Crisis Averted—What’s Next?

Crisis Averted—What’s Next? Rodrigo Valdés Western Hemisphere Department International Monetary Fund 22 October 2009

Agenda • External Shocks • Policy Reactions and Outlook • Short-term challenges ― Zooming in • Preparedness, vulnerabilities, and medium-term challenges ― Zooming out • Conclusions

External Shocks • Policy Reactions and Outlook • Short-term challenges ― Zooming in • Preparedness, vulnerabilities, and medium-term challenges ― Zooming out • Conclusions

WEO Baseline scenario for the world economy: slow recovery with downside risks Real GDP Growth in LA6 and the World 1/ (Four quarter percent change, seasonally adjusted) 4 Source: IMF staff estimates. 1/ For LA6, PPP-GDP weighted average.

Commodity prices are recovering as Asia rebounds Commodity Prices (Index 2002=100 of prices in U.S. dollars) 5 Sources: Bloomberg, L.P.; and IMF staff calculations.

Financial market turmoil has receded… Latin American Financial Markets: Heat Map 6 Sources: Bloomberg, L.P.; and IMF staff calculations.

Other external shocks to ease... …at different paces Remittances, Tourism, and External Demand 1/ (percent change, y/y) Source: IMF staff estimates. 1/ Remittances and Tourism are 4-qtr moving averages.

In contrast with the past, a number of countries implemented countercyclical fiscal policies… Change in primary deficits excluding commodity-related revenues (Percent of GDP 1/) 10 Source: IMF staff estimates. 1/ Simple averages of changes in primary balances

…and some countries also implemented expansionary monetary policies… Interest Rate Changes (Differences between September 2008 and the most recent data) 11 Source: IMF staff estimates.

Exchange rate adjustment buffered the shocks in countries with ER Flexibility Nominal effective exchange rate 1/ (Index 2008=100) 12 Source: IMF staff estimates. 1/ Index constructed using the simple average of monthly growth rates within each group. An increase (decrease) denotes an appreciation (depreciation). 2/ Excludes Jamaica.

Activity has started to pick-up in several countries Expanding and above or equal to trend (average) Expanding and below trend (average) Moving sideways Contracting at a moderate rate Contracting at a fast rate Data not available Regional “green shoots” 13 Source: IMF staff estimates.

Yet the path of recovery underscores regional heterogeneity GDP growth in Latin America and the Caribbean (percentage change; weighted average by GDP-PPP within groups) 14 Source: IMF staff estimates.

Challenges for commodity exporting and financially integrated countries • Timing and sequencing: • Start unwinding special financial facilities; • Pace fiscal withdrawal depending on strength of recovery; • Monetary policy normalization should follow fiscal. • And, confront a likely scenario of capital inflows in search for yield: • FX flexibility to avoid one-sided bets; • If inflows scale is large and problematic, step-up financial regulation/supervision; • Revisit the fiscal stance. 16

Challenges for other commodity exporters • Avoid procyclical fiscal policies: • Take advantage of firmer commodity prices, implement clearer policies to limit procyclicality. 17

Challenges for other net commodity importers • Preserve fiscal resources: • Avoid procyclicality, but… • Preserve some stimulus for worse-case scenario. 18

Challenges for commodity importing tourism intensive countries • Stay in crisis mode: • Prioritize spending. • Focus on macroeconomic stability. • Policy space limited by debt levels. 19

External Shocks • Policy Reactions and Outlook • Short-term challenges ― Zooming in • Preparedness, vulnerabilities, and medium-termchallenges ― Zooming out • Conclusions

Preparedness paid off – historical perspective A comparison of GDP in 2009 and in past crises (GDP index, 100 = year before the crisis) Source: IMF staff estimates.

Estimating the impact of the crisis suggests that… Growth in LAC-5 Real GDP 1/ (simple average, year on year percentage changes) Source: IMF staff estimates. 1/ Growth in Brazil, Chile, Colombia, Mexico and Peru; simple average of annual growth.

Latin American countries saved 4 percent of GDP during the current crisis Growth in LAC-5 Real GDP 1/ (simple average, year on year percentage changes) Source: IMF staff estimates. 1/ Growth in Brazil, Chile, Colombia, Mexico and Peru; simple average of annual growth.

Relative performance of emerging economies Changes in expected growth for 2009 (Percentage points of revision in growth forecasts, before and after crisis) • What explains the differences? • Pre-crisis credit boom • Bank leverage • Inflexible exchange rates • Lack of fiscal restraint • Greater trade links • International reserves are not found to have explanatory power Macro policies during the boom & financial regulation and supervision 24 Source: IMF staff estimates.

The cost of reserves is not trivial… possibility for cooperative solutions IMF Credit and Reserves in percent of GDP (2008) Source: IMF staff estimates.

The IMF in Latin America and the Caribbean IMF Lending, 2008-09 (Committed resources, millions of SDR) 26 Source: IMF staff estimates.

It is now necessary to rebuild fiscal space… Fiscal Adjustment (percent of GDP) Source: IMF staff estimates.

Concluding remarks – Limiting vulnerabilities and replenishing buffers • Fiscal policy should get better prepared. Aim at lower debt levels, larger automatic stabilizers, and systematic calculation of structural positions. • Financial regulation agenda should keep up with new learning. Examples: Consider capital charges for systemic risk contribution, clearer mandates for financial stability and enlargement of perimeter of regulation, and limiting procyclicality (eg, dynamic provisioning) • If consistent with FX regime, adopt more exchange rate flexibility. • Strike a balance on FX liquidity buffers. While apparently useful, they are costly.

Crisis Averted—What’s Next?