Investments That Pay Off: Latin America’s Response to Recent Global Shocks

IMF Blog, September 6, 2023

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• Authors: Rodrigo Valdes
• Published: September 6, 2023

Overview and key messages

• Over the past three years, most of Latin America remained resilient amid significant shocks, including the pandemic, surging global inflation, trade tensions between large economies, and tighter global financial conditions.
• The region responded appropriately from the perspective of macroeconomic policies, contributing to reduced public debt-to-GDP ratios and containment of inflation.
• Shared objectives highlighted: foster economic growth that benefits all segments of society; harness energy transition opportunities; further open economies to global trade benefits; strengthen existing safety nets.

Fiscal and monetary response — facts and outcomes

• The primary fiscal deficit for the five major economies with inflation targeting and floating exchange rates—Brazil, Chile, Colombia, Mexico and Peru, known as LA5—rose by 6 percentage points of GDP in 2020.
• The wider Latin American region saw an increase of 4 percentage points of GDP in 2020.
• This compares with a rise of 7 percentage points in advanced economies and just over 5 percentage points in emerging market economies in other regions.
• In 2021 and 2022, the LA5 countries, and almost the entire region, completely withdrew the fiscal stimulus, achieving primary results surpassing pre-pandemic levels.
• Advanced countries and other emerging economies maintained a significant part of the expansion, around 3 percentage points.
• Countries in the region raised interest rates earlier and to higher levels than other countries during the "biggest inflationary surge since the adoption of inflation targeting."
• Outcomes observed: inflation is decreasing; currencies have appreciated in recent months; several countries started cutting rates while deliberations in other regions still revolve around new hikes.
• Medium-term inflation expectations were little changed in Latin America, underscoring credibility of inflation target frameworks.
• The region did not suffer any significant financial stress despite sharp exchange rate movements, attributed to improved financial regulation and supervision, greater acceptance of exchange rate flexibility, and private sector risk management of exchange rate exposure.

Macroeconomic framework and policy components

• Core components identified:
  • inflation targeting
  • central bank independence
  • exchange rate flexibility
  • fiscal rules aimed at ensuring fiscal sustainability while allowing deviations in extraordinary cases
  • international financial integration
• The framework has expanded beyond LA5 to countries such as Uruguay, the Dominican Republic, Paraguay, and Costa Rica, with very positive results.
• The approach is likened to that of successful small, open, advanced countries (examples noted in the original text).
• Policy implication: build or rebuild buffers (including through reserves or additional insurance mechanisms like the IMF’s precautionary credit lines) to remain vigilant against unforeseen shocks.

Remaining challenges and policy priorities

• Several economies are grappling with excessive public debt; the problem predates the pandemic and showed a worrisome upward trajectory.
• Some countries face significant risks from unsustainable macroeconomic policies, complicated by short-termism.
• Deeper challenges across the region that demand urgent attention:
  • Enhancing long-term growth potential and overcoming stagnating productivity;
  • Improving the persistently uneven distribution of income and power among citizens;
  • Contributing to climate change mitigation and adapting to its effects;
  • Curbing the proliferation of crime and reducing insecurity, a concern consistently at the top of citizen surveys;
  • Adapting to automation, robotization, and digitalization.
• Recommendation: Tackling these challenges starts with an orderly macroeconomic foundation; the recent successes in macroeconomic management provide reason for renewed hope and optimism.

Rodrigo Valdés, September 6, 2023 — Investments That Pay Off: Latin America’s Response to Recent Global Shocks