IMF NEWS

LATIN AMERICAN GROWTH

Dear IMF Survey:

Recent speeches by IMF high officials and articles in the IMF Survey (April 23) convey the impression that these are exceptionally good times for Latin America. It is fair to say it is an impression shared by most of the official community. Since the fourth quarter of 2002, regional growth has been close to 6 percent per year, way above the region's mediocre long-run average of 3 percent.

Granted, this exceptional performance is partly due to an extremely favorable external environment—a strong world economy, high commodity prices, and exceptionally benevolent financial conditions. But the current expansion also owes a great deal to sound policies; that is, low inflation and a stronger external and fiscal position. The latter, in turn, makes the region less vulnerable to adverse changes in external conditions than in previous expansions.

Sounds rosy? Look again.

First, growth performance has been less than satisfactory. According to ongoing work with my colleagues Alejandro Izquierdo and Randall Romero, both at the Inter-American Development Bank, once the effect of the improvement in external conditions and the recovery from the 1998-2002 crisis and stagnation period is removed, regional growth has been slightly below its long-run average. Not much left there to be explained by good policies.

Second, fundamentals are weak and the region remains vulnerable. Although inflation has remained low and observed fiscal balances have improved throughout the region during the current expansion, structural fiscal balances have not improved—with the notable exception of Chile—and in many cases have deteriorated significantly. Why? Because expenditures have risen, most notably current expenditures, along with revenues. Even more troublesome, most countries in the region now display structural budget deficits even though public debt levels are still high by the IMF's own standards.

Terms of trade

Regarding the region's current account surplus, it is entirely attributable to the improvement in the terms of trade. In fact, if the improvement in the terms of trade since 2002 is removed, the region would display a current account deficit to the tune of 4 per cent of GDP. This means that some sectors in the economy, namely natural resource owners, have a surplus while the rest of the sectors are borrowing heavily in international financial markets. Such an unbalanced current account surplus will not insulate the region against a sudden interruption in external capital flows (see Calvo and Talvi www.rgemonitor.com, forthcoming).

In our view Latin America is between a rock and a hard place. Every indicator that looks good today will look lousy if the external environment deteriorates. But what if it doesn't? What if the "Chindia" phenomenon results in higher terms of trade and benign financial conditions for the foreseeable future? Even if this turns out to be the case, the impact on growth will be temporary and will peter out in a period of two or three years, according to the ongoing work with Inter-American Development Bank colleagues cited above.

With structural reforms stalling or in retreat throughout the region, with low productivity growth and investment rates still pervasive, growth is likely to return to its mediocre historical standard. In turn, slower growth will make it more difficult to accommodate current social pressures without compromising the fiscal situation or distorting incentives.

In short, the current bonanza is disguising a host of fragilities that will eventually come back to haunt us. We should all be prepared.

Ernesto Talvi

Executive Director, CERES (Center for the Study of Economic and Social Affairs)

Montevideo, Uruguay