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Capital Flows to Emerging Economies:

Capital Flows to Emerging Economies:. Global Dimensions and Implications for LAC. Ernesto Talvi. CERES. October 20 th , 2005. Prepared for Presentation at the XXII Meeting of the Latin American Network of Central Banks and Finance Ministries, IDB, Washington DC. OUTLINE.

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Capital Flows to Emerging Economies:

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  1. Capital Flows to Emerging Economies: Global Dimensions and Implications for LAC Ernesto Talvi CERES October 20th, 2005 Prepared for Presentation at the XXII Meeting of the Latin American Network of Central Banks and Finance Ministries, IDB, Washington DC

  2. OUTLINE • Capital Flight from EMs, 1997-2002: Global Repercussions • Revival of Capital Inflows to EMs, 2003-2005: • A Latin American Perspective • A Global Perspective • Unwinding of Global Imbalances and Latin America

  3. OUTLINE • Capital Flight from EMs, 1997-2002: Global Repercussions • Revival of Capital Inflows to EMs, 2003-2005: • A Latin American Perspective • A Global Perspective • Unwinding of Global Imbalances and Latin America

  4. 250 200 150 100 50 0 -50 -100 50 0 -50 -100 -150 -200 -250 190 150 110 70 30 -10 -50 -90 -130 -170 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Private Capital Flows: A Global Perspective (billions of US dollars) “Neoclassic” Period USA Industrialized Countries Emerging Countries Source: WEO

  5. The Asian and Russian Crisis: An Inflection Point Capital Flows International Financial Conditions (in billions of US dollars) (EMBI spread*, bp over US Treasury bonds) “Neoclassic” Period Crisis in EMs 187 190 1650 150 1450 110 70 1250 30 1050 -10 850 -50 650 -90 450 -130 250 -170 -164 Jun-97 Jun-98 Jun-99 Mar-97 Mar-98 Mar-99 Dec-96 Sep-97 Dec-97 Sep-98 Dec-98 Sep-99 1996 1995 1997 1992 1994 1999 2000 2001 2002 1993 1998 Source: WEO *adjusted by Argentina

  6. Crisis in EMs Private Capital Flows: A Global Perspective (billions of US dollars) “Neoclassic” Period 225 250 USA 200 150  = + 233 100 50 0 -8 -50 -100 50 -179 Industrialized Countries 0 -50  = + 41 -100 -150 -138 -200 -250 187 190 150 110 70 Emerging Countries 30 -10 -50  = -274 -90 -87 -130 -170 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: WEO

  7. Interest Rate (i) Supply of External Financing from the Rest of World to the US Increase in Supply of External Financing to USA i1 External Financing (q) q1 Capital Flight From EMs From the US Perspective: A Graphical Analysis Supply Hypothesis i0 Demand of External Financing from the US q0

  8.  = - 23,0% Capital Flight from EMs from the US Perspective Appreciation of the Dollar Decline in Interest Rates (RXR vis-a-vis the Euro and REXR, annual avg,1996 = 100) (real interest rate, 10-year Treasury bond, annual avg) 5.0% 4,7% 97 4.5% 92 4.0% 87 3.5% 82 3.0% 77 72 2.5% 2,1% 67 2.0% 1997 2001 2002 1996 1998 1999 2000 1996 2000 1999 1997 1998 2001 2002 Boom in Asset Prices Deterioration of the Current Account (Housing Price Index, Dec-1996 = 100) (in billions of US dollars and in % of GDP) 0 0.0% 147  = + 43.8% -50 -0.5% 142 120 -100 -1.0% 137 -150 -1.5% 132 -200 -2.0% 127 -250 -2.5% 122 -300 -3.0% 117 billions of US dollars -350 -3.5% 112 474 -400 -4.0% 107 % of GDP -450 -4.5% 102 -500 -5.0% 97 1996 1997 1998 1999 2000 2001 2002 1996 2002 2000 1997 1998 1999 2001

  9. Crisis in EMs “Neoclassic” Period 0 -100 -136 -200 -300 USA -400 -500 -474 -600 -700 220 250 196 200 Industrialized Countries 150 100 50 0 400 278 300 Emerging Countries 200 100 -84 0 -100 1992 1993 1996 1998 1999 2000 2001 2002 2004 1994 1995 1997 2003 Global Imbalances (Current Account, billions of US dollars)  = -338  = -24  = + 362

  10. 160 150 140 130 120 110 100 90 Capital Flight from EMs From a LAC-7 Perspective Depreciation of LAC-7 Currencies Increase in Interest Rates Collapse in Asset Prices (LAC-7, RXR vis-a-vis the Dollar, Euro and REXR, 1996 = 100) (EMBI spread*, bp over US Treasury bonds) (LAC-7, stock prices indices in dollars, 1996.I=100) 160 1600 150 140 1400 130 1200 120 1000 110 100 800 90 600 80 400 70 60 200 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 *adjusted for Argentina

  11. OUTLINE • Capital Flight from EMs, 1997-2002: Global Repercussions • Revival of Capital Inflows to EMs, 2003-2005: • A Latin American Perspective • A Global Perspective • Unwinding of Global Imbalances and Latin America

  12. Reflow of Private Capital to EMs 225 250 200 150 100 50 0 -50 -100 50 0 -50 -100 -150 -138 -200 -250 190 150 110 70 30 -10 -50 -90 -87 -130 -170 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Private Capital Flows: A Global Perspective (billions of US dollars) “Neoclassic” Period Crisis in EMs USA  = -239 -14 Industrialized Countries  = + 53 -85 99 Emerging Countries  = + 186 2003 2004 Source: WEO

  13. Crisis in EMs Reflow of Private Capital to EMs Capital Flows 150 (in billions of US dollars) 70 -10 -90 -170 1650 EMBI Spreads 1450 (bp over US Treasury bonds) 1250 1050 850 650 Pre-Asian Crises EM Spreads 450 360 250 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Capital Flows to Emerging Countries & EM Bond Spreads “Neoclassic” Period 1650 1040 390

  14. 480 430 380 EMBI spread 330 280 Emerging Markets 230 Greenspan’s “Conundrum” & EM Spreads (EMBI+ , 30-year Treasury Bonds and Fed Fund Target Rate) Fears of FED tightening 5,70 Greenspan’s “conundrum” testimony 3,75 Beginning of FEDtightening 5,50 5,30 30-Year Treasury Bond 5,10 4,90 30-year Treasury rate 4,70 4,50 1,0 4,30 FED Funds Target Rate 4,10 jul-04 jul-05 jun-05 jun-04 dic-04 abr-04 abr-05 oct-04 oct-05 feb-04 feb-05 nov-04 mar-05 mar-04 ene-05 ago-05 ene-04 ago-04 sep-04 sep-05 may-04 may-05

  15. Crisis in EMs Reflow of Private Capital to EMs Capital Flows 150 (in billions of US dollars) 70 -10 -90 -170 595 Asset Prices (LAC-7, stock prices in US dollars, 1991.I=100) 495 395 295 195  = + 368%  = - 50%  = + 174% 95 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Capital Flows to Emerging Countries & Asset Prices in LAC-7 “Neoclassic” Period

  16. Boom in Asset Prices (local stock indices in units of domestic currency, 09 Oct 02 = 100) % Change Greenspan’s “conundrum” testimony Fears of FED tightening due to stream of positive US economic data Oct 02– Sep 05 LAC - 7 345 +242.5% LAC - 7 +100.4% Emerging Asia 325 +89.8% Nasdaq +56.1% S&P500 305 +55.9% Nikkei +55.7% EU500 285 265 245 Beginning of easing in external financial conditions 225 Emerging Asia 205 Nasdaq 185 S&P500 165 EU500 145 Nikkei 125 105 85 jul-02 jul-03 jul-04 jul-05 nov-02 nov-03 nov-04 ene-02 ene-03 ene-04 ene-05 mar-02 sep-02 mar-03 sep-03 mar-04 sep-04 mar-05 sep-05 may-02 may-03 may-04 may-05

  17. Crisis in EMs Reflow of Private Capital to EMs 150 Capital Flows (in billions of US dollars) 70 -10 -90 -170 185 Bank Credit (LAC-7, real credit to private sector, 1991.I=100) 170 155 140 125 Average annual growth Dec-02 – Dec-04: +5.8% Average annual growth Jan-91 - Dec-97: +8.2% Average annual growth Dec-97 – Dec-02: -2.8% 110 95 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2002 2003 2004 2001 Financial and Capital Flows to Emerging Markets and Bank Credit in LAC-7 “Neoclassic” Period

  18. Revival of Domestic Bank Credit (LAC-7, real credit to the private sector, Jun-98=100 and yoy variation) 18% 100 96 13% real bank credit 92 8% yoy variation 88 3% Real Bank Credit 84 -2% 80 -7% 76 yoy variation 72 -12% Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 May-98 May-99 May-00 May-01 May-02 May-03 May-04 May-05

  19. Domestic Bank Credit in LAC’s G-3 (real credit to the private sector, yoy variation) Argentina Brazil Mexico 20% 12% 27% 22% 10% 7% 17% 0% 2% 12% 7% -10% -3% 2% -20% -8% -3% -8% -13% -30% -13% -18% -18% -40% Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

  20. Domestic Bank Credit in Other LAC-7 Countries (real credit to the private sector, yoy variation) Colombia Chile Venezuela 15% 80% 14% 10% 12% 60% 10% 5% 40% 8% 0% 20% 6% -5% 4% 0% -10% 2% -20% -15% 0% -2% -20% -40% Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

  21. Crisis in EMs Reflow of Private Capital to EMs 104.6 102,5 82,6 Capital Flows to Emerging Countries & Commodity Prices “Neoclassic” Period 190 Capital Flows 150 (in billion of UD dollars) 110 70 30 -10 -50 -90 -130 -170 110 Commodity Prices (Non-oil primary commodity prices index, annual average, Jan-1991 = 100) 105 100 95 90 85 80 75 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

  22. Commodity Prices Petroleum Metals Foods 120 340 149 100% 115 139 290 110 129 105 240 119 100 Avg 90-97 95 190 109 90 99 Avg 90-97 140 85 234% Avg 90-97 89 80 90 79 75 23% 40 70 69 1990 1992 1994 1996 1998 2000 2002 2004 1990 1992 1994 1996 1998 2000 2002 2004 1990 1992 1994 1996 1998 2000 2002 2004

  23. Focus on Venezuela: Oil Prices and Public Finances

  24. 150 140 Expenditure +39.5% 130 120 Expenditure 6.6% 110 - 4,4% 100 90 Mar-02 Oil Price 80 70 Oil Prices and Public Finances Oil Prices and Expenditure Adjusted Fiscal Balance (s.a real expenditures and US dollars per barrel, Mar-02=100) (central government balance, % GDP) 3.0% 232 Mar-02 Jun-05 2,2% Chavez Inauguration Oil Prices +129.1% 207 1.0% 182 Chavez Inauguration -1.0% 157 Oil Oil Price -3.0% 132 107 -5.0% Observed 82 -7.0% Expenditure 57 Beginning of rise in commodity prices Beginning of rise in oil prices -9.0% 32 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Sep-04 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

  25. Crisis in EMs Reflow of private Capital to EMs 190 Capital Flows 150 (in billions of US dollars) 110 70 30 -10 -50 -90 -130 -170 average annual growth 1991.I-1998.II: 8.6% 185 Investment 175 (s.a. GFKF*, 1991.I=100 ) 165 155 145 average annual growth 2002.IV-2004.IV: 11.9% 135 125 average annual growth 1998.II-2002.IV: -4.1% 115 105 95 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Capital Flows to Emerging Countries & Investment in LAC-7 “Neoclassic” Period *Gross Fixed Capital Formation

  26. Capital Flows to Emerging Countries & Investment in Brazil “Neoclassic” Period Crisis in EMs Reflow of private Capital to EMs 150 Capital Flows (in billions of US dollars) 70 -10 -90 -170 average annual growth: 1991.I-1998.II: 5.2% 145 Investment 135 (s.a. GFKF*, 1991.I=100) 125 average annual growth: 1998.II-2003.II: -3.0% average annual growth: 2003.II-2004.IV: 9.1% 115 105 95 I-1991 I-1992 I-1993 I-1994 I-1995 I-1996 I-1997 I-1998 I-1999 I-2000 I-2001 I-2002 I-2003 I-2004 *Gross Fixed Capital Formation

  27. Investment in Chile and Peru (s.a. GFKF*, 1991.I=100 ) Reflow of private Capital to EMs Crisis in EMs “Neoclassic” Period 299 Chile Average annual growth 1991.I-1998.II: 14.3% 249 Average annual growth 2002.IV-2004.IV: 12.6% 199 Average annual growth 1998.II-2002.IV: -2.3% 149 99 1991.I 1994.I 1995.I 1999.I 2000.I 2003.I 2004.I 1992.I 1993.I 1996.I 1997.I 1998.I 2001.I 2002.I 219 Peru Average annual growth 1991.I-1998.II: 12.1% 199 179 Average annual growth 2002.IV-2004.IV: 8.5% 159 Average annual growth 1998.II-2002.IV: -5.8% 139 119 99 1994.I 1995.I 1999.I 2000.I 2001.I 2004.I 1991.I 1992.I 1993.I 1996.I 1997.I 1998.I 2002.I 2003.I *Gross Fixed Capital Formation

  28. Investment in Colombia and Venezuela (s.a. GFKF*, 1991.I=100 ) “Neoclassic” Period Crisis in EMs Colombia Reflow of private Capital to EMs 190 180 Average annual growth 1998.II-2002.IV: -5,8% 170 160 150 140 130 Average annual growth 1991.I-1998.II: 6.0% Average annual growth 2002.IV-2004.IV: 13.8% 120 110 100 90 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I Venezuela 150 140 Average annual growth 2002.IV-2004.IV: 10.1% 130 120 110 100 90 Average annual growth 1991.I-1998.II: 2.2% Average annual growth 1991.I-1998.II: -4.0% 80 70 60 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2001.I 2002.I 2003.I 2004.I *Gross Fixed Capital Formation

  29. Investment en Argentina y Uruguay (s.a. GFKF*, 1991.I=100 ) Reflow of private Capital to EMs Crisis in EMs “Neoclassic” Period Average annual growth 2002.IV-2004.IV: 35.1% Argentina 232 Average annual growth 1991.I-1998.II: 12.8% 212 192 172 152 Average annual growth 1998.II-2002.IV: -16.0% 132 112 92 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2001.I 2002.I 2003.I 2004.I Uruguay 185 165 Average annual growth 2002.IV-2004.IV: 29.3% 145 125 Average annual growth 1991.I-1998.III: 9.1% Average annual growth 1998.III-2002.IV: -20.8% 105 85 65 1991.I 1994.I 1996.I 1999.I 2001.I 2003.I 2004.I 1992.I 1993.I 1995.I 1997.I 1998.I 2000.I 2002.I *Gross Fixed Capital Formation

  30. Reflow of Private Capital to EMs  = -24,0%  = + 52,3%  = - 14,4% Capital Flows to Emerging Countries & The Real Exchange Rate in LAC-7 Crisis in EMs “Neoclassic” Period Capital Flows 150 (in billions of US dollars) 70 -10 -90 -170 120 Real Exchange Rate (LAC-7, bilateral RER, quarterly average, Mar-1991 = 100) 110 100 90 80 70 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

  31. Crisis in EMs Reflow of Private Capital to EMs 2005Forecasts Argentina 6.8% Brazil 3.2% Chile 5.9% Colombia 3.7% Mexico 3.4% average annual growth 1991.I-1998.II: 4.6% Peru 5.0% Venezuela 6.3% average annual growth 2002.IV-2004.IV: 4.9% LAC-7 4.9% average annual growth 1998.II-2002.IV: 0.5% Capital Flows to Emerging Countries & Economic Activity in LAC-7 “Neoclassic” Period 190 Capital Flows 150 (in billions of US dollars) 110 70 30 -10 -50 -90 -130 -170 Economic Activity 148 138 (s.a. GDP, 1991.I =100 ) 128 118 108 98 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2002 2003 2004 2001

  32. Capital Flows to Emerging Countries & Economic Activity in Brazil “Neoclassic” Period Crisis in EMs Reflow of private Capital to EMs 150 Capital Flows (in billions of US dollars) 70 -10 -90 -170 149 Economic Activity 139 (s.a. GDP, 1991.I =100 ) average annual growth: 1991.I-1998.II: 3.7% 129 average annual growth 2003.II-2004.IV: 4.6% 119 average annual growth 1998.II-2003.II: 1.4% 109 99 I-1991 I-1992 I-1993 I-1994 I-1995 I-1996 I-1997 I-1998 I-1999 I-2000 I-2001 I-2002 I-2003 I-2004

  33. Economic Activityin Chile and Peru (s.a. GDP, 1991=100) Crisis in EMs Reflow of private Capital to EMs “Neoclassic” Period 217 Chile 197 Average annual growth 1991.I-1998.II: 8.1% 177 Average annual growth 2002.IV-2004.IV: 5.4% 157 137 Average annual growth 1998.II-2002.IV: 2,2% 117 97 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I 177 Perú 167 157 average annual growth 1991.I-1998.II: 4.8% 147 average annual growth 2002.IV-2004.IV: 4.8% 137 127 Average annual growth 1998.II-2002.IV: 2.4% 117 107 97 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I

  34. Crisis in EMs Reflow of private Capital to EMs Economic Activityin Colombia and Venezuela (s.a. GDP, 1991=100) “Neoclassic” Period Colombia 147 137 Average annual growth 1991.I-1998.II: 3.6% Average annual growth 2002.IV-2004.IV: 4.5% 127 117 Average annual growth 1998.II-2002.IV: 0,9% 107 97 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I 125 Venezuela average annual growth 2002.IV-2004.IV: 4.5% 120 115 110 105 average annual growth 1991.I-1998.II: 3.6% average annual growth 1998.II-2002.IV: 0,9% 100 95 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I

  35. Economic Activityin Argentina and Uruguay (s.a. GDP, 1991=100) Reflow of private Capital to EMs Crisis in EMs “Neoclassic” Period Argentina 147 Average annual growth 1991.I-1998.II: 5.7% 142 137 132 127 122 Average annual growth 2002.IV-2004.IV: 10,2% 117 Average annual growth 1998.II-2002.IV: -4,4% 112 107 102 97 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I Uruguay 137 average annual growth 1991.I-1998.III: 4,4% 132 127 122 117 average annual growth 2002.IV-2004.IV: 12,4% 112 average annual growth 1998.III-2002.IV: -6,0% 107 102 97 1991.I 1992.I 1993.I 1994.I 1995.I 1996.I 1997.I 1998.I 1999.I 2000.I 2002.I 2003.I 2004.I 2001. I

  36. US$ 76 (2005 US$ 80) Oil Prices: A Historical Perspective (USD per barrel in 2004 prices) US$ 99 100 90 80 70 60 US$ 59 US$ 49 50 40 30 20 10 US$ 12 0 Jan-70 Jan-72 Jan-74 Jan-76 Jan-78 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Oil: average of U.K. Brent, Dubai, and West Texas Intermediate

  37. Short Term Impact of an $80 Oil Price on Growth (deviations from WEO GDP growth baseline projections, in percentage points) Industrialized Countries Emerging Market Net Oil Importing Countries Central and Eastern Europe Newly Industrialized Asia Latin America Emerging Asia United States Japan Euro Area United Kingdom Africa -0.6% -0.7% -0.4% -0.7% -0.8% -0.6% Average: -0.6% -0.8% Average: -0.8% -0.9% -0.8% -0.9% Source: “Oil Market Developments and Issues”, IMF, March 2005.

  38. Reflow of Private Capital to EMs  = -24,0%  = + 52,3%  = - 14,4% Capital Flows to Emerging Countries & The Real Exchange Rate in LAC-7 Crisis in EMs “Neoclassic” Period Capital Flows 150 (in billions of US dollars) 70 -10 -90 -170 120 Real Exchange Rate (LAC-7, bilateral RER, quarterly average, Mar-1991 = 100) 110 100 90 80 70 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

  39. Exchange Rate Appreciation in LAC-7 (Oct-2002 = 100) Appreciation by country Oct-02 – Aug-05 115 Mexico (0.7%) 105 Venezuela (-6,8%) 95 Peru (-9,2%) 85 Chile (-23,4%) 75 Colombia (-27,2%) Argentina (-27,1%) 65 55 Brazil (-50,7%) 45 jun-03 jun-04 jun-05 dic-02 dic-03 dic-04 oct-02 abr-03 oct-03 abr-04 oct-04 abr-05 feb-03 feb-04 feb-05 ago-03 ago-04 ago-05

  40. Crisis in EMs Reflow of Private Capital to EMs  = + 113,1  = - 12,2  = + 53,4 Capital Flows to Emerging Countries & Official Reserves in LAC-7 “neoclassic” Period Capital Flows 150 (in billions of US dollars) 70 -10 -90 -170 195 Reserves (LAC-7, in billion of US dollars) 155 115 75 35 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

  41. Reflow of Private Capital to EMs Inflation Expectations (CPI, yoy variation) Expected 2005 Observed 2004 Argentina 6.1% 10.7% Brazil 7.6% 5.6% Chile 2.4% 3.3% Colombia 5.5% 5.2% Mexico 5.2% 3.7% Peru 3.5% 2.1% Venezuela 19.2% 17.4% Capital Flows to Emerging Countries & Inflation in LAC-7 Crisis in EMs “Neoclassic” Period 190 Capital Flows 150 (in billions of US dollars) 110 70 30 -10 -50 -90 -130 -170 40% Inflation 35% (median, in %) 30% 25% 20% 15% 10% 5% 0% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

  42. Focus on Argentina: Exchange Rate Intervention, Inflation and Sterilization

  43. Nominal Exchange Rate and Intervention in the Exchange Rate Market International Reserves Nominal Exchange Rate (RER vis-à-vis the US) (Millions of US Dollars) 3.9 26,105 27,000 3.8 25,000 3.7 23,000 3.6 XR stabilizes in a 2.7-3.1 range XR stabilizes in a 2.7-3.1 range 3.5 21,000 3.4 19,000 3.3 17,000 3.2 15,000 3.1 2.95 3.0 13,000 2.9 11,000 2.8 9,000 2.7 7,000 2.6 Jun-02 Jun-03 Jun-04 Jun-05 Oct-02 Oct-03 Oct-04 Oct-05 Jun-02 Jun-03 Jun-04 Jun-05 Feb-03 Feb-04 Feb-05 Mar-03 Mar-04 Mar-05 Sep-02 Sep-03 Sep-04 Sep-05 Dec-02 Dec-03 Dec-04

  44. Inflation and Expectations Observed Inflation Inflation Expectations (CPI, 12-month rate and annualized monthly rate of quarterly moving average) (2005, market expectatons and BCRA target band) 11.1% 11.5% 19% 17.2% Sharp Acceleration of Inflation 11.0% Sharp Acceleration of Inflation 17% 10.5% Annualized monthly rate 9.8% 15% 10.0% 9.5% 13% 9.0% 11% 8.5% 10.2% Upper limit 8.0% 9% 2006 Expectations 7.5% 2005 Expectations 7% Upper limit 7.0% 6.5% 5% 12-month rate Lower limit 6.0% 3% 5.5% Lower limit 1% 5.0% Jul-04 Jul-05 Jul-04 Jan-04 Jan-05 Jan-04 Jan-05 Jun-05 Mar-04 Mar-05 Sep-04 Nov-04 Sep-05 Mar-04 Mar-05 Sep-04 May-04 May-05 Nov-04 May-04 May-05 Aug-05

  45. Reserve Accumulation and Sterilization Monetary Objectives of the BCRA Interest Rates on BCRA Bills (billion of pesos) (180 day LEBACS in pesos) 67 88 Reserve Accumulation Financing 7.5 65 Average Maturity 180-d rates Monetary Base 29% 90-d rates 84 Repos + Lebacs 71% 62 May-04 1.1% 243 2.5% 80 Sep-05 6.9% 158 7.5% Repos + Lebacs 60 Sharp Acceleration of Inflation 76 57 72 55 Monetary Base Augmented Monetary Base plus LEBACS Augmented Monetary plus LEBACS* 68 52 64 50 60 47 Monetary Base Sharp Acceleration of Inflation 45 56 2.6 42 52 Jul-04 Jul-05 Jan-04 Jan-05 Mar-04 Mar-05 Sep-04 Nov-04 Sep-05 May-04 May-05 *Augmented Monetary Base = Monetariy Base + Repos

  46. 10.2% Sharp Acceleration of Inflation 10,5% 10,0% Nominal Exchange Rate 9,5% 9,0% 2.9 12-month Inflation 8,5% 8,0% 7,5% Real Exchange Rate 7,0% 2.7 6,5% Domestic Inflation 6,0% 5,5% 5,0% Exchange Rate and Inflation (TCR vis á vis the US dollar, ago-04 = NER) 3,05 3,00 2,95 2,90 Exchange Rate 2,85 2,80 2,75 2,70 2,65 2,60 2,55 jul-05 jun-05 oct-04 dic-04 feb-05 nov-04 abr-05 ene-05 sep-04 mar-05 sep-05 ago-04 may-05 ago-05

  47. Crisis in EMs Reflow of Private Capitals to EMs Capital Flows (in billions of US dollars) 190 150 110 70 30 -10 -50 -90 -130 -170 Fiscal Result 1% (% of GDP) 0% -1% -2% Average 2002-2004: -1.4% Average 1991-1997: -1.1% -3% Average 1998-2002: -3.0% -4% -5% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Capital Flows to Emerging Countries & Fiscal Performance in LAC-7 “Neoclassic” Period

  48. Crisis in EMs Reflow of Private Capitals to EMs 50% 45% 40% 35% 30% 25% 20% 1991 1992 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1993 Capital Flows to Emerging Countries & Public Debt in LAC-7 “Neoclassic” Period Capital Flows 190 (in billions of US dollars) 150 110 70 30 -10 -50 -90 -130 -170 Public Debt* 47.6% (% of GDP) 43.7% 40.8% 27.7% *adjusted by Argentina’s debt reestructuring

  49. Focus on Brazil: The Real Exchange Rate, Interest Rates and Fiscal Performance

  50. Interest Payments: 10.5% Fiscal Deficit: 6.3% Interest Payments: 7.9% Primary Surplus: 5.1% FiscalDeficit: 2.8% Primary Surplus: 4.2% Fiscal Balance (last 12 months, in % of GDP) 6.5% 11% 6.0% 10% 5.5% 9% 5.0% 8% 4.5% 7% Fiscal Deficit Primary Surplus & Interest Payments 4.0% 6% 3.5% 5% 3.0% 4% 2.5% 3% 2.0% 2% Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 May-02 May-03 May-04 May-05 Mar-02 Mar-03 Mar-04 Mar-05 Nov-01 Nov-02 Nov-03 Nov-04 Sep-01 Sep-02 Sep-03 Sep-04 Jan-02 Jan-03 Jan-04 Jan-05

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