Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: Latin America: Still Resilient, But Risks Ahead

April 11, 2008

  • Region benefiting from stronger policy frameworks
  • Yet deteriorating global economy poses risks to Latin America
  • Regional growth expected to dip to 4.4 percent in 2008

Deteriorating global economic conditions will present the first major test of the improved macroeconomic policy frameworks that most Latin American and Caribbean (LAC) countries have put in place during the past decade, the IMF said in its latest regional forecast.


Much of Latin America enjoyed strong growth between 2002 and 2007—the best sustained performance since the 1970s—because of the adoption of strong policy frameworks and favorable global economic conditions. With the exception of a handful of countries, that growth had been accompanied by relatively modest inflation.

But in response to a tightening of financial markets and a slowdown in growth in the advanced countries, the IMF projects that economic growth in the region will fall from about 5.6 percent last year to 4.4 percent in 2008 and 3.6 percent in 2009 (see Table 1). At the same time, inflationary pressures that began in 2007 as a result of strong domestic demand and rising world food and energy prices will persist.

"Navigating this period of financial turbulence and heightened uncertainty is the key near-term policy challenge," said Anoop Singh, Director of the IMF's Western Hemisphere Department.

Region better placed

"The region is better placed than in the past to absorb the sharp slowdown foreseen in global growth," the IMF noted in its regional outlook for the Western Hemisphere. The high level of reserves coupled with strong banking systems, lower public debt levels, reduced public sector financing requirements and generally flexible exchange rates provide Latin America with more room to deal with adverse global developments than in the past.

One major plus, so far at least, has been the stability of money and bond markets in Latin America despite the turmoil in financial markets in the advanced economies. Still, the region has not totally escaped the problems roiling global credit markets—that had their roots in the subprime mortgage market in the United States. External funding conditions have tightened, especially for the LAC corporate sector, the report, released on April 11, noted.

However, risks to the growth outlook are skewed largely to the downside. "Striking the right policy balance between mitigating downside growth risks and containing ongoing inflation pressures will be the challenge," it said. Among the key risks are a fall in exports if global growth slows more than expected or persistent inflation pressures, which could lead to difficult policy choices.

Possibly weakening external surpluses

The slowdown in global growth, which could be worse than expected, could hurt Latin America by reducing demand for its exports and bringing down the prices of many of the commodities that Latin American countries sell abroad. International prices for the LAC region's main commodity exports "have in aggregate risen by 150 percent since 2003."

Over the past few years, the largest Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela) have on balance benefited from strong increases in such goods as crude oil, copper, and soy beans. These seven countries have seen the value of their commodity exports rise to 10 percent of GDP in 2006 compared with 7 percent of GDP in 2003 and the share of commodities in total export receipts grow from 35 to 40 percent in the same period.

Strong current account surpluses (which measure trade in goods and services and profits and interest payments), a major source of strength in recent years, had also begun to weaken in 2007, because high import growth outpaced export growth in many major countries such as Argentina, Brazil, Colombia and Venezuela. The external current account surplus, about 1½ percent of GDP in 2006, registered a small surplus in 2007 is expected to slip into a small deficit in 2008 (see Table 2). Moreover, strong capital flows are expected to moderate this year As a result, LAC countries will accumulate international reserves at a slower pace than last year, although projected to be $500 billion (12½ percent of GDP) at year's end, they are quite high by historical standards and provide a strong buffer against adverse international developments.

Inflation pressures remain

Inflation in the region rose from about 5 percent in 2006 to 6 percent last year and is expected to remain at that level in 2008, with some countries exhibiting inflation much higher than that (see Table 3).

The run up in international prices of fuel and, especially, food prices, has been especially troubling because of the strong "impact on the poor, especially in the low-income countries," the IMF said. One of the important effects of the good growth and inflation performance in the LAC since 2002 has been a marked reduction in poverty and a some reversal of income inequality.

External food and fuel inflation explains about 30 percent of domestic inflation, according to an IMF analysis. Much of the rest is explained by "excess demand pressures," the IMF said.

In some countries, those demand pressures have been exacerbated by strong procyclical government spending, which began to outpace revenue growth in 2007, reducing structural balances. "Primary fiscal balances in the region are expected to fall to about 2.4 percent of GDP in 2008—down from the historical peaks of about 3.5 percent of GDP in 2005-06—with public debt falling slightly to 48 percent of GDP," the IMF said.

Policy options

In light of this assessment of risks, Western Hemisphere Department officials said there are several priority areas where governments could strengthen policy frameworks to help protect substantial recent economic gains:

    • Recent inflationary pressures constitute an important test of the autonomy of central banks in curbing the second round effects of food prices on inflation, and reining in very rapid recent credit growth. Their efforts need to be supported with flexibility in other aspects of the macroeconomic policy mix, especially exchange rate and fiscal policies.

    • Many countries, especially those dependent on commodities, need greater conservatism in public spending growth to build countercyclical capacity. In the near term, the priority is to protect recent fiscal gains from the deterioration of global economic conditions while better targeting infrastructure and social spending.

    • Continued vigilance over banks and regulatory systems remains vital. Well functioning disclosure and reporting frameworks will help insulate the region from unwarranted contagion from external confidence shocks. As the expansion in the region slows, private credit conditions are likely to tighten and supervisors will need to be alert to the impact on banks' balance sheets.

    • One last point that is very important for the region. The evidence suggests that structural investment and productivity trends have not yet turned sufficiently upwards, and the region needs to harness a larger share of available global savings and investment. In this context, the successive credit upgrades of many countries in the region will surely help.

Comments on this article should be sent to imfsurvey@imf.org