Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Can Latin America Dodge Subprime Shock?
February 5, 2008
- Latin America showing resilience to U.S. slowdown
- But economists divided on whether region now less vulnerable to outside shocks
- U.S. financial conditions continue to have a significant impact on region
The IMF expects growth in Latin America and the Caribbean to be around 4.3 percent this year, down from 5.4 percent in 2007, but still showing considerable resilience to the slowdown forecast for the United States.
A textile manufacturing plant in Recife, Brazil: Economists are debating whether or not the region is now less vulnerable to outside shocks (photo: Glowimages).
Latin American Growth
Is Latin America now less vulnerable to outside shocks than it was a decade or more ago as this forecast implies or is the region still tied to the coattails of the United States? Participants at a recent conference on "Economic and Financial Linkages in the Western Hemisphere" heard conflicting viewpoints. One paper asserted that the region is better able to cope today with such developments as a slowdown in the United States. But another presentation said that Latin America's seeming newfound resilience is the result of benign external factors not sharply improved policies.
The one-day conference, organized by the IMF's Western Hemisphere Department, focused on the changing nature of economic and financial linkages in the Americas, and policies needed to reduce the vulnerability of Latin American countries to changes in the external environment. The conference on November 27, 2007, was held against the backdrop of the continuing turmoil in world credit markets that has its roots in the U.S. mortgage markets.
Less vulnerable to outside influences?
Given Latin America's record of economic and financial crises, two papers examined whether the region continued to be vulnerable to changes in external factors such as an increase in emerging markets risk spreads, higher U.S. interest rates, lower world economic growth, or declining terms of trade. Estimates prepared by the IMF's Pär Österholm and Jeromin Zettelmeyer suggest that Latin American growth has become more robust to moderate external shocks, such as a slowdown in the United States or a decline in commodity prices. Although extreme shocks could still have a large impact on the region, the authors suggested that improvements in economic and policy fundamentals had boosted the resilience of many Latin American countries.
A somewhat more pessimistic view was presented by the InterAmerican Development Bank's Alejandro Izquierdo who—in a paper co-authored with his IDB colleague Randall Romero and Ernesto Talvi, executive director of CERES in Montevideo—suggested that much of the improvement in the region's economic fortunes reflects the impact of external factors, which also contributed to apparently better policy outcomes, such as lower fiscal and current account deficits. Consequently, he was concerned that a reversal in external financial conditions of the magnitude observed in the past could potentially have a large impact on Latin America.
Links to the U.S.
Some of the other papers presented at the conference focused on financial and real linkages within North America. Vladimir Klyuev, an IMF economist, presented strong evidence in support of strong real and financial linkages between Canada and the United States. This view was echoed in a paper prepared by the IMF's Andrew Swiston and Tamim Bayoumi, who found that a large proportion of the reduction in Canadian output volatility since the 1980s can be accounted for by the "Great Moderation" in the U.S. They also suggested that the Mexican economy, following the stabilization of domestic policies in the mid-1990s, has become more closely linked to developments in the United States. Shaun Roache of the IMF found a similar link for countries in Central America.
In contrast, IMF economists Ravi Balakrishnan and Fernando Goncalves found that although U.S. investors remain systemically important for countries in Latin America, their relative importance has declined since the Asian crisis. Nonetheless, U.S. financial conditions continue to have a significant impact on the region's macroeconomic and financial health. However, a long record of macroeconomic stability, as in Chile, has been found to help mitigate the adverse macroeconomic impacts of changes in U.S. or global investor sentiment.
Implications for macroeconomic policies
The conference was concluded by a panel discussion on policy lessons that could be drawn from the experience of the past few years. The panel included Augusto de la Torre, the World Bank's Chief Economist for Latin America; Claudio Loser of the Inter-American Dialogue, former Director of the IMF's Western Hemisphere Department; Michael Mussa from the Peterson Institute for International Economics, former IMF Economic Counsellor and Director of Research; and the IMF's David Robinson as moderator.
De la Torre pointed out that, at present, Latin America has stronger fundamentals than during the 1990s. In recent years, the region has benefited from external factors such as high commodity prices, and was accumulating reserves. This trend was expected to continue, especially as the U.S. dollar continued to depreciate. In terms of domestic policies, countries have strengthened their fiscal positions, and monetary and exchange rate policies have become more flexible. Liquidity buffers have been built up, and the debt structure is more favorable than in the past. In his view, the region has clearly become less risky, although growth rates have not yet increased.
De la Torre said that increasing global financial linkages have benefited the region through improved interactions between local and international financial markets, and by providing access for underserved market segments. One concern was the increasing concentration in Latin American exports towards primary commodities, both in terms of value and volume, and its potential adverse impact on terms of trade volatility.
Loser agreed on many of the factors that had led to the strengthening of domestic policies in Latin America. However, he was concerned that fiscal and external balances have been deteriorating since 2005, and that Latin America's growth rates were more in line with those of advanced countries, lagging China and India because of lower rates of investment and fewer improvements in education.
Higher credit spreads
Loser emphasized differences across the region, and pointed out that some countries face much higher credit spreads than the rest of the region, indicating continued vulnerabilities. He questioned the strength of institutions, noting that cross-sectional indicators such as the index of economic freedom, corruption perceptions index, business competitiveness rankings, among others, did not rate countries in the region very highly (with the exception of Chile). Financial systems in the region were small and created an additional vulnerability. He warned against complacency, suggesting further reforms are needed to address weaknesses and increase growth rates.
Mussa took a closer look at the role played by economic and financial linkages in engendering stability across the region. In the Mexican crisis of 1994-95, international linkages helped precipitate the crisis, but were also instrumental in a speedy recovery. The "great moderation" of volatility in the U.S. economy had resulted from better and more stable macroeconomic policies, and growing international linkages had helped propagate the benevolent effects. Similarly, sound macroeconomic policies would need to form the bedrock of future economic stability, with growing economic and financial linkages continuing to transmit their effects.