Latin America: This time round, the region is expected to fare better

April 20, 2009

Latin America is no stranger to financial shocks. The region suffered severe financial crises in the 1980s, 90s and during 2001-02. It is struggling once again due to the impact of the US recession, contracting demand, declining exports, and restricted access to capital flows. But this time round, the region is expected to deal with the global shocks better than in previous crises. This reflects the progress many countries have made in improving their macroeconomic fundamentals over the past decade.

Growth outlook and main drivers

The global economic outlook points to a major downturn in 2009. Output in the three largest mature economies — the United States, the euro area and Japan — is likely to contract dramatically in 2009, and growth in emerging markets looks set to slow very sharply. Latin America’s economies will also slow dramatically. Authorities around the world have taken massive, and increasingly coordinated, corrective actions. Our baseline scenario anticipates that these will be successful in stabilizing financial conditions and that a gradual recovery will begin in late 2009.

The LatAm boom is over; LatAm-7* grew by an average of 5 % in the last five years. But 2009 will be a year of severe economic contraction (-0.6%) for the region. While the vulnerability to the US recession varies significantly from country to country, the ongoing global financial turmoil and weaker global outlook will affect the region through four channels: lower commodity prices, weaker trade, declining capital inflows and lower remittances. Although we expect a rebound in growth dynamics in 2010, risks are tilted to the downside, reflecting the uncertain global outlook.

Weaker global conditions and uncertain commodity price projections will strain external and fiscal balances. The commodity boom of recent years has helped bolster both current accounts and fiscal positions throughout the LatAm-7. But weaker prices are now leading to widening current account deficits. In 2009, regional exports and remittances are expected to decline and FDI flows are expected to drop by half. With respect to fiscal balances, the LatAm-7 countries have reduced their deficits in recent years (to 1% of GDP during 2003-2007, from 2.9% in 1998-2002) and improved the public debt burden. However, fiscal positions are expected to be strained, as their performance still responds to the economic cycle.

Policy reactions to the crisis

Governments have announced support measures to buffer their economies against the global financial crisis. Most plans include FX support, liquidity aid to the banking sector, direct loans to targeted sectors and financial help for corporates. The governments seek to boost consumption via tax cuts, direct transfers and infrastructure spending. The Brazilian government has launched the most ambitious plan to support its economy (about 8.7% of 2008 GDP). Chile, Mexico and recently Colombia have also announced measures. However, tight fiscal accounts and high debt-to-GDP ratios limit the scope for fiscal stimulus in the region.

Most of the stimulus will come from monetary policy. Central banks have slashed their policy interest rates since the beginning of the year, signalling growing concern about the economic slowdown. The easing cycle will probably be more aggressive in the second half of 2009 but some countries will face restrictions arising from their above-target inflation rates.

Strong mitigants

Stronger banking sector. In contrast to previous crises, the banking sector will not amplify the effects of currency depreciation. Most countries have flexible exchange-rate regimes; credit expansion has been funded by domestic deposits and foreign currency exposures have remained low. Banking sector indicators and prudential regulation have improved significantly. Rising non-performing loans are already affecting banks, but high capital ratios and sufficient provisions will serve as a cushion to cover losses.

The LatAm-7 countries have accumulated considerable external funds (FX reserves and countercyclical funds) during the last few years. Most countries will be able to manage external financing requirements in 2009 and can rely on multilateral financial aid. Those countries that pursued unsustainable expansionary policies and spent the commodity windfall will be much more vulnerable to external shocks.

*LatAm-7: Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.

Please see our presentation: LatAm-7: 2009 Economic outlook

Please find the audio-files of the Talking point series  here...