Latin America and the Global Economy: Prospects for Growth and Stability, Speech by Agustín Carstens, Deputy Managing Director, IMF
March 4, 2005
Latin America and the Global Economy: Prospects for Growth and Stability
Speech by Agustín Carstens
Deputy Managing Director, International Monetary Fund
68th Banking Convention Asociación de Bancos de México
Acapulco, Mexico, March 4, 2005
1. Good morning. It is a pleasure to be here in Mexico today among friends and familiar faces. Let me first apologize for the absence of Mr. de Rato, our Managing Director. A last-minute schedule conflict prevented his attendance.
2. Drawing upon the International Monetary Fund's unique characteristic of being a global financial institution, I would like to begin by offering a summary of recent trends and current prospects for the world economy and Latin America. Then, in an effort to provide you with additional information on factors that may have an impact on the external environment that Mexico will face in the near future, I will turn to discuss two particularly relevant topics in greater detail: first, the issue of external imbalances between the United States and the main regions of the world, which, if not addressed in a timely manner, could create volatility in the international financial markets and slow global economic activity; and, second, the main economic policy challenges for Latin America, which are of particular relevance in ensuring that this region consolidates the more favorable performance observed in recent months.
The World Economy and Latin America in 2004
3. I begin with some good news. The world economy performed very well in 2004. According to our estimates, growth stood at around 5 percent, the highest rate of expansion in nearly 30 years. Certainly this result reflects accommodative macroeconomic policies implemented by the major industrialized countries. However, there were also notable improvements in variables that reflect more fundamental aspects of the economies. Corporate profitability increased, which contributed to healthier balance sheets. Interest rates around the world remained low, which, in combination with increased profitability, stimulated private investment. At the same time, job creation responded more strongly to economic growth in various countries, which boosted private consumption. All of this helped limit the economic impact of the recent oil price surges.
4. Last year's expansion, however, was not uniformly distributed. Although growth picked up in nearly all regions and countries, there were marked differences in performance. In particular, the United States and China remained the primary drivers of the economic recovery. Despite some quickening of activity in the euro area and Japan in the first part of 2004, a strong and durable recovery remained elusive there. This lop-sided growth pattern is an important concern, and I shall be returning to it in more detail later in the speech.
5. In the specific case of Latin America, it has been many years since economic developments were as favorable as in 2004. Latin American economies gained momentum in 2004, bolstered initially by robust global demand and strong commodities prices. This was followed, more recently, by a brisk pickup in household consumption and business investment. It is likely that region-wide growth in 2004 was even higher than the 4½ percent forecast of last autumn, and the best since 1997. This result is even more encouraging since it was achieved with moderate inflation.
6. There has also been a remarkable turnaround in the region's external position, with a small current account surplus likely to have been achieved. On the fiscal side, many governments are using the recovery, and the associated revenue boost, to reduce budget deficits and improve the debt structure. Considering the region's history of macroeconomic instability, these are all welcome developments. Mexico's own performance is an example of these positive trends.
7. Clearly, Latin America still faces significant challenges, perhaps the most pressing of which is how to step up the pace of economic growth while maintaining stability. It is well known that in 2004, a year in which all developing country regions posted strong economic growth rates, growth in Latin America was less vigorous. Additionally, unemployment and poverty remain unacceptably high, and severe income disparities persist. The current favorable environment provides an excellent backdrop against which action can be taken to ease these vulnerabilities.
The Outlook for 2005 and Challenges Ahead
8. Looking ahead for 2005, last year's momentum should ensure that global growth remains robust, albeit at a slightly slower pace. In particular, the United States is expected to see a slowdown in economic activity to a more sustainable pace—owing in large part to the fact that the monetary stimulus is being gradually eliminated—with activity in the euro area and Japan expected to remain below potential. As for this region, the strong performance should continue into 2005. This generally favorable outlook could be tempered by some concerns. Chief among these is the build-up of current account imbalances between the main regions of the world. By many accounts, this is the most urgent issue currently on the international economic scene.
Correcting the World Economy's Imbalances
9. When we speak of "global imbalances," we are referring to the constellation of the large current account deficit of the United States, with corresponding large surpluses in a few countries, mainly in Asia. These imbalances are partly explained by the undue dependence of global growth on the United States and emerging countries in Asia, particularly China. In the euro area and Japan—which together account for nearly one-quarter of global output—under-performance continues to dominate. If this trend persists, it will further widen existing imbalances. But why, you may ask, should such a development concern us?
10. Current account deficits are not harmful per se. Indeed, we recognize that the accommodative monetary and fiscal policies of the United States in recent years, which contributed to the increased current account deficits, also prevented a more severe downturn in the global economy in 2002-2003. These policies also helped foster the upswing the global economy is now experiencing. What is undesirable, however, is an unsustainable deficit. In that connection, the large current account deficits that the US has been posting—measuring some 5.5 percent of GDP in 2004—with matching surpluses in only a few countries, cannot go on year after year.
11. The US current account deficit has been financed by the acquisition of record levels of U.S. debt securities by foreign private investors and central banks. It is questionable whether the US can continue to avail itself of such easy external credit if its policies remain unchanged. As it is, the pattern of persistent and growing US current account deficits, and the increase in indebtedness that they entail, have contributed to the depreciation in real terms of the dollar in the last 18 months. Fortunately, this adjustment thus far has not jeopardized the global recovery. But, if we stay on this path, there is a danger that investors will force an abrupt adjustment, and bring disorder to not only currency and capital markets, but the world economy as a whole.
12. Much is at stake for the emerging countries, depending on how the global imbalances do adjust. If the adjustment is abrupt, rapid depreciation of the dollar would translate into higher interest rates and a contraction in global liquidity. Although most emerging countries have greatly improved their creditworthiness, access to external financing would be more expensive, and amounts and terms would be limited.
13. What then must be done to solve the imbalances problem in an orderly manner? Much focus has been directed at the need to narrow the fiscal deficit, and thereby also the current account deficit in the United States. Some on the other hand have urged Europe and Japan to take action. Yet others see greater exchange rate flexibility in China and emerging Asia as the answer. While there is much merit in all of these arguments, there is not a unique magic solution. Global imbalances, by definition, are a global issue. Given today's inter-connected economy, the concerted effort of all parties—especially the major players—is what is needed.
14. I turn first to what the United States should do. Here, measures must be taken to convince investors to continue channeling their resources into investments in US assets. The key to this lies in credible medium-term fiscal consolidation. The US budget proposals for fiscal year 2006 aim to halve the fiscal deficit in 4 years. If achieved, this effort at fiscal restraint will be a welcome step towards sustainability. However, firm implementation of these proposals is critical and slippage must be avoided.
15. Moving across the Atlantic to Europe, measures must be adopted there to boost domestic demand and growth, so as to generate another center of expansion for the global economy. Structural reforms remain at the heart of Europe's efforts to increase the region's capacity for growth. Clear progress has been achieved in some countries, but determined efforts must continue to be made. The greatest challenges lie in the labor markets and the significant financial pressures resulting from the aging of the population. Promoting competition in the markets even further would also be important, for example by easing restrictions on the trade in services between countries.
16. Japan's economic performance has continued to be uneven. For instance, the Japanese economy posted acceptable economic growth from mid-2003 to early 2004, but a sharp slowdown was recorded in the latter part of last year. To create the conditions for sustained growth over the medium term, Japan, like Europe, has no alternative but to accelerate its structural reforms. The financial sector needs to be strengthened, so that banks are able to extend credit and support investment and growth. The related process of consolidating the balance sheets of many companies and financial institutions should be accelerated. Other areas of priority include greater labor market flexibility, public enterprise reform, and promoting competition in sheltered sectors of the economy, such as the retail sector.
17. China and emerging Asia, needless to say, are also important players in the context of global economic issues. Here, rigidity of the respective exchange rate regimes remains the prime issue. Greater exchange rate flexibility would contribute not only to an orderly reduction of global imbalances. It would also give countries wider scope to use monetary policy to pursue national objectives, and facilitate the emergence of more dynamic economies. As China's economy continues to develop and open up, such flexibility will be an indispensable tool for macroeconomic management.
18. The orderly resolution of the emerging market crises of the late 1990s provides a vivid illustration of what can be achieved through international cooperation. Importantly, the world economic situation then was far more precarious than it is now. With the global economy in a position of strength today, a valuable window has opened up for reforms. Policymakers should seize this opportunity and take action, not only to secure global stability, but also as recognition that it is in countries' best interests to take these steps. I am confident that, through coordinated effort, the existing global imbalances can be unwound gradually and without major disruptions to economic growth and international financial market stability.
Key Reforms for Latin America
19. That brings me conveniently to the other critical topic that I would like to address: What must Latin American economies do to achieve greater sustained medium-term growth? To be sure, the region has already witnessed progress in recent years, particularly in terms of curbing inflation, strengthening domestic financial systems, and exercising fiscal discipline. All these commendable achievements have laid a solid foundation of macroeconomic stability that should be used to consolidate the sustainability of countries' public debt, and to promote structural reforms that increase competitiveness, the economies' capacity for growth and the creation of jobs, and thus have an impact on the reduction of poverty indices in the region.
20. For a start, public debt in many Latin American countries is still too high. Current debt-to-GDP ratios—averaging 55 percent—are far above the levels of the late 1990s. In some of the largest economies, that ratio is above 60 percent. Bringing these levels down would ease many vulnerabilities, increase the scope for flexible fiscal responses to external disruptions, and free up scarce fiscal resources for the most essential and productive expenditures. For oil-exporting countries, such as Mexico, the current economic circumstances have opened up an especially good opportunity to devote part of the surplus revenue to reducing the public debt and/or contributing to stabilization funds to be used in lean years.
21. On fiscal management more broadly, governments should cut back on nonessential spending and increase investments in infrastructure, health, and education. Inadequate investment in these areas hurts growth prospects and exacerbates social inequalities. Advancing tax reforms would also be important. Tax bases should be expanded, and distortions that impede sector development minimized.
22. Latin American countries must also guard against inflation. In the last ten years, substantial progress has been made in the fight against inflation. This is an historic achievement which should not be forgotten. Going forward, the prime objective of monetary policy should be to preserve and strengthen these advances. Many countries—including Mexico—have now adopted inflation targeting frameworks for implementing monetary policy in combination with floating exchange rate arrangements, which has increased their capacity to absorb external shocks, thereby protecting the productive sector of their economies.
23. Reforms in the structural and institutional areas are also in order. For instance, although continual efforts have been made to liberalize trade in the past decade, Latin America is still less open than other fast-growing regions. Regardless of progress in the multilateral Doha round, Latin America itself can, on its own, do much by reducing tariffs, limiting the use of non-tariff barriers, and relaxing restrictions on trade in services. These reforms should be underpinned by improvements in infrastructure, and in port and customs administration.
24. As with trade opening, labor market reforms have been quite limited in most Latin American countries. Such reforms will take on even greater significance as trade liberalization progresses, since they are essential for increasing competitiveness and driving private investment.
25. With regard to the financial system, particularly the banking system, the region should continue with the institutional strengthening of its regulatory and supervisory authorities. In the past 25 years, Latin America has become known as a region in which countries have been prone to recurring financial crises. IMF studies indicate that this propensity is due, in part, to the interaction between the cost of banking crises and the heavy fiscal burden they impose. If the region is to break the cycle of recurring crises, it is essential that countries spare no effort to protect their financial systems and require intermediaries to comply strictly with international prudential standards. This will avoid crises and place the banking system in a better position to contribute to economic growth, as the banking system in Mexico is, fortunately, already doing.
26. Finally, creating an environment that is more attractive to investment will be key to unlocking growth potential in the region. To encourage both domestic and foreign direct investment, business needs to be assured of the rule of law and the effectiveness of contract enforcement mechanisms. Other steps to improve the investment climate—for example, reducing regulatory and other burdens to starting a new business—will also be essential. At the minimum, reforms are needed to keep pace in the never-ending competition for FDI, especially among emerging economies in different regions.
27. In closing, allow me to return to the rosy picture of the global economy that I painted at the beginning of these remarks. We are going through a phase of growth and expansion that is important in both size and geographical coverage. Countries should therefore take full advantage of today's favorable economic conditions to plant the seeds of orderly and sustained future economic growth. Governments should act without delay, and we at the IMF stand ready to provide assistance and advice in these efforts.
Thank you very much.