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Larger Latin American Countries Face Major Capital Inflows

Sugar harvest in Brazil: larger commodity exporters with access to global financial markets are benefiting strongly from rising commodity prices (photo: Newscom)

IMF SPRING MEETINGS

Larger Latin American Countries Face Major Capital Inflows

By James Rowe
IMF Survey online

April 25, 2010

  • Some countries rebound more quickly than others
  • Cyclically advanced countries must guard against boom-bust cycle
  • Well crafted capital controls can be used as last resort to deal with large inflows

Latin American economies as a whole are recovering nicely from the global economic downturn, although the pace of that recovery varies across the region, Nicolas Eyzaguirre, IMF Western Hemisphere Department Director, said.

Larger commodity exporting countries with access to international financial markets are benefiting strongly from rising commodity prices and easy access to international finance. Smaller commodity importers that rely heavily on remittances have a more difficult outlook.

As a result, the policy issues facing the region also vary, Eyzaguirre said at a press conference April 24, during the IMF Spring Meetings. The larger commodity exporting countries more integrated into the world economy have to pay special attention to their policies to cope with the flood of cash from investors seeking the higher returns available in countries with good growth prospects.

Boom-bust risks

Eyzaguirre cautioned that “cheap and abundant external finances raise the risk of a boom-bust cycle.” To guard against that, these countries must first allow their exchange rates to appreciate to cope with excessive international liquidity, and return their fiscal policies to a neutral stance to lean against excessive growth. They must also use macroprudential policies to help keep their financial systems stable.

As a last resort, if these actions prove inadequate to avoid an overexpansion or excessive appreciation in the exchange rate, then “carefully designed taxes on capital inflows” may have a role on a temporary basis, he said.

While most advanced economies are projected to grow slowly in coming years, the prospects for Latin America are rosier. The regional economy contracted by 1.8 percent in 2009, but is expected to grow by about 4 percent this year, perhaps even a little more.

Not only has the region emerged more quickly from the downturn than have advanced economies, but “social costs in the region were more muted,” Eyzaguirre said. In the larger Latin American economies, unemployment rose about 2 percentage points. In the United States, by contrast, unemployment rose 5.5 percentage points.

Smaller countries

While the commodity exporting countries with broad access to international capital markets have to guard against too much of a good thing—“the strong tailwinds from the global setting,” as Eyzaguirre characterized it—other economies must adopt different policies.

Commodity exporters with less access to international markets will have to fight against their past habits of spending the increased government revenues from rising prices and build more credibility in their macroeconomic policy frameworks. They need to make some structural reforms to deal with supply side issues to enhance their ability to grow. They also need to normalize their relationship with financial markets, “an endeavor where the IMF could help,” Eyzaguirre said.

Some other countries with good macroeconomic frameworks, mainly in Central America, are also commodity importers that face a slowdown in remittances from citizens living abroad. They will grow, but should manage their fiscal policies carefully, focusing attention on the poor and keeping some flexibility in reserve in case “some downside risk scenarios were to materialize,” the IMF official said.

Smaller countries that rely on tourism and remittances face a bleaker future but should resume growth next year.

Difficulties of success

In response to questions, Eyzaguirre, said

• Brazil, which has instituted a tax on foreign capital inflows, is probably the most prominent example of a country that is targeted by foreign investors seeking a high return. Brazil has to “deal with the difficulties associated with success and for being considered a very promising economy.” He said the IMF is not critical of Brazil’s resort to a capital tax.

• “It will be very good for Argentina and for the world community” if Argentina were to resume its annual economic consultations with the IMF, which the second-largest South American nation abandoned several years ago. Eyzaguirre said that the recent global crisis showed how interdependent the world has become and how essential it is that a country knows what is going on in other countries when it develops its own policies, and that other countries know its policies. The IMF consultations, which it has annually with nearly all its 186 member countries, are at the core of the economic policy dialog among nations that the Group of 20 advanced and emerging systemic economies has called for. Eyzaguirre said it is especially important that Argentina hold such consultations because it is a G-20 member.