Brazil and the IMF
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People's Republic of China and the IMF
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Challenges and Opportunities in Latin America
1. Good afternoon. It is a real pleasure to be here in Madrid and to have the opportunity to address this distinguished group.
2. The world economy has been rebounding strongly across many regions in the past year, and we expect world growth to reach five percent in 2004, the highest rate in nearly 30 years. This robust outcome has been possible thanks to responsive macroeconomic policies, increased profitability and stronger balance sheets in the private sector, bullish financial markets, and improved labor markets. Nonetheless, after a very good first quarter, growth has slackened recently. Although this was to be expected in several large economies, the slowdown has been slightly more pronounced than forecast, and has been compounded by the sharp rise in oil prices. We expect world growth to continue apace next year, but since the oil market is still very vulnerable to crises because of limited excess productive capacity, this outlook is prone to risks.
The Economic Situation in Latin America
3. In Latin America last year, the recovery gathered strength and expanded, and today we forecast growth in 2004 of about 4.5 percent, the highest rate since 1997. The strong world economy, confidence in emerging markets, and sound commodity prices have buoyed the recovery. The rise in the price of oil benefits large exporters such as Columbia, Ecuador, Mexico, and Venezuela, while the increase in the other commodity prices will bring trade advantages for exporters of metals and agricultural goods such as Argentina, Brazil, and Chile. But oil importers, especially in Central America, are feeling the pinch of current developments in commodity markets. Despite the favorable external environment, domestic demand is now driving regional growth, owing to the brisk pick-up in private consumption and corporate investment.
4. Despite more intense activity and higher commodity prices, inflation remained more or less under control, though some countries saw a slight pick-up. There has also been a marked turnaround in the region's external position in the past two years, and a slight current account surplus can again be expected this year. On the fiscal side, many governments are taking advantage of the recovery to consolidate their budget positions, reduce the high levels of public debt, and improve debt structures by reducing their dependency on foreign currency and short-term instruments. These are all positive developments.
5. At this time, we believe that growth in Latin America will continue at a healthy, but slightly slower pace next year, although we do foresee certain risks. If interest rates in industrial countries rise more sharply than forecast, or if growth slows for an extended period of time, the negative effects will no doubt be felt in the region. Economic policy uncertainties and deviations that undermine confidence may also harm growth prospects. Certainly many countries still have very substantial external financing needs, and therefore remain exposed to external shocks. Nevertheless, I believe that the region is in a better position today to weather any potential storms thanks to the policy reforms adopted in recent years.
Challenges and Opportunities for Latin America
6. The economic situation in Latin America has greatly improved in the past few years, but some difficult tasks lie ahead. Levels of unemployment and poverty remain unacceptably high, and major income disparities between rich and poor persist. Having recently visited the region, I am aware that you are all striving to tackle these serious problems, and I am very pleased to see how committed the authorities are to accelerating reforms in their countries. I believe that, today, we understand the importance of reducing vulnerability to shocks, which have wreaked so much havoc in the region in the past, and of creating the necessary conditions for more investment and job creation in the medium term. However, we must realize that there are no quick fixes. What we need is sustained policy reform, not short-term solutions, which is why we should continue to forge a lasting political consensus on pro-growth policies. Moreover, the challenge of improving social conditions should be approached bearing in mind the continued high levels of public debt, which pose an obstacle to governments seeking to use more short-term public spending for social purposes.
7. Another key objective for Latin America is to respond to the rapid integration of China and, increasingly, of India into the world economy. China is both a major importer of commodities from the region and a competitor in textiles and labor-intensive manufactured goods, which may impact those sectors in Mexico and some Central American countries. The region will have to show economic flexibility to rise to those challenges and benefit fully from the opportunities afforded by China's take-off.
8. The reforms needed to deal with the arduous tasks I have just described are usually more successful when initiated in the early stages of recovery. This is the time when people know the costs of slow or negative growth, and what is more, when recovery can serve to ease some of the short-term costs of adjustment. That is why it is important to make the most of the current upswing to deepen reforms already underway. I would like to highlight some of the policies which, in my opinion, will be crucial in responding to the challenges at hand.
9. Public debt in many Latin American countries is still too high. Even with the recent fiscal consolidation, the average public debt for the region is hovering at around 55 percent of GDP, far above the levels at the end of the nineties. A reduction in public debt would ease existing vulnerabilities and broaden the scope for implementing countercyclical fiscal policies that would help to cushion the effect of future economic downturns. Chile, for example, has been pursuing a strong, sustained fiscal reform for several years, substantially cutting its public debt. The financial markets trust the country's policies, allowing it continual access to capital markets. This, in turn, has enabled the Chilean government to implement the countercyclical fiscal policies that are so beneficial to economic stability. More generally, a lower level of debt and the lower debt servicing costs that come with it make it possible, within budgetary constraints, to spend more on infrastructure, health, education, and the social safety net, and to resolve existing tax distortions. Nonetheless, it must be stressed that in the fight against poverty and inequality, more effective provision of social services and a well-targeted social safety net are factors that will be as decisive as increased public spending.
10. For those reasons, fiscal consolidation remains a priority. At the same time, broader measures must be introduced to improve the sustainability of public debt, such as expanding the tax base, improving the debt structure, and strengthening expenditure management. A clear lesson learned from previous episodes of fiscal consolidation is the importance of having a sustainable budget surplus, not one based on unrealistic spending cuts or distortionary taxes that undermine efficiency and growth, which must ultimately be abandoned. In this respect, it is essential to have strong institutions to support prudent fiscal policy. Brazil's recent success in strengthening its fiscal position and consistently meeting its fiscal targets was facilitated by a number of basic improvements in budget preparation and in the relationship between the central government and state governments introduced under the fiscal responsibility law.
11. In many Latin American countries, one of the main goals of effective fiscal reform is to address the level of existing pension commitments [as my colleague Anne Krueger emphasized in her speech at the Jackson Hole symposium last August]. The pace of demographic change seen in many emerging market countries is faster than we sometimes realize, and those countries will not have the same economic wherewithal as industrialized countries to provide for their aging populations. For this reason, pension reforms must be designed carefully, and be executed as soon as possible so that people have time to adapt their behavior. Reforms have been undertaken in many countries in the region, but the results have been mixed, and much has yet to be done to make pension systems sustainable. Overgenerous retirement benefits need to be re-examined, administrative costs must be brought down, limits have to be placed on open-ended financial commitments by governments to pension systems, and investment in pension funds must be made easier.
12. In the last ten years, substantial progress has been made in lowering inflation. In Peru, the inflation rate is currently 5 percent, compared to a rate of over 7,000 percent in the early nineties, and Argentina's inflation has fallen from a rate of around 3,000 percent in the late eighties to 6 percent today. The prime objective of monetary policy should be to lock in and strengthen these advances. High, volatile inflation has a negative impact on economic growth and exacerbates wealth distribution inequalities because the costs are borne disproportionately by the poor.
13. Many countries have introduced systems based on explicit inflation targets, which offer a promising framework for implementing monetary and exchange policies. The greatest advantage of these systems is that they center the policy debate on what monetary policy can achieve in a sustainable manner (i.e., control inflation), and not on what it cannot do (for example, boost production or external competitiveness). As we have seen in Brazil, Chile, and Mexico, these systems also provide an appropriate context in which to establish a flexible exchange rate regime, thus building resistance to shocks. In Brazil, the exchange market pressures that arose in 2002 and again last year truly put the inflation targeting system to the test. The system made the grade in that the impact of the exchange rate depreciation was less than expected, and inflation fell rapidly. Nevertheless, to enhance the credibility of these relatively new monetary policy frameworks, it is important for the central banks to intervene immediately at the slightest hint of inflationary pressure, including pressures that may be induced by the increase in the price of oil. The central banks of Chile, Brazil, Mexico, and Peru have done well to start tightening monetary policy in recent months. Another way of reinforcing inflation targeting systems would be to make central banks fully independent and take new steps to ensure transparency in monetary policy.
14. The correct macroeconomic policies should be accompanied by sweeping structural and institutional reforms to remove all obstacles to investment and efficient allocation of resources, and to strengthen the bases for sustainable growth.
· Despite bold efforts over the last decade to liberalize foreign trade, Latin America is still much less open than other dynamic regions. Further trade liberalization reforms are crucial for spurring growth and lessening vulnerabilities. The greatest benefits would flow from the successful completion of multilateral trade talks to improve market access for key exports such as agricultural products and textiles. However, Latin America can do much more on its side to reduce tariffs, limit the use of nontariff barriers, and relax some of the restrictions on trade in services. These reforms should also be underpinned by improvements in infrastructure, and in port and customs administrations, which in many countries are a source of costly delays and inefficiencies.
· Labor market reforms, which have been limited in most countries, will take on even greater significance in the context of enhanced trade liberalization. Experience in many countries shows that these reforms are essential for increasing flexibility, private investment, and growth. Institutional mechanisms that establish large severance packages and restrict temporary employment are becoming serious obstacles to labor market entry and exit, and thus flexibility. High indirect labor costs are another impediment to employment. Over time, policies that make hiring easier will speed job creation in the formal sector, which will lead to significant social benefits as workers in the regulated labor market will be covered by protections that do not exist in the informal sector. Clearly, however, the reforms may give rise to their own problems related to cross-sector mobility, which will require additional investment in education, training, and an adequate social safety net.
· Regional financial sectors must be transformed from sources of vulnerability to centers of economic strength that can sustainably generate the credit that is the lifeblood of economic growth. Efforts must also be redoubled to strengthen bank regulation and supervision, improve accounting and audit standards, and revise bankruptcy laws to give lenders a better chance of recovering their doubtful loans. More generally, heightening the credibility of the rule of law and contract enforcement will help improve the investment climate for both domestic and foreign investors. Despite the recent economic improvement, foreign direct investment in Latin America, which this year amounted to $40 billion (2 percent of GDP), is still modest compared to previous years. Creating an environment that is more attractive to foreign direct investment in the region will be key in unlocking growth potential.
15. I would like to conclude by saying once again that I am optimistic about the economic future of Latin America. The last few years have been difficult, but much progress has been made in constructing a framework that promotes strong and sustained growth, and the current upswing is a great opportunity to deepen these reforms. If economic growth can be maintained at its present level of between 4 and 5 percent over the next ten years, real per capita income in 2015 will be 40 percent higher than it is today, which will be a significant change from the relative stagnation of the last 25 years. This growth will play a major role in alleviating existing social tensions, improving the political environment, and shoring up democracy in the region. I believe that if the right policies are pursued, these rates of growth will be possible, and I am determined that the IMF will play its part in helping to reach these targets. My experience as Finance Minister taught me that firm political leadership is required to push through a program of reforms. I have every confidence that all of you here today will be up to the task.
IMF EXTERNAL RELATIONS DEPARTMENT