Press Release No. 10/389

Press Release: IMF's Western Hemisphere Regional Economic Outlook Shows Domestic Demand Leading Recovery in Many Latin American Countries; Risk of Overheating Must be Watched

October 19, 2010

Two years after the onslaught of the global financial crisis, some countries in the Western Hemisphere are growing at a pace that is second only to emerging Asia, according to the latest Regional Economic Outlook from the International Monetary Fund (IMF). Growth in many economies appears to be self-sustained and based on robust domestic demand, meaning their near-term prospects are positive even if recovery in advanced economies continues to be sluggish, says the IMF's Western Hemisphere: Heating up in the South, Cooler in the North, which was launched today in Bogotá in a seminar hosted by the Central Bank of Colombia.

Real GDP in the Latin America and Caribbean region is set to expand by 5.7 percent in 2010 and 4 percent in 2011. Within the region, countries are performing at different paces. Most commodity-exporting countries in South America enjoy very favorable external conditions––high international commodity prices and easy access to international finance ––and growth in some countries is projected to exceed 7 percent this year. Central American economies have kept a positive, but more moderate rate of growth (averaging about 3 percent in 2010), reflecting their greater linkages to the slower-growing U.S. economy. For most Caribbean countries, recovery is only beginning and prospects are still limited by high levels of public debt and weak tourism demand from the U.S. and other advanced economies.

"The marked heterogeneity across the region means varied challenges for economic policy formulation," Nicolas Eyzaguirre, Director of the IMF’s Western Hemisphere Department, said. "For most of South America, it is all about the risks of too much of a good thing, to avoid possible excesses of demand and finance. In Central America, governments have to continue to be prudent, to rebuild their defenses and continue pursuing reforms to boost competitiveness. Caribbean countries generally have no space for fiscal stimulus due to their high debts and still have to push ahead with fiscal consolidation plans."

Robust Domestic Demand

One of the most significant findings of the Regional Outlook is how domestic demand has been strengthening in the fastest-growing countries in South America. For such countries, the strength and momentum of domestic demand are likely to dominate their near-term growth prospects, provided advanced economies do not suffer any major setbacks. That is a different reality from the United States, where the recovery so far has been dependent on policy stimulus.

As commodity prices are expected to remain high, the commodity-exporting countries will benefit from strong export earnings. At the same time, those with stronger fundamentals and track records of sound policies will have ample access to foreign financing on easy terms. While those economies stand to benefit from low global interest rates and increased liquidity, policymakers must be alert to the risks of excesses. "Demand needs to moderate in these countries," said Mr. Eyzaguirre, "or they may risk experiencing overheating, inflation and widening current account deficits."

The report recommends that normalization of fiscal policy be the first line of defense, with emphasis on slowing the growth in public spending from recent high rates. This will allow monetary policy to play a following role, with policy interest rates moving to neutral levels more gradually than would otherwise be needed.

Credit cycles and new tools

This edition of the Regional Economic Outlook has a special focus on financial sector issues. In particular, the report examines and draws lessons from the recent credit cycle in Latin America—the rapid growth of bank credit that ended abruptly with the global crisis, and which is resuming again in some countries. While the region’s financial systems were generally resilient to the crisis, the goal of avoiding financial crises brought on by excesses remains as challenging as ever.

A separate chapter discusses the importance of considering "macroprudential" regulatory policies to complement––but not substitute for––traditional macroeconomic policy tools, which is particularly important in the current context of easy external financing conditions.

The report also looks at the record of economic growth in the Caribbean countries and shows how public debt has hampered growth considerably. It argues in favor of a combination of fiscal consolidation to reduce this drag of debt on growth, and for reforms that boost productivity and foster the continued development of the tourism industry.