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Macroeconomic Challenges for Latin America: Where do we Stand?

Macroeconomic Challenges for Latin America: Where do we Stand?. Ernesto Talvi. Director of CERES and Non-Resident Senior Fellow, Brookings Institution. October 22 nd , 2009.

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Macroeconomic Challenges for Latin America: Where do we Stand?

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  1. Macroeconomic Challenges for Latin America: Where do we Stand? Ernesto Talvi Director of CERES and Non-Resident Senior Fellow, Brookings Institution October 22nd, 2009 Prepared for Presentation at the XXX Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC

  2. OUTLINE I. Introductory Remarks II. Phase 1: “Indian Summer” (2007.I – 2008.II) III. Phase 2: “Winter” (2008.II – 2009.I) IV. Phase 3: “Spring” (2009.I) V. Policy Challenges and a Final Thought

  3. Phase 1: Indian Summer Phase 2: Winter Phase 3: Spring Variation in % Phase 1 Phase 2 Phase 3 S&P Financial S&P Industrial -28.0 13.2 -76.7 -61.3 130.4 61.0 Phases of the Global Financial Crisis 120 105 S&P Industrial 90 S&P Financial 75 60 45 30 15 Jul-07 Jul-08 Jul-09 Jan-07 Jan-08 Jan-09 Mar-07 Mar-08 Mar-09 Sep-07 Sep-08 Nov-07 Nov-08 May-07 May-08 May-09

  4. Levels Differences Latin America and Central America: Structural Differences Openness Remittances Commodity Prices (Exports + Imports, in % of GDP, 2007) (Remittances Inflows, in % of GDP, 2007) (Correlation Coefficient between Commodity Prices and Terms of Trade, in logs, Mar.90 – Jun.09) 12% 95% 100% 92.4% 92.1% 91% 11.1% 90% 11% 80% 85% 10% 60% 80% 9% 75% 8% 40% 70% 7% 20% 65% 6% 60% 0% 5% 55% 52% 4% -20% 50% -29.5% 3% 45% -40% 2% 40% 1.1% -60% 1% 35% -70.8% 0% 30% -80% LAC-7 CAC-7 LAC-7 CAC-7 LAC -7 CAC-7 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 93% of Latin America’s GDP. CAC-7 is the simple average of the seven major Central American countries, namely Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama .

  5. OUTLINE I. Introductory Remarks II. Phase 1: “Indian Summer” (2007.I – 2008.II) III. Phase 2: “Winter” (2008.II – 2009.I) IV. Phase 3: “Spring” (2009.I) V. Policy Challenges and a Final Thought

  6. Phase 1: Indian Summer Variation in % Phase 1 S&P Financial S&P Industrial -28.0 13.2 Phases of the Global Financial Crisis: Indian Summer 120 105 S&P Industrial 90 S&P Financial 75 60 45 30 15 Jul-07 Jul-08 Jul-09 Jan-07 Jan-08 Jan-09 Mar-07 Mar-08 Mar-09 Sep-07 Sep-08 Nov-07 Nov-08 May-07 May-08 May-09

  7. Macroeconomic Impact on Latin America of the Global Financial Crisis: Indian Summer • In the first phase of the crisis, the net impact of external factors turned out to be expansionary for Latin America • In fact, one year and a half into the US financial crisis, Latin America was experiencing all the symptoms of overheating: • Strong Capital Inflows • Booming Asset Prices • Currency Appreciation • High Growth Rates • Inflationary Pressures

  8. In % of GDP Dec-06 3.6% 0.9% 2.7% 4.0% 2.8% 1.2% Capital Inflows Financial Inflows FDI Inflows Phase 1 - Indian Summer: Capital Inflows (Last 4 quarters, billions of USD, Mar-08 prices) Latin America Central America (LAC-7) (CAC-6) US Financial Crisis US Financial Crisis 250 Beginning of the Boom Beginning of the Boom Russian Crisis Russian Crisis 238 20 18.3 225 18 In % of GDP Phase 1 (Δ) Dec-06 Phase 1 (Δ) 13.7% 5.7% 6.8% 3.1% 2.8% 0.2% Capital Inflows Financial Inflows FDI Inflows 200 16 175 14 164 150 12 12 125 10 100 8 103 75 6 5.5 50 4 2.9 25 2 17 0 0 2001 2003 2004 2005 2006 2008 2000 1991 1993 1994 1995 1996 1998 1999 2000 2001 2003 2004 2005 2006 1991 1993 1994 1995 1996 1998 1999 2008 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-6 is the simple average of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

  9. Phase 1 – Indian Summer:Real Exchange Rate (Bilateral RXR vis a vis the USD, Dec-90=100) Central America Latin America (CAC-7) (LAC-7) Russian Crisis 105 Beginning of the Boom 140 Beginning of the Boom US Financial Crisis Russian Crisis US Financial Crisis 103 Variation Jun.98-Sep.03: 7% 130 101 Variation Oct.02-Dec.06: -27% 120 99 97 110 Variation Dec.06-Aug.08: -7% 95 Variation Dec.06-Jul.08: -17% Variation Dec.90-Jun.98: -6% Variation Sep.03-Dec.06: -5% 100 Variation Dec.90-Jun.98: -25% 93 91 90 89 80 Variation Jun.98-Oct-02: 68% 87 85 70 1990 1991 1996 1997 1998 1999 2000 2004 2005 2006 2007 1992 1993 1994 1995 2001 2002 2003 2006 1998 1990 1992 1994 1996 2000 2002 2004 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 93% of Latin America’s GDP. CAC-7 is the simple average of the seven major Central American countries, namely Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama .

  10. 6.7% 6.6% Beginning of the Boom Russian Crisis 7% 6.4% Average Growth 03-06 : 5.6% 6% Average Growth 91-97: 4.6% 5% 4% 3% 2% Average Growth 98-02: 0.7% 1% 0% US Financial Crisis -1% -2% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008* Phase 1 – Indian Summer:Economic Activity (Real GDP, annual variation) Latin America Central America (LAC-7) (CAC-7) Russian Crisis Beginning of the Boom 7.0% 6.9% 7% 6.0% 6% 6% Average 91-98: 4.6% 5% Average 03-06: 5% 4% Average 99-02: 3.3% 3% 2% 1% 0% -1% US Financial Crisis -2% 2003 2005 2007 2001 1993 1995 1997 1991 1999 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-7 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama. * Year ended in Jun-08

  11. +3.9% +8.4% Phase 1 – Indian Summer:Inflation (CPI, inflation last 12 months) Central America Latin America (CAC-7) (LAC-7) 8% 15% US Financial Crisis US Financial Crisis 7.9% 14.0% 13% 7% 11% 6% 9% 5% 7% 4% 5.6% 4.0% 5% 3% 3% Jul-06 Jul-07 Jul-08 Jul-06 Jul-07 Jul-08 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Jan-06 Jan-07 Jan-08 Jan-06 Jan-07 Jan-08 Mar-06 Mar-07 Mar-08 Nov-06 Nov-07 Sep-06 Sep-07 May-06 May-07 May-08 LAC-7 is the median of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 93% of Latin America’s GDP. CAC-7 is the simple average of the seven major Central American countries, namely Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama .

  12. Macroeconomic Impact on Latin America of the Global Financial Crisis: Indian Summer • In the first phase of the crisis, the net impact of external factors turned out to be expansionary for Latin America • In fact, one year and a half into the US financial crisis, Latin America was experiencing all the symptoms of overheating: • Strong Capital Inflows • Booming Asset Prices • Currency Appreciation • High Growth Rates • Inflationary Pressures • The policy response in the ‘Indian Summer Phase’ of the global crisis was a combination of tight monetary policy cum expansionary fiscal policy (which maintained the expansionary bias of the previous years)

  13. Phase 1 – Indian Summer: Monetary Policy Response Latin America Central America (LAC-7*, CB Reference Rate and Nominal Exchange Rate, in % and 02-Jan-07=100) (CAC-4, CB Reference Rate and Nominal Exchange Rate, in % and Jan-07=100) 9.5% 105 9.5% 105 9.0% 100 100 9.0% Exchange Rate 8.5% Interest Rate 95 95 8.0% Interest Rate Exchange Rate Exchange Rate Interest Rate 8.5% Exchange Rate 7.5% 90 90 7.0% Interest Rate 8.0% 85 85 6.5% 6.0% 80 7.5% 80 jul-08 jul-07 jul-07 jul-08 dic-07 dic-07 jun-08 jun-07 jun-07 oct-07 oct-07 jun-08 feb-08 feb-08 feb-07 feb-07 abr-08 abr-07 abr-07 abr-08 sep-07 nov-07 ago-07 sep-07 ene-07 ene-08 nov-07 mar-08 mar-07 ene-08 ago-07 mar-08 ene-07 mar-07 may-08 may-07 may-08 may-07 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-4 is the simple average of Costa Rica, Dominican Republic, Guatemala and Honduras. *Excludes Argentina and Venezuela

  14. Phase 1 – Indian Summer: Fiscal Policy Response Latin America Central America (CAC-7, Structural Fiscal Balance, % of GDP) (LAC-7**, Structural Fiscal Balance, % of GDP) -0.6% 0.0% -0.5% -0.5% -0.8% -0.9% -1.0% -1.0% -1.5% -1.1% -1.2% -2.0% -1.4% -2.2% -2.5% -1.6% -3.0% Financial Crisis Financial Crisis -3.1% -1.7% -1.8% -3.5% Jun-07 Jun-07 Jun-05 Jun-05 Jun-06 Jun-06 Mar-05 Mar-07 Mar-07 Mar-05 Mar-06 Sep-07 Sep-07 Sep-05 Mar-06 Dec-07 Dec-07 Dec-04 Dec-05 Dec-06 Sep-06 Sep-05 Dec-06 Dec-04 Dec-05 Sep-06 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. **Excludes Venezuela CAC-7 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

  15. OUTLINE I. Introductory Remarks II. Phase 1: “Indian Summer” (2007.I – 2008.II) III. Phase 2: “Winter” (2008.II – 2009.I) IV. Phase 3: “Spring” (2009.I) V. Policy Challenges and a Final Thought

  16. Phase 1: Indian Summer Phase 2: Winter Phase 2 -76.7 -61.3 Phases of the Global Financial Crisis: Winter 120 105 S&P Industrial 90 S&P Financial 75 60 Variation in % Phase 1 S&P Financial S&P Industrial -28.0 13.2 45 30 15 Jul-07 Jul-08 Jul-09 Jan-07 Jan-08 Jan-09 Mar-07 Mar-08 Mar-09 Sep-07 Sep-08 Nov-07 Nov-08 May-07 May-08 May-09

  17. Macroeconomic Impact on Latin America of the Global Financial Crisis: Winter • During the ‘Winter Phase’, the global economic and financial conditions suffered a severe deterioration… • … which put an abrupt end to the expansionary cycle: • Severe International Credit Crunch • Collapse in Capital Flows and Asset Prices • Currency Depreciation • Recession • Disinflation

  18. 1,000 105 CAC-5 CAC-5 900 Variation in bps 100 Phase 1 Phase 2 800 LAC-7 CAC-5 EMBI+ 133 97 85 519 431 434 95 LAC-7 700 90 EMBI+ 600 EMBI+ 85 Variation in % 500 Phase 1 Phase 2 80 LAC-7 EMBI+ CAC-5 -3.6% -0.8% 0.1% -16.5% -18% -16.5% 400 75 300 LAC-7 70 200 100 65 Jul-07 Jul-08 Jul-07 Jul-08 Apr-07 Oct-07 Apr-08 Oct-08 Jan-07 Jan-08 Jan-09 Jan-07 Jan-08 Jan-09 Mar-09 Mar-07 Mar-08 Sep-07 Nov-07 Sep-08 Nov-08 May-07 May-08 Phase 2 – Winter: International Financial Conditions Sovereign Bond Spreads Sovereign Bond Prices (EMBI+ and Latin EMBI, in bps) (EMBI+, Bond Price Equvalent*; 01-Jan-07 = 100) *Assumes an 11% cupon and 10 year maturity LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala and Panama.

  19. Phase 2 – Winter: Capital Inflows (Last 4 quarters, billionsof Mar-08 USD and % of GDP*) Latin America Central America (LAC-7) (CAC-6) Phase 1 Phase 2 Phase 1 Phase 2 250 20 US Financial Crisis US Financial Crisis 238 (7.6%) 18.3 (15.4%) 225 18 Δ in % of GDP Δ in % of GDP -35% Phase 2 Phase 2 Phase 1 Phase 1 200 16 4.0% 2.8% 1.2% -4.0% -3.5% -0.5% -4.4% -4.1% -0.2% 3.1% 2.8% 0.2% Capital Inflows Financial Inflows FDI Inflows Capital Inflows Financial Inflows FDI Inflows 175 14 -67% 150 12 12 (12.3%) 11.9 (11.0%) 125 10 103 (3.6%) 8 100 79 (3.6%) 75 6 4 50 25 2 0 0 Jun-08 Sep-07 Jun-05 Mar-09 Mar-06 Dec-06 Sep-04 Dec-03 Dec-06 Jun-08 Dec-03 Jun-05 Sep-07 Mar-09 Sep-04 Mar-06 * % of GDP between brackets LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-6 is the simple average of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

  20. 5.2% 30.7% Phase 2 – Winter: Nominal Exchange Rate (Bilateral NXR vis a vis the USD, Dec-06=100) Latin America Central America (LAC-7) (CAC-5) Phase 1 Phase 2 Phase 2 Phase 1 108 116 115 107 113 107 110 106 107 105 104 104 101 103 98 102 102 95 101 92 100 89 89 99 86 Jul-07 Jul-08 Apr-07 Oct-07 Apr-08 Oct-08 Jun-07 Jun-08 Jan-07 Jan-08 Jan-09 Feb-07 Feb-08 Feb-09 Mar-07 Mar-08 Mar-09 Dec-06 Dec-07 Dec-08 Aug-07 Aug-08 Nov-07 Nov-08 Sep-07 Sep-08 May-07 May-08 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 93% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic, Guatemala, Honduras and Nicaragua .

  21. Forecast Apr-08** Forecast Apr-08* Forecast Oct-09** Forecast Sep-09* Phase 2 – Winter: Economic Activity (Real GDP, annual variation) Central America Latin America (CAC-7) (LAC-7) Phase 1 Phase 2 Phase 2 Phase 1 Beginning of the Boom Russian Crisis Russian Crisis Beginning of the Boom 7% 7% 6% Average Growth 03-06: 5.6% 6% 4.8% Average Growth 03-06: 5.0% 5% 4.7% Average Growth 91-98 : 4.6% 5% 4.5% Average Growth 91-97: 4.6% 4.4% 4% 4% Average 71-06: 3.4% Average Growth 99-02: 3.3% 3% 3% 2% 2% 1% Average Growth 98-02: 0.7% 1% 0% 0% -0.6% -1% -1% US Financial Crisis US Financial Crisis -1.9% -2% -2% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1997 2003 2007 2009 2005 1991 1993 1995 2001 1999 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-7 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama. • Source: JPMorgan. **Source: WEO

  22. -2.1% -9.0% Phase 2 – Winter: Inflation (CPI, inflation last 12 months) Latin America Central America (LAC-7) (CAC-7) Phase 2 Phase 1 Phase 2 Phase 1 15% 8% US Financial Crisis 7.9% 14% 13% 7% 11% 6% 5.7% 9% 5% 7% 4% 4.1% 5.6% 5% 5.0% 3% Jul-07 Jul-08 Jul-06 Jul-07 Jul-08 Jan-07 Jan-08 Jan-09 Mar-07 Mar-08 Mar-09 Nov-07 Nov-08 Sep-07 Sep-08 May-07 May-08 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Jan-06 Jan-08 Jan-09 Jan-07 LAC-7 is the median of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 93% of Latin America’s GDP. CAC-7 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

  23. Macroeconomic Impact on Latin America of the Global Financial Crisis: Winter • During the ‘Winter Phase’, the global economic and financial conditions suffered a severe deterioration… • … which put an abrupt end to the expansionary cycle: • Severe International Credit Crunch • Collapse in Capital Flows and Asset Prices • Currency Depreciation • Recession • Disinflation • In contrast with the Russian Crisis, the macro policy response was countercyclical: looser monetary policy and expansionary fiscal policy

  24. 10.0% 9.5% 9.0% 8.5% 8.0% Phase 2 – Winter: Monetary Policy Response Latin America Central America (CAC-4, CB Reference rate and Nominal Exchange Rate, in % and Sep-16-08=100) (LAC-7*, CB Reference rate and Nominal Exchange Rate, in % and Sep-15-08=100) 125 125 9.5% 120 120 9.0% 115 115 Exchange Rate Exchange Rate Interest Rate Interest Rate Interest Rate 110 110 8.5% Exchange Rate Interest Rate 105 105 Exchange Rate 8.0% 100 100 95 7.5% 95 16-sep-08 16-oct-08 16-nov-08 16-dic-08 16-ene-09 16-feb-09 16-sep-08 16-oct-08 16-nov-08 16-dic-08 16-ene-09 16-feb-09 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-4 is the simple average of Costa Rica, Domincan Republic, Guantemala and Honduras *Excludes Argentina and Venezuela

  25. Phase 2 – Winter: Fiscal Policy Response (Announced Fiscal Stimulus Plans, 2009, % of GDP) Latin America Central America Chile Panama 2.8% 4.7% Peru Costa Rica 2.5% 2.8% Mexico Guatemala 1.4% 2.7% Argentina El Salvador 1.3% 2.7% Domincan Brazil 0.9% 0.0% Republic Average: 1.8% Average: 2.6% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 0% 1% 2% 3% 4% 5% Source: Banco de España Own calculations based on national and international sources

  26. Russian Crisis: Macroeconomic Policy Response Monetary Policy Fiscal Policy (LAC-7*, Interbank Interest Rate and Nominal Exchange Rate, in % and Jul-98=100) (LAC-7, Structural Fiscal Balance, % of GDP) 0.0% 118 40% 116 38% -0.5% 114 36% Interest Rate -1.0% 112 34% -1.2% 110 -1.5% 32% Interest Rate Exchange Rate 108 30% -2.0% 106 28% -2.5% 104 26% Exchange Rate 102 24% -3.0% 100 -3.1% 22% Russian Crisis -3.5% 98 20% Jul-98 Ago-98 Sep-98 Mar-99 Mar-97 Mar-98 Jun-98 Jun-99 Jun-97 Sep-98 Sep-99 Sep-97 Dec-98 Dec-96 Dec-97 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. *Excludes Argentina and Venezuela

  27. Macroeconomic Impact on Latin America of the Global Financial Crisis: Winter • During the ‘Winter Phase’, the global economic and financial conditions suffered a severe deterioration… • … which put an abrupt end to the expansionary cycle: • Severe International Credit Crunch • Collapse in Capital Flows and Asset Prices • Currency Depreciation • Recession • Disinflation • In contrast with the Russian Crisis, the macro policy response was countercyclical: looser monetary policy and expansionary fiscal policy • At the peak of the crisis in March 2009, Latin America was haunted by the specter of: • a long and deep recession • ballooning fiscal deficits with sharp increases in public debt • potentially severe liquidity problems

  28. Asian / Russian Crises Dot-Com Crisis Beginning of the Boom Tequila Crisis 10% 8% World Growth Commodity Prices Actual 6% 4% 2% 0% -2% International Financial Conditions -4% Fitted -6% 2000 1992 1993 1994 1995 1996 1997 1998 1999 2001 2002 2003 2004 2005 2006 Economic Fluctuations in Latin America: The Role of External Factors* (LAC-7; real GDP, annual growth rate) Latin America External Factors LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. *Izquierdo, A., Romero, R. and Talvi, E. (2008): “Booms and Busts in Latin America: The Role of External Factors”, IADB and CERES Working Paper

  29. Dot-Com Crisis 9% Russian Crisis Beginning of the Boom 8% World Growth Commodity Prices 7% Actual 6% 5% 4% 3% 2% Fitted International Financial Conditions 1% 0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Economic Fluctuations in Latin America: The Role of External Factors* (CAC-5; real GDP, annual growth rate) Central America External Factors CAC-5 is the simple average of Costa Rica, Dominican Republic, El Salvador, Guatemala and Panama. * Based on the methodology of Izquierdo, A., Romero, R. and Talvi, E. (2008): “Booms and Busts in Latin America: The Role of External Factors”, IADB and CERES Working Paper

  30. International Financial Conditions Industrial Countries Growth Commodity Prices Sovereign Bonds Spread Global Commodity Prices US Economic Activity (2006 = 100) (EMBI +, bps) (2006 = 100) 600 106 135 Jun-08 Mar-09 -47.3% Dec-13 Peak Trough P. to T. Recovery** Peak Trough P. to T. Recovery** Mar-08 Jun-09 -3.5% Jun-12 550 105 500 125 450 104 115 400 Pre-Crisis Level 103 Pre- Asian Crisis Level 350 105 102 300 Pre-Crisis Level 95 250 101 Trough Peak T. to P. Recovery** Jun-07 Dec-08 512 Dec-13 200 85 100 150 100 99 75 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Source: JPMorgan Source: Own calculations based on WEO and JPMorgan, Oct-08. Source: IMF and Bloomberg **Recovry to pre-asian crisis levels (400 bps) **Recovery to pre-crisis levels **Recovery to Dec-06 levels Medium Term Macroeconomic Outlook for Latin America: Winter Scenario* EXTERNAL FACTORS *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  31. Peak Trough P. to T. Recovery** Dec-08 Dec-10 -5.1% Dec-13 Peak Sep-08 Trough Dec-10 P. to T. -1.9% Recovery** Jun-12 Economic Activity: Winter Scenario* Economic Activity GDP Growth (GDP 2006 = 100) (annual growth rate) Latin America 7% 115 Average 2003-2007: 5.8% Pre-Crisis Level 6% 5% (LAC-7) 110 4% Average1991-2007: 3.3% 3% 105 2% 1% Avg. 2009-13: 0.1% 0% 100 -1% -2% 95 -3% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 8% 123 Central America 7% Average 2003-2007: 5.8% 118 6% (CAC-5) Pre-Crisis Level Average 1991-2007: 4.8% 5% 113 4% 3% 108 2% Avg. 2009-13: 1.0% 1% 103 0% 98 -1% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 **Recovery to pre-crisis levels LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic El Salvador, Guatemala and Panama. *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  32. -2.1% -5.3% +23% +12% Fiscal Position: Winter Scenario* Fiscal Balance Public Debt (% of GDP) (% of GDP) 1.6% Latin America Pre-crisis Level 2% 58% 55% 1% 53% (LAC-7) 0% 48% -1% -2% 43% -3% 38% -4% -3.7% -5.0% Pre-crisis Level 33% -5% 32% -6% 28% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Central America 55% 2% 0.6% Pre-crisis Level 1% 49% 50% ‘Winter’ Scenario (CAC-5) 0% 45% -1% -2% 40% -2.7% Pre-crisis Level -3% 35% 37% -4% -4.1% 30% -5% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic El Salvador, Guatemala and Panama. *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  33. Definition Normal International Financial Conditions Rt where ILR t = B t+1 ST ILR = International Liquidity Ratio in t t R = International Reserves in t t Total Public Debt Amortizations + Short Term External Private Debt Amortizations (in the next 12 months) ST B = t+1 ‘Winter’ Scenario Liquidity Indicators: Winter Scenario* Latin America: International Liquidity Ratio (LAC-7, ILR) 140% 130% 120% 110% 100% 90% 80% 2008 2009 2010 2011 2012 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  34. Key Challenges At The Peak of The Crisis: IDB / RES Main Proposals* • The challenge is thus to anticipate gathering problems early on to act in a timely fashion, and to design a set of policies that prevent countries from entering into financially fragile territory that might expose them to a liquidity crisis and a major economic collapse • Precarious access to credit markets for many emerging market governments calls for multilaterals to step in and play a key role as a lenders-of-last resort, akin to the role that credible governments, such as the US government, play domestically * Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  35. OUTLINE I. Introductory Remarks II. Phase 1: “Indian Summer” (2007.I – 2008.II) III. Phase 2: “Winter” (2008.II – 2009.I) IV. Phase 3: “Spring” (2009.I) V. Policy Challenges and a Final Thought

  36. Phase 1: Indian Summer Phase 2: Winter Phase 3: Spring Variation in % Phase 1 Phase 2 Phase 3 S&P Financial S&P Industrial -28.0 13.2 -76.7 -61.3 130.4 61.0 Phases of the Global Financial Crisis: Spring 120 105 S&P Industrial 90 S&P Financial 75 60 45 30 15 Jul-07 Jul-08 Jul-09 Jan-07 Jan-08 Jan-09 Mar-07 Mar-08 Mar-09 Sep-07 Sep-08 Nov-07 Nov-08 May-07 May-08 May-09

  37. Macroeconomic Impact on Latin America of the Global Financial Crisis: Spring • During the ‘Spring Phase’ of the crisis, global economic and financial conditions improved significantly • Moreover, the G-20 initiatives deactivated potentially severe liquidity problems for the region…

  38. G-20 Initiatives: Financial Assistance for Emerging Markets • Increase in multilaterals lending capacity with a special focus on liquidity provision and crisis prevention • Recapitalization of the IMF (US$ 500 bn) • New Special Drawing Rights (SDR) allocation (US$ 250 bn) • Recapitalization of Development Banks (U$S 100 - 300 bn) • New support for trade finance (US$ 250 bn) • New (and more flexible) financial instruments • IMF Flexible Credit Line (FCL) and High-Access Precautionary Arrangements (HAPAs)

  39. FCL Assumptions (1000% of Quota) Mexico* Brazil Colombia* Peru 47.0 bn 45.0 bn 10.4 bn 9.5 bn FCL 112 bn With Multilateral Support Source: Barclays FCL = U$S 111.9 billion FED = U$S 60 billion *These countries already requested the FCL. Mexico USD47bn (1000%) and Colombia USD10.4bn (900%) Liquidity Indicators post G-20 Initiatives ILR with Multilateral Support (LAC-7, International Liquidity Ratio) 150% 140% 130% 120% 110% Threshold 100% Without Multilateral Support 90% 80% 2008 2009 2010 2011 2012 ILRt = Reservest / (Public Debt Amortizationst+1 + Short Term External Private Debt) LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.

  40. Macroeconomic Impact on Latin America of the Global Financial Crisis: Spring • During the ‘Spring Phase’ of the crisis, global economic and financial conditions improved significantly • Moreover, the G-20 initiatives deactivated potentially severe liquidity problems for the region… • … which together with the improvement in the global economic and financial conditions, significantly changed the macroeconomic outlook for Latin America • The recession is now expected to be relatively short and a rebound is expected in 2010, and the fiscal and debt outlook improved substantially

  41. International Financial Conditions Industrial Countries Growth Commodity Prices ‘Spring’ ‘Spring’ Jun-08 Mar-09 -50.6% Sep-10 Mar-08 Jun-09 -3.9% Sep-10 ‘Spring’ Scenario ‘Spring’ Scenario ‘Spring’ Scenario ‘Spring’ Jun-07 Dec-08 512 Sep-10 Medium Term Macroeconomic Outlook for Latin America: Spring Scenario* EXTERNAL FACTORS Sovereign Bonds Spread Global Commodity Prices US Economic Activity (EMBI +, bps) (2006 = 100) (2006 = 100) 600 113 ‘Winter’ Scenario ‘Winter’ Scenario 135 Jun-08 Mar-09 -47.3% Dec-13 Peak Trough P. to T. Recovery** 550 ‘Winter’ Scenario Peak Trough P. to T. Recovery** Mar-08 Jun-09 -3.5% Jun-12 111 500 125 109 450 115 400 107 Pre- Asian Crisis Level 350 105 105 300 Pre-Crisis Level Pre-Crisis Level 250 95 103 ‘Winter’ Scenario Trough Peak T. to P. Recovery** Jun-07 Dec-08 512 Dec-13 200 ‘Winter’ Scenario 85 101 ‘Winter’ Scenario 150 100 99 75 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Source: JPMorgan Source: Own calculations based on WEO and JPMorgan, Oct-08. Source: IMF and Bloomberg **Recovery to pre-asian crisis levels (350 bps). In the case of spring scenario the recovery is to 300 bps **Recovery to pre-crisis levels **Recovery to Dec-06 levels *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  42. ‘Spring’ Sep-08 Sep-09 -3.8% Sep-10 ‘Spring’ Scenario ‘Spring’ ‘Spring’ Scenario Sep-08 Jun-09 -0.8% Mar-10 Economic Activity: Winter Scenario* Economic Activity GDP Growth (GDP 2006 = 100) (annual growth rate) Latin America 7% Scenarios ‘Winter’ 130 Average 2003-2007: 5.8% Peak Trough P. to T. Recovery** Sep-08 Sep-10 -5.1% Jun-13 6% 125 5% (LAC-7) 4% 120 Average1991-2007: 3.3% 3% Pre-Crisis Level 115 2% 110 1% 0% 105 ‘Winter’ Scenario -1% 100 -2% -3% 95 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Central America Scenarios ‘Winter’ 8% 135 Peak Trough P. to T. Recovery** Sep-08 Dec-10 -1.9% Jun-12 7% 130 Average 2003-2007: 5.8% 6% (CAC-5) 125 Average 1991-2007: 4.8% 5% 120 4% Pre-Crisis Level 115 3% 110 ‘Winter’ Scenario 2% 105 1% 100 0% -1% 95 2006 2007 2008 2009 2010 2011 2012 2013 2013 2006 2007 2008 2009 2010 2011 2012 **Recovery to pre-crisis levels LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic El Salvador, Guatemala and Panama. *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  43. 0.3% ‘Spring’ Scenario ‘Spring’ Scenario -2.6% 39% -0.8% ‘Spring’ Scenario ‘Spring’ Scenario -3.2% 39% Fiscal Position: Winter Scenario* Fiscal Balance Public Debt (% of GDP) (% of GDP) 1.6% Latin America 2% 58% 55% 1% ‘Winter’ Scenario 53% (LAC-7) 0% 48% -1% -2% 43% -3.7% -3% ‘Winter’ Scenario 38% -4% -5.0% 33% -5% 32% -6% 28% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Central America 55% 2% 0.6% 1% 50% ‘Winter’ Scenario (CAC-5) 0% 49% 45% -1% -2% 40% -2.7% -3% 35% 37% ‘Winter’ Scenario -4% -4.1% 30% -5% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-5 is the simple average of Costa Rica, Dominican Republic El Salvador, Guatemala and Panama. *Based on Izquierdo, A. and Talvi, E. (coords.) (2009), “Policy Trade-Offs for Unprecedented Times: Confronting the Global Crisis in Latin America”

  44. OUTLINE I. Introductory Remarks II. Phase 1: “Indian Summer” (2007.I – 2008.II) III. Phase 2: “Winter” (2008.II – 2009.I) IV. Phase 3: “Spring” (2009.I) V. Policy Challenges and a Final Thought

  45. POLICY CHALLENGES FOR LATIN AMERICA • This improved outlook implies a shift in the monetary and fiscal policy focus towards: • Exchange rate / inflationary impact of renewed capital inflows and rising commodity prices • Gradually undoing expansionary fiscal policies set in motion during the ‘Winter Phase’, in a manner consistent with an intertemporal sound fiscal policy and safe levels of public debt • Looking ahead: Chilly Spring or Hot Summer?

  46. LOOKING AHEAD: CHILLY SPRING OR HOT SUMMER? Chilly Spring • Possibly higher US interest rates might imply tighter credit conditions for EMs in the foreseeable future • Countries should prepare themselves by concentrating on self-insurance (reserve accumulation and rescheduling of debt maturities) and strengthening fiscal positions while capital market conditions remain favorable for the region Hot Summer • Excess world savings imply a very low real interest rate scenario cum high capital inflows to EMs

  47. Twin Deficits in the US Fiscal Balance Current Account (Last 4 quarters, % of GDP) (Last 4 quarters, % of GDP) 4% 0% 2% -1% 0% -2% -1.2% -2% -1.9% -3% -3.2% -4% -3.1% -6% -4% -8% -5% -4.9% -5.2% -10% -6% -6.0% -12% US Financial Crisis US Financial Crisis -7% -13.1% -14% 2007 2008 2009 1997 1998 1999 2000 2001 2005 2006 2007 2008 2009 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2002 2003 2004

  48. LOOKING AHEAD: CHILLY SPRING OR HOT SUMMER? Chilly Spring • Possibly higher US interest rates might imply tighter credit conditions for EMs in the foreseeable future • Countries should prepare themselves by concentrating on self-insurance (reserve accumulation and rescheduling of debt maturities) and strengthening fiscal positions while capital market conditions remain favorable for the region Hot Summer • Excess world savings imply a very low real interest rate scenario cum high capital inflows to EMs • Countries should manage the capital flow bonanza concentrating on: • More aggressive countercyclical monetary and fiscal policy • Achieving structural fiscal surpluses and public debt reduction to safe levels • Channeling world savings into socially productive investments

  49. A Final Thought

  50. Venezuela Current Crisis (01-Sep-08 = 100) Macroeconomic Fundamentals (% of GDP) Fiscal Balance Current Account Reserves Latin America (LAC-7) Argentina Current Crisis (01-Sep-08 = 100) Pre-Russian Crisis (1997) -0.9% -3.0% 12.7% Russian Crisis Pre-Current Crisis (2007) 1.9% 1.9% 14.3% Latin EMBI Russian Crisis (20-Jul-98 = 100) Countries with Strong Fundamentals (2007) Latin EMBI Current Crisis (01-Sep-08 = 100) Argentina 1.1% 2.8% 17.7% Current Crisis Venezuela 3.0% 8.7% 15.1% Average 2.1% 5.8% 16.4% Latin America’s Resilience during the Global Crisis: Strong Fundamentals or International LOLR? Sovereign Bond Spreads (in basis points, t = 0) 2000 1800 1600 1400 1200 1000 800 600 400 200 0 9 18 27 36 45 54 63 72 81 90 99 108 117

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