13th Regional Conference on Central America, Panamá, and the Dominican Republic (CAPDR), Keynote Speech by Mitsuhiro Furusawa, Deputy Managing Director, International Monetary Fund

July 23, 2015

Keynote Speech by Mitsuhiro Furusawa
Deputy Managing Director, International Monetary Fund
July 23, 2015
San Salvador, El Salvador

As Prepared for Delivery

Good evening. It is a great honor to be here today, before such a distinguished audience of policymakers. I would like to thank the Salvadoran authorities for their warm welcome and hospitality. It is, indeed, a great pleasure to be visiting Central America—and El Salvador in particular— as part of our so-called “Road to Lima.” As you know, the Annual Meetings of the IMF and the World Bank will be held in Lima this October.

Almost 50 years have passed since the Annual Meetings were last held in Latin America—in Rio de Janeiro in 1967. The focus of our work along this Road to Lima is on Latin America’s prospects. Of course, this is no longer your father’s Latin America. Much has changed—and mostly for the better. Over the past two decades, this region has seen remarkable economic and social progress.

But there are still numerous challenges on the horizon. Today’s policymakers have an immense opportunity—and an immense responsibility—to resolve these challenges. This, of course, requires making the right choices at the right time. Given the complexity and pressing nature of some of these challenges, I would like to assure you that the IMF has been—and will always be—here to assist our Latin American member countries in any way we can.

Our commitment to this region—to you, the policymakers—is now stronger than ever. With that in mind, I would like to focus on three issues:

(i) First—the outlook for global economy.

(ii) Second—the outlook for Latin America.

(iii) Third, I would like to talk about the specific challenges and opportunities for Central America, Panama, and the Dominican Republic—to which I will refer as Central America for short.


The global economic environment remains challenging. The recovery from the global financial crisis continues, but at a fairly subdued pace. According to our latest update of the World Economic Outlook, we expect real global GDP to grow by 3.3 percent this year. This represents a small downward revision to our earlier projections, but we still expect growth to strengthen to 3.8 percent next year as the underlying drivers of acceleration in economic activity remain intact.

As usual, these headline growth numbers mask many underlying dynamics. For a start, let’s take a look at the prospects for advanced economies. The United States is still the strongest engine of global growth. Private consumption is powering the U.S. recovery, supported by a firmer labor market, still easy financial conditions, and healthier household balance sheets.

The downward revision to our U.S. growth projection for this year to 2½ percent—after a disappointing first quarter—was the main reason for our scaling down of global growth. But many of the factors weighing on growth in the first quarter were temporary in our view, and recent data broadly confirm that underlying activity is robust. The situation is also improving in the Euro Area and Japan.

While growth prospects remain more subdued than in the U.S., central banks in both economies have taken additional steps since the beginning of this year to increase monetary stimulus. These steps have helped to arrest the decline in inflation expectations and have provided a positive impulse to activity. That said, inflation expectations in both the Euro Area and Japan remain low, and there are important risks and uncertainties, including the developments in Greece and Ukraine.

This environment—where monetary conditions in the Euro Area and Japan have continued to be loosened while the Federal Reserve edges closer to the lift-off—has affected currency markets. In particular, the U.S. dollar has appreciated markedly over the past year—against the euro and yen but also against most other currencies. So far, these shifts in global currencies have been in line with the asynchronous economic developments in the world economy—and, as such, they are helpful in rebalancing demand and supporting global growth.

When speaking of global growth, we must bear in mind that the biggest contribution for many years has come from emerging and developing economies. This continues to be the case, even though their dynamism has moderated. As a group, they are still growing significantly faster than advanced economies—4.2 percent compared to 2.1 percent—but their rate of growth rate has decreased.

China is the most prominent example. As its economy rebalances away from excessive reliance on investment, growth has slowed from double-digit rates. For 2015, we are forecasting growth at 6.8 percent, down by around half percentage point from last year. This slowdown, we think, is healthy because it helps to put the Chinese economy on a more sustainable path. But there can be no doubt that it has important implications for many other parts of the world economy.

This is particularly relevant for global commodity markets, which experienced a major boom in the first decade of the 2000s, but have since cooled down significantly. The correction started with metals in mid-2011. Since mid-2014, the energy sector has been in the limelight because oil prices have fallen about 40 percent. For emerging market and developing economies, the implications are twofold:

• First, prospects for net exporters of commodities have dimmed, while net importers are reaping the benefits of cheaper imports.

• Second, the normalization of U.S. interest rates—at a time when many emerging markets are slowing down—could create some financial headwinds. In a benign scenario, these headwinds would be moderate and would be more than offset by the benefits of a stronger U.S. economy, which will support activity in the rest of the world. That said, more abrupt financial market adjustments cannot be ruled out. And of course, any negative impact will be felt most in those countries that have weak fundamentals.

If we also take into account geopolitical risks, particularly in the Middle East, it is fair to say that there is a considerable risk of negative surprises in today’s global economy. As I said at the beginning, the outlook remains challenging! All this underscores the need for policies that support strong and sustainable growth, while reducing financial vulnerabilities.

For example:
• Monetary policy in the Euro Area and Japan should stay highly accommodative for the foreseeable future.
• Fiscal policy should remain as growth-friendly as possible, while taking into account the limited policy space in many countries, including in emerging economies.
• Moreover, policymakers should press ahead with structural reforms to reverse the decline in productivity and potential output in almost all economies. This push for structural reform would create a strong foundation for sustained improvements in living standards.


This brings me to the outlook for Latin America. As I said at the beginning, Latin America has made important strides over the past two decades. Economic prosperity, financial stability, and social progress: these are only some of the areas in which major improvements have been made. Economic policy frameworks have been strengthened in most countries.

This is a reflection of the lessons learned from over-indebtedness, high inflation, and repeated crises in the 1980s and 1990s. To secure greater stability, many countries reined in unsustainable fiscal deficits and reduced public debt ratios, including through the adoption of fiscal rules. Most countries have also been successful in reducing inflation and anchoring inflation expectations at low rates, by moving toward inflation targeting regimes. These efforts have been supported by greater exchange-rate flexibility—a key tool to better absorb external shocks.

Overall, these improvements in economic policy put Latin America in a much stronger position and helped the region to weather the global financial crisis. Despite a short-lived recession in 2009, the region saw average annual growth of almost 5 percent between 2003 and 2011—well above the 2½ percent average during the previous two decades. Solid growth delivered important social gains. Poverty rates decreased sharply—from an average of 26 percent in 2000 to 11 percent in 2014. Inequality diminished considerably, and about half the population in the region now belongs to the middle class. So there has been impressive progress. But we also know that much remains to be done to consolidate and extend this progress.

The biggest challenge, of course, is the economic slowdown. In 2015, Latin America’s growth rate is expected to decrease for the fifth year in a row, falling below 1 percent. The region suffers from lower commodity prices and derives only limited benefits from stronger U.S. growth due to relatively weak trade linkages. This slowdown has yet to create sizeable economic slack: unemployment generally remains low, even though labor markets have started to weaken. Inflation hovers above official targets in most of the larger economies.

And external current account deficits remain wide. All this suggests that activity is not simply constrained by weak demand, but that supply-side constraints are playing an important role. In other words, it is not just growth that has come down, but potential growth is also looking weaker. The specific supply-side constraints obviously differ across countries.

But there are a few common themes. First, there is weak infrastructure, which causes big delays in the shipping of goods and raises transportation costs. Second, weak educational outcomes are constraining productivity growth. And third, weak business environments complicate the process of setting up, running, and growing dynamic, successful businesses. Clearly, these are important policy challenges that need to be addressed—and they need to be addressed with an increased sense of urgency, given the weak growth outlook in the context of lower commodity prices and rising U.S. interest rates. Another key challenge is related to capital flows.

Over the past decade, Latin America saw considerable capital inflows and domestic credit growth. A possible reversal of those flows could cause economic and financial strains—especially in cases where leverage has risen too much, or where foreign exchange exposures are not properly hedged. That said, we believe that these risks are manageable because of the greater role of exchange rate flexibility and because of the considerable foreign exchange buffers that central banks built during the good years. Policymakers will need to be extremely vigilant—to safeguard financial stability and protect the economic progress that the region has made.


This brings me to my third and final topic: the specific challenges and opportunities for Central America. Unlike Latin America as a whole, Central America is greatly benefiting from its close ties to the U.S. economy and from cheaper commodities. As you know, most Central American economies are commodity importers. Cheaper oil has reduced import bills and has boosted domestic purchasing power. And in some countries, these positive effects are expected to outweigh the possible loss of subsidized financing from Venezuela under the Petrocaribe program.

Inflation and external balances are also benefitting from this favorable external environment. Because of lower oil prices, inflation has fallen below central bank targets in several countries and is expected to remain moderate. On the external side, foreign direct investment and portfolio flows have so far remained steady. Sovereigns continue to tap international capital markets, and international reserve coverage has also improved. Going forward, lower oil prices and higher U.S. growth should result in narrower current account deficits that could be fully financeable by foreign direct investment in several countries.

At the same time, policymakers in Central America need to be ready to address potential downside risks. They include increased financial market volatility due to rising U.S. interest rates, as well as sharp changes in the terms of trade due to further fluctuations in oil and commodity markets. Past experience clearly shows that strong domestic fundamentals can significantly limit adverse spillover effects.

In the long term, countries in Central America need to make progress in resolving underlying macroeconomic and structural challenges. For example, several countries have high and rising public debt, deep-rooted competitiveness problems—especially associated with weak educational standards—and difficult business environments. These factors stifle private investment, weigh down productivity and limit potential growth.

This is why I would like to call on policymakers to re-double their efforts in four key areas: First, fiscal vulnerabilities should be reduced. This is essential to prevent excessive increases in sovereign borrowing costs in the case of worsening capital market conditions. Countries with significant fiscal adjustment needs should at least save the direct budgetary windfall gains from faster U.S. growth and, where energy subsidies are sizable, from lower oil prices.

Beyond that, policymakers should also take advantage of the favorable external environment to press ahead with key consolidation measures. These include phasing out energy subsidies and increasing VAT rates in the wake of lower oil prices and inflation. Countries would also benefit from stronger policy frameworks. This would require introducing fiscal rules and adopting measures to enhance transparency and minimize contingent risks—including those related to public-private partnerships.

Second, inflation targeting frameworks should be strengthened. For example, greater exchange rate flexibility should be allowed to establish inflation as the undisputed monetary anchor and to reduce incentives for dollarization. Also, financial market development should be fostered in order to strengthen monetary transmission. The positive oil-price shock provides a favorable environment for these efforts.

First round effects on inflation should, in principle, be accommodated without relaxing monetary policy. And continued vigilance will be required because of the possible future inflationary pressures in countries where output gaps are essentially closed. The fall in headline inflation should help to better anchor inflation expectations, which have remained sticky in some cases.

In the financial sector, a further strengthening of prudential regulations will be essential to reduce vulnerabilities—especially those related to credit dollarization. To be sure, banks are generally well capitalized and they comfortably meet regulatory requirements. But a further bolstering of prudential regulations is needed to contain potential credit risks from unhedged borrowers after a period of rapid growth in foreign currency loans.

Further progress in structural reforms will also be critical to reap the full benefits of the favorable external outlook and to set the foundations for inclusive growth. Tax reforms are vital to support higher public investments and education spending that can help overcome existing supply bottlenecks, enhance human capital, and achieve higher sustainable growth. Additional improvements in the business environment and governance are also critical to support greater private investment.

All this suggests that prospects for Central America have become more favorable. And there is no better time to tackle some hard policy challenges. The IMF stands ready to support policymakers in this region through our surveillance, technical assistance, and—if needed— financial support. The Fund is looking forward to our Annual Meetings in Lima. This will be a great opportunity for us to further deepen our engagement with our members in Central and Latin America. It will be a great opportunity to share views on how to craft the most effective policies for this and other regions. In Lima, we will have a chance to bolster global economic and financial stability and to make progress in achieving greater shared prosperity for all.

Thank you!


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