Latin America: Sustaining Reforms and Growth, Remarks by Anoop Singh, Director of the Western Hemisphere Department, IMF
March 27, 2004
Remarks by Anoop Singh
Director of the Western Hemisphere Department
International Monetary Fund
Delivered at investors' meetings in Lima, Peru at the time of the 45th Annual Meeting of the Inter-American Development Bank
Lima, March 27-28, 2004
1. It is worth reminding ourselves that Latin America's economic situation is certainly better today than most of us would have predicted just a year ago. True, there are many fragilities, and the outlook varies significantly from country to country. Overall, though, Latin America has emerged from a very difficult period of global and domestic uncertainties in much better shape than we could have imagined just a year ago. The regional and global outlook is perhaps more favorable than at any time since the late 1990s. It offers a vital breathing space for economies in the region to take the steps necessary for rapid and sustained growth. But it is no more than a breathing space and the opportunity must be seized now.
2. Global prospects are improving with the recovery deepening and broadening. Robust growth in the United States is still the main driving force, with emerging Asia, and especially China, playing an increasingly important role. Although the potential for some upside surprises remain, rising oil prices and renewed geopolitical risks have increased downside risks in the short term.
3. In the United States, with monetary policy still exceptionally accommodative and the dollar having depreciated significantly, overall financial conditions and productivity growth are expected to provide continued impetus to activity. Of course, growth is bound to slow from the rapid pace seen at the end of 2003, but it should still exceed 4 percent this year. Corporate profitability remains robust and growth should benefit from a strengthening of business investment and a pickup in employment expected for later this year.
Recent developments in Latin America
4. Latin America is rebounding from its deepest recession in over two decades and growth this year should be markedly higher—at close to 4 percent. Initially, the recovery was led by external demand, as exports responded to the global economic firming as well as the substantial real exchange rate depreciations in the region. More recently, though, domestic demand has also begun to pick up as interest rates have declined and confidence has returned. There is no mistaking the enormous adjustment the region has made. The current account position went from a deficit of 3 percent of GDP in 2001 into a small surplus in 2003, the first time in several decades.
5. Financial markets have responded well to these improvements. As all of you are well aware, financial indicators in the region have improved dramatically over the past year, with sovereign spreads declining—in many cases to historical lows—and exchange and equity markets firming. Capital flows to the region are at their highest levels in several years. Equity placements are being facilitated by the strong rally in emerging stock markets and there are indications that foreign direct investment flows are beginning to recover following two years of sharp declines. Latin American bond issuance was nearly US$40 billion in 2003—the highest since 1997. Issuance has remained strong so far this year, with a number of countries being able to prefinance their 2004 borrowing needs. It is particularly noteworthy that most of the new issuances over the past year have included collective action clauses. This is an important step toward strengthening the international financial framework.
6. The political consensus for maintaining sound macroeconomic frameworks has been generally impressive in the region. Despite the depth of the recession over the past two years, governments have resisted alternative paths of interventionism and protection, and have stayed the course. They are now reaping the benefits. Most Latin American economies are well positioned to benefit from higher commodity prices and the improving global environment.
7. At the same time, we have to recognize that many parts of the region continue to have important vulnerabilities.
- The state of the public finances remains fragile in many countries and widespread poverty and high unemployment could undermine social support for needed further adjustment.
- The region's still-sizable external financing needs make economic prospects highly vulnerable to shocks in emerging bond markets—particularly in the current environment which has been driven to a considerable extent by the low interest rates in industrial countries.
- Dollarization in the region remains high—unofficial dollarization has probably grown over the past decade—constituting an important vulnerability and limiting the scope for an independent monetary policy in some countries.
8. My sense is that the region has a historic opportunity in the near term to tackle these vulnerabilities. There is no doubt that reforms have the best chance of success when the outlook is benign. This is especially the case now, in Latin America, when it is institutional reform that needs to top the agenda.
9. Why institutional reform? Recent research in the IMF as well as elsewhere is increasingly pointing to institutional factors being more important than differences in capital labor ratios and factor accumulation in explaining cross-country differences in income per capita. This has lessons also for us at the IMF, but it is even more important for our member countries. It means that, in looking at the future agenda for Latin America, we must avoid focusing on the short term. Countries need to embrace institutional change that will improve the sustainability of policies.
10. What are the priorities for institutional reform? Given Latin America's record of "crisis vulnerability," an early priority must be to strengthen institutions that will build and sustain increased levels of "crisis proofing" and help countries graduate from their history of recurrent default and inflation. Bringing down the public debt to a safe range must be an overarching goal—but this needs to be done in a sustainable way by addressing weaknesses in revenue, spending, and intergovernmental relations. Consolidating newly adopted inflation targeting regimes, including by establishing a clear framework for central bank independence, accountability, and transparency, is another clear priority.
11. These reforms will help further reduce the risk and incidence of crises, but other reforms are also needed to raise growth and living standards, and ensure that countries' performance will rise to their potential. This is imperative for Latin America. Over the past 25 years, real per capita GDP growth in the region has been barely positive, with considerable volatility, and high or rising poverty and income inequalities. Thus, Latin America has generally not been able to close the relative income gap with advanced economies—at a time when many countries in East Asia have been able to make considerable progress in this direction.
12. Reforms that will deliver improved growth are those that will provide the right environment for efficient economic activity. I have in mind reforms aimed at protecting property rights, improving governance, and reducing corruption, as well as the kind of measures that will promote lasting social stability. Among the latter, I include the need to give priority to building an adequate social and fiscal infrastructure within a sound framework of debt sustainability. This will require much improved targeting of social spending, improved land access and property rights, and labor market reforms to encourage job creation in the formal sector.
13. While this is, in my view, an imperative agenda, it is clearly not an easy one. Across the world, a variety of institutional arrangements and approaches have been used successfully to raise growth, and Latin America will need to develop its own specific institutional reforms based on its own context. Fortunately, there is widespread recognition in the region of the need to move more forcefully in this direction, and important steps have already been taken.
14. Chile and Mexico provide important role models for the region. Institutional strengthening in both countries has allowed them to establish a successful inflation targeting framework, lower public debt, open the trading regime, and build a strong regulatory and oversight framework for the banking system. Both countries also provide important lessons of targeted social spending. Chile's example, in particular, of institutional changes that limit the room for inconsistent fiscal behavior by the Congress or the regional governance, provides an especially valuable lesson to other countries that have frequently witnessed high fiscal volatility.
15. Institutional strengthening is also underway in other countries. In particular, efforts have been stepped-up to strengthen institutions through fiscal responsibility laws and ensuring independent central banks. Many countries have taken advantage of the strong investor appetite for emerging market debt to make significant strides in liabilities management. President Lula's government has taken important early steps to tackle Brazil's difficult and long-standing structural problems in the areas of pension and tax reform. Here, in our host country, tax reforms and fiscal decentralization are being advanced within a strong macroeconomic framework and the country has taken important steps to lower the risks associated with financial dollarization. These are only a few examples to illustrate that the process of institutional strengthening is under way in the region and needs to be supported domestically and internationally as best as possible, and I will turn to this issue shortly.
16. Before that, let me make some remarks about the situation in Argentina. The strong and broad-based recovery—over 8 percent—that Argentina witnessed in 2003 is continuing in the early months of 2004, supported by a three-year Stand-By Arrangement with the IMF. With an output gap still remaining, and continued cautious macroeconomic policies, the outlook for 2004 is also good. The emphasis in Argentina's program is to lay the foundation for sustained growth and poverty improvements over the medium term. The program, therefore, heavily emphasizes structural reforms that aim at ending Argentina's long history of particularly severe boom-bust cycles associated with institutional weaknesses. Thus, the three-year program emphasizes structural fiscal reforms that would put in place a more even set of incentives for the center and the provinces. In the near term, much will depend upon the ability of the authorities to conclude an early, comprehensive, and sustainable debt restructuring with its private creditors—that is the focus of their efforts over the coming months. Other key structural reforms in the program include taking the banking system back to profitability by entrenching a supportive policy environment. The context for these and other reforms in Argentina is particularly good with, as I have said, a strengthening recovery, that is also raising employment and reducing poverty.
17. Finally, let me offer a thought on the role that external incentives or anchors can play in catalyzing institution building in Latin America:
- Greater trade openness in Latin America would help to improve institutions. The opening up of markets can play an important role in weakening vested interests and reducing economic rents associated with longstanding economic and institutional arrangements. Trade can thus spur improvement in domestic institutions that otherwise would not have been possible.
- In addition, international agreements can be an important external anchor and catalyst for institutional change by breaking through domestic impediments to reforms. For example, participation in NAFTA has helped to build stronger institutions in Mexico that otherwise might not have been possible. The emerging trade agreements under consideration with the United States—such as the U.S.-Central American Free Trade Agreement—are likely to provide a boost to institutional development in a number of countries. From a broader perspective, membership requirements in the World Trade Organization are also likely to contribute to reforms.
18. In concluding, let me express my cautious optimism for a steadily improving economic outlook in Latin America. The region is rich with lessons from its own experience and many countries have already demonstrated admirable political resolve in taking the steps that are necessary to entrench a new era of rising prosperity. The international community, I am sure, will do all it can to nurture and support this process.