Latin America and the Caribbean: Building a Sustainable Recovery, Speech by Anoop Singh, Director of the Western Hemisphere Department, IMF
May 2, 2003Latin America and the Caribbean:
Building a Sustainable Recovery
Director of the Western Hemisphere Department
International Monetary Fund
Prepared text for remarks at the 21st Annual Journalists and Editors Workshop on Latin America and the Caribbean
Miami, May 2, 2003
1. It is a pleasure to be here in Miami, an important gateway to Latin America and the Caribbean, and to meet so many influential opinion-makers. After the extreme pessimism that has prevailed about Latin America over the past year, it is also a pleasure to be able to strike a cautiously optimistic tone about the outlook for many Latin American economies. Just six months ago, the outlook was dominated by the declines in Argentina and Uruguay, market anxieties about Brazil and, externally, fears of a global credit crunch and downside risks to the world economic outlook. Now, some of the downside risks in the world economy have receded, and financial market confidence and economic growth are returning to many of the Latin American economies. While we should be relieved, there is no room for complacency—and there are still many risks in the domestic and external environment facing economies in our region.
I. Global and Regional Trends
2. In the IMF's most recent forecast, this Spring's World Economic Outlook (WEO), world output growth is set to improve from about 3.2 percent in 2003 to over 4 percent in 2004, with the United States—on which Latin America is especially dependent—accounting for a substantial part of the improvement. Since this forecast was made, some of the downside risks—those associated with the war in Iraq—have receded, and growth should begin to rise in the second half of 2003.
3. Latin America as a whole is expected to grow by 1.5 percent in 2003, rising to over 4 percent in 2004, certainly an improvement over last year when overall growth was negative. However, the aggregate numbers can be misleading; much of the negative growth of last year is explained by the deep recession in Argentina and its impact on neighboring countries, notably Uruguay, and the special circumstances in Venezuela. Indeed, several economies in the region with strong policy frameworks have been able to maintain positive growth. Notably, in Brazil and Mexico—which together account for close to 60 percent of regional GDP—growth should exceed 2 percent this year and rise to 3½ percent next year. I will talk about some of the individual economies, their circumstances, and the IMF's role in them a little later.
II. Recent Developments in the Region
4. The generally improved situation in Latin America is being driven primarily by rising net exports. This reflects, of course, the substantial real exchange rate depreciations that have taken place over the past year—and confirms that Latin American economies are following the kind of recovery path that we saw after the Asian crisis. Indeed, the export performance of many countries in Latin America has exceeded expectations. Low or negative export growth rates in a wide range of countries in Latin America in 2001-02 have given way to double-digit increases recently. With imports curtailed, we are witnessing a much stronger turnaround in the external current account situation of most countries than many expected. For example, Brazil's recent export growth rate has been in the 20-25 percent range, and its trade balance has shifted from a deficit of about $1 billion in 1999-2000 into a prospective surplus as large as $16 billion in 2003.
5. Underlying these improvements is an encouraging political reality that has allowed economic policies to be strengthened. Over the last year or so, democratic elections in a number of countries have put in place governments that are publicly committed to achieving more rapid growth and reducing poverty, by working within sustainable macroeconomic frameworks and closely with the international community. This has been the case, for example, with President Uribe in Colombia, President Lula da Silva in Brazil, President Gutiérrez in Ecuador, and President Sánchez de Lozada in Bolivia. The IMF has tried to respond flexibly and quickly with financial support and technical advice in these and other cases, and we are looking forward now to engage with the new government that will be formed in Paraguay by President-elect Duarte Frutos, and with the new government that will emerge in Argentina later this month. It bears recalling that, during the Asian crisis, the economic turnarounds generally took place after the political conditions for reforms had improved.
6. Markets have started to respond to these stabilizing political and economic policy trends. As all of you are well aware, financial indicators in key countries have improved since the beginning of the year, with sovereign spreads down and exchange and equity markets firming. Latin American bond issuance has rebounded in the first quarter of 2003, to close to $7 billion, with a number of countries being able to regain market access and prefinance their 2003 borrowing needs. Just three days ago, Brazil made a highly successful sovereign bond issue, its first since April 2002. Let me now make some remarks about individual countries.
7. Brazil: Brazil's financial indicators speak for themselves. The exchange rate stands at its strongest level since August 2002, and country risk spreads have fallen well below 900 basis points. The appreciation of the currency is helping to reverse much of the inflationary pressure that followed last year's depreciation, and it is now being reflected in a drop in interest rate futures. To sustain these gains, the Brazilian authorities have supplemented fiscal and monetary prudence with a well-focused structural policy agenda, and they are acting with urgency to address and improve the social and poverty situation in Brazil, reallocating public finances within a sustainable macroeconomic framework. Finance Minister Palocci crystallized the agenda for Brazil in his usual succinct and direct way when he spoke recently of the priorities of "implementing reforms that increase the efficiency of the public and private sectors... Brazil's full integration into the global economy...and the effectiveness and coordination of government policies to improve income distribution." As you know, the IMF is supporting these efforts with a stand-by arrangement that was put in place at the height of the market uncertainties last year, and that remains well on track.
8. Argentina: Argentina has sustained the stabilizing trends that began to emerge last year, improving the short-run macroeconomic situation substantially, and providing a good basis for the incoming government to adopt the kind of enduring structural reforms that would deliver sustained growth. As Latin America's third largest economy, and with a large share of the population below the poverty line, the importance of this task cannot be overstated. I am encouraged by the much stronger consensus in Argentina for the kind of fiscal framework, banking reforms, and institutional changes—including in the legal environment for private economic activity—that can spur sustained growth.
9. Ecuador: President Gutiérrez's new administration has moved rapidly after taking office to begin implementing strong fiscal and structural measures to place the economy on a sustainable growth path compatible with dollarization. With a new oil pipeline nearing completion, the prospects for the balance of payments and growth remain good. But the discipline of the dollarized system requires continuing structural reforms to enhance the flexibility of the non-oil economy, while using fiscal surpluses from oil revenues to lower public debt. A well-targeted social agenda is also needed to make a decisive change in the economic and social situation of the people of Ecuador. Such reforms are part of President's Gutiérrez's program, which is being supported by a recently agreed stand-by arrangement from the Fund.
10. Bolivia: In Bolivia important stabilizing trends have emerged in the economy, and in the banking system in particular, since the unfortunate events of February. The IMF has moved flexibly and forcefully to support President Sánchez de Lozada's economic program for 2003 with a new stand-by arrangement. We will soon resume the discussions begun last year to put in place as quickly as possible a medium-term economic program, supported by the IMF's PRGF facility, that would further strengthen the banking and corporate sectors, raise growth, and generally improve economic and social conditions in Bolivia.
11. There are, of course, other countries that are making important progress in strengthening their economic fundamentals and reducing vulnerabilities. In Colombia, the government is implementing important fiscal reforms. Uruguay is pressing ahead with an ambitious stabilization and reform program, and it took an important step in April with the announcement of a comprehensive debt exchange operation. In Peru, tax reforms and fiscal decentralization are being advanced within a strong macroeconomic policy framework. In all these countries, growth is expected to rise or, in the case of Peru, remain high.
12. Finally, in the Latin American region, I should recognize the continuing strong economic performances in Mexico and Chile, that have been underpinned by sound macroeconomic policies and high degrees of integration with the world economy. There are many important lessons from the experiences of Mexico and Chile, in lowering public debt, entrenching an inflation-targeting framework, and maintaining a strong regulatory and oversight framework for the banking system. Spreads have remained low and Chile's fiscal situation has allowed room for automatic stabilizers to operate.
13. Elsewhere in the region—in Central America and the Caribbean—important fiscal, structural, and governance reforms are being taken forward in sometimes difficult political and social conditions. For example, in Nicaragua, President Bolanos and his economic team have been trying to put in place a sound fiscal framework, while expanding social support, and their efforts are being supported by a PRGF arrangement with the Fund. The situation in the Caribbean region has been aggravated by the slump in tourism, but we are working with a number of countries to support their own efforts to advance fiscal reforms, ensure debt sustainability, and improve growth prospects.
III. Looking Ahead
14. The first priority must be to sustain the economic recoveries that are already underway and to reduce further the vulnerability to crisis. In doing so, many countries in Latin America and the Caribbean may face greater challenges than was the case in the recovery from the Asian crisis.
15. For one, given the debt constraints, and continuing concerns in some cases about inflation, fiscal and monetary policies cannot be eased in the way this was done during the Asian crisis. Rather, Latin American and Caribbean countries are appropriately following a different route toward making the macroeconomic environment more supportive of recovery. This is being done by fiscal tightening that also has the potential to deliver a virtuous cycle. There are many examples in recent economic history of this phenomenon. Most recently, Brazil's own experience is instructive, with fiscal tightening—in the context of deeper structural reforms—producing a sustained reduction in the risk premium, and holding out the clear potential for lower domestic interest rates. Entrenching such a cycle in Latin American economies will depend critically on the success of ongoing efforts to strengthen institutions through fiscal responsibility laws and independent central banks.
16. The second important challenge facing Latin America is restarting domestic credit flows and attracting back long-term foreign direct investments, both of which would raise the contribution of investment to growth. The clear lesson from other crisis experiences is that under-capitalized banking systems cannot be expected to raise their credit exposure as long as concerns remain about weak balance sheets and uncertainties have not been resolved about the framework for bank resolution and for corporate restructuring. Given the high level of capital market integration of Latin American economies, measures to improve risk management and further develop prudential and supervisory systems must be given a clear priority. New private investments will be necessary for recapitalizing banking systems and raising growth, and high assurances of legal certainty within a strong institutional framework of property rights will be essential.
17. The third challenge lies in trade policy. We have already seen the important role being played by net exports in leading the recent economic recoveries in many countries, despite their relatively low trade share compared with, say, the Asian countries. However, the favorable exchange rate effects on trade performance will begin to fade, as real exchange rates begin to strengthen in Latin America, from the very low levels that they reached at the end of last year. Thus, maintaining a high contribution of net exports to growth will require structural reforms to open economies further. Indeed, several of the crisis countries, and perhaps Latin America more generally, have suffered in the past from an imbalance between a high level of financial market integration and a relatively low level of participation in world trade. This imbalance has, typically, limited the growth potential of these economies, while increasing their vulnerability to recurrent financial and current account crises. Thus, boosting growth and better "crisis-proofing" will require greater trade openness in Latin America. Again, one does not have to look beyond the region itself for the favorable effects of a high trade share in domestic output—the experiences of Chile (through unilateral liberalization) and Mexico (which strongly benefited from NAFTA's provisions for better access to the U.S. market) are important examples of this.
18. In this context, it is worth noting that a number of bilateral and regional trade agreements are now being negotiated in the region. Some like the FTAA have significant potential to increase exports—it has been estimated that the FTAA would increase Latin America's exports by up to 10 percent. The prospective free trade agreement between the United States and Central America would also help spur the region's growth performance. But such bilateral agreements should not be the overriding focus of trade policy. Model simulations suggest that the benefits for Latin America of multilateral liberalization are much higher—reflecting the greater complementarity of Latin America's product range with other regions, and the still significant barriers to trade that exist in promising export markets in the United States, Europe and Asia. At the same time, there is much that can be done within the Latin American countries to build a stronger domestic consensus for trade opening—such as strengthening safety nets to protect displaced workers.
19. This brings me to the final challenge facing Latin America—perhaps its most compelling. This challenge involves tackling inequalities and decisively reversing recent rising poverty trends. An important recent paper by Guy Pfefferman observes that inequality has been high and rising in Latin America because of the region's vulnerability to recurrent financial crises. The low per capita income growth in the region over several decades is clearly also part of the problem. Improving economic fundamentals, maintaining macroeconomic stability, and achieving a better balance between trade and capital market integration are obviously important in these respects. But, in addition, a stronger focus within the policy framework on improving the weak social and poverty indicators will be essential. In this context, I can only applaud Finance Minister Palocci's recent statement that President Lula da Silva's administration in Brazil has made social inclusion the central organizing principle of its economic development plan, and his recognition that fiscal stability is a crucial step in this regard. To be sure, we do not have all the answers on how best to raise the anti-poverty orientation of economic policy. At stake are some crucial issues including, a better targeting of social safety nets, removing labor regulations that favor insiders, better-targeted education spending, and more equitable and funded pension schemes. We need to be as supportive as possible from the international community to the efforts being made to tackle these issues.