Western Hemisphere Regional Economic Outlook: Stunted by Uncertainty - October 2019
Western Hemisphere, October 22, 2019
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- Published: October 22, 2019
- Series: Western Hemisphere
Outlook for Latin America and the Caribbean (LAC)
- Growth slowed from 1.0 percent in 2018 to 0.2 percent in 2019, with a tentative pick-up to 1.8 percent expected in 2020.
- External headwinds: sluggish global growth, subdued commodity prices, and volatile capital flows.
- Easier global financial conditions provide some respite.
- Domestic risks: policy uncertainty in some large LAC countries is a drag on growth; Venezuela’s economic and humanitarian crisis drives large migration flows within the region.
- Recovery hinge: a pickup in private consumption and investment anchored on a rebound in business and consumer confidence.
- Downside risks include: further falls in global growth and commodity prices; spikes in risk premiums; heightened domestic policy uncertainty; contagion from financial turmoil in Argentina; and natural disasters.
- Policy balance: support growth while rebuilding policy space. Fiscal consolidation to lower public debt remains a priority in several countries. Monetary policy can continue to support growth given the stable inflation outlook and well-anchored expectations. Corporate vulnerabilities require enhanced surveillance. Structural reforms should aim at greater openness to trade and investment, bolstering competitiveness, and addressing stringent labor market regulations.
Capital Flows to LAC after the Commodities Super-Cycle
- After the end of the commodity super cycle in 2014, capital flows to the region have declined and their composition has become riskier, with a larger prominence of portfolio flows.
- Sensitivity of capital inflows to global financial conditions and growth differentials has increased, raising the likelihood of a sudden stop if regional growth falters and global financial conditions tighten.
- Empirical findings:
- Countries with floating exchange rate regimes tend to experience shorter and less costly sudden stops in capital flows.
- A tightening of monetary policy following a sudden stop episode is associated with a reduction in the duration of sudden stops and the ensuing deceleration in growth.
- Tighter capital controls do not have statistically significant effects on the duration of sudden stops.
Sovereign Spreads and Fiscal Consolidations
- Lower commodity prices, mediocre growth, and prolonged low global interest rates have contributed to rising public debt in many LAC countries.
- Financial markets’ perception of credit risk in LAC has deteriorated somewhat amid a more challenging external environment.
- Policymakers have announced fiscal consolidation measures aimed at reducing public debt and improving sovereign confidence, as measured by sovereign bond spreads.
- Using a new database on fiscal policy news for 2000–18:
- Sovereign spreads decline significantly following news that fiscal consolidation measures have been approved by Congress, particularly in periods of high sovereign spreads or in countries under an IMF program.
- Fiscal adjustment packages are more effective—leading to smaller output losses and larger reductions in the public debt-to-GDP ratio—when sovereign spreads significantly decline following the announcement.
- These results provide direct evidence that credible consolidation efforts during fiscal stress are rewarded through confidence effects that mitigate the drag on economic activity after consolidation.
Labor Market Dynamics and Informality over the Business Cycle in LAC
- Labor markets characterized by high informality, low female participation rates, and relatively rigid employment protection legislation.
- Informality is countercyclical and the formal/informal adjustment margin reduces the importance of the employment/unemployment margin (informality dampens the usual Okun’s coefficient relating unemployment to cyclical changes in GDP).
- Informality slows adjustment to shocks, with negative impact on growth.
- Correlates of higher informality: higher redundancy costs, cumbersome dismissal regulations, and high minimum wages.
- Aggregate participation rates move positively with GDP changes; however, there is some evidence that the female participation rate is countercyclical in recessions in LAC.
Spillovers to Latin America from Growth Slowdowns in China and the United States
- China and the United States are projected to slow due to cyclical forces, population aging, and sluggish productivity growth; heightened trade and technology tensions could accelerate the near-term slowdown.
- Spillovers are larger for countries more exposed via trade, commodity prices, and financial flows.
- Quantified examples:
- A temporary fall of 1 percentage point in China’s growth would reduce growth in Chile and Peru by 0.2–0.3 percentage points.
- A similar 1 percentage point US growth shock would lower growth in Costa Rica and Mexico by 0.5 percentage points.
- Spillovers could be significantly larger if slowdowns in China and the United States also lead to tighter financial conditions in emerging market economies, including those in Latin America.
Western Hemisphere Regional Economic Outlook: Stunted by Uncertainty - October 2019
Content in this bundle
- Annex 1. Summary of Background Papers
- Capital Flows to Latin America in the Aftermath of the Commodities Super-Cycle
- Annex 1. Surges in Capital Inflows and Domestic Investment
- Welcome to a visually integrated Fund
- Whd Reo
- Labormarket
- Labormarketannex
- Welcome to a visually integrated Fund
- Welcome to a visually integrated Fund
- Sovereign
- Sovereignannex
- Welcome to a visually integrated Fund
- Staff Paper
- Staff Paper
- Table 1econ
- Table 2fiscal
- Full Report