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Latin America in the Global Economy--Challenges and Opportunities, Remarks by Rodrigo de Rato, Managing Director of the IMF
February 4, 2005
Latin America in the Global Economy—Challenges and Opportunities
Remarks by Mr. Rodrigo de Rato
Managing Director of International Monetary Fund
Canning House
London, United Kingdom
February 4, 2005
As prepared for delivery
1. Good morning. Thank you for inviting me. I am delighted to address this distinguished group today, since I fully support the efforts of Canning House to promote closer ties between Great Britain, Latin America and Iberia.
2. This morning, I will touch briefly on the outlook for the global economy and that for Latin America. The relatively favorable picture that emerges will form the basis for a few reflections on some key challenges and opportunities for Latin American countries.
The Global Outlook
3. The global economy performed well in 2004, with growth expected at around 5 percent. That is the highest rate of expansion in nearly 30 years. In many countries, this strong performance was supported by accommodative macroeconomic policies. There were also notable improvements to economic fundamentals, with increased corporate profitability, healthier balance sheets, favorable financial market conditions, and a better labor market environment. These advancements helped limit the economic impact of the recent oil price surge.
4. Last year's expansion, however, was not uniformly distributed. Although growth picked up in nearly all regions and countries, there were marked differences in performance. In particular, the United States and China remained the primary drivers of the economic recovery. Despite some quickening of activity in the euro area and Japan in the first part of 2004, a strong and durable recovery remains elusive there.
5. Looking ahead for 2005, last year's momentum should ensure that global growth remains robust, but at a slightly slower pace. In particular, the United States—which has been the principal engine for global growth in recent years—is expected to see a slowdown in economic activity to a more sustainable pace. At the same time, activity in the euro area and Japan is expected to be below potential. On top of these factors, there are, as always, risks to the outlook. I mention four for your consideration:
· First, although oil prices have stabilized recently, the security situation in the Middle-east, as well as the limited excess production capacity, are conspiring to make the outlook uncertain. While the world economy has coped well with recent oil price increases, further spikes in oil prices could have seriously disruptive effects, especially for emerging market countries.
· Second, there could be potential for instability in the currency markets, especially given existing current account imbalances. The large US current account deficit—and the fiscal deficit that it mirrors—requires significant financing from the rest of the world. It is an open question whether the appetite of foreign investors can be sustained at the current level indefinitely.
· Third, reflecting the continued accommodative stance of many central banks, short-term interest rates in many countries are still well below "neutral" levels. At the same time, longer-term yields and spreads are also at very low levels. These factors suggest an asymmetric risk. An inflation, fiscal or other surprise could require interest rates to be increased at unexpectedly fast rates.
· Fourth, uncertainties associated with the continuing war on terrorism look likely to persist in the foreseeable future. Any new terrorist events could have significant macroeconomic impact.
The Outlook for Latin America
6. Let me turn now to the outlook for Latin America, where economic prospects are the brightest they have been in many years. Latin American economies gained momentum in 2004, bolstered initially by robust global demand and strong commodities prices. This was followed, more recently, by a brisk pickup in private consumption and business investment. Indeed, while industrial countries have slowed noticeably in recent months, Latin America's growth momentum has remained strong. Overall, region-wide growth is expected to be even higher than the 4½ percent forecast of last autumn. 2004 could turn out to be the best year since 1997.
7. What is truly promising is that Latin America's recent performance was achieved with modest inflation—about 7 percent for 2004, with possibly even lower inflation for this year. There has also been a remarkable turnaround in the region's external position, with a small current account surplus likely to have been achieved. On the fiscal side, many governments are using the recovery, and the associated revenue boost, to reduce budget deficits and restructure debt. These are all welcomed developments, especially given the region's history of macroeconomic instability.
8. Within the above context, we expect Latin America's broad-based recovery to continue into 2005. However, this favorable near-term outlook must not lead to complacency. We must recognize that, despite recent developments, difficult problems continue to loom. For example, unemployment and poverty remain unacceptably high, and severe income disparities persist in the region. The importance of continued and sustained reforms cannot therefore be over-emphasized. More importantly, in the case of many Latin American countries, a lasting political consensus needs to be forged in support of policies that are essential to poverty reduction and growth.
Challenges and Opportunities for Latin America
9. Let me now go into more detail on some of the specific challenges and opportunities for Latin American countries. These may be conveniently divided into macroeconomic issues and structural and institutional issues.
10. On the macroeconomic front, Latin American policymakers need to keep their eyes on:
· Maintaining appropriate public debt levels;
· Balancing spending and capital investment; and
· Keeping inflation in check.
11. First, public debt. Public debt in many Latin American countries is still too high. Even with recent successful efforts at fiscal prudence, average public debt hovers around 55 percent of GDP. In the largest economies of the region, it is above 60 percent. These ratios are far above the levels of the late 1990s. A reduction in debt levels would ease existing vulnerabilities and increase the scope for flexible fiscal responses to macroeconomic shocks. Lower debt service burdens would also free up scarce fiscal resources. Debt sustainability could also be strengthened by expanding the tax base, improving debt structures, and bolstering expenditure management. Sound pension reform would be important as well.
12. Next, spending versus investment. Governments need to cut back on spending in nonessential areas, so they can increase investments in infrastructure, health, and education. Inadequate investment in these critical areas hurts growth prospects. It also makes it more difficult for the region to tackle social inequalities. The IMF has been working with a number of countries in the region to find ways in which additional infrastructure investment could be accommodated while maintaining macroeconomic stability and debt sustainability.
13. Third, taming inflation. In the last ten years, substantial progress has been made in the fight against inflation in Latin America. Many countries have brought runaway prices under control. This is an historic achievement which is often overlooked, but should not be forgotten. Going forward, the prime objective of monetary policy should be to lock in and strengthen these advances. In that regard, many countries have now adopted inflation targeting frameworks for implementing monetary and exchange rate policy. These offer a promising structure for maintaining strong and stable growth over time.
14. I turn now to the broader structural and institutional issues. Sound policies in these areas are needed to generate the region-wide boost to investment and resource allocation that Latin America needs for sustainable growth and poverty reduction. Additionally, globalization and the further opening up of markets will continue to pose challenges that have to be addressed, mainly through adjustments on the structural and institutional fronts. In this respect, four areas dominate the discussion:
· Trade policies;
· Labor market reforms;
· Financial sector stability; and
· Improvements to the investment climate.
15. Concerning trade policies, the past decade has seen bold liberalization efforts. But Latin America is still less open than other fast-growing regions. Further trade liberalization would be crucial for spurring growth and reducing vulnerabilities. The greatest benefits would flow from the successful completion of multilateral trade talks to improve market access for key exports such as agricultural products and textiles. However, Latin America itself can, on its own, do much more to reduce tariffs, limit the use of non-tariff barriers, and relax restrictions on trade in services. These reforms should be underpinned by improvements in infrastructure, and in port and customs administration.
16. As with trade liberalization, labor market reforms have been quite limited in most Latin American countries. Countries will find that such reforms will take on even greater significance as trade liberalization progresses. Experience shows that such reforms are essential for increasing flexibility and private investment, the very ingredients of growth. Institutional mechanisms that require large severance packages and restrict temporary employment are serious obstacles to the hiring of new workers and the flexible redeployment of resources. High indirect labor costs are another impediment to employment. Over time, policies that make hiring easier will speed job creation in the formal sector. There are social benefits to this, since workers in regulated labor markets receive protections that do not exist in the informal sector. Additional investments in education, training, and social safety nets will also be needed to ensure access by all to new opportunities, and to protect workers in declining industries.
17. Achieving financial sector stability is also key for sustainable growth. Financial sectors in the region must be transformed from sources of vulnerability to centers of strength. They must be able to provide the credit that is the lifeblood of economic growth. Progress in dealing with these issues has been made in Latin America, but many countries still have far to go to:
· Strengthen bank regulation and supervision;
· Improve accounting and audit standards; and
· Revise bankruptcy laws to give lenders a better chance of recovering value from problem loans.
18. Finally, creating an environment that is more attractive to investment will be key to unlocking growth potential in the region. To encourage both domestic and foreign direct investment, businessmen need to be assured of the credibility of the rule of law and the effectiveness of contract enforcement mechanisms. Other steps to improve the investment climate—for example, reducing regulatory and other burdens to starting a new business—will also be essential. At the minimum, reforms are needed to keep pace in the never-ending competition for FDI, especially among emerging economies in different regions.
Concluding Remarks
19. In closing, let me affirm my optimism about Latin America's economic future, particularly in light of the current positive global outlook. The ongoing expansion offers a timely window for Latin American countries to deepen the reforms of the past few years and to build upon its recent gains. Indeed, if growth can be maintained at its present level for the next 10 years, real per capita income in 2015 will be 40 percent higher than it is today in the region. That will be a significant change from the relative stagnation of the last 25 years.
20. Once again, thank you for inviting me to be here. I wish you buen provecho!
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