Latin America: What’s Ahead in 2012?

IMF Blog, January 4, 2012

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Author and date: Nicolás Eyzaguirre, January 4, 2012.
Overall view: Growth has softened in the larger countries of the region and the outlook for 2012 “will not be better than what we thought in October” (official IMF forecasts to be published on January 24 in the World Economic Outlook Update).
No recession expected in Latin America if the European crisis remains contained, but weaker growth is likely due to falling confidence and declining commodity prices.

The future course of the European crisis is identified as the biggest risk; progress so far has not yet calmed financial markets.
The United States faces a fiscal policy challenge balancing near-term support for growth with long-term sustainability.
Financial risks dominate the outlook and could transmit to the region if advanced-economy strains intensify.

Euro zone banks account for “one quarter” of banking assets in the larger Latin American countries, on average.
Many euro zone banks are restricting lending or not rolling over existing lines to shore up balance sheets.
Risk scenarios highlighted:
- A deepening European crisis could lead euro zone banks to be starved for short-term dollar funds.
- Reduced external credit lines to Latin American banks could trigger a credit crunch.
- A credit squeeze combined with declining confidence, slower investment, and falling commodity prices (if malaise spreads to Asia) would be “a toxic mix for growth and stability.”

Monetary policy:
- Some countries are already moving to neutral or easing monetary policy because they have inflation under control and activity is ebbing.
- Easing may not be an option in countries with higher inflation or heavy dollarization.
Fiscal policy:
- Sound public finances are crucial—lessons from Europe and Latin America’s past.
- Where fiscal room permits, there may be a time to spend public money to fight a downturn (as in 2009), but that time is “later, if the risks appear; not now.”
- The European crisis demonstrates that countries with wide fiscal deficits can suffer a sudden loss of credibility that triggers capital flight, even when public debt is at manageable levels.
Financial sector vigilance:
- Financial systems should be under extra scrutiny for signs of stress, with a particularly watchful eye for liquidity strains.
- Maintaining healthy liquidity conditions is essential to avoid a credit crunch, which is very difficult to combat with macroeconomic policies.

Many countries in the region enter 2012 from a position of strength, having managed economies and markets skillfully since the 2008 crisis.
Specific strengths cited:
- Banks are sound for the most part.
- Monetary policy frameworks are increasingly credible.
- International reserve coverage is adequate.
- Public finances are strong.
Central advice: “Hope for good news, but prepare for the bad.”

Source: Latin America: What’s Ahead in 2012?, Nicolás Eyzaguirre, January 4, 2012.