Latin America: Making the Good Times Last

IMF Blog, March 22, 2012

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The global setting is described as “favorable, but still risky.”
Two reasons for a favorable global setting:
- Recent data slightly stronger than expected, particularly U.S. economic activity and employment. Emerging markets growth remains fairly solid; China continues to perform well, though growth is easing and its exports are down somewhat. Good growth in Asia supports demand for Latin America’s key commodity exports, keeping terms of trade favorable.
- Major countries have taken policy steps to underpin global growth and stability:
- In Europe, the European Central Bank’s Long Term Refinancing Operation eased liquidity pressures for European banks and sovereigns and headed off a large deleveraging that would have crimped growth. Stronger fiscal adjustment programs and progress in resolving Greece’s stresses have supported confidence.
- In the United States, the Federal Reserve’s lengthening into 2014 of its commitment to maintain ultra-low interest rates, along with the extension of payroll tax relief and unemployment benefits, are bolstering demand and employment.
Consequences for Latin America:
- Commodity prices remain high overall, supported by buoyant emerging-market demand.
- Accommodative monetary policies and ample liquidity maintain easy financing conditions for more creditworthy countries.
- Reemergence of strong capital inflows is putting upward pressure on exchange rates in some financially-open countries.

IMF January global forecast projection:
- Growth for Latin America and the Caribbean projected to slow from 4½ percent in 2011 to close to 3½ percent this year.
- The 3½ percent forecast is close to the average growth rate for the region over the past decade.
Interpretation:
- Given lukewarm growth in major economies, a region-wide 3½ percent is considered a respectable showing.
- Most economies are growing close to potential and operating near full capacity; many show record low unemployment.
- Demand and credit growth have moderated but continue to expand briskly, in some countries supported by public financial institutions.
- The region stands out as a relatively bright spot in a gloomy global scene.

Three key assumptions for the near-term outlook:
- Europe takes remaining steps to resolve its crisis, most importantly by strengthening the firewall around the most vulnerable countries and breaking the adverse feedback loop between sovereign and financial risks.
- U.S. fiscal policy strikes the right balance between medium-term stability and near-term support for activity.
- Geopolitical tensions remain contained, avoiding a sharp and prolonged spike in oil prices.
If any assumption fails, potential consequences for Latin America include:
- Falling commodity prices.
- Weaker export demand.
- Tightening of financial conditions.
- An oil shock would also hit prices of metals and food, key regional exports.

Monetary policy:
- Continue to use monetary policy as the first line of defense against risks, but only where frameworks are credible and inflation is well anchored.
Exchange rate policy:
- Maintain exchange rate flexibility as a proven shock-absorber.
Fiscal policy:
- Continue rebuilding fiscal buffers to bring public debt back to pre-Lehman levels.
- Avoid premature fiscal stimulus; change course only if extreme risk materializes.
Macroprudential and financial sector policies:
- Macroprudential policies should remain part of the toolkit, but are no substitute for sound macroeconomic policies; use them to prevent buildup of financial sector vulnerabilities and, in downturns, to avoid funding or liquidity pressures.
- Strengthen financial supervision further (including by addressing information gaps) to head off bubbles in domestic credit markets.
Capital flow management:
- For countries with appropriate fiscal and macroprudential policies but facing excessive capital inflows, capital flow measures remain an option.

The region has proven resilience through two major crises: Lehman and the Euro area.
Investor confidence has been rewarded with capital inflows, appreciation of exchange rates, and in some cases risks of overheating.
Guidance to policymakers:
- Now is not a time for excessive worry or premature policy stimulus.
- Now is also not a time for overoptimism or complacency.
- Guard against boom-bust cycles and financial excesses—sustained strong credit growth warrants vigilance.
- Manage the good times well and prepare for bad times to help ensure that good times last.

Nicolás Eyzaguirre, March 22, 2012