarter of 2009. This preliminary evidence suggests that FDI has been a source of capital account stability during the recent financial distress.
Behavior of FDI and Non-FDI Inflows during the Recent Crisis by LAC Region 1/
Sources: IMF , Balance of Payments Statistics; and IMF staff calculations.
1 To control for country size while abstracting from exchange rate effects, capital flows for each period for all countries with quarterly balance of payment data are divided by national GDP for 2007. The aggregate is the simple average of the resulting ratios.
The drop in FDI inflows has been less dramatic than that for other financial flows, but FDI inflows are still projected to decline significantly and remain below precrisis levels for some time. The forecast for the region is for net inward FDI flows of US$72 billion in 2009, down from US$125 billion in 2008. This contrasts with a fall in other financial inflows (excluding reserves) to US$32 billion in 2008 from US$113 billion in 2007. The forecast decline in FDI is in line with developments in the first quarter of 2009 and, for countries with data, the second quarter. However, the typical persistence of shocks in regard to FDI suggests that flows will remain below 2006–08 levels for some time. Another factor limiting FDI in the present circumstances may be financing constraints on companies that typically serve as the funding sources of intrafirm FDI or initiate mergers and acquisitions. The most vulnerable countries are those in the Caribbean and Central America that experienced the largest precrisis buildup, especially where flows relied on industries such as tourism and finance that will likely lag the recovery. For much of the region, though, because the run-up in FDI during the boom years was less dramatic, coupled with solid macroeconomic fundamentals, it could temper the extent of the decline relative to some other regions.Note: This box was prepared by Herman Kamil, Ben Sutton, and Andrew Swiston.1 Throughout this box, the terms FDI and FDI flows both refer to net inward FDI flows (defined as gross inflows by foreigners net of redemptions).2 Throughout this box, ratios to GDP refer to the average (mean) ratio within each country grouping. Using the median ratio does not appreciably change the findings.3 Movements in ratios to GDP in current dollars can be affected by changes in a country’s real exchange rate against the dollar. In particular, real appreciation in countries such as Argentina, Brazil, Chile, and Colombia during the period 2004–08 pulled down FDI-to-GDP ratios, other things constant.4 The breakdown of FDI by component for Central America and the Caribbean includes only data through 2007, because they are not available for 2008 for most countries in these groups.5 The composition of FDI flows varies greatly across regions. In LA7 and other South American countries, reinvested earnings have become a more significant source of FDI, substituting for equity capital inflows, which have declined. Because a large part of the FDI to these regions has been directed to commodity-producing sectors, the surge in commodity prices until 2008 increased profitability for those companies and contributed to higher reinvested earnings of foreign affiliates. On the other hand, the recent surge in FDI inflows to the Caribbean is attributable almost entirely to equity capital inflows, whereas flows to Central America are more balanced between equity flows and reinvested earnings.6 Thus, the stylized facts for the LAC region are consistent with the empirical evidence broadly supporting the view that FDI flows are more stable than all other forms of capital (see Levchenko and Mauro, 2006). FDI payments also have, in principle, desirable cyclical properties: payments associated with equity finance tend to be lower when economic performance is worse. Yet the flip side to this increased risk sharing with the rest of the world is that FDI investment is typically “more expensive”; that is, there is a higher required return on these foreign investments.7Hausmann and Fernández-Arias (2000) maintain that it is only the accounting choices of firms that drive the distinction between FDI and other capital flows. However, this view fails to explain the continued positive FDI inflows seen during crisis episodes. One possible explanation for this phenomenon is that FDI-related subsidiaries can more easily obtain intrafirm financing from their parent company than nonrelated lending from abroad during sharp reversals of capital inflows.8 Quarterly data for the Caribbean countries were not sufficiently available to construct a regional aggregate. Annual data show a decline in FDI to 14 percent of GDP in 2008 from 16 percent of GDP in 2007.
… Helped in Some Cases by Active Policy Responses
Breaking from historical patterns, the better-prepared LAC countries were able to implement countercyclical macroeconomic policies in response to this crisis. As stressed in the May 2009 Regional Economic Outlook, this was the payoff from significant efforts made over the past decade to reduce vulnerabilities and strengthen policy frameworks. This preparedness made a difference, and preliminary estimates suggest that output losses will be significantly lower than they would have been otherwise (Chapter 3).
The most financially-integrated commodity exporters reacted by easing monetary conditions (Figure 2.8). They sharply lowered policy interest rates and allowed the exchange rate to depreciate, while also using a portion of their international reserves (through direct foreign exchange sales, foreign exchange lending, or foreign exchange swaps). This move helped firms and some financial institutions meet their immediate external obligations. A few lowered the reserve requirements on bank deposits to support their overall strategy. The transmission to bank interest rates worked well, with deposit and lending rates falling significantly.
Figure 2.8.Some countries effectively eased monetary conditions and allowed the exchange rate to absorb part of the external shock. Reserves were broadly stable.
Most other countries were constrained in their monetary policy response. Countries with less flexible exchange rate regimes did benefit in part from lower interest rates in advanced economies. Yet many suffered from an increase in interest rate spreads. In a few countries, bank rates increased despite a lowering of money market interest rates because of ineffective transmission mechanisms or increased risk perceptions. With falling inflation, real interest rates increased in many of these countries.
Public banks stepped in to support credit conditions in several countries. To compensate for tightening credit conditions, public banks in some countries adopted lending policies that increased their market share and allowed these to play a countercyclical role (e.g., Argentina, Brazil, Chile, and the Dominican Republic).4 In some countries, domestic capital markets also provided alternative financing opportunities (e.g., Chile and Peru).
Fiscal policy also played a role in buffering the impact of the crisis, but to varying degrees, according to countries’ fiscal space (Figure 2.9). As discussed in detail in Chapter 4, fiscal authorities in the commodity exporting, financially integrated countries were able to provide the most support to domestic demand among all LAC countries in 2009. The buildup of buffers and policy credibility during the upswing of the cycle in these countries enabled the adoption of countercyclical fiscal policy responses. In other commodity exporting countries and commodity importing groups, fiscal policy also was generally supportive, but much less than in the commodity exporting, financially integrated countries.
Figure 2.9.Support from fiscal policy varied across country groups.
Source: IMF staff calculations.
1/ Simple average of change in primary deficits excluding commodity related revenues and foreign grants in percent of GDP.
A Phased Recovery Ahead …
Taking account of developments since the May 2009 Regional Economic Outlook, we have revised our baseline forecast for the LAC region. We now expect the LAC region to resume growth in the current semester (2009:H2) and pick up moderately in 2010 (Figure 2.10). As discussed in Chapter 1, the external environment will not favor a quick return to previous growth rates.
Figure 2.10.LAC growth should resume in 2010, but at lower rates than in the recent past. The recovery will lag in many commodity importers, which depend on labor conditions abroad.
Source: IMF staff calculations.
Our weighted LAC regional growth forecast for 2009 is −2.6 percent, weaker than at the time of the May 2009 Regional Economic Outlook. This revision reflects a weaker than projected outturn for activity in 2009:H1, particularly in the case of Mexico (see Box 3.3).
For 2010, LAC overall growth is projected to recover to slightly below 3 percent. As for the United States and other regions, we do not anticipate a rapid bounceback, so output gaps will not narrow quickly. In fact, notwithstanding the uncertainties in estimating output gaps, we expect that slack will remain large and inflation pressure muted in most LAC countries.
Within the LAC region, we expect the fastest recovery in commodity exporting countries. with a median growth of about 3.5 percent. Commodity importing countries can expect to have slower recoveries given their strong links to U.S. unemployment dynamics and their limited room for additional policy stimulus in most cases.
The projected recovery will hinge primarily on a recovery of domestic demand. A portion of this rise in domestic demand naturally will fall on imported goods. LAC export volumes also should expand moderately, in line with world trade developments. Overall, however, the projected recovery is not based on an expected strong contribution of net exports.
We see average growth in the region resuming gradually during 2011–13. However, we do not expect growth to return to the boom levels of 2004–07. In our forecast, the process of closing output gaps will not involve a period of rapid, catch-up growth.5
In summary, our new baseline assumes that the growth of potential output in the LAC region in the next five years will be somewhat lower than in the years before the crisis. Potential output growth is lower in the near term because capital accumulation is low.
The downward revision in potential output growth of course affects the level of GDP implied by our revised growth projections. In our revised baseline, the level of real GDP for the region will be on average 3 percent below the level anticipated before the crisis by 2014 (Figure 2.11). This calculation, however, is subject to forecast uncertainty and will need to be reviewed in the future.
Figure 2.11.The global crisis will have a long-lasting impact on U.S. and LAC output.
Source: IMF staff calculations.
A downside scenario
Among alternatives to the baseline path outlined here, we would highlight in particular the risk of a less favorable near-term scenario for the advanced economies, as discussed in Chapter 1. Such a double downturn in advanced economies would likely trigger a second deceleration or even a contraction in the LAC region and the rest of the world.
… Shaping Policy Decisions
Near-Term Policy Challenges
What are the policy challenges that authorities will face if the recovery proceeds as envisaged in our baseline forecast? These will naturally vary across the LAC region with the stage in the economic cycle, the amount of stimulus applied already, and the remaining room for policy maneuver given existing vulnerabilities (Figure 2.12).
Figure 2.12.Public sector borrowing requirements have increased across the board, while external financing requirements and reserve adequacy varied by groups.
Managing flexibly, where possible …
For countries able to implement stimulus in 2009, and where growth has resumed, the key macroeconomic-policy theme will be the eventual timing and sequencing of the stimulus withdrawal (the “exit strategy”).
Regarding timing, the high degree of uncertainty about the speed of recovery, including at the global level, will make it difficult to get the timing completely right. Errors in both directions will have consequences. Generally, it would be appropriate to begin withdrawing discretionary stimulus when private sector domestic demand recovery is well entrenched. Yet the consequences of removing stimulus too early in the LAC region may not be as severe as they would be for the United States and other advanced economies. Because LAC financial systems have not been put under severe stress and the recovery in LAC economies does not depend exclusively on the existing monetary and fiscal policy stimulus (as could be the case in some advanced economies), tightening would not be as serious an impediment to demand recovery in the LAC region.
Regarding the sequencing of stimulus withdrawal, it seems best to begin early on closing down and unwinding special financial facilities, because they are no longer needed. This could prevent possible buildup of contingent liabilities. In general, fiscal stimulus should be withdrawn before monetary stimulus. The general recommendation is that fiscal policy should return to a neutral, or passive, role in demand cycle management (as discussed further in Chapter 4). Central bankers will need to take these fiscal developments into account as they formulate monetary policy, so coordination of policies will be important. Removing the fiscal stimulus in time will facilitate the job of monetary policy.
Where output gaps remain large and the economy is not on a firm footing, there is no imminent need for monetary policy to quickly return to a neutral mode. That said, policy stances are highly stimulative in a number of cases and given lags in monetary policy transmission, the authorities will need to begin the process of unwinding interest rate cuts well before output gaps appear to be nearly closed. Countries where output gaps are smaller will need to be more alert than others to the risk of being too slow to tighten.
Within our baseline scenario, there is the possibility that significant amounts of foreign capital may soon flow to countries where risks are relatively low and the recovery is better established, with implications for the macroeconomic policy mix. With low returns on savings in advanced economies, those searching for higher but reasonably safe yields could well rediscover several LAC countries. Rising commodity export prices could add to confidence and become another “pull factor.” Although greater availability of foreign capital on easier terms in general would be welcome, a sudden large inflow could create overly strong currencies or other tensions, especially if there were concerns that the new inflows could be suddenly reversed. This possibility is another reason to withdraw fiscal stimulus ahead of monetary stimulus (and another reason for exchange rate flexibility, to avoid creating one-sided bets on the domestic currency). If capital inflows were to persist on an undesirably large scale, the situation could call for revisiting the fiscal stance.
In a downside scenario, in which the recovery of advanced economies slows, LAC countries with strong policy frameworks and balance sheets would generally be in a position to renew monetary stimulus. If necessary, delayed withdrawal of discretionary fiscal stimulus could be considered also, along with steps to ensure that this stimulus is removed at a later point.
… and managing with fewer options
Policy options are more constrained for other LAC countries, in varying degrees.
For a number of countries, including some in Central America, recovery will be slow, but it is not clear whether new fiscal stimulus would be feasible or advisable. Indeed, stimulus implemented in 2009 may need to be reversed sooner than would be desirable from a demand-management perspective, simply because the “room” for stimulus is running low (buffers have been substantially depleted). In some cases, it would be prudent to conserve remaining buffers in the baseline scenario—to have them ready if needed for the more challenging double-dip scenario.
In other cases, including many in the Caribbean, policy choices are even more limited. The global crisis has increased public debt levels that were already very high—a development that severely constrains new financing, even as government revenues continue to decline. Maintaining stability during this period will require prudent policy actions and well-designed plans developed with maximum social consensus. The focus should be on measures that ease hardship on the poor.
Finally, the commodity exporters that generally have followed procyclical fiscal policy would seem to be at a crossroads. For some, the plunge a year ago in commodity prices forced undesirably rapid cuts in public spending and sudden reliance on financing sources that could not be sustained. The bounceback of commodity prices has eased their situation, at the same time fueling pressures to restore rapid spending growth. Although such spending might help support output in the short term, uncertainty and the potential for economic volatility will remain high in the absence of clearer policies for smoothing public spending owing to wide revenue swings. The recent experience underscores the value of developing such frameworks, as discussed in Chapter 4.
Medium-Term Policy Challenges
For the medium term, three broad areas of policy challenges for the LAC region are identified.
1. Fiscal policy will need to adapt to a less favorable environment and better prepare countries for future shocks.
The new medium-term outlook includes the possibility of higher global interest rates (particularly for government debt), as well as slower growth of output and therefore tax revenue. Other things constant, these prospects would leave less room for increasing public spending, and it will need to be factored into medium-term fiscal planning. Countries should consider developing more robust frameworks that systematically commit them to saving during favorable times so that they can weaken fiscal balances during difficult times.
A challenge for many LAC countries is to bring public debt down toward levels that are more consistent with stability and growth—and that allow countries some room for maneuver during troubled times. This applies especially to countries that already had very high debt levels before the crisis. But it is also relevant to others with debt levels that rose significantly during the crisis. More broadly, all countries that engaged in discretionary fiscal stimulus this year will need to resist pressures to allow a permanently weaker fiscal balance.
2. Financial sector policies will need to address the new lessons learned from the advanced economies' financial crisis and to continue to address weaknesses that were known before the crisis.
Among others, (1) the perimeter of regulation needs to encompass all systemically important institutions, (2) capital charges should cover risks in contingent off-balance-sheet positions, and (3) dynamic countercyclical provisioning can play a role in aggregate demand management (see Chapter 3).
3. Promoting faster economic growth and reducing poverty is now even more important.
Not everything has changed since the onset of the global crisis. Before the crisis, and even in the good years of 2004–07, the LAC region in general did not keep up with the per capita income growth of other countries. Moreover, poverty rates, despite some improvement, remained high. Now, with a postcrisis environment less favorable to growth, the case for acting on deep reforms to accelerate growth and reduce poverty is stronger than ever.
|Output Growth (Percent)||Inflation (End-of-period, percent) 1/||External Current Account Balance (Percent of GDP)|
|1995-2004 Avg.||2005||2006||2007||2008||2009||2010||1995-2004 Avg.||2005||2006||2007||2008||2009||2010||1995-2004 Avg.||2005||2006||2007||2008||2009||2010|
|Latin America and the Caribbean|
|PPP-GDP weighted average||2.6||4.7||5.7||5.7||4.2||-2.5||2.9||12.0||5.9||5.1||6.3||8.3||5.3||5.5||-1.9||1.3||1.5||0.4||-0.7||-0.8||-0.9|
|Commodity exporting, financially integrated countries||3.2||4.9||5.7||6.0||4.4||-1.6||3.8||9.1||3.7||3.1||5.1||6.9||2.5||3.3||-2.4||0.5||1.4||0.4||-2.3||-1.4||-1.8|
|Other commodity exporting||3.0||6.1||7.1||5.8||5.5||-0.9||2.2||17.4||9.6||8.7||9.7||12.9||7.3||8.4||-1.7||5.0||11.1||7.4||7.3||2.2||3.1|
|Commodity importing, tourism intensive countries||2.8||4.6||4.7||3.0||1.3||-2.4||0.4||2.9||5.1||3.4||6.4||6.1||2.4||3.2||-13.0||-17.5||-19.7||-24.6||-25.5||-19.4||-18.9|
|Other commodity importing||3.3||4.6||6.0||6.5||4.4||0.0||2.3||9.6||8.3||6.5||9.6||10.0||2.8||4.4||-5.8||-4.9||-6.2||-7.6||-11.2||-7.0||-8.3|
|Antigua and Barbuda||3.3||5.5||12.4||6.9||2.8||-6.5||-1.5||1.5||2.5||0.0||5.2||0.7||-1.4||2.5||-8.6||-12.3||-30.8||-32.9||-31.3||-29.4||-27.9|
|St. Kitts and Nevis||3.7||5.6||5.3||0.9||2.4||-2.0||0.0||3.2||6.0||7.9||2.1||7.6||2.0||2.2||-25.7||-18.2||-20.4||-24.2||-28.1||-22.8||-23.8|
|St. Vincent and the Grenadines||3.7||2.6||7.6||7.0||0.9||-1.1||2.1||1.5||3.9||4.8||8.3||8.7||2.9||2.9||-17.7||-22.3||-24.1||-35.1||-33.7||-29.5||-31.6|
|Trinidad and Tobago||7.7||6.2||13.5||4.6||2.3||-0.8||2.0||4.2||7.2||9.1||7.6||14.4||4.0||6.0||2.0||22.5||39.6||25.7||25.5||11.2||16.9|
|Public Sector Revenue (Percent of GDP)||Public Sector Primary Expenditure (Percent of GDP)||Public Sector Overall Balance (Percent of GDP)||Public Sector Primary Balance (Percent of GDP)|
|2005||2006||2007||2008||2009 Proj.||2010 Proj.||2005||2006||2007||2008||2009 Proj.||2010 Proj.||2005||2006||2007||2008||2009 Proj.||2010 Proj.||2005||2006||2007||2008||2009 Proj.||2010 Proj.|
|Latin America and the Caribbean|
|PPP GDP–weighted average||27.9||28.5||28.7||29.7||28.2||28.7||24.7||25.4||26.0||27.2||28.8||28.0||-1.4||-1.1||-1.2||-0.9||-4.2||-2.5||3.2||3.1||2.8||2.5||-0.6||0.7|
|Commodity exporting, financially integrated countries||26.3||27.3||27.8||28.2||26.0||26.3||23.1||23.1||23.3||24.6||26.9||26.0||-0.1||1.0||1.5||0.8||-3.6||-2.2||3.2||4.2||4.6||3.5||-0.9||0.3|
|Other commodity exporting countries||30.8||32.6||32.2||33.4||30.0||31.5||26.1||27.6||29.3||31.0||31.8||31.4||1.4||2.2||0.4||0.5||-4.1||-2.2||4.7||5.0||2.9||2.4||-1.8||0.0|
|Commodity importing, tourism intensive countries||30.6||31.6||32.9||32.3||32.1||32.4||27.2||27.6||30.2||30.8||32.5||31.8||-4.2||-3.1||-4.1||-4.2||-6.7||-6.0||2.5||2.8||1.7||1.4||-0.2||0.4|
|Other commodity importing countries||23.4||24.4||24.7||23.9||23.2||23.8||22.8||23.4||23.2||23.8||24.9||25.0||-2.8||-1.9||-0.6||-1.7||-3.8||-3.4||0.1||0.7||1.6||0.1||-1.8||-1.3|
|Trinidad and Tobago||31.7||33.8||33.2||31.3||27.3||28.0||23.2||26.2||28.0||26.1||29.6||28.0||6.0||5.5||3.2||3.4||-4.8||-2.3||8.5||7.7||5.3||5.3||-2.3||0.1|
Note: This chapter was prepared by Jorge Iván Canales-Kriljenko with significant contributions from Ana Corbacho, Gabriel Di Bella, Herman Kamil, Steve Phillips, Rafael Romeu, Carolina Saizar, and Bennett Sutton.
Some economies were also hit by weather-related shocks, such as the drought that affected output of Southern Cone countries, especially Paraguay.
A U.S. dollar swap facility with the United States also bolstered the external liquidity of Brazil and Mexico.
Because the supply of commodities tends to be price inelastic in the short run, fluctuations in demand tend to be reflected more in prices than in volumes.
Such public lending can in some cases bring quasi-fiscal losses, the extent of which will become clear only with time.
In the past, some LAC countries that faced financial crises could catch up with previous trends in potential output thanks to fast export growth. However, this took place during good times for the world economy and is not likely to happen when the global economy is weak.