Regional Economic Outlook: Tale of Two Adjustments
Western Hemisphere, May 19, 2017
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- Published: May 19, 2017
- Series: Western Hemisphere
Overview
- Economies of Latin America and the Caribbean are recovering from a recession at the regional level in 2016.
- Growth has been held back by weak domestic demand, reflecting:
- ongoing external adjustment to earlier terms-of-trade shocks,
- in some cases, fiscal adjustment,
- and other country-specific domestic factors.
- Regional activity overall is expected to pick up gradually this year and next, but the outlook is weaker than projected last fall.
- The projection for medium-term growth remains modest at about 2.6 percent.
- The outlook is shaped by:
- a modest rebound in commodity prices,
- a modest rebound in partner demand,
- and higher policy uncertainty at the global level.
- Domestic fundamentals and developments will continue to play a significant role in determining growth in many economies.
- Risks to regional growth have widened in a setting of higher global policy uncertainty.
- In this challenging external context, countries should aim for completing fiscal and external adjustments to preserve or rebuild policy buffers.
- Charting a course toward higher, sustainable, and more equitable growth will also require strengthening structural reforms aimed at:
- closing infrastructure gaps;
- improving the business environment, governance, and education outcomes;
- encouraging female labor participation to boost medium-term growth and foster income convergence.
Chapter 1 — A Shifting Global Landscape and the Outlook for the United States and Canada
- Against the backdrop of lackluster global growth in 2016, the world economy is seeing underlying shifts in its economic and policy landscape.
- Since last October, the outlook for advanced economies for 2017–18 has improved, reflecting better growth prospects in the United States, Europe, and Japan—alongside some rebound in manufacturing and trade and likely U.S. fiscal stimulus.
- With the anticipated change in the U.S. policy mix, including faster monetary tightening and a stronger U.S. dollar:
- market sentiment in advanced economies has improved;
- equity markets have been buoyant.
- Domestic financial conditions initially tightened in emerging markets, where growth prospects have worsened slightly, but market conditions have since noticeably improved.
- On balance, global growth is expected to rise modestly in 2017 and 2018 but with widely dispersed risks around this baseline.
- Longer-term uncertainty surrounds the direction and extent of shifts in U.S. policies.
- Global vulnerabilities include a rising tide of economic nationalism in major advanced economies—marked by higher antipathy toward trade, immigration, and globalization.
Chapter 2 — Latin America and the Caribbean: Setting the Course for Higher Growth
- The economies of Latin America and the Caribbean are recovering from a regional recession in 2016.
- Activity is expected to pick up gradually this year and next, but:
- the outlook is weaker than projected last fall;
- medium-term growth remains modest at about 2.6 percent.
- Inflation is easing in many economies as the pass-through from past depreciations is fading.
- Risks to growth have widened in a setting of:
- higher growth in advanced economies;
- higher global policy uncertainty involving possible changes in the underlying direction of U.S. policies;
- a rising tide of economic nationalism in advanced economies;
- potential tightening of financial conditions.
- Policy priorities:
- complete fiscal and external adjustments to preserve or rebuild policy buffers;
- strengthen structural reforms to close infrastructure gaps;
- improve the business environment, governance, and education outcomes;
- encourage female labor force participation to boost medium-term growth and foster income convergence.
Chapter 3 — External Adjustment to Terms-of-Trade Shifts
- External adjustment in Latin America is ongoing in the wake of large and persistent shifts in the region’s terms of trade.
- In the past, external adjustment to negative terms-of-trade shocks typically occurred through:
- weakening of domestic demand and import compression (negative income effects),
- rather than stronger supply growth and export recovery, despite a real depreciation.
- The ongoing adjustment reflects increased use of exchange rate flexibility as a shock absorber.
- The real depreciation has led to:
- a small boost to exports;
- a stronger reduction in imports than in the past, with demand shifting toward locally produced goods.
- Although the income effect still appears to be strong, the expenditure-switching effect seems to have become more relevant.
- These effects have alleviated the burden on domestic demand, thereby reducing the “sacrifice ratio” of external adjustment for flexible exchange rate regimes in Latin America.
- With flexible regimes becoming more widespread, the cost associated with exchange rate rigidity has increased in the region, as common shocks have led to multilateral appreciation for less flexible currencies.
- The aggregate responsiveness of exports to real depreciation masks differences within and across countries:
- export performance responds more significantly to changing relative prices for noncommodity products;
- exporters that trade manufactured goods more heavily see stronger responses.
- Exchange rate flexibility can support structural policies aimed at shifting resources to noncommodity sectors.
Chapter 4 — Drivers of Capital Flows and the Role of the Investor Base in Latin America
- Following a decade of strong capital inflows, Latin America is now experiencing weaker economic growth and weaker financial inflows accompanying the end of the commodity super-cycle.
- Global factors, notably global commodity prices, are strongly associated with cyclical movements of capital inflows in emerging markets; this holds particularly true for Latin America.
- Country-specific structural factors, such as good governance and strong institutional and regulatory frameworks, play a key role in attracting inflows over longer time horizons.
- Regarding vulnerabilities:
- capital flows in countries with deeper financial markets and stable, large domestic investor bases exhibit lower sensitivity to external shocks;
- a larger presence of foreign investors and more open capital accounts increase sensitivity to external shocks.
- Other policy dimensions, such as exchange rate flexibility, can mitigate the vulnerabilities of capital flows to the region.
Regional Economic Outlook: Tale of Two Adjustments — May 2017
Content in this bundle
- Western Hemisphere Regional Economic Outlook; April 2017 - Executive Summary
- Resumen ejecutivo
- 1. Un cambiante panorama mundial y las perspectivas para Estados Unidos y Canadá
- Western Hemisphere Regional Economic Outlook; April 2017 – Chapter 1
- Western Hemisphere Regional Economic Outlook; April 2017 – Chapter 2
- Western Hemisphere Regional Economic Outlook; April 2017 – Chapter 3
- Western Hemisphere Regional Economic Outlook; April 2017 – Chapter 4
- Western Hemisphere Regional Economic Outlook; April 2017 – Chapter 5
- Executive Summary
- wreo0517